Apollo sold worthless options to cut Caesars lenders off from its parent cash
Squeezed lenders forced the company into court over a single sentence in an earlier ruling.
The Wall Street Skinny · Restructuring 101: How Private Equity Pits Debt Investors Against Each Other | Caesars Part 2/3By the time Apollo ran out of ways to keep Caesars alive under its debts, it had one legal maneuver left to protect the owners. Every loan and bond at the operating company, the unit that ran the casinos, carried a guarantee from the parent company. That promise was what gave those lenders a claim on anything sitting at the parent, including the original equity that Apollo and TPG, the two buyout firms that owned Caesars, had put in.
Apollo set out to sever that guarantee. Its tool was a sale of options to buy shares in the operating company, options that were effectively worthless because the unit was headed toward bankruptcy. The buyers included investors like John Paulson, an investor who already owned pieces elsewhere in Caesars and stood to gain from other parts of the structure.
Apollo argued that once outsiders held options on operating company shares, the unit was no longer entirely owned by its parent, and the parent guarantee therefore fell away. It was betting that this claim would hold, that selling nearly worthless options could cut operating company creditors off from the parent's money.
To the lenders, it looked like the ground had been sold out from under them. They hired their own lawyers and decided to fight, and they were not small players but big players in the industry.
The counterattack came from Oaktree Capital, an investment firm, and other junior creditors whose debt had fallen sharply in value after the earlier transfers. They filed for involuntary bankruptcy, a petition in which creditors ask a court to push a company into bankruptcy even if the company does not want to go. That filing forced everyone, the buyout firms, the bankers, the lawyers, and the lenders, to argue in front of a judge where they actually stood.
What the judge had to decide was how to read the earlier ruling Apollo relied on to sever the guarantee, down to a single sentence whose wording is not given. One reading would keep Apollo's maneuver intact and cut off the lenders. The other would undo years of maneuvering. Which reading the judge chose is not reported.
By then the numbers left little room for delay. Leverage that had started at eight times cash flow at the buyout had reached 18 times, and the company was running short of cash to pay interest.
Questions people ask
What is a parent company guarantee?
A parent guarantee is a promise by a parent company to pay if its subsidiary cannot. Lenders want it because the operating unit can run out of cash, while the parent may still hold equity, cash, or other assets they can claim.
Why did owning a tiny piece matter so much?
A wholly owned subsidiary is a company whose stock is entirely owned by its parent. Apollo argued that once outsiders held options that could become operating company stock, that 100 percent ownership was broken, even if the options were then nearly worthless.
What is an involuntary bankruptcy?
Normally a company files for bankruptcy itself. In an involuntary case, a group of creditors files to force it in, usually because they want a judge to stop further asset moves and decide who has what claim before more value disappears.