Why It Is Necessary to Withhold Your Vote

In a new report we argue that it is necessary for Red Rock Resorts’ shareholders to withhold votes from the company’s three independent directors – James E. Nave, D.V.M., Robert E. Lewis, and Robert A. Cashell, Jr. – on their proxies for the company’s July 6, 2017 annual stockholders meeting.

Read our report encouraging shareholders to withhold votes on Red Rock’s independent directors.

We fully support ISS’ recommendation to withhold votes on all of Red Rock’s directors.

These long-serving directors have failed to advocate for the sunsetting of the company’s myriad of poor corporate governance features since its IPO last year, and they have not acted to prevent the enrichment of company insiders and related parties. We believe it is essential to send an unambiguous message to management that investors expect a higher standard of corporate governance at a publicly-traded company, especially now that outside shareholders own a majority of the economic interest in the company.

In taking the company public, Red Rock’s board of directors implemented several antitakeover measures, including a dual-class ownership structure with 10:1 super voting stock for insiders.

Red Rock’s three independent directors are the sole members of its Nominating and Corporate Governance Committee, which is responsible for monitoring the company’s governance matters. Furthermore, Red Rock’s independent directors have a history of approving transactions that are not in the best interest of the company or its outside shareholders.

For these reasons, we encourage Red Rock’s Class A shareholders to withhold their votes from the elections from Directors Nave, Lewis, and Cashell at the company’s upcoming annual meeting of stockholders.

Red Rock Corrects Violation of Securities Law in Proxy Statement

On June 8, 2017, we sent a letter to the SEC regarding Red Rock Resorts proxy statement filed on May 1, 2017 and its amended proxy statement filed on May 26, 2017. We noticed that Red Rock did not provide shareholders with the ability to withhold votes on its director elections even though the company uses a plurality voting system.

Under 17 C.F.R. § 240.14a-4(b)(2), a proxy that provides for the election of directors must provide means for security holders to withhold authority to vote for each nominee.  The proxy may do so by providing: (1) a box indicating that authority to vote is withheld; (2) an instruction that indicates a vote may be withheld by striking out the name of any nominee; (3) a blank space in which the voter may enter the names of nominees for whom votes are withheld; or (4) any similar means, provided that clear instructions are provided about how to withhold authority.

By not providing shareholders with the ability to withhold votes, the company was effectively preventing investors from registering their dissatisfaction with director nominees.

On June 16, 2017, Red Rock filed an amended proxy statement that corrected the voting options by providing shareholders with the ability to withhold their authority to vote.

When Management Destroys 2% of Shareholder Value with a Related-Party Deal

In its recently filed 10-Q, Red Rock Resorts discloses that it borrowed $120 million from its revolver to buy the land under two of its Las Vegas casinos from a related party. This means the April 27 transaction reduced the company’s equity by approximately $0.43 per share, or 1.93%. Investors should ask why Red Rock management thought this was a smart thing to do and whether the company’s independent directors reviewed and approved the costly related-party transaction.

Shareholder value destruction

On the first-quarter conference call with analysts, then-CFO Marc Falcone claimed the Boulder Station and Texas Station land purchase would let the company “pick up approximately $7 million of incremental EBITDA” on an annual basis (approximately the total savings of not having to pay rent anymore under those two leases.) What this implies is that the transaction created an approximately $70-million bump in the company’s enterprise value, if we use a 10x EV/EBITDA multiple on its Las Vegas business.

But the company added $120 million of debt in the process, which means that, net-net, there was in fact a negative $50 million hit on the equity value of the company, or the reduction of approximately $0.43 of equity value per share (based on a share count of approximately 116 million).

