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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.

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

Red Rock Resorts is a Second-Class Gaming IPO

Download our unauthorized roadshow presentation and presentation notes here.

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

Prospective investors should ask management the following questions:

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

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

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

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

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


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

 

 

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:

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:

What is the Red Rock Resorts IPO?

Download our unauthorized roadshow, “Red Rock Resorts: A Second-Class IPO”.


Red Rock Resorts, Inc. is not planning to use IPO proceeds to grow through either asset purchase or new development. It is not planning to reduce its overall indebtedness with the IPO proceeds. Instead, concurrent with the IPO, it is paying out a large sum to insiders in an “internalization” deal that will not generate any new revenues. It is not even planning to buy out the ownership stake held by Deutsche Bank.

Highlights from the report:

  • RRR to pay insiders $460 million to buy zero new revenue. The $460-million price tag of the Fertitta Entertainment acquisition is 8.9 times the trailing-12-month management fee the firm receives from Station Casinos. The non-insider cost for acquiring Fertitta Entertainment should be closer to $52 million, not $460 million because its management agreement covering 13 of the 19 managed properties provides for a termination fee of 1x TTM management fee upon third-party sale of the properties. And existing Fertitta Entertainment executives and corporate employees will stay on and become directly employed by RRR. Moreover, Fertitta Entertainment, whose only existing business is to manage Station Casinos properties, will not generate any revenues after the acquisition, which effectively “internalizes” management. The planned $460-million payout follows payments of over $1.25 billion to the Fertittas and other company insiders over the past decade. If the Fertittas are confident in the future of Station Casinos, why aren’t they taking further equity in the company instead of cashing out?
  • RRR is letting insiders cash out substantial funds through the IPO instead of reducing debt, funding growth or simplifying risks. A Fidelity fund’s filing implies that it valued Station Casinos’ equity value at approximately $1.12 billion at the end of August. This means that the $460 million to be paid for Fertitta Entertainment would equal approximately 41% of RRR’s equity based on this value. Why are the Fertittas choosing to take the new IPO money out of the company rather than strengthen its financial condition or improve its growth prospects?
  • RRR is not planning to buy out Deutsche Bank as an owner, which poses licensing risks because Deutsche Bank has a criminal affiliate. Red Rock Resorts makes it clear that Deutsche Bank is not selling all of its 25% in the company. But RRR has not disclosed the bank’s recent and mounting regulatory problems: a bank subsidiary recently pled guilty to felony wire fraud, the bank itself paid a record $2.519 billion in fines to the U.S. Treasury and world financial regulators, and Deutsche is still under ongoing criminal investigations. These regulatory problems, which are not disclosed in the registration filings, could have implications for RRR shareholders because the company primarily operates in the highly regulated Nevada gaming industry.
  • RRR’s Class A shares will be second-class shares with negligible votes and unclear prospects for dividends. The company will remain controlled by the Fertittas after the IPO. While the family will sell a portion of their equity interest in the offering, they will enjoy 10:1 super voting rights for the foreseeable future, while new public shareholders’ prospects for dividends may be hamstrung by the company’s debt restrictions and tax-benefit obligations that limit Holdco’s ability to pay dividends to the new public company. Moreover, the cost of dual class shares was recently illustrated in hospitality when Marriott prevailed in a contest to acquire Starwood Hotels over a company whose shares had disparate voting rights.
  • How confident are RRR and its controlling shareholders in the company’s core Las Vegas locals business if they are selling valuable casino sites? The company has disclosed in its registration filings that it is selling potential casino sites in spite of the “legal limitations that restrict the development of additional off-Strip gaming properties.” Those sales listings, coupled with a substantial transfer of cash from the company to the Fertittas in this IPO beg the question: Do the Fertittas and the company they control have confidence in its core Las Vegas “locals” business, which provides over 90% of its net revenue?

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