Unpaid bills may deter a bid for Fontainebleau

By Liz Benston

Tuesday, Oct. 13, 2009 | 2 a.m.

Whether front-running bidder Penn National Gaming buys the unfinished Fontainebleau Las Vegas resort out of bankruptcy in coming weeks may turn on the success of recent negotiations with attorneys representing the resort’s subcontractors. They are owed about $375 million for work completed in the months leading up to the end of work on the resort.

Penn wants to use the Fontainebleau as the flagship destination for customers who patronize its nationwide network of smaller casinos, much as Harrah’s Entertainment does with its Las Vegas properties.

Subcontractors might accept less money if Penn can finish the building, putting people back to work and generating revenue in the future to pay bills. That would allow Penn to whittle down the estimated $1.5 billion needed to complete the resort — which remains the biggest hurdle for any interested buyer in this economy.

At a bankruptcy court hearing in Miami last week, Fontainebleau attorney Scott Baena said Penn was expected to offer “substantially less” than $300 million to acquire the property.

Even though Penn’s purchase price would be less than contractors’ claims against the property, the company’s investment would put it in control of the project.

Penn’s offer would include money for day-to-day operations, cash to pay back lenders who have funded day-to-day operations since Fontainebleau declared bankruptcy in June and money to protect the structure from the elements, including a roof to seal off the 63-story tower and more than 3,800 rooms.

That would be less than 15 cents on the dollar for a building that has already cost about $2 billion. Penn National Chief Financial Officer Bill Clifford said at an analyst conference last month that the building’s relative worth was “about zero” given the cash needed to finish it.

“It’s not worth anything until you finish it,” he said.

Penn believes it could justify spending the cash to finish the building if, by one of the company’s own estimates, the resort generates annual earnings of at least $150 million.

The $1.5 billion to complete the project would cover more than construction costs; it would include overhead, interest expenses, architectural bills, marketing and training leading up to opening, information technology, interior furnishings and fixtures, as well as gambling devices and equipment.

Penn is working with a construction consultant that is analyzing how the company could trim construction expenses by outfitting certain spaces, such as restaurants, less expensively.

Clifford told analysts the company is crunching numbers on how a Las Vegas resort could draw customers to its network of smaller casinos, including gambling halls attached to racetracks, across the country.

Harrah’s Entertainment pioneered a strategy of luring gamblers to rack up loyalty points at its smaller casinos that can be redeemed in Las Vegas. Other companies are smitten with that model and have for years scouted resort properties in Las Vegas for that purpose. They include Pinnacle Entertainment, a Las Vegas-based casino company with no Vegas casinos and mostly smaller properties in the Midwest and South. (Four companies including Pinnacle fought to acquire the Aztar casino chain during the real estate boom in 2006, hoping to pick up Tropicana-brand resorts in Las Vegas and Atlantic City that could be used to attract regional customers. Columbia Sussex, whose gaming arm declared bankruptcy in 2008 after being forced to give up its New Jersey casino license and its Atlantic City resort, outbid Pinnacle for Aztar and the Tropicana.)

If Penn were to buy the unfinished property, it would have fewer hotel rooms in Las Vegas than Harrah’s current 18,000, as well as a smaller ratio of rooms to regional customers in its database, Clifford told analysts last month.

Increased profit projections for Penn’s regional casinos could help the Pennsylvania company justify buying Fontainebleau and spending the money needed to finish the building, analysts say.

While other potential buyers have toured the Fontainebleau and may bid in an upcoming bankruptcy auction, Penn — cash-rich after a failed private equity deal in 2008 yielded a breakup fee of $1.5 billion — has done the most homework on Fontainebleau, initiating its investigation about a couple of months ago.

An offer could emerge from Penn in a matter of days, as U.S. Bankruptcy Court Judge A. Jay Cristol wants to expedite a purchase so the building doesn’t languish, losing value by the day and delaying payments to creditors. Cristol is appointing an examiner to negotiate the sale of the property but is giving Penn some lead time to make the first bid.

No firm offer has emerged for Fontainebleau in the four months since the project sought bankruptcy protection, while lenders have forked over $16 million for expenses, including fees for securing the site and attorneys. Contractors remain furloughed and Fontainebleau has laid off all but a skeleton crew of managers.

“There are not many people or entities with a few hundred million dollars and ... a billion or more in their back pocket to complete the project,” Cristol said at the hearing.

And yet, Baena said Fontainebleau is negotiating nondisclosure agreements with other potential bidders and arranging tours of the property.

“We are going to have a lively auction,” he said at last week’s hearing.

Penn, which declined to comment on the negotiations, has several other irons in the fire, including plans to build casinos in Kansas, Ohio and Maryland. Not wanting to drain its valuable hoard, Penn won’t be able to pursue all of these opportunities unless it attracts a business partner or significant financing, which could be a challenge in this economy, analysts say.