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Buyout Expenses Hamper Harrah's Q1 Profitability

Buyout Expenses Hamper Harrah's Q1 Profitability 0001

As with several other poor earnings statements posted by land-based gambling concerns, casino giant Harrah's posted a loss of $187 million in the first quarter of 2008. This represents a reversal for the WSOP host, which posted a gain of $185 for the same period last year. "Our first-quarter results reflect the consequences of challenging economic conditions," said Gary Loveman, Harrah's chairman, president and chief executive officer. "However, we ended the first quarter with ample liquidity, and we continued to reduce expenses companywide."

While Harrah's revenues were down in most of the regions where they operate, the loss for the quarter can be directly attributed to the costs associated with the company's private equity buy-out. On January 28th, Apollo Global Management LLC and TPG Capital LP acquired Harrah's with the largest leveraged buyout in the industry's history. The price tag to take the casino conglomerate private was $17.1 billion and the assumption of $10.7 billion in debt.

In the first quarter, the company posted merger and acquisition costs of $142.6 million and $557.6 million in interest expense. The interest expense alone exceeded Harrah's higher 2007 first-quarter operating profits. One likely assumption is that this loss, and the losses likely to follow, had been expected and calculated by the private equity firms going into this venture.

Overall, Harrah's revenues were down only 2% for the quarter, while operating profits were down a little less than 10%. Compared to its rivals, Harrah's top line fared relatively well in a quarter marked by domestic economic challenges. And while the rest of their competition faired particularly poorly in Atlantic City, Harrah's, while citing the pressures of higher gas prices, new smoking regulations, and competition from Pennsylvania slot parlors, saw increased revenues from the region. The increase in revenues was driven primarily by two properties, Harrah's Atlantic City and Harrah's Chester Casino and Racetrack. Harrah's Atlantic City $565 million expansion is only partially complete, and will continue to open in phases throughout the summer.

The company continues to break its financials down into two categories: those for Harrah's Operating Company; and those for Harrah's Entertainment. For now, the distinction is mostly a paper designation. But pending regulatory approval, initially eight properties will be transferred from Harrah's Operating Company to Harrah's Entertainment. The initial eight properties include Harrah's Las Vegas, Rio, Flamingo Las Vegas, Harrah's Atlantic City, Showboat Atlantic City, Harrah's Lake Tahoe, Harvey's Lake Tahoe, and Bill's Lake Tahoe. After the first approval, two additional properties will join Harrah's Entertainment; Paris Las Vegas and Harrah's Laughlin. And then, to complete the process, a number of properties will then transfer back to Harrah's Operating Company: Harrah's Lake Tahoe, Harvey's Lake Tahoe, Bill's Lake Tahoe, and Showboat Atlantic City.

Reducing interest expense, through the reduction of debt, has to be at the heart of this accounting tangle. One could assume that departmentalizing properties is being done to facilitate the eventual sale of some of those same properties. While this was probably all part of the plan for the acquiring entities, timing may still work against them in the short term. The purchase price for Harrah's was set at a time when casino valuations were relatively high. However, while awaiting the lengthy regulatory approval, the credit market crisis enfolded, raising debt financing costs for large leveraged buyouts. So while property sales are probably needed to offset Harrah's high debt costs, they will come at a time when casino property valuations have deteriorated. And while credit pressures appear to be easing on some fronts, potential acquirers may still have problems securing the kind of financing needed to pick up Harrah's castoffs.

Harrah's has spoken about economic conditions and cost reductions, as their competitors have done this quarter, but cost cutting and efficiency will only help them at the margins. Indeed, Harrah's biggest hurdle toward profitability over the near term is likely to be undoing the debt associated with their acquisition.

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