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Red Rock Resorts’ deficient board diversity claims [updated]

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Updated: Red Rock Resorts Inc. disclosed a revised diversity policy on April 26, 2022. Based on those changes, Red Rock Resorts seems to make the goal of diversifying the Board even harder to reach. In the revised policy, Red Rock Resorts stated that, while it is open to recruiting diverse candidates, it would continue to evaluate the benefits of adding new Board members against the additional costs and impact on efficiency that may result from a larger Board—a consideration that it had not stated in its prior policy. See those revisions here and the 2022 policy here. We originally published the content below on January 31, 2022.

Red Rock is the only one of the nine publicly traded Nevada-based casino gaming companies with zero women on its board of directors. Its five-person board has been the same white men since its 2015 IPO and its justification to shareholders for its board composition relies on deficient claims.

See our letter to the SEC about Red Rock’s deficient board diversity claims here here.

In the Corporate Governance – Diversity section in its 2020 and 2021 proxy filings, Red Rock tells investors that it considers gender among its diversity characteristics and then explains that:

“Gaming regulatory agencies in certain of the jurisdictions in which we operate may require our directors to maintain licenses. The licensing process is onerous, invasive, time consuming and expensive. Because of this, it is difficult to identify well-qualified candidates willing to subject themselves, as well as their families, to the rigorous and intrusive process necessary to obtain a gaming license. As a result of the limited pool of potential directors and the strong qualifications of our present Board, we believe that the current composition of our Board is in the best interest of the Company. We remain continuously open to recruiting well-qualified diverse candidates to our Board.”

There isn’t a limited pool of potential directors for Nevada-based gaming companies

There are several indicators that suggest there is not a limited pool of potential directors for Nevada-based gaming companies. Every publicly traded Nevada-based casino gaming company except Red Rock has at least one woman serving as a director, amounting to 20 out of 76 directors, or 26%, with half of them joining these boards since 2018 [1].

Nationally, women now make up 30% of all directors in the S&P 500, which is up from 28% last year and 16% a decade ago. And in the Russell 3000 index, women of all races account for 27 percent of all directors, up from 24 percent.

The pool of female directors for Nevada casino gaming companies appears to be no smaller than national averages so it is concerning Red Rock justifies its board composition through the problematic idea that if only there were a larger pool of candidates then the Board might look different.

[CHART JANUARY 27, 2022]

A gaming license is not a justifiable obstacle to board diversity

Red Rock’s claims about board diversity also rely on the problematic assumption that the pool of potential directors is too small because of the gaming license process. The gaming license process is not a justifiable obstacle to board diversity, as evidenced by the presence of women on the boards of every publicly traded Nevada-based gaming company except Red Rock.

In fact, at least in Nevada, the licensing process should present no obstacle. Nevada gaming regulation 16.415 does not require licensing of every director of a publicly traded corporation, only of directors who are actively and directly engaged in the administration or supervision of gaming activities. The regulation identifies the board chair and chair of the audit committee as among the directors who must normally be licensed.

Meaning Red Rock can elevate directors to the Board without their undergoing the rigors of the licensing process where they do not require licensing.

Red Rock has an obligation to assess the effectiveness of its diversity policy

Red Rock shareholders deserve to know whether the Company’s diversity policy is effective or not. SEC rule 229.407(c)(2)(vi) states that “if the nominating committee (or the board) has a policy with regard to the consideration of diversity in identifying director nominees, describe how this policy is implemented, as well as how the nominating committee (or the board) assesses the effectiveness of its policy.”

So, what does Red Rock mean when it states in its diversity policy that “we remain continuously open to recruiting well-qualified diverse candidates to our Board”?

Red Rock’s three independent directors, Mr. Robert Cashell Jr., Mr. Robert Lewis, and Mr. James Nave, have been on the Red Rock board since its IPO, comprise the Nominating and Corporate Governance Committee, and were board members of Red Rock’s predecessor company since 2011.

What can the Company disclose to back up the claim that the recruitment of diverse candidates is active and ongoing?

