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In 2006, a consortium of investors including Dubai World, a Goldman Sachs fund and Colony Capital raised USD 3.2bn to take Kerzner International private. That CMBS debt falls due in September, and with no clear avenue for refinancing, the Bahamas-based empire of luxury resorts has hired Blackstone Group for advice, two financial advisors and a real estate investor told Debtwire.

Although Kerzner’s sponsors will likely exercise a one-year extension option on the buyout debt, they retained Blackstone to proactively address the overhang, said the sources. Distressed investors have already begun sizing up the subordinate tranches of the debt, specifically junior CMBS and unique rake bonds backed by Kerzner’s assets, said two traders and an asset manager already invested in the debt.

Brookfield Asset Management and CDOs managed by Guggenheim Asset Management have both been pegged as holders of various junior pieces of debt within the multi-tiered capital structure, according to the real estate investor, rating agency releases and the CMBS traders.

Kerzner continues to conform with performance covenants, but operating income dropped 15% in fiscal 2009 and the inexorable rise of Libor will tighten cash flows. The hotelier could look for refinancing in the fixed-rate market but its businesses can’t support the interest rate investors would demand, leaving its shareholders between a rock and a hard place, said a CMBS investor.

Blackstone’s private equity arm recently closed the benchmark liability management exercise for hotel-backed CMBS when it restructured USD 20bn of Hilton Hotels debt. The sponsor convinced investors in junior debt to swap for equity, financed a USD 800m recapitalization and extended USD 8bn of senior debt to 2015 from 2013 in exchange for improved economics.

Growing pains

Dubai World’s Istithmar, a 2005 Whitehall fund run by Goldman Sachs, and the Kerzner family led a consortium that took the public company private in 2006 for USD 3.8bn. With LIBOR trading at more than 5% at the time, Deutsche Bank and Credit Suisse underwrote loans to the buyout group and repackaged them into CMBS to feed the ravenous appetite for the asset class at the time.

The company’s crown jewel – Paradise Island in the Bahamas – was the principal functioning asset and bankers on the LBO valued the property at USD2bn, according to proxy documents at the time. Those same bankers claimed the public markets were undervaluing the company’s slew of glitzy new joint venture projects in the queue. JP Morgan projected USD 847m in EBITDA for new projects between 2007-2010, according to proxy documents.

On the eve of the buyout, Kerzner was poised to expand into Dubai, Morocco and the Philippines, via JVs. Because of this somewhat transitional profile, the LBO was well suited for floating rate debt that could be refinanced into fixed rate once cashflows were more stable, noted a rating agency official.

Now the company absolutely must refinance, but stable cashflows have yet to materialize.

Net operating income for FY09 was USD 171m, down from USD 206m in FY10, according to remittance reports and Realpoint. Net cash flow dropped USD 30m between 2008 and 2009 and occupancy slipped from 70% to 61%, according to servicing notes. Nevertheless, Kerzner’s debt service coverage ratio remains at a healthy 6.11x due to slimmer operating expenses, significant debt reduction and low LIBOR rates.

Three month LIBOR was quoted at 1.42% in January 2009 before crashing sub 1% in June of last year. Since October 2009, LIBOR has been pegged at around 0.25% until doubling in June to 0.53% today.

Minority shareholder The Baron Funds provides a glimpse into sponsor returns on the Kerzner investment to date. The mutual fund manager refused to sell out at the time of the LBO and held onto stub stakes in two of its funds. The investments were valued at USD 52m and USD 39m, respectively, in 2006 and Baron marked them at USD 20.8 and USD 15.6m in March.

Kerzner, Colony, Baron and Istithmar declined to comment. Brookfield, Guggenheim and Goldman Sachs did not return calls. Blackstone did not return calls

Raking it in

Thanks to the slice-and-dice nature of the market when Kerzner’s buyout took place, Blackstone must now deal with a fairly fragmented capital structure.

The consortium put in USD 1.5bn of equity while taking on USD2.7bn of mortgage debt broken into two pari passu senior pieces placed into CMBS deals and USD 1.35bn of junior B notes that stand outside the trust, according to SEC filings, deal prospectuses and data from Realpoint. The whole loan balance has been paid down to USD 1.3bn while the junior piece is USD 1.2bn, according to remittance reports and Realpoint.

The deal is complicated by the creation of USD 461m of so called rake bonds – a boom-market feature of the CMBS market that allowed borrowers to pile on the leverage. The bonds are attached to CMBS deals but “rake” cash flows from only one underlying asset rather than the entire pool. Though they are the first to take a loss, the rake bonds also have some control rights when the deal runs into trouble, noted the second CMBS trader.

The Kerzner mortgage is split between two CMBS structures – COMM 2006-FL12 and CSMC 2006-TFL2. The COMM deal includes USD 164m of rake bonds while the CSMC deal includes a USD 313m chunk related to rake bonds, according to the latest remittance reports.

Standard & Poor’s lowered its rating on all classes of the rake bonds in August 2009, with the lowest rated class dropped to CCC minus. The rakes have recently traded hands in the low 80s – despite the fact that they are technically “covered” as a part of the trust. The CMBS loans are backed by mortgage fees related to existing properties in addition to rights to proceeds from future joint ventures and properties under construction.

Finally, Kerzner’s capital structure also includes a USD 575m credit facility backed primarily by all non-Paradise Island assets. That includes cash flow from management contracts, gaming assets and equity interests in JVs and developments, according to a prospectus. The loan is thinly quoted at 59/61 by Credit Suisse and Deutsche Bank, down from 61/64 on 27 May, according to Markit.


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