Red Rock Resorts’ deficient board diversity claims [updated 7.28.22]

Update 7.28.22: Red Rock Resorts Inc. disclosed a revised diversity policy on April 26, 2022. Based on those changes, Red Rock Resorts removed its commitment to being open to recruiting well-qualified diverse candidates. 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?

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

Questions about “Durango Station”

Back in 2007, Station Casinos received approvals from Clark County to build a 120,000-square-foot casino with 1,000 hotel rooms on its 71-acre property in southwest Las Vegas. The project had a $700 million budget and was to open in 2010 with a projected EBITDA of $110.1 million by 2012.[1] Then in 2008, the company reduced the size of the project, with new approvals for an 86,883-square-foot casino with 726 hotel rooms, plus 8 retail buildings totaling 139,071 square feet. The company received a fourth extension of time for this project in October, 2018, with a deadline to commence by September 3 this year.[2] On May 4, the company said it was looking to redesign the project to be “significantly tighter than anything that we’ve done in the past”, with “a focus on slot machines and table games, our primary business.”[3]

We believe investors should pose the following questions about the “Durango Station” project to management:

  1. Is there market demand for another Las Vegas Locals casino? While total slot handle in the Las Vegas Locals market reached a record of $41.1 billion in 2006, it had dropped to $35.1 billion in 2019. This happened in spite of the fact that Clark County’s population grew from 1.78 million in 2006 to 2.29 million in 2019.[4] Corresponding to this decline in local residents’ spending on slot machines, the number of slot machines in the market had been reduced from 52,947 at the end of 2006 to 44,696 at the end of 2019 and stood at 34,799 at the end of May, 2021. Station Casinos itself has yet to reopen four of its ten major properties after Nevada casinos were allowed to reopen more than a year ago (and is in fact selling one of them, the Palms). Will Durango Station be able to grow the Las Vegas Locals market given the long-term market-wide decline in slot handle?
  2. How many “Durango Station” customers will come from Red Rock Casino? Looking specifically at the area around the Durango site, we see that Station Casinos’ Red Rock Casino is 9 miles north. The 10-minute drive from the neighborhood around the Durango site to Red Rock is not a long distance to travel in Las Vegas. Given its player rewards program, the company likely has detailed data on where its regular Red Rock customers live. How many “Durango Station” customers then does management expect to be new customers instead of customer who will merely shift their business from Red Rock to the new property?
  3. How will “Durango Station” compete against nearby mixed-use developments? Again, looking at the Durango site, we see that, across the street from the Durango site, construction has already started on the $400-million UnCommons mixed-use project,[5] which is slated to open in early 2022,[6] at about the same time Station Casinos plans to start its own project.[7] UnCommons will have 20 vendors in a food hall, [8] including a celebrity chef’s new restaurant.[9] Less than a mile north of the Durango Station site, another mixed-use development called The Bend also broke ground in January, 2020, which will have 170,000 square feet of retail space, including a movie theater.[10] How will these large mixed-use projects nearby change the economics of the Durango Station project?
  4. What will happen to the Flamingo/I-215 site after “Durango Station”? One of Station Casinos’ future casino development sites in Las Vegas is the 58-acre Flamingo/I-215 parcel, which is located about halfway between Red Rock and the Durango site. After “Durango Station” opens, will the Flamingo site continue to be considered a future casino development site, or will the company seek to monetize some other way?

Check out our map of key properties and sites in the Las Vegas Locals market here.

Notes:

[1] See “Report of Investigation by the Special Litigation Committee of the Board of Directors of Station Casinos, Inc.”, filed as docket 353-3 in the Chapter 11 case of Station Casinos, Inc., case 09-52477-gwz in the U.S. Bankruptcy Court, District of Nevada. The merger proxy contains the project cost, and the attached Odyssey Capital Group’s Report to the Special Committee to the Board of Directors of Station Casinos, Inc., September 9, 2009 shows the projected EBITDA in “Valuation of short-term Development Assets” (by Bear Stearns Presentation to Station Casinos Special Committee on February 22, 2007).

[2] 10/17/2018 Clark County Zoning Commission meeting, agenda item #25, ET-18-400190 (UC-0726-08) by NP Durango, LLC. http://clark.granicus.com/MinutesViewer.php?view_id=17&clip_id=6025.