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NOTE 1:

COMPANY DIRECTOR YEAR JOINED
Full House Resorts Inc. 1 Kathleen M. Marshall 2007
Golden Entertainment Inc. 2 Ann N. Dozier 2019
Monarch Casino & Resort Inc. 3 Yvette Landau 2010
Las Vegas Sands Corp. 4 Micheline Chau 2014
5 Nora M. Jordan 2021
6 Yibling Mao 2021
Caesars Entertainment Inc. 7 Bonnie Biumi 2020
8 Jan Jones Blackhurst 2019
9 Sandra Douglass Morgan 2021
Boyd Gaming Corp. 10 Marianne Boyd Johnson 1990
11 Christine J. Spadafor 2009
12 Veronica Wilson 2003
MGM Resorts International 13 Mary Chris Jammet 2014
14 Alexis M. Herman 2002
15 Rose McKinney-James 2005
16 Jan Swartz 2018
Wynn Resorts Ltd. 17 Betsy S. Atkins 2018
18 Patricia Mulroy 2015
19 Margaret J. “Dee Dee” Myers 2018
20 Winifred “Wendy” Webb 2018

Three Reasons to Eliminate Red Rock’s Dual-class Voting Structure

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Lagging Performance

Since Red Rock Resorts went public 5 years ago, its Class A share price has underperformed its peers and the market.

As of 5/26/21, RRR’s Class A shares have gained 116.61% over a 5-year period. Over the same timeframe, the share prices of other regional gaming operators Golden Entertainment, Inc. (GDEN), Boyd Gaming Corp. (BYD), Monarch Casino & Resort, Inc. (MCRI), and Penn National Gaming, Inc. (PENN) share prices went up 231.16%, 243.55%, 241.32%, and 463.43%, respectively. The NASDAQ also went up 180.27.91% over the same period.

Doing away with the dual-class share structure would be a good first step toward maximizing the value of Class A shares of Red Rock Resorts. In the words of a recent Wall Street analyst report: “RRR’s dual-class share structure is suboptimal for most investors and has historically been an impediment to valuation optimization.” (1)

An Entrenched Board

Two years ago, CalPERS raised the issue of board diversity with Red Rock. See Red Rock’s All-White, All-Male Board Draws Calpers’ Attention (Bloomberg, June 2019). At the time, Red Rock said “because the casino business requires an extensive licensing process for board members,” it is “difficult to find qualified candidates.”

Two years later, Red Rock continues to nominate the same five white men to its board and again blames the gaming licensing process for making it difficult to find diverse candidates in this year’s proxy. The company, however, fails to mention that other public-traded Nevada gaming companies have all somehow managed to seat women on their boards.

Doing away with the dual-class share structure is a smart step toward reforming an entrenched, all-white, all-male board at Red Rock Resorts.

Greater Transparency

Family office investments and share pledging by Red Rock’s controlling insiders raise questions about potential conflicts of interest.

Red Rock’s chairman and vice-chair, Frank and Lorenzo Fertitta, have dual roles at Fertitta Capital, their family office founded in 2017 that has overlapping business interests with Red Rock in gaming, sports, betting, leisure, wellness, and food and beverage.

In 2019, Fertitta Capital led a $17.5 million funding round for a sports betting media company, The Action Network.  It remains unclear if Red Rock’s board vetted the deal and whether the family firm receives opportunities owed to shareholders and now competes with Red Rock.

Also, Frank and Lorenzo Fertitta pledged six million or 13% of Class B shares in Red Rock in September 2018 for a margin loan worth up to an estimated $155 million from UBS AG, a bank that was a lender to Red Rock but stopped doing so. The loan pledges appear no longer to be in effect.

To date, Red Rock has not made any disclosures about Fertitta Capital, nor has it explained why UBS started lending to company insiders and stopped lending to the company.

Doing away with the dual-class share structure is a smart step toward transparency and fully protecting Red Rock from potential conflicts of interest.

