Paul S. West and Rudy J. Cerone, partners in the Louisiana-based law firm of McGlinchey Stafford, spoke recently with Associate Editor Craig Berosh about the financial crisis gripping the casino industry. Experts in casino law and bankruptcy, neither is afraid to use the “B” word in discussing the industry’s current dilemma, although, somewhat ironically, they note that lending markets are running so scared right now that for casino operators, or businesses in any industry for that matter, there is scarce capital available even to fund a Chapter 11 reorganization … it’s that bad.

The big question on many people’s minds is the possibility of a major public casino company filing for Chapter 11. What are the chances of this happening?

West: It’s really hard to predict. Everyone keeps asking if a major Strip operator will go into bankruptcy. I would imagine that every lender of the major operators will do everything they can to keep them out of bankruptcy. I would say that it will take real tragic times to put one of them in bankruptcy, but I’m not sure that’s not what we are facing right now. I’m not saying it won’t happen, but if a major operator goes into bankruptcy, you can pretty much believe that that was the last chip they had. 

How did the gaming industry get to this point?

West: The generally accepted view is that two or three years ago credit was extremely easy to obtain at very favorable terms. And the casino companies went out and borrowed a whole lot of money and built a lot of projects on fairly short-term debt. As the bottom fell out, that debt started to become due at the same time the whole country started moving more and more toward a recession, which meant that less people were coming to gamble, so their cash flows started to take a significant hit. At the same time, the interest rates started going up on some of the bonds, some of these bonds started coming due, and as the interest rates go up, their debt payments become higher as their cash flow goes lower.

How big of a role does debt play in the equation?

Cerone: Think about what happened with Harrah’s [Entertainment]. Harrah’s was taken private by the hedge funds at the top of the market, which looks to be a bad deal right now. The hedge funds, the other equity holders and the debt holders of some of the casinos may in fact convert the debt side of it and just take them private.

West: What that means for the debtors, instead of having to pay quarterly debt service, they could just give them stock, and they would just sit and wait and hopefully cash out when the thing bottoms out and comes up the other end. That would reduce the gaming company’s cash flow requirement. I would imagine you are going to see some of that going forward.    

Cerone: There has been a lot of that outside the casino industry, where the hedge funds, instead of putting companies into bankruptcy, have done what we call “work-out” deals with companies to convert their debt to equity and avoid bankruptcy altogether.

Beyond construction delays and outright cancellations of projects, how have these dried-up credit markets affected the casino industry?

Cerone: The real problem with bankruptcies right now, and this goes for all industries, not just the casinos, is that there is no money, there’s no liquidity. There’s no capital available for companies to run in a Chapter 11. They can’t get what we call DIP (debtor-in-possession) financing. They can’t get money to operate while they are in bankruptcy, and they can’t get what we call “exit” financing for coming out of bankruptcy, where new financing replaces what was available while you are a debtor-in-possession. Then you are not going to be able to function. It’s generic in the Chapter 11 situation right now. There’s just no money available.

Rudy J. Cerone is a certified specialist in business bankruptcy law and has represented bondholders in numerous casino cases.

What options does a company have then?

Cerone: What happens is, there are no bankruptcies. Companies just fold. We’ve seen it in the retail industry with the Bennigan’s franchise. Instead of filing Chapter 11 they filed Chapter 7 and just folded because there was no ability for them to reorganize. General Electric Credit Corp. is one of the prime movers and lenders in that area, in DIP financing, and they have stopped with their DIP financing. That sent shock waves through the financing world. Being a Chapter 11 lawyer and not having any Chapter 11’s in a downturn, there’s a reason for that.

If it’s difficult to find money even to finance a bankruptcy right now, how would you describe the conditions for selling a casino that is in trouble, like the Tropicana in Atlantic City?

West: It’s not just hard to sell a casino right now, it’s hard to sell anything. Because not too many people can get the financing. If you have the money you might be able to buy what looks like a pretty good deal. The overarching concern is, who is going to come to your casino in this economy? People aren’t gambling right now, and it’s not solely because they don’t have the money, everyone is a bit morose right now. It’s hard to justify spending $300 at the riverboat when things aren’t looking good right now.

It seems the market is ripe for buyers who are liquid.

West: If you are out there with cash right now, and you are a bottom-feeder or a vulture, and you have some staying power, and you believe that the economy is going to turn around in the next two or three years, there are bargains in the gaming industry like you have never seen in your life.

What lessons can be learned from the current situation?

West: The main lesson is to not get so far ahead of yourself. They always said that the gaming industry was recession-proof, and Las Vegas could never over-build itself. Answer that question now. Obviously, someone thinks that Las Vegas is over-built.

Cerone: My comment on that would be that “cash is king.” The gaming operators always have relied on junk bonds and very high-coupon Wall Street instruments to finance their operations. The ones that have relied on cash flow, more so, they’re going to be in much better shape than the ones that are highly leveraged.

How do you see this playing out over the next 12 months?

West: The big companies are going to come out of it. Some of the mid-cap companies are taking the right steps. You look at a Boyd Gaming, who saw it coming and shut down the Echelon project, a tough decision for them to do, but I think it will turn out to be the right decision. Companies like that who make the right decisions, who are prepared for it and can weather the storm, will come out of it. But if I had to bet, so to say, somebody is going to take a major hit. 

Cerone: I agree. I don’t know who it is going to be, but somebody is going down.