Summary analysis -- Stockbridge/SBE Investment Co. LLC ------------
CREDIT RATING: B-/Negative/-- Country: United States
Primary SIC: Coin-operated
Credit Rating History:
Local currency Foreign currency
22-May-2012 B-/-- B-/--
Standard & Poor's Ratings Services' corporate credit rating on Las Vegas based Stockbridge/SBE Investment Co. LLC (SLS) reflects our assessment of the company's business risk profile as "vulnerable" and our assessment of its financial risk profile as "highly leveraged," according to our criteria.
Our business risk profile assessment reflects the property's disadvantaged northern Las Vegas Strip location, a highly competitive market with many well-established operators, and the company's reliance on a single property for cash flow generation. We have also incorporated the vulnerability of new gaming projects to uncertain demand and difficulties managing initial costs, which can lead to poor profitability during the first several months of operations. The project is a redevelopment of the former Sahara Hotel & Casino and faces the associated construction and execution risks that come with a renovation project, which are lower than those of a new build. Our expectation for a muted supply of new properties coming onto the Las Vegas Strip over the next several years should offset these business risks somewhat. In addition, we believe continued positive visitation trends will allow the market to absorb SLS' additional capacity. Furthermore, the rating incorporates our expectation that management will successfully leverage the existing platform of hotels, food and beverage (F&B) outlets, and nightlife venues of sbe Entertainment Group (sbe), the manager of SLS Las Vegas, to drive customer traffic.
Our assessment of SLS' financial risk profile as highly leveraged reflects the challenges that a new hotel and casino property often faces to ramp up cash flow generation quickly enough to a level sufficient to satisfy fixed charges, as well as our expectations for relatively weak credit measures. Based on our performance expectations, we are forecasting that SLS will be cash-flow neutral in 2015, its first full year of operations, and have EBITDA coverage of total interest in the low-1x area.
The proceeds from the $300 million of term loan were placed in escrow for six months, along with sponsor equity sufficient to fund interest that accrues over the six-month period. The initial six-month escrow period expired at the beginning of November, and SLS exercised its option to extend the escrow period for an additional three months; as required by the extension, SLS contributed the additional interest. The release of the term loan proceeds is contingent on SLS raising $115 million in junior-priority debt with a blended cash interest rate not in excess of 6% within the next 3 months. If SLS cannot raise the additional financing, the term-loan proceeds will be returned to lenders. As a result, construction and development of the project will not begin until the junior-priority financing is raised and proceeds from the term loan are released from escrow.
SLS intends to finance the junior-priority funds from the U.S. Immigrant Investor Program (the EB-5 program). This program allows foreign citizens to potentially obtain green cards and permanent residence status upon satisfaction of certain requirements stemming from their investments in new commercial enterprises, which create jobs for U.S. citizens and legal residents. SLS has established SLS Lenders LLC for the purpose of pooling EB-5 investor capital for investment in SLS. Based on the proposed terms of the EB-5 offering, the total interest rate is expected to be around 5% of noncompounding accrued interest, which, in our view, provides a significant savings in interest expense relative to market-based rates. It also improves the potential that SLS will generate cash flow sufficient to meet fixed charges. The proposed term of the EB-5 financing is five years, and the borrower would have the option to extend the maturity for up to an additional two years.
If SLS cannot raise most, if not all, of the $115 million in junior-priority capital via EB-5 financing and uses an alternative source of junior-priority funding, we believe that these alternative investors would likely require additional compensation beyond 6% cash interest, such as pay-in-kind (PIK) interest, based on the risk of the project and current market conditions. If the company needs to raise any meaningful amount of junior-priority debt at current market interest rates, we believe that, based on our performance expectations, the capital structure would be unsustainable, and we would downgrade the company to the 'CCC' category.
We expect SLS Las Vegas to open in the second half of 2014. The facility will feature the following at opening:
-- Three hotel towers with a total of 1,622 rooms;
-- A 66,154-sq.-ft. casino with 860 slots, 112 tables, and a 2,840-sq.-ft. sports book area;
-- 32,700 sq. ft. of convention space;
-- An 8,000-sq.-ft. spa and fitness center;
-- 12 restaurants, with a total of 43,000 sq. ft. and 1,671 seats;
-- 8,000 sq. ft. of bars and lounges;
-- Four nightlife venues, with 71,650 sq. ft. and capacity for 5,000 customers;
-- 7,500 sq. ft. of retail space;
-- A 39,150-sq.-ft. pool area with cabanas, a show stage, and cocktail and snack bars; and
-- 2,564 parking spaces.
SLS has entered into a guaranteed maximum price contract (GMP) with its contractors covering the majority of hard construction costs. The GMP, along with approximately $13 million in contingencies, partially mitigates the risk of construction delays and cost overruns. Because the project is a redevelopment of the existing Sahara property, it carries a smaller risk of cost overruns versus a ground-up development project. The contingencies represent approximately 8% of contracted hard costs, which is likely an appropriate level given the risk associated with a redevelopment project.
Gaming revenue on the Las Vegas Strip grew 5.1% in 2011 and 2.5% through the first nine months of 2012. We believe that the Strip should continue to realize at least modest mid-single-digit percentage growth in gaming revenue over the next few years as the economy continues to gradually improve. However, the lodging side of the business was the key catalyst for the market last year, as many of the larger operators reported revenue per available room (RevPAR) growth in excess of 10%. The growth in RevPAR has continued in 2012 albeit at a more moderate pace. We expect visitation trends to remain positive, which, combined with ongoing improvement in group booking levels and very limited additional room supply scheduled to come online over the foreseeable future, should support continued strong occupancy and improving room rates. Consequently, SLS Las Vegas stands to benefit from what we believe will be a positive operating environment in Las Vegas upon the property's opening in the second half of 2014.
