Three structural "evolutions" put Wynn casino bond deal over the top, buyer says

By Paul A. Harris

St. Louis, Mo., Nov. 4 - Call them "sloppy" or "choppy," current conditions in the high-yield market are said to be driving both issuers and buyers onto the sidelines.

Beaten-up bond investors want additional assurances on new deals. And they are doing some of the driving as the investment banks structure those deals.

Tim Collins who manages Northwestern Mutual's Mason Street High Yield fund with Steve Swanson recently told Prospect News that in the run-up to the offering by Wynn Las Vegas LLC and Wynn Capital Corp. of $370 million of 13½% eight-year second mortgage notes Collins and other buy-siders suggested structure changes. And in the present market circumstances the investment banks were all ears.

"It was actually a nice change of pace," said Collins, whose Mason Street High Yield Fund played the deal. "Too often when you have a $300 million or $400 million bond deal in a more bullish environment, and it becomes a take-it-or-leave-it proposition."

Wynn's deal, which priced Oct. 25, came with nearly $1 billion of equity; the stock offering price backed up significantly as the company tried to complete the IPO. Its completion was an essential prerequisite for the junk bonds according to Collins. He added that along with the equity Wynn and the underwriters - Deutsche Bank Securities, Banc of America Securities, Bear Stearns and Dresdner Kleinwort Wasserstein - ultimately brought the bond deal's structure through three "evolutions" enabling Wynn, through debt and equity, to raise the money he needed to complete casino projects in Las Vegas and on Macao.

"Basically Le Reve, the Las Vegas project and Macao are in sister subsidiaries," Collins explained. "If you buy the Le Reve bonds you have recourse to Le Reve-related entities, but you don't have any direct recourse to the Macao entities. So you had public stockholders with dual interest in Macao and in the equity of Le Reve, and you had a situation where it was hypothetically possible that Le Reve could be a failure, Macao could be a home run and the equity guys get rich and the bondholders get killed because their only recourse was to the one side of the project - the Le Reve side.

"So one of the real structural evolutions that occurred that provides a lot of potential upside support - and there is certainly no downside to having it - is the downstream guarantee that was added, that runs from Wynn Resorts down into Le Reve for the benefit of the banks and the bondholders there. That provides indirect credit support to the Le Reve project bonds from Macao. That's important because Macao will be up and running probably a good year to a year-and-a-half before Le Reve opens its doors.

"That prevents equity holders in the Wynn transaction from prospering in a scenario where bondholders are losing money."

Another "evolution" that Collins and other buy-siders persuaded Wynn and the banks to include in the deal is a call structure that allows investors to keep clipping coupons after the Vegas property is completed.

"It was structured as an eight-non-call-four deal," Collins said. "If you stop and look at the timeline it's going to be 15 months before you have anything going on in terms of an operating business in Macao and it's going to be 2½ years until you have anything real to look at in Las Vegas. So you're a good 3½ years into this deal until you start to have a sense of what the mature cash flow of the company is going to be.

"If you're going to take the upfront risk as a bondholder in a transaction like that - the risk that it doesn't get built on time, that Macao blows up, that the Chinese renege on the concession and all this value implodes - it's important that there be some source of upside, some symmetry that allows you, if you do make a good call and you do navigate the minefield of risks successfully, to enjoy a little bit of sunshine on the back side where you continue to clip your coupon for a while at some sort of in-the-money rate because of your call protection.

"By setting the coupon the way they did and pricing the deal at a discount, and then ratcheting up the standard 50% of the coupon call provision in the first call year to almost a full coupon in the first call year the underwriters really created some upside. Instead of creating a bond at par that's callable at 106 in the fourth year the have created a bond at 92 that's callable at 110 in the fourth year. All of the sudden you have 18 points of upside rather than six points, to complement the coupon.

"I think that was a real important change that helped them draw some interest at the margin," Collins added. "It certainly helped us get more excited."

The final evolution, Collins said, was that Wynn and the banks escrowed the first five coupon payments.

"The initial transaction was proposed where all the proceeds from the bond and the equity deal were essentially going into one big pot," the portfolio manager said. "That puts you at some risk if you do have overages relative to budget, or timing delays, that before the thing opens you may have a default on your bonds.

"So they set up an escrow so that these bonds are segregated from all the other cash collateral, and are available for the exclusive use of servicing bondholder debt.

"The comfort that the escrowed cash is not going to be available to fund an overage that might accrue to the benefit of the first mortgage bank holders if something goes wrong, was a nice enhancement."

Collins conceded that present "sloppy" circumstances in the high-yield and IPO markets cost Wynn possibly 200-250 basis points on the bond deal.

"He certainly picked a tough environment to do a deal in," the Mason Street High Yield Bond Fund manager said. "It's an accident of timing and history since he has been working on this transaction ever since he sold Mirage, 2½ years ago.

"It had to be done now though," Collins added. "He's got the concession in Macao to do the Chinese casino development. He can't really afford to sit on that very long. He's expended significant amounts of money in the up front planning and design phase of the Le Reve project in Las Vegas.

"So he found himself in a situation where he was coming into kind of a sloppy high-yield market, here and a sloppy IPO market, but really needing to get the deal done even if the money was expensive."

Collins was in a congratulatory mood with regard to the investment bankers that worked out the structure of the deal.

"I think the underwriters did a particularly good job on that," he said. "Deutsche Bank, Bear Stearns, Banc of America and Grantchester [part of Dresdner Kleinwort Wasserstein] were on the cover of that deal, and they should be commended. They are four of the strongest gaming underwriters and have some of the strongest gaming research on the Street."

A syndicate source contacted by Prospect News on Monday confirmed Collins's description of the structure of the Wynn deal, and conceded that the buy-side was active in creating that structure.

"No one's ever done a deal like this," the source said. "No one has really financed a construction project using the public markets like this. The IPO is the second largest ever for the gaming sector. And there is that second priority lien on the assets of Le Reve, on the bond side...all sorts of firsts.

"There was a lot of give and take. There were not a lot of comps because it had never really been done. So it was a matter of trying to find out what the market would do."

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