Harrah's keeps on gambling with IPO

Harrah's plans to take a gamble on the public markets, but already is telling investors that it doesn't know when to walk away.

Harrah's Entertainment Inc., the casino operator taken private for $31 billion in 2008 by Apollo Management and TPG Capital, yesterday said that it plans to raise $575 million in an IPO of common stock.

Like many companies acquired during private equity's "golden age," Harrah's is mortgaged to the hilt. According to a July Moody's report, the company's annual interest consumes 90% of property income, and its overall leverage is around 10x EBITDA. For Harrah's even to reduce its leverage multiple to 8x, it would have to increase EBIDTA by 40 percent.

Faced with such fundamental problems, one might assume that Harrah's plans to use its IPO proceeds to pay down some of its debt. But those assumptions fade just a few pages into the company's SEC filing, where it discloses plans to use the first $500 million "to fund a near-term pipeline of growth projects."

That project pipeline includes LINQ, a retail and entertainment complex located between the Imperial Palace and the Flamingo in Las Vegas, and the completion of a 660-room tower at Ceasers Las Vegas.

In other words, Harrah's plans to spend its way out of debt (we'd call this the government option, except that Harrah's can't print its own money). 

Such strategy seems to validate what Moody's wrote in July, after the company used debt-for-equity swaps to finance new projects: "Harrah's management seems more interested in jump-starting growth initiatives than in reducing debt."

At the time, however, Moody's assumed that any forthcoming IPO would be used to repay debt (in the absence of major asset sales of debt restructuring). Now, the IPO just seems to be more of the same -- without any redline for when Harrah's would be willing to switch course, were the growth initiatives to yield unsatisfactory dividends.

Not only is Harrah's eschewing outside counsel, it also is ignoring precedent whereby big PE-backed companies almost always use IPOs to repay debt.

Just take a look at what HCA, the hospital operator taken private for $33 billion in 2006, said in its own recent IPO filing: "We intend to use the anticipated net proceeds to repay certain of our existing indebtedness, as will be determined prior to this offering, and for general corporate purposes."

Or Toys 'R' Us, which was bought for $6.6 billion in 2005:  "We intend to use the anticipated net proceeds primarily to repay certain of our existing indebtedness and also for general corporate purposes."

Harrah's, on the other hand, is trying to play a game with much steeper odds. There is always the chance it could pay off, just like some people leave Vegas richer than when they arrived. Most, however, wish they had known when to walk away.