(1) J.P. Morgan, “Red Rock Resorts: Takeaways from Investor Meetings. Story Still Has Legs. Reaffirm Overweight. PT to $48 (+$1),” North America Equity Research, p. 6 (May 14, 2021).

Who’s on the Hook for the Palms?

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Red Rock Resorts has set a big ROI target for its Palms Casino Resort. What started as a $312.5 million acquisition with $35 million of EBITDA expected in the first full year of RRR ownership, has now become a $1 billion project, with a capex budget that has increased to $690 million over the past year-and-a-half.

Can they get there?

Investors should ask management to set clear markers: who will be held accountable if the post-renovation Palms doesn’t generate the kind of ROI management has projected?

Read out report: Who’s on the Hook for the Palms?

Outside Shareholders Dissent at Red Rock Resorts’ Annual Meeting

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Outside shareholders of Red Rock Resorts demonstrated their dissatisfaction with the company’s directors at its July 6th meeting of stockholders, with the most opposition shown toward the independent directors.

Assuming all insiders voted their Class A and Class B shares in favor of management’s recommendation, then the total outside Class A shareholder vote “for” the directors was between 59% and 71%.[i] That means between 29% and 41% of outside shareholders did not vote “for” the company’s directors

Outside Class A Shareholder Support for Red Rock’s Directors

Director Outside Class A “For” Outside Class A “For” %
Frank J. Fertitta III 47,606,865 71%
Lorenzo Fertitta 46,912,406 70%
James E. Nave 40,389,581 60%
Robert E. Lewis 40,425,855 60%
Robert A. Cashell, Jr. 39,415,189 59%


Ernst & Young reports that only 3.8% of Russell 3000 directors received less than 80% support from all shareholders (combined inside and outside) in 2017 (YTD, 5/31/2017). Therefore, a significant number of Red Rock’s outside shareholders expressed discontent with the entire board.

Alternatively, we can look directly at the “withhold” vote. Commenting on a 2012 study commissioned by the Investor Responsibility Research Center Institute, GMI’s Ratings director of research Kimberly Gladman said: “The average level of withheld votes in a director’s election is 5 percent; companies should be concerned when the level in an election exceeds 10 percent.”

To measure shareholder dissatisfaction this way at the recent Red Rock meeting, we reduce the super voting shares held by insiders to a one share, one vote standard. This adjusted votes figure more accurately reflects the desires of all equity holders, not just the Fertitta insiders. If all shareholders of Red Rock had equal voting rights and assuming no Class B shareholders withheld their votes, then the vote results show between 9% and 16% of shareholders withheld from the company’s directors.

Adjusted Votes Withheld from Red Rock’s Directors

Director Adjusted Votes Withheld Adjusted Votes Withheld %
Frank J. Fertitta III 10,593,246 9%
Lorenzo Fertitta 11,287,705 10%
James E. Nave 17,810,530 15%
Robert E. Lewis 17,774,256 15%
Robert A. Cashell, Jr. 18,784,922 16%

Red Rock’s closing share price on July 5th (the day before the annual meeting) was down 3.1% year-to-date compared with NASDAQ Composite Index’s gain of 13.3%. As of May 8th, Class A shareholders held 58.4% of the equity but only controlled 12.9% of the vote.[ii]

Read the letter and report we sent to Red Rock’s public investors, criticizing the company’s independent directors for anti-shareholder corporate governance measures and related-party transactions and encouraging investors to withhold votes from its independent directors.

ISS recommended withholding on all of the company’s directors, which we fully supported.

See table below for how we calculated inside, outside, and adjusted votes.

