By Colin Barr
June 4, 2010

The hedge fund manager is turning a distressed bond bet into a big stake in Harrah’s.

John Paulson, the hedge fund manager who became a billionaire by betting on the subprime bust, took a 9.9% stake Friday in Harrah’s, the casino operator that has been staggering under massive debts incurred two years ago in a private equity buyout.

Under the agreement, Harrah’s will sell new debt at a 33% discount to Paulson (right) and the Las Vegas-based company’s owners, Apollo and TPG. Paulson will then swap $710 million of existing debt for a voting equity stake in the company.

Harrah’s said it will raise $557 million all told in the deal. It will register Paulson’s stock with the Securities and Exchange Commission so he may sell it.

Harrah’s chief Gary Loveman said the agreement will give the company, which has been straining under its $22.5 billion debt load, another chance to slim down its balance sheet. Harrah’s lost $195 million in the first quarter, as interest expense hit $492 million.

The company has spent this year swapping existing bonds for newer ones that mature further in the future, easing its finances and sending the value of its bonds up from the doldrums. The new agreement will mean the company has no major debt due till 2015.

“The investment from Paulson, an independent third party and a large sophisticated investor, reflects the strong and resilient performance of our company, particularly as we emerge from a difficult economic climate, and the encouraging prospects for our future,” Loveman said.

The deal comes just two weeks after Paulson’s latest regulatory filing revealed he has built large stakes in two other casino companies, MGM Mirage

 and Boyd Gaming

.

News of Paulson’s purchase initially sent casino stocks higher on May 18, the day after the filing was made. MGM and Boyd have since given up those gains, as fears about the longevity of the global economic recovery have weighed on stocks and chased money into Treasury bonds.

But Friday’s news says Paulson, who has been betting on a recovery via the big bank stocks for the past year, believes buying casinos will pay off as well.

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