[3] Red Rock Resorts 1Q21 quarterly call on 5/4/2021, transcript by Seeking Alpha.

[4] Based on Nevada Gaming Control Board data.

[5] https://www.reviewjournal.com/business/developer-of-400m-las-vegas-complex-lands-new-tenant-2404247/

[6] https://www.naiop.org/Research-and-Publications/Magazine/2021/Summer-2021/Development-Ownership/New-Noteworthy

[7] Red Rock Resorts 1Q21 quarterly call on 5/4/2021, transcript by Seeking Alpha.

[8] https://www.reviewjournal.com/business/400m-development-project-taking-shape-in-southwest-las-vegas-2317761/

[9] https://www.reviewjournal.com/entertainment/food/celebrity-chef-michael-mina-to-head-off-strip-at-uncommons-2375335/

[10] https://www.reviewjournal.com/local/local-las-vegas/work-begins-on-the-bend-retail-complex-in-southwest-las-vegas-1947323/

Red Rock Resorts Public Shareholders Vote for Change

Submitted by the New York State Common Retirement Fund and co-filed by SEIU Pension Plans Master Trust, Proposal 4 at Red Rock Resorts’ most recent annual meeting asked the board of directors to take steps to eliminate the company’s dual-class share structure. We argued that there were good reasons to support the proposal. Now, despite the proposal’s defeat, we assess that approximately 87% of the publically-held (non-insider) shares that were voted were cast in favor of it.

From the April 22 proxy filing, we estimate that the company’s named executive officers and directors, including controlling owners Frank and Lorenzo Fertitta, had approximately 464.4 million votes thanks to the fact that each of the approximately 45.4 million B shares owned by the Fertittas was entitled to 10 votes. Assuming all the insiders voted against Proposal 4, approximately 6.7 million votes controlled by public holders were cast against the proposal, while more than 43.7 million votes were cast for it. (See the official tally here.) This means that 86.7% of the publically-held shares that were voted were cast in support of the proposal to change and improve the company’s corporate governance.

Proposal 4 Voting Results by Publically-Held Shares

Votes Percentages
FOR 43,758,349 86.7%
AGAINST 7,309,136 13.3%

This is the second time in three years public shareholders of Red Rock Resorts have voted to support a shareholder proposal to improve corporate governance. In 2019, CalPERS submitted a proposal to adopt majority voting for director elections (“Red Rock’s All-White, All-Male Board Draws Calpers’ Attention”, Bloomberg, 6/5/2019). We calculate that CalPERS’ proposal was supported by approximately 83.3% of the publically-held shares that were voted. Nevertheless, the company has not changed its plurality voting standard for director elections.

While Red Rock Resorts traces its history to the founding of Bingo Palace (which later became Palace Station), it cannot hold on to an anachronistic view of itself as a family business and continue to deny public investors a fair say in corporate governance. Red Rock Resorts can do better, and public shareholders of Red Rock Resorts deserve better. It should listen to public shareholders and adopt majority voting for directors and take steps to eliminate the dual-class share structure.

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

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).

Why did UBS start lending to Fertittas and stop lending to Red Rock? [updated 4.28.21]

Note: On 3/10/21, we published the following update: “Since publishing this article on February 8, 2021, we discovered the financing statement for the UBS loan to the Fertittas was terminated on March 23, 2020. Notwithstanding, the pledge and margin loan were still identified as in effect in Red Rock’s April 22, 2020 Form DEF 14A.” Now we can report that there is no pledge and margin loan identified as in effect in Red Rock’s April 22, 2021 Form DEF 14A. We have updated the report to reflect this new information. 4/28/2021.

The controlling owners of Red Rock Resorts Inc. (NASDAQ: RRR), Frank Fertitta III and Lorenzo Fertitta, pledged six million or 13% of Class B Red Rock shares to UBS AG in September 2018 for a margin loan worth up to an estimated $155 million.

In February 2019, Red Rock disclosed the termination of a $50 million UBS commitment that had been identified as in effect in its Form 10-Q for the quarter ending September 30, 2017.  In February 2020, it disclosed the termination of an $18.5 million commitment that had been identified as in effect in an amended credit agreement dated February 8, 2019.

On March 23, 2020, the financing statement for the UBS loan to the Fertittas was terminated. But the pledge and the margin loan were identified as in effect in Red Rock’s April 22, 2020 Form DEF 14A. No pledge and margin loan are identified as in effect in Red Rock’s April 22, 2021 Form DEF 14A.