Inside and Outside Votes

Share Class Number of Shares Votes
Class A Shares Outstanding 67,778,152 67,778,152
Insider Class A Shares 516,326 516,326
Outside Class A Shares 67,261,826 67,261,826
Class B Shares Outstanding 48,327,396 456,799,632
Insider Class B Shares (1 vote per share) 2,941,592 2,941,592
Insider Class B Shares (10 votes per share) 45,385,804 453,858,040
Class A + B Outstanding 116,105,548 524,577,784
*Number of adjusted votes equals the number of Class A + B outstanding

[i] At the July 6th annual meeting, Richard Haskins, President of Red Rock Resorts, said as of record date (May 8, 2017) there were 67,778,152 Class A shares outstanding, 48,327,396 Class B shares outstanding, and 45,385,804 Class B shares with 10 votes per share. These figures were used to calculate the number of Class B shares with one vote per share, the voting power and equity of each class, and to estimate the number of insider and outsider “for” votes. The number of insider Class A shares comes from Red Rock’s DEFR14A, filed on May 26, 2017, p. 47.

[ii] See note i

Should You Pay Someone Else’s Income Taxes?

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Would you like someone else to pay $40 million in income taxes for you? How would you like to pay some else’s income taxes with $40 million of cash?

Tax returns, or the lack thereof, have been in the news these past several months. While there are many ways people can manage their income tax obligations, one of the more interesting tactics appears to be what owners of Station Casinos LLC set up when they took it out of Chapter 11 bankruptcy in 2011. The company became party to a “tax distribution agreement” that requires cash payments to cover each LLC member’s share of the LLC’s income tax. That is, the LLC members get cash from the company to pay their share of the income tax bill based on the company’s profits.

This arrangement has persisted after Station Casinos became a subsidiary of Red Rock Resorts, Inc., which currently owns approximately 57% of the economic interest in Station Casinos. As described in Red Rock’s recently filed 10-K for the year 2016:

Tax Distributions

Station Holdco [which is partially owned by Red Rock Resorts and owns 100% of the economic interest in Station Casinos LLC] is treated as a pass-through partnership for income tax reporting purposes. Federal, state and local taxes resulting from the passthrough taxable income of Station Holdco are obligations of its members. Net profits and losses are generally allocated to the members of Station Holdco (including [Red Rock Resorts]) in accordance with the number of Holdco Units held by each member for tax reporting. The amended and restated operating agreement of Station Holdco provides for cash distributions to assist members (including [Red Rock Resorts]) in paying their income tax liabilities. 

None of this has been a secret. The term sheet for the company’s reorganization filed in bankruptcy court back in October, 2010, called for “the making of distributions to equityholders of amounts estimated to be necessary to pay taxes (including estimated taxes) on taxable income allocated to them by New Propco Holdco from time to time”. A “Holding Company Tax Distribution Agreement,” dated June 16, 2011, has been referenced in several of the company’s debt agreements going back to August, 2012, even though this tax distribution agreement itself was never publicly disclosed. During the Red Rock IPO last year, the LLC agreement of Station Holdco LLC filed with the SEC describes how the firm should fulfill its obligations to make these tax distributions in cash every quarter. In fact, over the year Station Casinos has taken to describing such payments to cover its owners’ income tax expenses simply as “customary tax distributions” in its public filings.

What has not been disclosed until now is how much Station Casinos has actually spent on these tax distributions. Thanks to Station Casinos’ most recent 10-K filing (separate from Red Rock Resorts’ 10-K filing), we now know how much in cash the company paid out to its owners for their LLC income tax bills in 2016.

During [the year ended December 31, 2016], cash distributions totaled $153.9 million, consisting of $142.8 million paid to members of Station Holdco and Fertitta Entertainment, of which $43.6 million represented tax distributions, and $11.1 million paid by MPM to its noncontrolling interest holders [emphasis added].

In other words, Station Casinos spent approximately 9% of the company’s adjusted EBITDA ($484 million), 12% of its cash flows from operations ($346 million), or 27% of its net income ($164 million) in 2016 to cover some of the federal income tax obligations of the Fertitta family and other owners.

Should Red Rock shareholders continue to let Station Casinos, of which they own 57%, spend cash on covering the income tax liabilities of pre-IPO owners like the Fertittas?

 

Fidelity Would Have Valued Station Casinos at $9.19 at the End of January

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If Fidelity bond funds valued Station Casinos at an estimated $9.19 per share at the end of January, what will Fidelity equity funds value the company at if they decide to participate in the upcoming Red Rock Resorts IPO?