Equity Impact of RRR’s April 27 related-party land purchase

Add: Incremental EBITDA $7M
EV/EBITDA multiple 10x
Increase in Enterprise Value $70M
Subtract: Additional Net Debt $120M
Net Change in Equity Value ($50M)
Shares 116M
Net Change in Equity Value Per Share ($0.43)

The pre-transaction closing price of RRR Class A shares was $22.34. Red Rock management thus directly destroyed 1.93% of the company’s shareholder value with the April 27 related-party transaction. Alternatively speaking, management made its public shareholders take a $50M hit in their RRR holdings to pay for this related party deal. On a pro rata basis, Cohen & Steers, Red Rock’s largest institutional shareholder, lost $3.85M million of the value of its RRR shares; Fidelity lost $3.44M, Diamond Hill lost $1.88M, and Baron Capital lost $1.86M. No wonder some shareholders sounded less than thrilled with the related-party deal when approached by Bloomberg.

GAAP implications

Our analysis above would hold even if the company had use cash on hand to pay for the deal. Spending down cash would have increased net debt in the same way as borrowing more, which would have resulted in the same negative impact on equity value. But since Red Rock borrowed money to fund the transaction, there are implications for the company’s financials beyond EBITDA, a non-GAAP number that does not account for interest expense. At the very least, not all of the $7 million incremental EBITDA will flow through to net income and earnings per share because there would be increased interest expense on the new $120 million debt.

In addition, the 10-Q also states:

As a result of such acquisition and the termination of the ground leases, the Company expects to recognize a charge in an amount equal to the difference between the aggregate consideration paid by the Company and the acquisition date fair value of the land and residual interests, which charge is expected to have a material impact on its net income and earnings per share for the three and six months ending June 30, 2017 (emphasis added).

This begs the question: why did Red Rock pay more than market value? And, again, did the company’s independent directors review and approve the deal?

The Myth of the Las Vegas Locals Market Recovery

Red Rock Resorts is heavily dependent on the health of the Las Vegas locals gaming market. In this report, we examine key gaming metrics in the Las Vegas locals market – going beyond simple measures of gaming revenue – in order to gauge the company’s potential to grow back up to the peak levels of 2007.

We challenge the myth that growth in the Las Vegas locals market will lead to recovery of the 2007 heights anytime soon. As we focus on slot handle and slot payout trends, we find there is little increase in slot handle while higher gaming revenue has come from tighter slots.

What we see is that the slot handle has been increasing at a slow pace in the Las Vegas locals market. From January 2012 to January 2017, slot handle in the locals market increased by only 1.88% with a CAGR of 0.37%. These monthly handle numbers show a relatively stagnant market with little growth.

In contrast, the monthly handle numbers leading up to the Las Vegas locals market’s historic peak in 2007 paint a very different picture. From January 2002 to January 2007, monthly handle increased by 33.8% with a CAGR of 5.99%.  As of March 2017, total slot handle in the Las Vegas locals market was down 20.6% from its historic peak in March 2007.

Las Vegas Locals Market Handle Increase CAGR
Run up to peak (Jan 2002 – Jan 2007) 33.8% 5.99%
Current (Jan 2012 – Jan 2017) 1.88% 0.37%

Our analysis of historical slot handle and win percent numbers for the Las Vegas locals market shows that one reason for the increases in gaming revenue in the Las Vegas locals market (and the myth about the locals market recovery), is tighter slot machines. Investors should ask management when Red Rock will be able to grow to pre-recession levels of business in this stagnant and saturated Las Vegas locals market.

Read Part I: How Will Red Rock Grow in a Saturated and Stagnant Market?

Read Part II: The Myth of the Las Vegas Locals Market Recovery 

 

(Picture source: https://commons.wikimedia.org/wiki/File:Sandro_Botticelli_021.jpg)

Red Rock Resorts buys out two related-party land leases for $120 million

Red Rock Resorts disclosed in its DEF 14A, filed on May 1, that it had bought out two long-term land leases it had with a related party in Las Vegas:

On April 27, 2017, the Company purchased entities that own the land subject to the Boulder land lease and the Texas land lease from the Related Lessor for aggregate consideration of $120 million.