Why did UBS end up by lending to the Fertittas personally but not to the public-traded company they controlled? And what caused the Fertittas to take on the margin loan in the first place? Why did UBS terminate the financing statement for the margin loan on March 23, 2020?

[See our letter to the SEC and Nasdaq requesting a closer look at pledged shares at Red Rock here.]

Red Rock has not explained what prompted the changed relationship with UBS. And why the Fertittas secured liquidity through a margin loan is also of potential interest to public shareholders given the Fertitta’s control of Red Rock.

On one hand there appears to be cash, lots of it. The Fertittas reportedly cleared $870 million each in the 2016 sale of the Ultimate Fighting Championship, and in August 2020 spent $74 million to purchase five million Red Rock shares (see here, here, here, here and here).

On the other hand, they have borrowed money—$64 million from a related party to buy Red Rock shares in August 2019—and, between one or the other of them, they have acquired a number of luxury assets:  two superyachts, a support yacht, and a penthouse near Manhattan’s Central Park.

Two Fertitta yachts have been delivered since 2018, with a third delivered in 2021: the 285-foot Lonian ($160 million estimated); the 217-foot Hodor support yacht ($55 million estimated); and the 308-foot Viva ($175 million estimated).

Two helicopters share the initials of Frank and Lorenzo Fertitta and the Las Vegas area code (N702FF, N702LF) and are owned by entities that share the superyacht names (Viva Eagle LLC, Lonian Raven LLC).

Hodor Holdings Limited is named as a secured party in an August 2017 financing statement related to the construction of an “equipped submersible” by Seamagine Hydroscape Corporation. Hodor Holdings, Ltd.’s address is identified as the same Las Vegas address as Fertittas Enterprises, Inc.

UBS promotes its securities-backed loans as useful for purchasing yachts, among other things.  But as it stands, Red Rock investors have no basis to know what the loan proceeds were used for.

Red Rock’s securities pledging policy, a summary of which was first disclosed in April 2020, does not appear to cap pledging even though it requires certain insiders to “pre-clear” transactions in company securities.

Moreover, it is not clear which persons would review and approve such “pre-clearances.” And Red Rock has not disclosed whether the 2018 margin loan transaction was subject to the current policy.

Investors are in the dark about the details of pledged shares at Red Rock. They deserve sufficient information to decide whether such pledges benefit the company.

New Costs to Pressure Margins at Station Casinos

In December, Station Casinos announced a company-wide new benefits package, immediately after the National Labor Relations Board (NLRB) announced there was going to be a union election at the company’s flagship Red Rock Casino. We estimate the new benefits would add nearly $70 million in operating costs on an annual basis, or a 400-bps hit to the EBITDA margin at the company’s Las Vegas operations, which had a 25.9% margin in 2019 ($454.8 million in adjusted EBITDA over $1.76 billion in net revenues).[1] Our estimate includes only the costs of the new free HMO plan with family coverage and no deductibles and a new 401(k) program with direct employer contributions (see Appendix 2).

Station Casinos took on these higher costs even as it continues to lose operational flexibility with respect to labor cost as a result of a series of union elections since 2016. Employees have voted – sometimes overwhelmingly – to unionize through NLRB elections (for example, 67% for the Culinary and Bartenders Unions at Boulder Station, 78% at Green Valley Ranch, 82% at Sunset Station, 83% at the Palms, and 85% at Fiesta Rancho), and the company – the operating subsidiary of Red Rock Resorts, Inc. – is now legally required to collectively bargain over working conditions, including benefits, at its casino hotels where unions are negotiating for a contract. Local affiliates of Operating Engineers and Teamsters have also won union elections at various Station properties, creating legal bargaining obligations for the employer. The company cannot unilaterally take away the new benefits it now provides where it has an obligation to bargain. And it is hard to see management try to reduce benefits only at non-unionized properties without creating significant issues among the workforce.

In the past, Station Casinos was able to take away or change benefits at will. For example, between 2008 and 2016, the annual employee premium for the company’s HMO plan went from zero to $420 for individual coverage and from $1,080 to $3,000 for family coverage. It also “suspended” its 401(k) matching contributions in December, 2008, and didn’t restore the match until 2012.[2] Station Casinos cannot make such unilateral changes anymore at its unionized properties without negotiating with the representative union. The new benefits and their higher costs can therefore become more or less locked in even without a settled union contract.

It is also worth noting that Station Casinos has been an outlier in the Las Vegas gaming industry in not participating in the cost-effective multi-employer union health plan of the Culinary and Bartenders Unions, which provides a premium-free, no-deductible PPO family coverage plan. Healthcare costs are rising fast for Station Casinos, even before the most recent improvement in benefits (expanded no-premium family coverage no more deductible for its HMO). Other large casino operators in Las Vegas (including MGM, Caesars, Wynn, Boyd Gaming, Penn National, Golden Entertainment) have seen more modest increases in what they pay to provide good healthcare for their unionized employees under the multi-employer union health plan. Station Casinos’ own health insurance plan cost, on a per covered person basis, increased by 37.5% from 2013 to 2018.[3] In contrast, the required employer contribution rate for the union health plan only increased by 10% over the same period.

Station Casinos investors should ask management why the company would rather unilaterally raise labor costs instead of agreeing to participate through a collective bargaining agreement in the cost-effective multi-employer union health plan and other union benefit plans. After all, it is not management’s own money that is going out of the company’s coffers to pay for these escalating costs.

 

Appendix 1: The new benefits package at Station Casinos

  • Starting in January this year, employees making less than $41,600 in annual salary or $20.00 per hour will be eligible for a premium-free HMO health plan, even with family coverage. Previously, an employee would have to pay $780 a year to get family coverage on the company’s HMO plan.
  • Also, the company eliminated deductibles for employees enrolled in its HMO plan. Previously, the company’s HMO plan had a $500 annual deductible for those with individual coverage and $1,000 deductible for those with family coverage.
  • The company will open three on-site “medical centers” at Red Rock Casino, Sunset Station, and Texas Station or Santa Fe Station. These centers will provide “free medical provider visits”, “free generic drugs”, “free lab work”, and fast appointments”. The Culinary Health Fund – the multi-employer health plan for Culinary and Bartenders union members and their families – had opened its own health center in 2017 at a cost of $30 million.
  • Station Casinos also now offers a “unique and expanded” 401(k) plan. For those with 1 to 24 years of service, the company will contribute $0.50 per hour worked into their 401(k) accounts. For those with 25 years or more of years of service, the company will contribute $1.00 per hour worked. It is not clear how this new scheme of nonelective contributions[4] will work alongside the company’s “traditional” 401(k) plan, which provides for a matching contribution of 50% of the first 4% of a participant’s own contributions.
  • The company also announced “new training programs”, “Team Member recognition program”, “fast hiring”, and a new attendance policy.

Appendix 2: The cost of the new benefits package at Stations Casinos

In 2018, Station Casinos paid $62.7 million for its HMO and PPO contract with its health insurance provider. The cost would have likely increased for 2020 even if the company had made no changes. With the changes:

  • No premiums for HMO family coverage: We estimate about 40% of the workforce would choose to enroll in the free HMO with family coverage and about 17% of the workforce would choose free HMO with individual coverage. Based on Kaiser Family Foundation data, the average annual premium cost of an employer-sponsor health plan was $18,357 for family coverage and $6,032 for individual coverage in 2018. We estimate Station Casinos would pay at least $112.2 million in annual premiums for its new HMO plan.
  • No deductible: The company HMO plan had a $500 annual deductible for individual coverage and $1,000 for family coverage. If the company pays these on behalf of the participants, the total would be approximately $6.7 million.
  • We therefore estimated the cost of the new HMO plan to be about $118.9 million, or $56.3 million more than the 2018 cost of $62.7 million.

The employer contributions under the new 401(k) program can be estimated as follows:

  • We estimate that 90% of the workforce of 14,000 have more than 1 and fewer than 25 years of service and will receive $0.50 per hour worked under the new 401(k) program.
  • We estimate that 5% of the workforce have more than 25 years of service and will receive $1.00 per hour worked under the new 401(k) program.
  • We estimate the average number of hours worked in a year to be about 1,900. This means that the company will make about $13.3 million of new contributions a year to employees’ 401(k) accounts.

Putting the two benefits together, we therefore estimate these two new benefits alone would add approximately $69.6 million to Station Casinos’ annual payroll.

We do not have a good way to estimate the additional cost of the three new on-site medical centers or the new training and hiring initiatives announced in December.