As a result of Station Casinos’ Chapter 11 bankruptcy reorganization in 2011, Fidelity owns approximately 8.7% economic interest in the gaming company in the form of Station Holdco LLC units held by several of its bond funds. These funds disclose the value of their Station Holdco holdings regularly.

Most recently, 22,418,968 Hold LLC units in the Fidelity Capital and Income Fund (FAGIX) were given a value of $78.018 million as of 1/31/16 in a 3/30/16 N-Q filing.

Using the same methodology as before, we estimate that this implies a valuation of Station Casinos’ equity at approximately $1.06 billion, which would translate to about $9.19 per share based on the fully-diluted number of shares outstanding of Red Rock. That is, Fidelity would have valued Red Rock at $9.19 at the end of January.

What valuation will Fidelity give Red Rock if the mutual fund giant decides to participate in the IPO, which has an offering price range of $18 to $21 per share? Will Fidelity ask itself, internally, how Station Casinos could have doubled in value in less than three months?

Deutsche Bank Would Have Valued Red Rock at $5.39 Per Share a Year Ago

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Prospective investors in Red Rock Resorts should ask Deutsche Bank how, in its opinion, the value of Station Casinos could have more than tripled in little over a year.

According to a 2/17/15 analyst report by Deutsche Bank gaming high-yield analyst Andrew Zarnett, Station Casinos LLC, as of 12/31/2014, was estimated to have an enterprise value to be $2.59 billion, which would have implied an equity valuation of $624.6 million after subtracting net debt of $1.97 billion. That equity valuation would have translated to about $5.39 per share with the fully-diluted number of shares outstanding of 115.9 million found in Red Rock’s 4/15/16 S-1/A filing

Red Rock’s 4/15/16 S-1/A filing shows an IPO price range of $18.0 to $21.0 per share. Using the mid-point of $19.5 per share and the fully diluted shares outstanding figure of 115.85 million, the company and its underwriters, one of whom is Deutsche Bank, are offering an equity valuation of $2.26 billion and, adding net debt of $2.04 billion, an enterprise value of $4.30 billion for Station Casinos LLC.

Station Casinos Valuation Jump

12/31/14 4/15/16
Enterprise value $2,590 million $4,298 million
Net debt $1,965 million $2,039 million
Equity $625 million $2,259 million
Implied per share price on 115.85 million shares outstanding $5.29 $19.5

From 12/31/14 to 4/15/16, the share prices of four publicly-traded regional gaming operators (BYD, PENN, PNK, ISLE) rose by an average of 61%.

Investors should ask Deutsche Bank how, in its opinion, the value of Station Casinos could have more than tripled in little over a year.

(See also our earlier piece on the estimated valuation Station Casinos equity as implied by SEC filings by Fidelity, a current minority owner.)

Dividends on Your Second-Class Red Rock Shares? Don’t Count on It

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Red Rock Resorts says they “intend to pay quarterly cash dividends” to Class A shareholders “initially equal to $0.10 per share” starting in 3Q16. For an investor buying second-class shares in a company facing stagnant growth and market contraction, dividends are perhaps the only upside. But how likely is it that Red Rock will pay dividends at the promised level? Will it have enough free cash flow to pay dividends? We take a closer look.

Red Rock has a number of obligations that must be met before it can pay dividends to Class A shareholders. The first obligation stems from the indebtedness of Red Rock’s affiliate, Station Casinos LLC. According to Red Rock’s S-1/A filing on April 15, 2016:

The existing debt agreements of Station LLC limit the ability of Station LLC to make distributions to Station Holdco, which effectively restricts the ability of Station Holdco to distribute sufficient funds to permit Red Rock to pay dividends to its stockholders.

On a consolidated basis, Red Rock had total long-term debt of $2.16 billion as of December 31, 2015. The company estimates that in 2016, following the public offering, it will be required to pay $209 million in principal and interest payments on this indebtedness.