On its quarterly conference call with analysts on May 4, the company stated that the deal “will be immediately accretive to cash flow and will provide the company full control of this real estate.” Specifically, it would “pick up approximately $7 million of incremental EBITDA related to the purchase of the two ground leases.” This figure likely refers to the combined savings on annual rent payments. Monthly rent was $222,933 per month under the Boulder lease and $366,435 per month under the Texas lease, so total annual lease payment by Red Rock was approximately $7.1 million. The company therefore paid about 17 times annual rent to terminate the two leases.

It is unclear how the company paid for the purchase. If it had financed the purchase – perhaps under its $350-million revolving credit facility — it would have incurred some additional interest expense, so not all of the $7-million incremental EBITDA would flow through to the bottom line.

The two ground leases covered 27 acres of land under Boulder Station and 47 acres of land under Texas Station (The size of the Boulder Station parcel can be found in Station Casinos LLC’s 2017 10-K, p. 77). Red Rock thus purchased 74 acres for $120 million, or approximately $1.62 million per acre.

To put this $1.62-million-per-acre purchase by Red Rock in further context:

For further context, we note that $120 million equals approximately:

  • 8.3% of Red Rock’s 2016 net revenues of $1,452 million
  • 24.8% of its 2016 adjusted EBITDA of $484 million
  • 34.7% of its 2016 cash flows from operations of $346 million, and
  • 77.0% of its net income of $156 million in 2016

The announcement in Red Rock’s proxy does not say whether an independent appraisal was performed to determine a fair market price for either or both of the two properties before the company consummated the transaction. It is also unclear whether the transaction was reviewed and approved by the Audit Committee of the company’s Board of Directors.

Should You Pay Someone Else’s Income Taxes?

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?

 

Why is Red Rock Resorts’ Share Price Underperforming the Market and Its Peers?

Why is Red Rock Resorts’ Share Price Underperforming the Market and Its Peers?

In the first quarter of 2017, Red Rock Resorts’ Class A share price declined by 7% while the S&P 500 index went up by 4.65%.

rrrvsp500-1q17

(Source: Yahoo Finance)

RRR’s share price dropped while other regional gaming operators’ share prices rose in the quarter:

rrrvregionals-1q17

(Source: Yahoo Finance)

What explains this significant underperformance of RRR stock? We believe investors are likely concerned with the Palms acquisition and the uncertainty in the company’s growth pipeline:

Is the Palms acquisition meeting management expectation?

When the $316-million Palms acquisition was first announced last May, the company said that “[f]actoring in anticipated synergies, the Company estimates that the Palms will generate $35 million in EBITDA during the Company’s first full year of ownership.” Is the company on track to meet this goal?

When Station Casinos officially took ownership of the Palms on Oct. 1, Michael Jerlecki, who had been the general manager of Palace Station, became the resort’s GM. However, Jerlecki was replaced by Anthony Faranca by early February without any public announcement from the company. (The new GM is mentioned in passing in a local columnist’s write-up on new assistant manager Jon Gray.) We do know from the company’s recently filed 10-K that Palms had a net pretax loss of $1.3 million in the fourth quarter on net revenues of $38.5 million.

Given these numbers, investors might wonder whether the Palms is on track to make $35 million in EBITDA through September 30 this year. While the company did not provide property-level breakout of Palms’ EBITDA for the fourth quarter, investors should demand greater clarity going forward so they can better understand whether the expensive, debt-financed purchase is paying off as management had anticipated.

What happened to the Palms Place hotel rooms?

The company’s 10-K shows there were 713 hotel rooms at the Palms, but makes no mention of the condo-hotel units at Palms Place. Back in September, the company’s investor presentation showed that, at Palms, in addition to 713 rooms across two hotel towers, there were “approximately 448” condo units at the stand-alone Palms Place tower in the “room rental program, pursuant to which the Company receives 50% of the room rate and 100% of the resort fee on any such rentals.”

What happened to these 448 hotel units at Palms Place? They would account for about 39% of total available hotel units at the company’s new acquisition. The 10-K does not say anything about this Palms Place condo-hotel program. Has the company decided not to manage Palms Place’s hotel pool anymore? If so, how might that affect the goal of making $35 million in EBITDA at the Palms through September 30?

