“Too-Big-To-Regulate”

We recently sent a letter to Nevada Governor Brian Sandoval  to provide the governor with “specific examples of problems related to the approval of the Station Casinos/Red Rock Resorts IPO by the Nevada Gaming Commission on January 21, 2016 in order to illustrate the challenges Nevada faces in regulating a ‘too-big-to-regulate’ significant owner of one of the major gaming companies in Las Vegas.”

The entire letter can be viewed here.

In the letter, we discuss the rushed nature of the approval of the IPO by the Gaming Control Board and Nevada Gaming Commission, Deutsche Bank’s accountability as the parent company and affiliate of a felon, federal regulators’ reactions to the bank’s misconduct, and the relationship between the bank and its designated director at Station Casinos, Mr. Robert A. Cashell, Jr. We also ask whether Nevada’s gaming regulators are too permissive toward “too-big-to-regulator” investors.

Our letter concludes with the following:

We cannot help but worry that Nevada gaming regulators appear unwilling to confront head-on the admittedly complex issues related to a “too-big-to-regulate” investor like Deutsche Bank, which is affiliated with a felon. We are fearful that this apparent unwillingness on the part of our state regulators might invite unwelcome scrutiny from federal officials, especially as federal regulators and investigators continue to work to hold Deutsche Bank accountable for its actions. Some might even begin to question whether Nevada is capable of upholding the “gold standard” of gaming industry regulation when our regulators continue to look the other way and refuse to ask hard questions about why the affiliate of a felon continues to own and profit from casinos in our state.

The entire letter can be viewed here.


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

Poor Corporate Governance of Red Rock Resorts Draws Attention of Institutional Investors

Update: On March 23, “[m]embers of the Council of Institutional Investors voted to adopt a new policy that all investors in initial public offerings have equal voting rights among their shares.” See also here. The official press release on the new policy is here.


The Council for Institutional Investors (CII) called Red Rock Resorts a “perfect example” for why the CII Policies Committee and board of directors approved its latest policy statement on newly public companies. CII’s policy statement calls on newly public companies to include sunset mechanisms for corporate governance provisions that insulate management from public shareholders. According to CII, Red Rock is a “perfect example” because its board approved five antitakeover provisions without including sunset mechanisms or requiring a future vote of shareholders. These provisions include:

  1. A dual-class share structure
  2. Supermajority approval provisions
  3. Limitations on actions by written consent and special meetings of stockholders
  4. Fertitta family exemption from a Delaware antitakeover statute
  5. The board’s right to issue preferred stock

The March 3, 2016 CII Governance Alert can be found here (subscription required).

In the ISS benchmark policy update for 2016, the proxy firm recommends voting against or withholding votes from directors, committee members, or the entire board, if they take actions in connection with an IPO that are adverse to shareholder rights, such as limiting shareholders’ ability to amend the company’s bylaws and charter. Glass Lewis has similar recommendations for pre-IPO boards that adopt anti-takeover provisions, poison pills, and other unilateral actions. And Stanford’s Rock Center for Corporate Governance and the SEC are hosting an event this March to discuss governance issues related to pre-IPO companies.

We have criticized the corporate governance of Red Rock Resorts, Inc. since its IPO was announced last October (and when it was still called Station Casinos, Inc.). Prospective investors should look to CII, ISS, and Glass Lewis policy recommendations on pre-IPO corporate governance and ask: “Do I want to be a second-class shareholder of Red Rock Resorts?


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

The $460-Million Fertitta Entertainment “Internalization Fee”

See our follow-up post, “More Questions about the $460-Million Valuation of Fertitta Entertainment”.


Based on the company’s presentation at the Nevada gaming regulators’ meeting on Jan. 21, Red Rock Resorts’ acquisition of Fertitta Entertainment is to be understood as the internalization of an external manager. How does the $460-million Fertitta Entertainment “internalization fee” compare to those commonly found in REIT internalization transactions?

REIT internalization fee from 1997 to 2013Fertitta Entertainment internalization fee
As % of acquirer equity2.7% – 10%43.0%
As % of acquirer’s invested capital0.9% – 6.0%14.4%
As multiple of manager’s TTM EBITDA2.9x – 14.0xNA

The historical REIT internalization fee figures in the table above are from a September 2014, study of REIT internalization fees by Sherry Cefali and Nick Tarditti of Duff & Phelps, which shows the range of REIT external manager valuations from 1997 to 2013.

