Harrah’s Apparently Underwhelmed by Offer

While some of the less-knowledgeable anchors on CNBC today were saying that Harrah’s was being bought out by private equity, I couldn’t help but sit back and consider the odds that the casino giant accepts the $81 per share cash offer from Apollo and Texas Pacific. After all, the company’s shares opened at $75.42, jumped to as high as $80.01, and closed back down at $75.62 each.

Since I play arbitrage deals every once in a while, a quote of $75 and change would be intriguing indeed, if the odds of a deal were fairly high. It would likely take 6 to 9 months for a deal to close upon an official agreement, which makes for a nice annualized return for merger arbs. However, after thinking it through, I decided not to pounce yet. And the reasons below might partly explain why the stock is more than $5 below the offer price.

If Harrah’s was truly happy with the offer, wouldn’t they have accepted $81 per share? Instead they merely issued a press release announcing that they had received the offer and formed a special committee to consider it. The way I see it, there are only two reasons why Harrah’s would not have agreed to the proposal. Either they aren’t totally sold on the idea of going private, or they are open to it, but want a better price.

Now it’s true that by making the offer public knowledge, other interested parties could emerge and a bidding war could push the price up. However, we are talking about a $15 billion offer for the HET equity, plus another $10 billion or so in debt, for a total deal value of $25 billion. How many other buyers can afford a deal like this? Not many, so a bidding war seems unlikely.

A more plausible scenario would be for other private equity firms to join in on the bid, allowing for a second offer to be extended if Harrah’s balks at $81 per share. With more investors, the acquiring group can increase their bid, and at the same time, reduce the amount that each must put into the deal.

Who knows exactly what Gary Loveman and the other folks at Harrah’s are thinking here. The offer does represent a 22% premium, but is also slightly below the stock’s 52-week high. Loveman, the CEO of Harrah’s, likely won’t have to worry about losing his job, since it is unlikely that private equity firms have a seasoned gaming executive who would be a better fit for the company. Going private does take away the flexibility of paying for future acquisitions with stock, rather than cash, so that could be a consideration as well.

So how should investors play this? Current holders of HET should hold on, since anything is possible and the stock is not most likely not overvalued at $75 per share. If you are considering getting in as an arbitrage opportunity, make sure you do a stand-alone valuation for the company and feel confident that there is not much downside longer term at $75 should no deal materialize. And finally, for you corporate bond investors out there; Standard and Poor’s downgraded Harrah’s debt to junk status after word of the offer hit the wires. This seems silly to me.

It should be interesting to see how this all plays out and as events unfold, I’ll be sure to post my thoughts.