The company will also have to spend a significant amount of cash flow on maintenance capital expenditures every year. For 2016, Station Casinos expects to spend “approximately $100 million to $125 million” on capex. From 2013 to 2015, capital expenditures consisted “primarily of various renovation projects at our properties, information technology equipment purchases and slot machine purchases.”

After debt obligations and maintenance capex, Station Casinos or its direct parent Station Holdco can make distributions to its members. We remind you again that Red Rock will have only one-third economic interest in Station Casinos, so any distributions upstream made will primarily go to pre-IPO owners who stay on after the IPO. And these LLC distributions will include payments to cover LLC members’ income taxes.

In addition, after Red Rock receives its one-third distributions from Station Casinos, it is required to make payments under the tax receivable agreement (TRA) to pre-IPO owners equal to 85% of its tax benefits. The company estimates it will owe a maximum aggregate payment of $28.1 to $59.0 million under the TRA, although we have seen how TRA liabilities can dramatically increase after an IPO.

For some historical perspective, let’s take a look at Station Casinos’ dividends the last time it was a public company. The following table compares Station Casinos’ historic dividends with Red Rock’s proposed dividends.

Station Casinos, Inc. Dividends vs. Red Rock Resorts Proposed Dividends

Year Annual Dividends Prior Year EBITDA

(millions)

 Total Dividend Payments (millions) Total Dividend Payments/Prior Year EBITDA
2004 $0.69 295.2 $44.3 15.0%
2005 $0.92 385.4 $62.6 16.2%
2006 $1.08 480.9 $65.4 13.6%
Red Rock (proposed) $0.40 $451.4 (2015) $15.4 3.4%

*Station Casinos paid no dividends from 1993-2002 and only two quarterly dividends in 2003.

Red Rock’s proposed 10 cent quarterly dividend at the midpoint of its pricing range ($19.50) equates to around a 2% dividend yield. For those looking for a dividend play, there are plenty of companies with higher dividend yields. Furthermore, Red Rock’s dividend as a percentage of EBITDA is significantly lower than what Station Casinos used to pay out before. Red Rock’s proposed dividend is only 3.4% of 2015 EBITDA, whereas Station Casinos paid an average 15.0% of prior-year EBITDA in dividends from 2004 to 2006.

With questionable prospects for growth and poor corporate governance, investors in the Red Rock IPO might want to look to dividends for a reason to invest in Red Rock. But, as a result of its other obligations, there is no certainty the company will be able to pay dividends at a level that satisfies public shareholders.

Red Rock Resorts is a Second-Class Gaming IPO

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Download our unauthorized roadshow presentation and presentation notes here.

Investors who buy Red Rock’s second-class shares on offer will gain a minority (33%) stake in the once-bankrupt Las Vegas casino and tavern operator, Station Casinos. The terms of the offering beg questions about company insiders’ confidence in its long-term prospects.

Prospective investors should ask management the following questions:

Should new shareholders expect significant dilution soon after the IPO thanks to Deutsche Bank’s expected exit? After the IPO, Deutsche Bank owns 16.2-18% of the company after selling very few shares in the current offering. The German lender, which is also an underwriter of this IPO, has been selling off its non-core assets at a loss, including a Las Vegas Strip resort and a New Jersey port operator as it continues to deal with its capital and regulatory challenges. Will it sell off its large Station Casinos/Red Rock stake immediately after the 180-day lock-up period, which may even be waived by Deutsche Bank and J.P. Morgan as underwriters?

Why is Red Rock paying $460 million in cash to insiders to internalize management with the Fertitta Entertainment acquisition? Red Rock’s prospectus does not present any specific potential benefits of this proposed transaction, yet the price represents (1) 20% of the $2.3-billion IPO valuation of Station Casinos’ equity at the mid-point of its offering price range; (2) 8.7x TTM management fees instead of the 1x TTM management fees for a potential termination of the Fertitta Entertainment management agreements covering at least 13 of 19 casinos; and (3) 31x our estimate of Fertitta Entertainment’s 2015 pro forma EBITDA of about $14.8 million. Even though it did not complete a $300-million dividend recapitalization last spring, Station Casinos has paid out over $477 million to its existing owners from 2013 through April 2016, before consummating this pricy acquisition.