Why is no one adding significant capacity in the Las Vegas locals market?

We recently took a closer look at the company’s new development pipeline in Las Vegas and found little that was “shovel ready.” Given the lack of discussion on this issue during the analyst call, we believe some further questions are warranted.

For example, when will the company tell investors more about the planned second hotel tower at Palace Station, which received planning approval in September? The planned tower is absent from the discussion of the on-going $115-million “upgrade” of Palace Station in the company’s latest investor presentation from March 20.

While the company continues to tout its “Existing Development Sites” in Las Vegas such as “Durango” and “Viva” in its March presentation, it has not announced any concrete plans to build out those sites. Moreover, there are ten “Gaming Enterprise Districts” in the Las Vegas Valley which are not owned or controlled by Station Casinos.

non-rrr_geds

(See our interactive map of casinos and casino sites in the Las Vegas locals market.)

The existence of these non-Station future casino sites should make investors skeptical of any claims of barriers of entry to the Las Vegas locals market. Moreover, if the Las Vegas locals market is growing significantly, why have these other developers not seen fit to build out new Las Vegas locals casinos?

What will happen in the company’s tribal casino management segment in 2021?

Outside of Las Vegas, there are looming challenges in the company’s tribal casino segment. Its two existing management agreements expire in February, 2018, and November, 2020, respectively. The company estimates that its only other tribal casino project will require another 36 to 48 months to begin construction and 18 months after construction begins to complete and open.

This means the earliest opening date would fall around September, 2021, and that the company most likely will not have a tribal casino management fee revenue stream in 2021. To be clear, the tribal casino management segment accounted for 7.6% of the company’s net revenues and 18.0% of adjusted EBITDA in 2016.

It should be noted that the company’s $225-million Term Loan A and $685-million Term Loan B both mature in June 2021, and its $500 million of 7.5% senior notes are due March 1, 2021. That is a total of approximately $1.4 billion of debt coming due when the company will likely not have any tribal casino management revenue. Will the company be able to roll over that debt given this potential lack of tribal casino management revenue in 2021?

Fallow Land, Hollow Claims

Red Rock Resorts has been talking up its Las Vegas development sites and master-planned expansions in its presentations to investors and SEC filings. However, after a review of local real estate listings and planning agency documents, we found development sites for sale and no approvals on file for some of the company’s master-planned expansions. We present our findings in a new report that you can download here.

Our report on Red Rock’s Las Vegas growth pipeline raises some important questions for investors:

  • Why does the company continue to describe the Cactus and Castaways parcels as “development sites” when they are listed for sale?
  • After over a decade of delays, what is the timeline to build out the Durango development site?
  • Does the company still see value in developing a resort hotel on the Flamingo site, which lies between Red Rock Casino and the Durango site?
  • When will the conditions of Inspirada’s master-planned community improve enough to warrant building a resort hotel?
  • When will the company submit plans for the new hotel tower and meeting space at Red Rock Resort or the meeting space expansion at Sunset Station?

See our report for more information from our review into RRR’s development sites and master-planned expansions.

Check out our map of existing properties and future casino development sites in Las Vegas, including those not controlled by RRR.

Deutsche Bank Sells 19.6 Million Class A Shares After IPO Lock-Up Period Expired

Update 2: Deutsche Bank sells off its ownership stake, per Red Rock Resorts 8-K filing on Nov. 10, 2016.

Update 1: See “Deutsche Bank to sell $400m stake in Las Vegas gambling group” in Financial Times (Oct. 30, 2016).


Deutsche Bank will soon be able to dispose of its 17% ownership of Red Rock Resorts (NASDAQ: RRR), when the Las Vegas gaming company’s IPO lock-up period expires on October 24.

Deutsche Bank is in dire need of additional capital, so we expect it to sell off the Las Vegas casino stake as soon as it can on or after October 24. Deutsche Bank investors should certainly welcome the cash infusion and capital boost that can come from selling and exiting the casino assets.

