Posts

Withhold the Vote 2018: Failure to Sunset Perpetual Dual-Class Stock

We encourage Red Rock Resorts shareholders to withhold authority to vote on their proxy card for the company’s board of directors – Frank J. Fertitta III, Lorenzo J. Fertitta, Robert A. Cashell, Jr., Robert E. Lewis, and James E. Nave, D.V.M. – at the upcoming annual stockholders meeting on June 14.

The many problems arising from the company’s perpetual dual-class stock make it necessary for outside shareholders to withhold their votes, especially after the company has made no attempt to address the significant shareholder discontent expressed at last year’s annual meeting.

Perpetual dual-class shares trade at a significant discount, risk index exclusion, and are opposed by major shareholder advocacy groups.

Read our report, Withhold the Vote 2018: Failure to Sunset Perpetual Dual-Class Stock

Selected Results: 2017 Corporate Governance Survey of Red Rock Shareholders

Following shareholder discontent at Red Rock’s annual meeting this July, in which 9% to 16% of equity holders withheld from the directors, we decided to survey Red Rock investors about their corporate governance issues. The survey this year measured shareholder sentiment toward Red Rock’s takeover defenses and features of its board of directors. We believe these topics are particularly important following another year of strong M&A activity in the gaming industry.

Despite the dissatisfaction expressed by shareholders and the negative voting recommendations from Institutional Shareholder Services for Red Rock’s entire board of directors surrounding the 2017 annual meeting, the company has not announced plans to remove, sunset, or put to a vote its takeover defenses. Nor has the company done anything to resolve its problematic board structure, which ISS gave its highest governance risk rating of 10 (as of June 19, 2017).[i]

The results of our survey reveal shareholder respondents expressed consensus for a hybrid format for the annual general meeting, took issue with the dual-class capital structure and other takeover defenses, and shared their preference for a more diverse board, an independent board chair, and their doubt regarding shareholder representation on the board.

See the selected results of the corporate governance survey below:

supervoting

preferred-stock tra supermajority written-consent special-meetings agms board-diversity independent-chair shareholder-representation

Notes

[i] Institutional Shareholder Services, “Proxy Alert: Red Rock Resorts, Inc.,” June 19, 2017, original publication date June 16, 2017, p. 1.

Law Firms Announce Investigations into Red Rock Resorts

Six law firms have announced investigations into Red Rock Resorts following the company’s annual meeting in July, when shareholders showed their dissatisfaction with the company’s directors.

1. Harwood Feffer LP
“Our investigation concerns whether the Company board of directors has breached its fiduciary duties to shareholders, grossly mismanaged the Company, and/or committed abuses of control in connection with potential self-dealing and related party transactions.”
Read the press release: http://www.prnewswire.com/news-releases/harwood-feffer-llp-announces-investigation-of-red-rock-resorts-inc-300489300.html

2. Andrew & Springer LLC
“Andrews & Springer LLC, a boutique securities class action law firm focused on representing shareholders nationwide, is investigating potential securities violation claims and breach of fiduciary duty claims against Red Rock Resorts, Inc.”
Read the press release: http://www.businesswire.com/news/home/20170717005016/en/

3. Levi & Korsinsky, LLP
“Levi & Korsinsky announces it has commenced an investigation of Red Rock Resorts, Inc. (NASDAQ:RRR) concerning possible breaches of fiduciary duty.”
Read the press release: http://www.businesswire.com/news/home/20170717006253/en/

4. Glancy Prongay & Murray LLP
“The investigation concerns whether the Company board of directors has breached its fiduciary duties to shareholders, grossly mismanaged the Company, and/or committed abuses of control in connection with potential self-dealing and related party transactions, including allegedly overpaying for Red Rock real estate.”
Read 1st press release: http://www.businesswire.com/news/home/20170718006073/en/
Read 2nd press release: http://www.businesswire.com/news/home/20170822006124/en/

5. Lifshitz & Miller LLP
“Lifshitz & Miller announces investigation on behalf of RRR investors concerning whether RRR’s board breached its fiduciary duties and engaged in self-dealing transactions, including allegedly overpaying for RRR real estate.”
Read the press release: http://www.prnewswire.com/news-releases/lifshitz–miller-llp-announces-investigation-of-blue-apron-holdings-inc-irobot-corporation-monogram-residential-trust-inc-quadrant-4-system-corporation-red-rock-resorts-inc-west-marine-inc-and-zto-express-cayman-in-300492913.html

6. Kahn Swick & Foti, LLC
“KSF’s investigation is focusing on whether Red Rock Resorts’ officers and/or directors breached their fiduciary duties to the Company’s shareholders or otherwise violated state or federal laws.”
Read 1st press release: http://www.businesswire.com/news/home/20170728005837/en/
Read 2nd press release: http://www.businesswire.com/news/home/20170811005623/en/

Outside Shareholders Dissent at Red Rock Resorts’ Annual Meeting

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

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?

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.