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Morningstar | Caesars Shareholders Win With Eldorado's $12.75 Per Share Bid, Leaving Shares Fairly Valued

We think Eldorado Resorts' $12.75 per share offer for Caesars is a good price for shareholders and marginally enhances the company's competitive position. We plan to lift our Caesars fair value estimate to around $12 (discounted for the time value of money, with the deal scheduled to close in the first half of 2020). Although we see this merger leading to marginally higher competition for no-moat peer MGM, we don’t expect any meaningful change to our $38 fair value estimate for that company and view its shares as attractive.

The $12.75 per share offer represents a 20% premium to our existing $10.50 fair value estimate for Caesar, valuing the company at an 11.1 forward enterprise value/EBITDA multiple. We view this valuation as attractive for shareholders, given that MGM currently trades at around 9 times forward EV/EBITDA despite having 20% exposure to narrow-moat Macau assets (versus none for Caesars) and strong prospects to obtain a gaming license in the attractive Japan region around the end of 2020 (we don’t expect Caesar to obtain a license here).

In our view, the increased scale from the merger slightly enhances the competitive positioning of Caesars, although not enough to alter its no-moat rating, as all its exposure will remain in the low-barrier U.S. gaming market, which hosts 1,000 casinos with a total population of 325 million (generating single-digit returns on invested capital), well in excess of the 41 casinos in Macau (typically generating ROICs above 20%) with a Chinese population of 1.4 billion. Eldorado’s domestic regional property portfolio expands to around 60 properties from 27 (versus 20 domestic facilities for MGM), while its loyalty membership jumps to 65 million from 10 million (versus around 32 million for MGM). In our view, the combined company should be able to leverage the larger loyalty program across a bigger property footprint, driving incremental revenue share.

Eldorado has identified $500 million in first-year synergies (75% costs/25% sales) as it decentralizes Caesars’ operating model, eliminates duplicate costs, and leverages the rewards program. We have confidence in the company achieving this target, given that it has exceeded synergy targets in the handful of acquisition integrations it's done over the past five years.

We think the 11.1 times forward EV/EBITDA Eldorado is proposing for Caesars supports our view that MGM shares are undervalued. We think MGM’s leading scale on the Las Vegas Strip, supporting domestic regional portfolio, attractive Macau assets, and expectation of being awarded a Japanese gaming license warrant a forward multiple of around 10.6 times, which is what our $38 fair value estimate implies. That said, we may slightly reduce our 10-year Las Vegas and domestic regional revenue forecast for MGM by a few tenths toward a 2% average annual growth rate (similar to what we currently model for Caesars domestic assets) to reflect the competitive risk from the combined Caesar-Eldorado. Still, this potential change would largely be offset by the time value of money, leaving our existing $38 fair value estimate intact.

Caesar and Eldorado are both highly leveraged at nearly 8 times each. Encouragingly, real estate investment trust Vici is buying two Caesar assets and restructuring higher rents on others that provide $3.2 billion in aftertax proceeds to the combined company to work down debt. Also, Eldorado has secured additional financing and could do other small asset sales. Finally, both companies and the gaming industry are exiting a capital expenditure cycle, allowing for a ramp-up in free cash flow, which should allow for additional debt payments. As a result, Eldorado expects combined gross leverage of 5.8 times when the deal closes next year, with the potential to bring the metric down further to below 4 times by the end of 2021.

The two largest shareholders--Icahn Enterprises (owning around 18% of Caesar) and Recreational Enterprises (owning about 14% of Eldorado)--support the transaction, and we expect other shareholders to follow suit. We don’t expect much pushback on the deal from the Federal Trade Commission, although the company acknowledges that some small divestitures in overlapping regions might be necessary. Given Caesars' high leverage, we don’t expect other competitive bids. While MGM is large enough to acquire Caesars, we believe the deal would face antitrust headwinds and risk MGM’s opportunity to win a license in the attractive Japanese gaming market around the end of 2020.

Terms of the deal are for Eldorado to acquire Caesar stock and debt for $17.3 billion, which includes $7.2 billion in cash and roughly 77 million shares of Eldorado stock. The purchase price of $12.75 per share comprises $8.40 in cash and 0.899 share of Eldorado common stock for each Caesars share. After the deal, Eldorado will own 51% of the combined company, which will retain the Caesars name. Eldorado’s executives will remain, and the 11-member board will be consist of 6 people from Eldorado and 5 from Caesars.