The $460-million Fertitta Entertainment internalization fee is much higher compared to these figures:

Three more observations:

  1. The internalization fee will be paid entirely in cash instead of equity or a combination of cash and equity. Red Rock will pay the $460 million “internalization fee” entirely in cash instead of equity or a combination of equity and cash as has been done in the REIT sector. For example, common shares were used in January 2016 to finalize the internalization of management of Starwood Waypoint Residential Trust, merging them with Colony American Homes inside the larger company known Colony Starwood Homes.
  1. Some REITs have internalized external managers with no fee. The Duff & Phelps study excludes transactions with no internalization fees. While some REITs have been criticized for large internalization fees, some “have stopped paying their management companies any money to bring them in-house.” In 2008, Healthcare Trust of America was one of the first to “transition into a self-managed company without an internalization fee” and many have followed suit. Philips Edison – ARC Shopping Center REIT waived the internalization fee of its external managers in 2010, and Chamber Street Properties “internalized its management structure, with no separate fee paid” in 2012 before announcing its IPO in 2013.
  1. The non-insider cost for acquiring Fertitta Entertainment should be closer to $50 million, not $460 million, based on termination provisions in the casino management agreements. The $460 price tag is 8.9x the $51.7 million trailing-twelve-month management fee Fertitta Entertainment received from Station Casinos as of September 30, 2015. According to the Fertitta Entertainment management agreement covering 13 of the 19 Station Casinos properties, termination of the agreement upon sale of the managed properties to a third party would only cost Station Casinos a fee equal to the trailing-twelve-month management fee. See Exhibit “D” Financial Terms of this management agreement, which can be found as Exhibit 10.21 of Station Casinos LLC’s 10-K, filed 3/10/15.

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

An Update on Station Casinos Valuation, as Implied by Fidelity Filings

Last November, we noted that a Fidelity fund’s SEC filing implied that it valued Station Casinos’ equity at approximately $1.12 billion at the end of August. On January 28, the same Fidelity fund filed a new quarterly report and presented the values of its holdings as of November 30. The value of its Station Casinos stake dropped by over 5%.

Value as of 8/31/15Value as of 11/30/15Change
1,194,419 shares of Station Holdco LLC$4,384,000$4,157,000-5.2%

Source: Fidelity Puritan Trust Form N-CSR filed 10/28/15 and Form N-Q filed 1/28/16

The implied valuation of Station Casinos would have thus dropped to $1.06 billion at the end of November.

Fidelity, whose funds collectively own 8.7% of economic interest in Station Casinos, did not disclose its valuation methodology. A Fidelity spokesman did say in a statement to the Wall Street Journal last October that the firm has “a rigorous and thorough fair market valuation process for mutual fund holdings.”


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

The IPO Is Postponed, Per Deutsche Bank

Deutsche Bank announced on January 28 that the Station Casinos (Red Rock Resorts) IPO had been postponed. According to Co-CEO John Cryan, the decision was made in the previous week “due to market conditions.” On January 21, Station Casinos CFO Marc Falcone had made a presentation of the company’s “$450 million of primary offering of shares” at a special meeting of the Nevada Gaming Control Board.”

Two questions come to mind:

1. Will the Fertitta family and other insiders seek other ways to fund the $460-million Fertitta Entertainment deal even before the IPO goes to market?

Last March, the company sought approval from holders of its $500 million bonds to issue another $300 million of bonds to fund a special distribution to its owners. It cancelled those plans by May for “off-the-record” reasons. In the third quarter last year, it paid distributions of $106.4 million to Station Casinos LLC members, which was more than the company’s EBITDA of $90.0 million in the quarter. According to CFO Marc Falcone’s comments at the Gaming Control Board meeting on January 21, the company currently has $350 million available under its revolving credit facility. Will the company tap the revolver to fund the Fertitta Entertainment acquisition or make other cash distributions to the owners now that the IPO is on hold?

2. Will the terms of the IPO be modified?

We have pointed out various issues with the way the public offering has been structured since it was first announced in October. See more of our analysis of the Red Rock Resorts/Station Casinos IPO:

We also sent a letter to the SEC on January 26 to draw attention to certain information missing from the prospectus filings by Red Rock Resorts.

We will keep you updated with more in-depth analysis of the Red Rock Resorts/Station Casinos IPO. Sign up for updates here or follow us on Twitter at @UHGamingRe.

Will Station Casinos’ Fourth-Quarter Financials Surprise Like They Did in the Third Quarter?

At the Nevada gaming regulators’ meeting on January 21, Red Rock management “hinted that it would like to launch the IPO before it announces fourth-quarter earnings next month,” according to the Las Vegas Review Journal. But what is the rush? Will there be any surprises in the fourth-quarter numbers?

There was a surprise in the company’s third quarter financial statements with respect to cash distributions to members: Station Casinos’ third-quarter cash payouts to its owners was were approximately 118% of its EBITDA. Through the prior eight quarters, from the third quarter of 2013 through the second quarter of 2015, the company’s distributions to members had been running at an average level of about 30.9% of EBITDA per quarter.