How confident is management in Red Rock’s growth prospects? The Las Vegas locals market, which made up over 90% of Red Rock’s total EBITDA in 2015, has been contracting in terms of total amount wagered and number of slot units, and gaming revenue at the company’s Las Vegas operations grew at an annual compounded rate of only 1.4% from 2012 to 2015. The company has even listed hard-to-come-by potential casino sites in Nevada for sale. As for its tribal business, the company has not signed any new tribal gaming development or management agreements since 2004. Its two current contracts are due to expire in 2018 and 2020, with only one more project in development.

If the Fertitta family is cashing out, why should investors buy Red Rock’s second-class shares with uncertain prospects for dividends? The Fertitta family’s Class B Red Rock shares with 10:1 voting power make the Class A Red Rock shares second-class shares in more ways than one. Furthermore, a lopsided tax receivable agreement without a hard cap on future payments to pre-IPO owners will lead to uncertainty about Red Rock’s future free cash flow and its ability to pay dividends to Red Rock’s second-class shareholders.

It is alarming that potential investors in Red Rock’s second-class IPO are being asked to buy out an insider management company at a high, $460-million valuation, instead of paying down company debt or funding new growth initiatives. Data on the ground in Las Vegas show tepid growth in Red Rock’s core business, underscoring the contrast between an IPO that strengthens a gaming company’s finances and one that drains funds to buy a related-party management company, like Red Rock.

See more of our analysis of the Red Rock Resorts/Station Casinos IPO:

 

 

Questions about the Audited Financial Statements of Red Rock Resorts

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Last week, we wrote to the SEC with questions concerning the audited financial statements of Red Rock Resorts. In our letter, we ask two specific questions:

  1. Did Fertitta Entertainment, which will be acquired by Red Rock for $460 million, provide audited financial statements with an unqualified opinion by its auditor – also Ernst & Young – after it agreed to be acquired by Red Rock?
  2. If Fertitta Entertainment did not provide audited financial statements, how did Ernst & Young handle the inclusion of Fertitta Entertainment when it produced the audited consolidated financial statements of the Station Holdco holding company?

Our questions were based on this disclosure from the Fertitta Entertainment purchase agreement:

With respect to [Fertitta Entertainment LLC’s] consolidated financial statements for the years ended December 31, 2012, 2013 and 2014 and for the six months ended June 30, 2015, the Company did not record share-based compensation expense associated with equity incentives issued to current and former executives of the Company from FI Station Investor LLC.  FI Station Investor LLC is an entity that is owned by the parent entities of the Company.  Pursuant to GAAP, this non-cash share-based compensation is required to be recorded as a component of the Company’s statement of operations since these executives were employees of the Company and FI Station Investor LLC is a common-controlled entity of the Company’s equity holders.  The Company’s auditor, Ernst & Young LLP, has determined that each of the foregoing financial statements would require to be restated and has withdrawn its opinions for each audit period that are dated March 25, 2015, May 14, 2014, April 16, 2013 and May 15, 2012, respectively.

This disclosure makes one question how the unnamed financial advisor to the special committee of Red Rock was able to provide a fairness opinion on the Fertitta Entertainment acquisition, if the target company’s auditor had withdrawn its opinion on its financial statements.

It is possible that, since last October, when the purchase agreement was signed and the above disclosure was made, Fertitta Entertainment restated its financial statements for the named periods and Ernst & Young has since audited and provide an unqualified opinion on its restated financial statements. But if that is what has transpired and new financial statements acceptable to the auditors are available now from Fertitta Entertainment, should the $460-million agreement signed last October be revisited to ensure the deal is still fair to Station Casinos and its current and future investors?

See our full letter to the SEC here.

See more of our analysis of the Red Rock Resorts/Station Casinos IPO: