Fontainebleau: Half-built bargain bid up by billionaire

TIFFANY BROWN / LAS VEGAS SUN FILE

Construction on the Fontainebleau resort was halted in June. A bankruptcy judge has set a Jan. 27 hearing to consider the sale of the resort to the highest bidder.

By Liz Benston

Monday, Dec. 7, 2009 | 2 a.m.

Last year, Carl Icahn boasted of turning a billion-dollar profit by buying and selling the Stratosphere and three other casinos.

Fontainebleau Resort

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At stake is control of the most spectacular bankrupt building in the country, the half-built Fontainebleau resort on the Las Vegas Strip.

For months a casino company known for measured growth and financial conservatism had been crunching numbers on what it would pay to take over the beleaguered project.

It’s complicated, because it involves determining the cost to complete the interior, and then guesstimating the value of the real estate and building in today’s economy. And that is further complicated by factoring in the new competition in town, CityCenter.

Penn National Gaming concluded that it would cost $1.5 billion to finish the project at a level of quality equal to, say, Mandalay Bay.

Indeed, this wouldn’t be any charity project or rescue project. Penn, a Pennsylvania-based company known for its chain of mass-market racetrack casinos, was cautiously betting big on the long-term health of Las Vegas.

In order to afford the tab to finish the stalled development, the company would offer only another $100 million in cash and loans to purchase the building — enough to keep the vacant structure from degrading further and to pay attorneys, financial advisers and numerous other experts involved in the property’s convoluted bankruptcy case. Blown-out windows would be fixed and the building’s temperature maintained constant so as not to ruin carpet, wallpaper and other finishings in rooms that were outfitted up to the 30th floor before lenders pulled the plug on financing, forcing the project to seek bankruptcy protection in June.

“We’re somewhat dispassionate about this,” Penn National CEO Peter Carlino said in a mid-November interview. “All we can do is do this right and put up a number we think is best and, win or lose, move on.”

By Penn’s math, the company would get a discount of up to 60 percent on the building’s original cost given that developers had already sunk $2 billion into Fontainebleau — money now worth next to nothing in today’s economy.

The company swallowed hard and bid $101.5 million.

But for all its careful planning and calculating, Penn got a big surprise in billionaire investor Carl Icahn, who last year boasted of turning a billion-dollar profit by buying and selling the Stratosphere, two Arizona Charlie’s and a Laughlin casino.

Just days after Penn National filed its offer, Icahn presented an unexpected bid of his own in bankruptcy court.

Penn countered.

And then, after a few counter-bids, and for all of its planning and budgeting, Penn walked away. It didn’t want to pay more for the building than it thought the structure was worth.

Icahn’s high bid of $156 million outpaced Penn by a mere $10 million.

But the bidding isn’t over. A bankruptcy judge has set a Jan. 27 hearing to consider the sale of the resort to the highest bidder — which may well be Icahn unless Penn or some as-yet unknown buyer emerges with a higher offer.

Will Penn get back in the game?

Penn — which has turned down seemingly expensive deals competitors couldn’t pass up during the boom years — has good reason to be gun-shy.

In 2006 Columbia Sussex outbid three companies in its $2.75 billion purchase of Aztar Corp. and its flagship Tropicana hotels in Las Vegas and Atlantic City. Critics say that inflated price tag helped fuel the severe cost-cutting that led to the company’s downfall, especially in Atlantic City, where regulators revoked the company’s casino license for, among other infractions, failing to adequately staff the property.

Penn doesn’t want to fall into that kind of trap — which could threaten the company’s ability to secure financing to complete the purchase.

“Our offer may appear low but it’s really not,” Carlino said in an interview last month, before news of Icahn’s bid. “It’s only worth what it can earn, and it’s not going to be finished inexpensively.”

Values for Las Vegas resorts such as the newly opened CityCenter have been permanently damaged in the recession, Carlino said. The value of resorts built during the most recent boom years, he said, have little to do with what their owners spent to build them.

Penn executives say the $1.5 billion completion figure is a conservative estimate that will enable the company to outfit a mid- to high-end market resort rather than competing with the top of the market — say, Wynn Las Vegas or Bellagio.

“We are more prepared than (other potential buyers) in terms of understanding this property,” Carlino said. “We’ve been on the ground for months, trying to understand what the real cost of completion will be. Others have not spent that kind of time, which could be bad because you could have someone make a reckless bid.

“The potential for people to do something foolish is limitless.”

Though Penn may well believe Icahn is foolish for bidding up the Fontainebleau, the shrewd investor, according to sources familiar with the bidding process who declined to be named, is operating under a different scenario.

These sources say Icahn believes he can complete the Fontainebleau for less than $1 billion — bringing his overall discount closer to 70 percent, which could go higher if he spends less. If Icahn spent only $500 million to finish the resort, for example, his investment in the building would be close to 20 percent of what the resort cost to build.

