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Pocket Aces for (Distressed) PE?

By Stefan Larsen

Loan sharks and bookies are famed for having little patience for outstanding debts – we learned this from Tony Soprano and almost every character portrayed by Joe Pesci. Ironically however, the script appears to have been flipped for their legal counterparts today.

In the carnage that was March’s public markets, no sector was dealt more punishment than the leisure and hospitality sector. The devastating effect that the coronavirus will have on these sectors is compounded by the fact that even larger-cap issues have rather substantial and, in some cases, possibly untenable debt loads. This is especially true for casino operators, which in addition to substantial borrowings also have contractual CAPEX and lease obligations to casino lessors. Because these businesses are operators, and by definition asset-lite, fixed income investors would be a hard sell for capitalizing the business further; this is exactly why opportunistic private equity investors might buy in if the situation becomes distressed.

Cash Generation

Casino operator businesses are usually established in regional markets, as marquise locations such as Las Vegas tend to be dominated by owner-operators including Las Vegas Sands, Wynn Resorts and MGM. They exist primarily as a consequence of concentration of regional gaming real estate assets controlled by a handful of publicly listed REITs such as Vici Gaming and Gaming & Leisure Properties.

Although operators must sign onto rather burdensome triple-net lease agreements to operate gaming assets – requiring them to foot the tax bill as well as all CAPEX requirements – they remain incredibly cash generative with high margins and cash conversion. This is partially because of the characteristics of regional gaming assets, which tend to be filled with slot machines which are a space efficient and high advantage games from the house’s point of view. Moreover, their revenue is highly recurring, with substantial repeat customers due to the addictive nature of gambling, as well as the regional geography providing a local base of customers.

Stakeholder Support

Indeed, these cash generative qualities are why operators were able to obtain the leverage they are now saddled with, and it also constitutes a more structural reason for why the businesses are so attractive, in that governments have a vested interest in regional casinos’ monopolistic position and profitability. Licensing policies tend to be favorable for regional gaming as state governments prefer to handle and tax as few operators as possible in order to maximize state revenue on what is a highly inelastic good. Pennsylvania, for example, is a limited-license state where gaming tax revenue has become so profitable that it constitutes 21% of the state’s total tax revenue. This is also the reason why casino operators feel entitled to the bailouts that Trump was signaling he’d dole out if the outlook continues to deteriorate.

Offering limited licenses not only allow operators to make more money, but also enable governments to leverage the exclusivity of the license to ask for substantially higher tax rates. So while Nevada is home to companies that produce the most gaming revenue including grandiose assets like the Bellagio and the Venetian, it’s eclipsed by Pennsylvania and New York in terms of gaming tax revenue because PA and NY can demand much higher tax rates than simply 7%.

In addition to governments, other stakeholders such as the lessor REITs also have an interest in keeping operators afloat. Indeed, just last week Penn National Gaming received rent credits from Gaming & Leisure Properties so that they would have sufficient liquidity to deal with mandated closures for another 6 months. Of course, these credits did not come free, requiring Penn to give up one of its owned Las Vegas gaming assets in exchange. Nonetheless, even if the lessors didn’t care about the equity value of their operators, in a distressed situation, they would be partial to having a private investor capitalize and takeover the business in order to keep their properties from becoming vacant. After all, tenant creditworthiness is a critical value driver for REITs as their leases are valued like debt due to the credit-like characteristics of the triple-net arrangement.

Proven Markets with Growth Areas

In addition to the fact that these businesses have the fundamentals to constitute a good PE investment, this market has also been proven profitable by the specialized mid-market funds. Clairvest, for example, has a proven track record in this sector with recent closes, including Rivers Casino which 8x-ed their investments over 6 years, and are continuing to pursue this sector not only in the US but also abroad. This makes the sector wieldier for PE investors to approach, as comps are available and sellers are aware of the de-risking opportunities available to them in the private markets.

The industry continues to be attractive as the online sports betting opportunity develops as well, with states beyond New Jersey adopting legislation to make it legal. Under New Jersey’s model, the online sports book has to be tied to a facility, which will encourage operators to adopt an omni-channel approach, such as Penn National gaming acquiring Barstool, and also reduces the risk that physical operators might be encroached on by online players.

Overall, with the coronavirus exacting its toll on gaming assets due to forced closures and what will likely be a slow normalization until patrons are comfortable in public spaces again, we should expect that there will certainly be some regional gaming assets on the private markets soon as appetite for these cash generative businesses will be high with the mark-down.

Editor: Eric Peghini

Author: Stefan Larsen

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Bocconi Students PE Club
Bocconi Students PE Club
The Bocconi Students Private Equity Club (BSPEC) is a student-led organization at Bocconi University. The club publishes articles related to private equity and venture capital, conducts interviews with active PE professionals and hosts events featuring funds and advisors. BSPEC is one of the oldest and most active student associations at Bocconi University and its alumni are currently employed at top tier investment banks and PE funds. Learn more at

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