Harrah's Files for IPO (HET)

One of the most talked about names in the distressed debt / event driven land is Harrah's Operating Company. There is so many different securities in the structure that it would be a shame not to have a position (either long or short) in one of the bonds of the company. How have those bonds performed? Let's take the 10.75% senior notes due 2016:

Seems like a pretty good investment from early 2009. During 2010 though, it looks to be following the more liquid stressed / distressed names, giving back a lot of gains in may and then rallying the past few months.

The news today was surprising in that in addition to the shares being registered by Paulson & Co, the company also added an IPO of an additional $575M in stock ($475M net to Harrah's). These monies are going to development projects. Development projects? Isn't the company nearly 12x levered? Why not use the cash to pay down debt?

Well for one, the various bank agreements and indentures allow this sort of thing. More importantly, Harrah's has done an amazing job of managing their maturity structure in that very little of the debt actually matures before 2015. Yes, there is some bank amortization payments, but those are manageable. Their return on the incremental capital probably far exceeds the 13-15% pre-tax yield on the bonds if they bought them on the open market.

Paulson & Co is a large large investor here. Assuming all goes according to plan with regulatory commissions, they will own 9.9% of the company's stock. Using round numbers, the operating company is running at about $1.5B of EBITDA, and $17B of debt. That debt is at various levels (call it 6x through the bank debt and 1st lien, 10x through the second lien and 12x overall). The company has a massive runway of liquidity - cash + revolver availability will be approaching $5B.

So what do you have here? A company with massive financial leverage, an incredible amount of operating leverage, and a long long runway, whose prospects are tied to the consumer. These are one of those weird situations where I think the most attractive securities are the most senior and the most junior - I think the senior bonds are in a weird "no-man's land" If you want exposure to beta CCC credit, than these are your bonds. The parent company (Harrah's Entertainment) owns nearly a billion of these bonds so you'd be in pretty good company.

With that said, if the equity works here it's going to be a ridiculous home run. And the 11.125% 1st lien notes are fully covered in my opinion and offer an above market yield and spread given the limited downside risk. The bank debt is a bit trickier in my opinion because of the extension option - but again is covered in a distressed scenario. The senior bonds run the risk of getting primed to the near bottom of the heap if the company does draw down the revolver (a negotiating tactic maybe?) or further issuance of 1st lien notes.