Deutsche Bank is in the process of selling other non-core assets such as Abbey Life and its stake in China’s Hua Xia Bank. CEO John Cryan noted in July that the lender’s second-quarter revenues “benefited from the IPO of Red Rock Resorts.”

We estimate the German bank’s Las Vegas casino stake to be worth approximately $440 million. (The bank has not disclosed the specific number of Red Rock shares it beneficially owns.) In addition, according to the tax receivable agreement Red Rock signed as part of its IPO, the company is required to pay Deutsche Bank and other pre-IPO owners 85% of certain tax benefits to be realize when Deutsche Bank and other pre-IPO owners sell their ownership interests. The TRA payments will need to be made in cash before the company makes its dividend payments. As of June 30, the company’s TRA liability was $44.5 million.

As Deutsche Bank gaming analysts observed on May 22: [I]t is worth noting that at present, ~21% of the shares outstanding are held by legacy strategic investors, whose core business does not include owning gaming equities. Thus, post the 180 day, from IPO, lock up expiration, we believe the risk of secondary issuances could potentially weigh on shares.”

Workers at Boulder Station Vote to Unionize Through NLRB Secret-Ballot Election

LAS VEGAS, NV – Over Labor Day weekend, workers at Boulder Station Casino & Hotel have voted by a landslide of 67% to be represented by the Culinary Workers Union Local 226 and the Bartenders Union Local 165 through an NLRB secret-ballot election. Over 570 Boulder Station workers will be represented by the Unions.

“It is very simple: we voted for the union because we want to have a union at Boulder Station,” said Rodrigo Solano, a cook at the casino, which opened in 1994. “After all these years of fighting to make our jobs better, it is time for management to listen to us: we want to have fair wages and good health benefits like tens of thousands of other casino workers in Las Vegas.”

The union filed for an election on August 15, and over 530 employees in the union’s bargaining unit voted on September 2 and 3 on-site at the Boulder Station casino-hotel. The decision by Boulder Station workers to unionize comes less than a year after workers at a Station Casinos-managed tribal casino in Northern California ratified their first union contract. Boulder Station is the first of Station Casinos’ properties in Nevada to unionize with the Culinary and Bartenders Unions.

“We applaud the tremendous courage and determination of the Boulder Station workers, who have resoundingly rejected the company’s anti-union campaign to discourage and scare them over the years, especially over the last two weeks,” said Geoconda Arguello-Kline, Secretary-Treasurer for the Culinary Union. “Workers at Boulder Station have made their choice to unionize, and we look forward to contract negotiations starting as soon possible.”

The Culinary Union continues to call on Station Casinos to agree to a fair process at its other Las Vegas properties so that workers can decide whether to unionize free from management interference, intimidation, bullying, and litigation.

“We know about the Culinary and Bartenders Union and the union standard that workers have fought to have for over 80 years, and we made our decision to unionize based on those facts,” said Jeri Allert, a cocktail server at Boulder Station. “I look forward to negotiating a good union contract that protects my coworkers and our families.”

“Our company has enjoyed great success because of the hard work we put in every day to provide great service and hospitality,” said Maria Portillo, a food runner at Boulder Station. “We deserve to have a union contract that gives us job security, fair wages, good healthcare, and a pension so that we can have the opportunity to provide for our families through our hard work.”

At the large casino-hotels owned and operated by Station Casinos in Las Vegas, including soon-to-be-acquired Palms, workers have been demanding publicly a fair process to exercise their right to choose whether to unionize. Responding with a vicious anti-union campaign, Station Casinos has broken federal labor law eighty-eight times and is the worst labor law violator in the history of Nevada gaming. Recent changes to NLRB rules have created new opportunities for workers to choose whether to unionize through secret-ballot elections despite the continued prospect of management interference, intimidation, bullying, and litigation.

Boulder Station is a subsidiary of Station Casinos LLC, which is partially owned by Red Rock Resorts, Inc. (NASDAQ: RRR). Deutsche Bank owns approximately 16% of the Las Vegas gaming company.

(Cross-posted from Culinary Workers Union’s website.)