We expect occupancy and average daily rate (ADR) to gradually increase during the initial opening phase, typical of a new project. Our forecast incorporates an expectation of mid-$130s ADR and occupancy in the mid-80% area in 2015. We expect occupancy to gradually reach the low-90% area, comparable with other Strip operators, and to reach the mid-$140s by 2017. The forecast translates to RevPAR of approximately $114 in 2015, which we assume will grow at a compound annual growth rate (CAGR) of approximately 4% to 5% through 2018, with hotel margins ramping up to and stabilizing in the low-70% area. Although we believe SLS can benefit from significant weekend traffic because of its nightlife offerings, with a disadvantaged north Strip location and limited convention capacity, we are skeptical SLS can attract business and leisure travelers during midweek dates without meaningfully reducing room rates.
We derived F&B assumptions as a function of hotel room revenue, with an assumption that F&B will be 160% of hotel room revenues in 2015. Under our performance assumptions, we believe F&B will grow to 170% of hotel room revenue by 2018, and that F&B margins will stabilize in the low-30% area. Although F&B as a percentage of total revenue is on the high end as compared with some other Strip operators, the manager of the property, sbe, has significant expertise and proven success in Southern California with various nightlife venues and restaurants, and we believe they will be able to leverage their existing platform with at least moderate success to the Las Vegas Strip. We expect gaming revenue to be in the $80 million to $85 million range in 2015, with a CAGR of approximately 3% through 2018. We project gaming margins to eventually stabilize in the mid-40% area, which we believe reflects the gaming floor mix of slots versus tables and the target customer. In our view, the property may be challenged to generate gaming profitability comparable with some of the larger Strip operators, which have an established gaming customer base.
Our analysis includes a management fee of 2% of net total revenues paid to sbe and subordinated to debt service. Based on these assumptions, we are forecasting that the company will generate EBITDA in the mid-$40 million area in 2015, with a CAGR of approximately 9% through 2018, at which point we believe growth at the property will likely stabilize to market levels. Under our performance expectations, and assuming the successful raise of at least $115 million of EB-5 program debt, EBITDA coverage of total interest would be in the low-1x area at the end of 2015, rising to the mid-1x area by 2018. Because of the PIK component assumed in the $115 million of EB-5 financing, we expect EBITDA coverage of cash interest in the mid-1x area at the end of 2015, rising to around 2x by the end of 2018. We expect total debt to EBITDA of around 9x at the end of 2015, improving to 7x at the end of 2018.
Based on the proposed capital structure and incorporating our performance expectations, we assess SLS' liquidity profile as "adequate." Our assessment includes the following expectations:
-- We expect sources of liquidity over the next 12 to 18 months to cover uses by around 1.2x.
-- Assuming full access to a planned revolver, we believe net sources would be positive following the property's ramp-up period, even if EBITDA were 15% lower than our current expectations.
SLS' sources of liquidity will include funds from the proposed financing (including $115 million of EB-5 program debt), to be deposited into construction and interest reserve accounts. Uses will include renovation capital expenditure, pre-opening expenses, interest expenses, the repayment of existing debt, and transaction fees and expenses. The proposed capital structure includes a prefunded interest reserve of $78 million, which will support interest payments on the first-lien credit facility throughout the construction period--and for approximately six months following the scheduled opening of the property.
The credit facility also includes a carve-out for a $25 million revolving credit facility, which would represent an additional source of liquidity that we expect will be raised closer to the opening of the property. In addition, if the proposed EB-5 financing or other qualified junior-priority financing exceeds $115 million in proceeds at the time of closing, SLS has the option to prepay up to $50 million of the $300 million first-lien term loan at 103% of the principal amount. The credit facility includes financial maintenance covenants, including a maximum first-lien leverage covenant and a minimum first-lien interest coverage covenant. Based on our performance expectations, we believe SLS will be challenged to meet the first-lien leverage covenant in 2015.
SLS's $300 million first-lien term loan due 2017 has a recovery rating of '3', indicating our expectation of meaningful (50% to 70%) recovery for lenders in the event of a payment default. For the complete recovery analysis, please see See Standard & Poor's recovery report on Stockbridge/SBE, published May 29, 2012, on RatingsDirect.
The negative rating outlook reflects our belief that Sp up cash flow generation at the property to a level sufficient to service the proposed capital structure. While the rating incorporates a scenario in which the property ramps up to the point that EBITDA generation in 2015 meets total fixed charges under the proposed capital structure, this scenario relies not just on strong execution by the management team, but continued modest growth in gaming revenues and RevPAR on the Las Vegas Strip. Given SLS' disadvantaged northern Strip location, a highly competitive market with many well-established competitors, and the vulnerability of new gaming projects to uncertain demand and difficulties managing initial costs, the negative outlook reflects the risks in achieving a sufficient ramp up in EBITDA to meet fixed charges.
We could lower our rating on SLS to the 'CCC' category if it needs to raise any meaningful amount of junior debt at current market interest rates, as we believe that, based on our performance expectations, the capital structure would be unsustainable. Additional downward rating pressure could result if the property opens up materially worse than our expectations, or if construction delays and cost overruns signal a potential liquidity shortfall. A revision of the rating outlook to stable would require a strong opening in 2014 and demonstration of an ability to generate EBITDA sufficient to achieve EBITDA coverage of total interest in excess of 1x.
Related Criteria And Research
-- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
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