The company made $106.4 million of distributions to members of Station Casinos LLC (excluding $3.5 million to non-controlling interests in certain subsidiaries). This amount was greater than the company’s third-quarter Adj. EBITDA of $90.0 million. This large cash distribution followed approval by the Nevada Gaming Commission to allow Station Casinos to “pay financial distributions to the company’s owners without approval from gaming regulators” on May 28, 2015.

Investors should wait until the company has released its fourth quarter results before making a decision on whether to invest in the Red Rock IPO.

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

The Tax Receivable Agreement of the Red Rock Resorts IPO

Read our in-depth analysis of the tax receivable agreement here.

Investors should demand a cap on the TRA payments to protect themselves and Red Rock Resorts against potentially unlimited exposure and draining of the company’s cash.

Tax receivable agreements are criticized by experts. TRAs found in IPOs are frequently criticized for benefiting pre-IPO owners at the expense of the public company and outside shareholders. Moreover, TRAs have been promoted by corporate tax firms as a way to monetize tax attributes for the
pre-IPO owners during an IPO even though such agreements “are not fully understood by public stockholders.”

What are the terms of the Red Rock Resorts TRA? Red Rock Resorts will be required to pay pre-IPO owners a yet-to-be-disclosed, “substantial” amount of money for the tax benefits it realizes from acquiring partnership interests in Station Holdco LLC. The January 14th amended S-1 filing states that the public corporation will pay pre-IPO owners 85% of its tax benefits in cash and keep only 15% for itself. The 15-plus year agreement will not be based on continued ownership by the pre-IPO owners and the Fertittas, who will be the controlling shareholders after the IPO, can cause Red Rock Resorts to accelerate the TRA payments at any moment.

TRA payment liabilities can increase after the IPO. An examination of other companies which have gone public with similar TRAs reveals that estimates made at the time of an IPO commonly increase, exceeding the company’s IPO proceeds and annual EBITDA. Red Rock Resorts admits its calculations will be “imprecise” and there is no guarantee the company will realize the tax benefits it is paying to insiders. Furthermore, the company discloses that payments made under the agreement will spur additional payments to insiders and may significantly impact the liquidity of the company.

Investors deserve more information and protection. Red Rock Resorts should provide justification for the 85%-15% split, clear estimates of the annual and lump-sum payments to the pre-IPO owners, and disclosures regarding how the payments will affect free cash flow and capital expenditures. Furthermore, prospective investors should demand a cap on Red Rock Resorts’ TRA payments to the Fertittas and other pre-IPO owners to avoid potentially outsized or even unlimited exposure in the future.

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

The IPO and the Fertitta Entertainment Airplane

In September 2015, Fertitta Entertainment LLC, the entity that Station Casinos LLC is proposing to acquire for $460 million using Red Rock Resorts, Inc. IPO proceeds and additional debt, borrowed $30 million to buy “an asset.”  As the company says in its IPO filings, “Fertitta Entertainment entered into a $22.0 million secured promissory note and drew an additional $8.0 million under its revolving credit facility to finance an asset purchase.” The company has not disclosed the nature of the asset purchased.

Loan documents we have found show that Fertitta Entertainment bought a 2011 Bombardier Global Express jet in September with a $22 million loan from Guggenheim Aircraft Opportunity Master Fund LP.  The five-year loan from Guggenheim was made with a Fertitta Entertainment subsidiary, FE Aviation II LLC.

Deciding How to Pay $30 Million

Red Rock Resorts will at least pay off some of the financing used for the purchase.  According to the IPO filings, “All amounts outstanding under the [Fertitta Entertainment] Credit Facility are expected to be repaid, and the FE Credit Facility is expected to be terminated, upon consummation of the Fertitta Entertainment Acquisition.” Red Rock Resorts will therefore pay off at least the $8 million Fertitta Entertainment borrowed from its revolver to finance the private jet purchase.

What about the $22 million loan? The IPO filings do not make clear if the company will also pay off the $22 million loan Fertitta Entertainment took for the private jet.  What the filings do make clear is that paying off this $22 million loan will not be part of the $460-million purchase of Fertitta Entertainment.

Other than the date and the asset’s $30 million price tag, this is the extent of the details disclosed by the company about the $22 million loan: “The promissory note has a term of five years and requires Fertitta Entertainment to make monthly principal and interest payments. The promissory note bears interest at LIBOR plus 5.25% and contains a number of customary covenants and events of default.”

Meanwhile, the company states that, “an airplane will be transferred by Fertitta Entertainment to one or more of its members or their affiliates prior to the consummation of the Fertitta Entertainment Acquisition.”  No further details about this transfer are disclosed in the IPO filings.