Any buyer who thinks he can spend less than $1.5 billion is kidding themselves, Carlino says.

One way to do that, he said, might be to leave many of the resort’s 3,900 rooms, or other resort offerings, unfinished.

“The right way to do this is to get it done now, upfront and when the project is mobilized. You don’t want to go back in there later and finish it.”

Icahn’s seemingly last-minute interest in Fontainebleau, which sought bankruptcy protection in July, isn’t surprising to some observers.

Icahn doesn’t build casinos, he trades them — profiting when formerly depressed properties are resold with leaner operating costs and once the overall market for casino investments improves. Most casino deals have happened in good years when buyers have access to cheap loans. Icahn zags, funneling cash into failing or underperforming businesses and industries.

In June a group of investors led by Icahn snapped up the Tropicana resort in Atlantic City at an 80 percent discount. The property had been on the market for more than a year after New Jersey regulators forced its sale. Entrepreneurs struggled to raise cash while more established casino operators — many of them trapped under mountains of debt — shunned Atlantic City, which has suffered worse than Las Vegas in the recession, as its aging casinos face tough competition from newer resorts in Pennsylvania and other nearby states.

By contrast, the problem faced by casino operators in Las Vegas is an economic one rather than one endemic to Las Vegas and the quality and breadth of its attractions, Penn executives say.

“If we thought this was the beginning of the end for Las Vegas, we wouldn’t be interested in the Fontainebleau,” Carlino said. “It’s our view that Las Vegas is going to be fine ... though we think it’s going to be a slow recovery.”

In the short term, however, the timing of the Fontainebleau sale — just as MGM Mirage’s CityCenter is opening across the Strip — isn’t good for Las Vegas, he said.

Though MGM Mirage executives believe the property will lift all boats by attracting new visitors to town, Carlino believes, like many industry observers, that CityCenter will steal business from other properties.

“More likely they are going to be rearranging the deck chairs,” he said. “It’s going to affect a lot of people — not just their own properties but everyone else in town.”

While Strip giants MGM Mirage and Harrah’s Entertainment labor to pay down billions in debt incurred during the boom years, Penn is in the enviable position of having more than $1 billion of cash at the ready — some of that in the form of breakup fees after a private equity deal to take the company private collapsed in the weakening economy.

Besides Icahn and Penn, there hasn’t been much interest in the Fontainebleau — though the resort’s original developer, Jeff Soffer, is believed to be preparing his own bid for the project.

Penn believes that’s a function of the lack of available financing for a major resort — especially one located on the recession-battered Strip.

The days of putting 20 percent down on a new resort are over, as lenders nowadays will likely require a two-thirds equity stake, Penn Chief Financial Officer Bill Clifford said. That could mean cutting a check for a billion dollars, he said.

Before Icahn’s bid, Penn anticipated raising at least $500 million to help finish the Fontainebleau and has attracted an undisclosed partner — not a lender but a company with some sort of resort expertise — to assist in the process. Regardless of what happens with the Fontainebleau, the company is pursuing other casino projects, including a casino in Columbus, Ohio, and another in Kansas.

Icahn couldn’t be reached for comment on his plans for the Fontainebleau.

That’s par for the course, casino consultant Bill Lerner of Union Gaming Group said.

“Guys like Icahn, in my experience, don’t show their hand very often unless it benefits them,” Lerner said. “I suspect Icahn was quietly doing work on the Fontainebleau” and is also doing homework on other potential deals for recession-battered casinos, he said.

Icahn may have some plan to finish the property more cheaply, or he might be betting that the economy will rebound before needing to make that decision, in which case he might be able to resell the unfinished building for a profit, Lerner said.

Penn — hoping to acquire a resort that could serve as a lure for customers of its smaller, regional casinos — had been quietly sniffing out potential deals in Las Vegas for a few years before the recession.

As others gobbled up land and casinos — properties now trapped under a pile of debt — Penn wisely walked away.

“When we finally decided we were big enough to (acquire a casino in Las Vegas), the market had become untenable,” Carlino said. “Costs were clearly spiraling out of control and land prices had gone up to crazy levels.”

Now that prices have come down, Penn may yet again walk away.

For many ambitious executives who dream of owning a megaresort on the Strip, that can be a difficult thing to do.

And yet, Penn’s relative success over the years stems from the company’s ability to walk away from deals that might have otherwise boosted the company’s image or influence, Lerner said.

“The same can’t be said for other operators and developers in this sector,” he said.

Unlike the heated bidding wars of years past, this showdown over the Fontainebleau and the meager bids it has attracted so far reflect the detached mood of its bidders — with Carlino and Icahn displaying their best poker faces.

“This is a classic case of ... be careful what you wish for, because you’re going to have this thing and you’ve got to be prepared to write checks to see it through,” Carlino said.