When private equity comes out fighting, beware the sucker punch

US Outlook

Sugar Ray Leonard takes on Thomas Hearns in Caesars Palace, Las Vegas, in 1981 – during the glory days of both boxing and the casino (Getty Images)

It’s hard to recall the glory days of boxing without thinking of Caesars Palace. But now it is more than just a legendary fight venue: through its parent company Caesars Entertainment, it has turned into the perfect metaphor for the decline of the sport and the hubris of private equity.

Apollo Global Management and TPG bought Caesars in January 2008 in a deal worth something like $30.8bn (£20.3bn), of which all but about $6bn was debt. The timing couldn’t have been worse, the deal completing just as consumer spending performed an emergency stop and gambling revenues tanked.

Caesars, then known as Harrah’s Entertainment, was already deep in debt but Apollo and TPG loaded up the balance sheet with more borrowing, presumably in order to pay themselves a fat dividend and get their own cash out as fast as possible. That’s pretty much how private equity works.

Fast forward to 2015 and Caesars has been on the public market for three years, albeit with a limited float and 70 per cent of the equity still in the hands of Apollo and TPG. It has been a dog too, underperforming the sector and the market by a wide margin.

Last week Caesars announced yet more grim results and another billion-dollar quarterly loss, leaving its survival in the balance. Debt, and therefore interest, is what’s killing it – $28bn of liabilities will do that. Its numbers make the average Premier League football club look prudent, possibly amusing for a casino company but for investors no laughing matter.

So Apollo and TPG are trying to salvage what’s left of their investment and their reputation by shuffling the debt around and creating two new companies, one a real estate investment trust (Reit) to own the property assets and the other to run as the casino operator. Caesars already has an operating company – it’s in Chapter 11 bankruptcy protection at the moment.

That deal, which is in the court system and may not get the green light for another year, sounds good for holders of senior debt. But those holding less secure debt, including a couple of angry hedge funds, look like they will be stuck with a bum deal. They are right: swapping $5.2bn of debt for just 30 per cent of the Reit is a clear win for the house. What equity holders will be left with is unclear, but it won’t be much.

Not surprisingly, the junior debt holders are in the process of suing Apollo and TPG for what amounts to asset stripping – taking the best bits for themselves and senior debt holders while leaving the garbage for everyone else. There’s so much irony in this story, it’s almost impossible to measure.

The sad thing – and Caesars employs 68,000 people in 14 states, so there could be a real impact outside boardrooms – is that if Apollo and TPG hadn’t taken Caesars private, the company would probably be doing far better by now. Its debt would still be a burden and the company would still probably be worth less than it was pre-crash, but the casino and gaming sector has made a decent recovery. Except Caesars.

The name should survive, but like boxing, its glory days appear long gone. Caesars is even struggling to get new licences, with regulators citing its precarious financial position as the reason. Easy to say with the benefit of hindsight, but its private equity owners should have admitted defeat in 2008 and left it well alone.

As it happens, Apollo and TPG may already have made money out of Caesars through the various fees they charge simply for keeping an eye on a business they own. However, even if court decisions go in their favour, there is virtually no chance that Apollo and TPG will make the kind of blockbuster money out of Caesars they imagined they would. Their reputations and their relationships are deeply tarnished.

This is one big gamble that still has lots of cards left on the table – one that has the potential to become much uglier before a winner is declared.

Justice contaminated by Exxon’s slap on the wrist

You could be forgiven for thinking that BP’s Deepwater Horizon settlements would set a precedent. If there was any upside to the 2010 spill in the Gulf then it was the huge reparations BP is still paying, even if the final bill remains subject to US judges.

So when it was revealed on Thursday that Exxon had settled with the state of New Jersey over a $9bn claim against the company, you might guess that the State did quite well out of it. In fact, it settled for a pathetic $225m, less than 3 per cent of the total damages sought.

Two Exxon refineries had already been found responsible for long-term contamination of 1,500 acres of wetlands in northern New Jersey, so Exxon has got off extraordinary lightly. The settlement ends 11 years of litigation.

The former commissioner of New Jersey’s environmental protection agency, Bradley Campbell, described the settlement as “an embarrassment”. He’s not wrong there. It was reached following intervention by the chief counsel to the New Jersey Governor Chris Christie, whose office was in effect accused by Mr Campbell of forcing a settlement that is clearly beneficial to Exxon and rides roughshod over a decade of work by state employees.

Well, call me a cynic, but Mr Christie has a presidential campaign to run; can’t have some inconvenient environmental disaster getting between him and his donors. Not only that but riding roughshod over state employees is his shtick. There isn’t a state worker that Mr Christie isn’t willing to bully to get his own way, and in this case Exxon’s.

While taking a settlement after 11 fruitless years is a wise thing to do – look at how long Exxon fought over the Valdez spill 27 years ago – settling like this is, as Mr Campbell also put it, “a disgrace”. It also sends out a pretty dreadful message: Exxon does what it likes.

Drug deals will keep coming as big pharma flexes muscles

AbbVie’s $21bn acquisition of the biotech outfit Pharmacyclics is the biggest M&A deal of the year so far. But considering both AbbVie and Pfizer had even bigger plans thwarted recently, don’t expect it to be the biggest by the end of the year.

We have been hearing for years about how the weak pipeline of new drugs at big pharmaceutical companies is going to spark a huge wave of acquisitions. According to Thomson Reuters, 2015 has already seen just short of $60bn of deals in the sector.

AbbVie, which failed to buy Shire for $55bn last year, beat off stiff competition for Pharmacyclics. It produces a leukaemia drug called Imbruvica, which is expected to sell about $7bn worth per year at its peak. Last year the company sold under $500m worth, so it’s a gamble.

Pfizer has already spent $15bn of its war-chest on Hospira, but considering it planned to shell out $118bn for AstraZeneca, there should be plenty more where that came from.

Perhaps it’s no wonder pipelines are thin. For life scientists, the way to get rich is to leave Big Pharma.