53 Flights in One Month

The same month Fertitta Entertainment borrowed $30 million for a private jet, two other private jets owned by the Fertitta family made 53 flights in September alone.  Both private jets are registered through entities that list Frank J. Fertitta III, and Lorenzo J. Fertitta as managing officers (see here and here).  One private jet made thirteen round-trips between Las Vegas and southern California, and the other private jet made three round-trips between Las Vegas and Indiana, and also flew to Pennsylvania, Virginia, California, and New Mexico.

Red Rock Resorts, whose primary business lies in the Las Vegas locals market, claims “that one of [their] competitive strengths has been the ability of our highly experienced management team, led by the Fertitta family, to identify, develop and execute innovative and value-creating opportunities.”  The company has not disclosed what out-of-Las Vegas opportunities its owners might have been pursuing with their frequent travel.

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

Do You Want to Be a Second-Class Shareholder of Red Rock Resorts?

Read our report, “Do You Want to Be a Second-Class Shareholder of Red Rock Resorts?” 

Red Rock Resorts is proposing a corporate governance structure that will severely limit non-Fertitta shareholder influence.

  • Upon consummation of the IPO, Red Rock Resorts will have a dual-class ownership structure consisting of Class A and Class B shares voting as a single class. While the prospectus does not yet lay out the exact post-IPO numbers of LLC units, Class B shares, and Class A shares, the registration statement makes it abundantly clear that the Fertittas will control the company. Since the Fertittas, through affiliates, are currently the only owners of Station Holdco who own over 30% of the LLC Units, the “super voting stock” provision will only apply to them, assuming they maintain at least 10% of Class A shares after the IPO.
  • Studies show that dual-class structures can affect return for non-controlling shareholders, and a dual-class structure is rare in hospitality companies.
  • The newly formed Red Rock Resorts will include other anti-takeover provisions in addition to the dual-class structure and super voting stock described above.

Red Rock states its board will include three directors it considers independent: Dr. James E. Nave, D.V.M., Robert E. Lewis, and Robert A. Cashell, Jr.

  • Nave and Lewis were also part of the board of former Station Casinos Inc. when it allowed “excessive” equity compensation despite opposition from outside shareholders.
  • Mr. Cashell has served on the board of Station Casinos since 2011 when he was selected as German American Capital Corporation’s (GACC) at-will designee to own 38.58% of Station Voteco LLC, the pre-IPO sole voting member of Station Casinos LLC. Given Deutsche Bank’s multiple levels of transactions with Station Casinos – i.e. existing large LLC unit holder, lender, and IPO underwriter – we question Cashell’s independence and his ability to represent the interests of both a current and future LLC unit holder (as GACC is not selling all of its ownership interest) and new public investors who will hold the Class A shares.
  • Finally, Nave and Lewis comprised the special committee of the board of managers of Station Casinos LLC that recently negotiated the Fertitta Entertainment acquisition, in which Station Casinos will purchase the management company owned by the Fertitta family for $460 million. While it will pay a substantial amount of cash to the Fertittas and other top company executives, it is not clear what benefits Station Casinos LLC derives from the transaction.

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

Selling Growth While Cashing Out

Read our updated report, “Selling Growth While Cashing Out”.

Is the Las Vegas locals market in decline? Data from the Nevada State Gaming Control Board show a continuing decline in the number of slot machines in the Las Vegas locals market since 2009. This is accompanied by a similar decline in the total amount wagered by customers in the locals market. Both total slot units and amounts wagered have declined to 2003 levels. Station Casinos derives “approximately 80% to 85%” of its gaming revenue coming from slot play.

Why is Red Rock Resorts selling hard-to-come-by casino sites? Historically, Station Casinos built its leading position in the Las Vegas locals gaming market by acquiring a portfolio of competing locals casinos and undeveloped land shielded from competition thanks to Nevada’s SB 208 legislation. The company touts its gaming-entitled land holdings in its IPO prospectus, but it has not disclosed that some of its casino sites are now on the market or explained why it is ceding some of its “highly desirable” and “strategically located” gaming-entitled locations in Las Vegas.

When will Red Rock Resorts grow again? Station Casinos has seen little growth in its core Las Vegas business over the last several years. Casino revenues from its properties in Las Vegas barely increased from 2009 to 2014, with a compound annual growth rate of only 0.07%. A significant portion of the company’s EBITDA growth over the past three years has come from its tribal casino management agreements, but the company has not signed a new tribal casino development agreement in over a decade.

Investors deserve better analysis of Las Vegas economic conditions. We reviewed how the company in its IPO filings describes certain of its own key metrics for understanding the Las Vegas economy and the potential for growth in the Las Vegas locals gaming market (e.g. average weekly wages and home value appreciation). When Station Casinos says that it believes the Las Vegas locals gaming market is one of the most attractive in the U.S. because of, among other things, “its strong economic and demographic fundamentals,” what is the company talking about? How confident is the company in its claims?