Colony Capital LLC plans to apply its familiar strategy — buying properties, upgrading and selling them — to the purchase of four casinos from Harrah's Entertainment and Caesars Entertainment in a deal valued at $1.24 billion.

The Los Angeles-based real estate investment firm, founded in 1991, began investing in casinos in 1999. “It fits the Colony profile of investing mostly in operating businesses that have real estate as a major component,” says Owen Blicksilver, spokesperson for Colony. “The gaming industry also has strong, stable cash flows.”

To date, Colony has invested more than $10.5 billion in over 7,500 assets, including casinos, banks, storage facilities and exclusive hotels.

The gaming acquisition includes one Chicago-area casino in northwest Indiana, two in Tunica, Miss., and the Atlantic City Hilton. Blicksilver says the properties need only some cosmetic changes to the casino floors, entranceways and some hotel rooms.

Equally important are the operational improvements. “It's not just the appearance, but it's also the promotion, marketing and customer service that will attract patrons to the facility,” Blicksilver says.

This approach has proved profitable. Colony bought Harveys Casino Resorts in Lake Tahoe in February 1999 for $405 million, including debt. Colony sold it in 2001 for $625 million after adding capital and new on-site management.

Without the quarterly earnings pressure of Wall Street, the firm has more flexibility to execute its improvements. Late last year, Colony also bought the Las Vegas Hilton for $280 million with plans to build on its unused land and make renovations.

The recent purchase, announced in September, will be financed mostly by debt and some investor fund equity. The sale price is 8.5 times the trailing 12-month cash flow of the four properties, which is higher than the industry average of 7.5 times or 8 times. However, Colony sees much upside potential.

“There's still tremendous growth in gaming,” Blicksilver says. “There's potential to create flagship Hilton brands in Atlantic City and Las Vegas, and there's value in having a portfolio of gaming properties, which makes it a strong buy.”

For Harrah's and Caesars, the sale helps reduce debt and ease anti-trust issues. “Analysts said we would only get 5 times [the trailing 12-month EBITDA], because they considered these assets ‘forced sales,’” says Gary Thompson, spokesperson for Harrah's. Both entities needed to shed assets in certain markets. If not, Harrah's would have had more gaming operations than regulators allow in Indiana, Tunica and Atlantic City following its merger with Caesars, which will be finalized in 2005.

Gaming analyst Joseph Greff of New York-based Fulcrum Global Partners also sees the potential value of the four assets. He notes one exit strategy for Colony would be to increase the operations' cash flow and then take the properties to the public markets. Colony did just that with its investment in Punch Taverns, a firm that now owns over 8,300 pubs in the U.K. and is listed on the London Stock Exchange.

More private equity investors are considering gaming following the summer announcements of Harrah's acquisition of Caesars and MGM Mirage's purchase of Mandalay Resort Group, Greff says. “With the consolidation of the industry from the big four to the big two, there's potential for displaced gaming executives to join up with the private equity firms, making it easier for these firms to enter the casino business.”

For now, Colony is one of the few investment firms with a gaming license. In addition to Colony's ability to move quickly, Blicksilver says, casino operators find the firm a favorable buyer because “they're not selling to an operator who is a direct competitor.”