[1] 2019 10-K, filed 2/21/2020.

[2] https://www.reviewjournal.com/news/station-casinos-suspends-matching-contributions-for-employees-retirement-plans/

[3] See the 5500 filings by Station Casinos LLC Employee Benefit Plan. In 2013, it paid $45,468,966 to cover approximately 18,407 person through its HMO-PPO-prescription drug contract with Health Plan of Nevada. In 2018, it paid $62,651,752 to cover approximately 18,440.

[4] https://www.investopedia.com/terms/n/non-electivecontribution.asp

Red Rock Resorts Silent on Sports Betting

Red Rock Resorts has not made any significant moves to bolster its position in sports betting following the overturn of the Professional and Amateur Sports Protection Act (PASPA) in May 2018. Public investors in Red Rock Resorts should ask: Does management at Red Rock Resorts have plans to pursue sports betting or other gaming opportunities outside of Nevada? If not, why not?

Read our new report, “Red Rock Resorts Silent on Sports Betting“. 

Estimates about the potential size of a mature, national U.S. sports betting market vary from $67 billion to $287 billion in annual wagers.[1],[2] Legal sports betting in the U.S. has amounted to $763 million of gaming win over the last twelve months.[3] Over half of the gaming win in the last twelve months ($430 million) was generated outside of Nevada.

Other gaming companies acted quickly by partnering with sports leagues and teams, betting and data firms, and even with competitors in order to build strong foundations for emergent sports betting markets.

Frank and Lorenzo Fertitta reportedly led a $17.5 million investment round in The Action Network via their family office, Fertitta Capital, in February 2019.[4] Fertitta’s investment in The Action Network not only presents a potential conflict of interest to Red Rock Resorts public shareholders, but also a potential risk.

Read our new report here.

Notes

[1] $67 billion estimate. Jay L. Zagorsky, “Opinion: The U.S. market for sports betting is far smaller than the $150 billion proponents claim,” MarketWatch, May 15, 2018, https://www.marketwatch.com/story/the-us-market-for-sports-betting-is-nowhere-close-to-150-billion-no-matter-what-proponents-say-2018-05-15.

[2] $287 billion estimate. Oxford Economics, “Economic Impact of Legalized Sports Betting,” American Gaming Association, May 2017, p. 5, https://www.americangaming.org/wp-content/uploads/2018/12/AGA-Oxford-Sports-Betting-Economic-Impact-Report1-1.pdf.

[3] Last twelve months refers to November 2018 through October 2019. Gaming win data come from state government gaming agencies or lotteries.

[4] Action Network Staff, “The Action Network Completes $17.5 Million Series B Financing Round Led by Fertitta Capital,” The Action Network, press release, February 21, 2019, https://www.actionnetwork.com/press/action-network-funding-series-b-fertitta-capital.

Amidst chaos at Palms, Fertittas’ UBS margin loan collateral fell 38%

The now-closed KAOS day/nightclub at Palms was canceling shows the same month shares in Palms’ parent company Red Rock Resorts hit their lowest since the company’s IPO. When in that same month Red Rock controlling owners Frank and Lorenzo Fertitta borrowed $64 million from a related party to fund the purchase of 3.4 million Class A shares in the company (see here, here and here), some claimed the purchases were a show of confidence in the company.

But that is not all that happened in August.

Almost a year prior to these transactions, Frank and Lorenzo Fertitta pledged 6 million Class B shares in Red Rock to secure a margin loan from UBS AG in September 2018 (see UCC here). We estimate the loan was up to $155 million, assuming the ability to borrow 95% of the pledged share value and that the Class B shares were valued the same as Class A shares.

At the time of loan’s filing on September 27, 2018, RRR’s Class A shares traded at about $27.21. When the company’s stock price dropped to $16.76 per share on August 7 this year, the value of the Fertittas’ Class B share collateral for the margin loan would have lost over 38% of its value.

While RRR has not disclosed why the Fertittas needed the UBS margin loan in the fall last year, UBS promotes its securities-backed loans as useful for purchasing yachts, among other things.

Since the UBS loan to the Fertittas, two of the three new Fertitta yachts have launched. Lorenzo Fertitta’s 285-foot Lonian (estimated cost of $160 million) was ready to launch one month prior to the UBS loan, the 216-foot “crazy custom catamaran” Hodor launched in February, 2019, and the 308-foot Viva (Feadship project 817) is scheduled to launch for 2020.

How much has Palms cost Red Rock Resorts shareholders?

The simple cost of Palms to Red Rock Resorts so far is well known: the company paid $312.5 million to buy the casino in May, 2016, and by the end of September this year had completed a $690 million project to “fully reimagine and repurpose the property.”[i] In spite of the billion-dollar overall capex, management disclosed on the third-quarter conference call that Palms has not generated significant incremental EBITDA. The property’s 3Q19 adjusted EBITDA was either negative $9.8 million (including the now-shuttered KAOS day/nightclub) or positive $3.7 million (excluding KAOS). (The company overall had $110 million in adjusted EBITDA in the quarter.) It appears the property is unlikely to achieve management’s one-time “mid-teens return” goal any time soon.

For Red Rock shareholders, there is a significant cost to management’s decision to borrow and spend $1 billion on a project that has ended up not meeting ROI expectations. Net long-term debt increased from just under $2.00 billion at the end of 1Q16 (just before the Palms purchase was announced) to over $2.94 billion at the end of 3Q19 (when the renovation was completed). The company essentially borrowed and spent a billion dollars to gain no new EBITDA when it comes to Palms.

In a basic valuation model: EV (EBITDA x multiple) – debt = equity. With no new EBITDA and thus constant enterprise value, one billion dollars of additional debt means one billion dollar less of equity value. Therefore, Red Rock’s $1 billion “Palms debt” means a $1 billion reduction of Red Rock’s equity value. With the Palms project, Red Rock management wiped out $1 billion of shareholder equity. More than $8.00 per share of equity value (with 117 million diluted shares outstanding) evaporated because of the Palms project.

On the company’s quarterly call on Nov. 5, management announced the company’s goal is now to “[reduce] our net leverage ratio to a targeted level of 4x or less through a combination of paying down debt and increasing EBTIDA.” There was no acknowledgement that the company had levered up its balance sheet for no gain in EBITDA from Palms and thus significantly hurt shareholder value. In fact, if Red Rock had not borrowed $1 billion to spend on Palms over the last three-plus years and stuck with organic growth from its pre-Palms Las Vegas operations and tribal management fees, it would have already achieved a pro forma leverage of 3.94x at the end of 3Q19. Instead, now more of the company’s cash flow must go toward paying down the “Palms debt”, leaving less free cash flow for potential share buybacks or dividend increases.

It is true that Red Rock enjoys relatively low borrowing cost because of the company’s strong overall cash flow. But even at its current blended long-term debt interest rate, $1 billion of debt would require about $45 million of annual interest expense. Some Wall Street analysts have projected Palms to produce $25 million in annual EBITDA by the end of 2021.[ii]

Notes

[i] Red Rock Resorts, 3Q19 conference call, 11/5/2019, transcript by FD Wire.

[ii] JP Morgan, “Red Rock Resorts: Another Mixed Quarter; 3Q19 Core LV Fine, Palms Not So; Palms’ Chaos and EBITDA Losses Coming to an End. PT to $24”, 11/5/2019.

Fertitta Capital’s sports betting deal highlights disclosure dilemma at Red Rock Resorts

Investors in Red Rock Resorts (NASDAQ: RRR) lack the necessary information to know if they lost a business opportunity to Fertitta Capital, the investment firm founded in 2017 and run by Red Rock Resorts controlling owners, according to letters sent by the Culinary Union to the U.S. Securities Exchange Commission (SEC) and NASDAQ Stock Market.

See press release here.

In the letters to regulators (available here), the Culinary Union asks for a determination if potential conflicts of interest for those with dual roles at Red Rock Resorts’ and Fertitta Capital should be disclosed to investors, and questions whether Fertitta Capital’s investment in The Action Network, a sports betting media company, means the family firm receives opportunities owed to shareholders and now competes with Red Rock Resorts’ sports betting business.

To date, Red Rock Resorts has not informed investors that its principals, brothers Frank and Lorenzo Fertitta, and its Senior Vice President of Government Relations, Michael Britt, have dual roles at a firm whose business interests are similar to Red Rock Resorts, including in gaming, sports betting, leisure, live events, wellness, and food and beverage. The company’s proxy statement, released this week on April 29, makes no mention of Fertitta Capital at all.