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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.

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?

Questions about the Palms Acquisition

When will Red Rock disclose the Palms purchase agreement?

Since the May 10 press release announcing the acquisition, Red Rock has not filed the definitive purchase agreement with the SEC yet. Investors should be able to review and evaluate the details of this significant transaction, which, at $312.5 million, cost nearly 70% of the company’s 2015 Adjusted EBITDA ($451 million) and is expected to be financed with new debt.

What will Red Rock have to do to bump up Palms’ EBITDA by 25% in one year?

Back in May, Red Rock management stated that they expect the Palms to generate “over $35 million” in EBITDA in the first full year of ownership by Red Rock. At the same time, they say the property’s EBITDA run rate is at “approximately 60% below its peak level.”

The Palms reportedly had EBITDA of about $70 million before the Great Recession, according to Debtwire/Financial Times. If one assumes that was the peak, then “60% below peak” would imply current annual EBITDA of about $28 million. Will Red Rock be able to expand Palms’ EBITDA by 25% (to $35 million) during its first full year of ownership? What kind of revenue growth and/or cost cutting will be required to achieve such a large increase in EBITDA in one year?

Will “Palms Station” cannibalize Palace Station?

Also back in May, Red Rock management described Palms as being “located in one of our most underpenetrated areas in the Las Vegas Valley from a boarding pass member standpoint.”

But the Palms is only 2.3 miles away from Red Rock’s Palace Station, and if you draw a five-mile-radius circle around each of these two properties, there is a 71% overlap between the two circles. How will the company ensure that its efforts to grow the business of Palms will not come at the expense of Palace Station?

 

How Will Red Rock Grow in a Saturated and Stagnant Market?

In its IPO prospectus, Red Rock Resorts (NASDAQ: RRR) told investors two important pieces of information about its Las Vegas business:

  1. “Our Las Vegas properties are broadly distributed throughout the market and easily accessible, with over 90% of the Las Vegas population located within five miles of one of our gaming facilities.”
  2. “[W]e estimate that nearly half of the adult population of the Las Vegas metropolitan area are members of our Boarding Pass program and have visited one or more of our properties during the year ended December 31, 2015.”

(Check out our interactive map of “Station Casinos and the Las Vegas Regional Market“)

While these numbers may sound impressive, they also appear to leave little room for growth with respect to the company’s Las Vegas locals business. It is difficult to envision significant revenue bumps from building or acquiring more properties to cover the 10% of the population not currently living within a five-mile radius of an RRR property. In addition, if the company’s estimate is right a nd nearly half of the adult population in Las Vegas are members of its player rewards program, RRR will find difficulty signing up new locals since  a recent survey tells us that only slightly over half of the adult population gambles (see section below on “Local gaming behaviors”).

The flip side of the company’s saturation of the locals market means growth in its core Las Vegas business would have to come from significant increases in (1) the population of Las Vegas and/or (2) customer spending per capita. In this report, we examine available data to assess the likelihood of either happening. Our conclusion: facing low population growth and a decline in locals’ gaming behaviors, RRR is unlikely to experience much, if any, upside in its core Las Vegas locals business, which accounted for 92% of its net revenues and 89% of its adjusted EBITDA in the first quarter of 2016.

Las Vegas population trends

The Las Vegas metropolitan area has shown some growth in population over the past five years, in spite of a slight dip in 2011. However, what we are seeing now does not compare to the significant population growth Las Vegas experienced during the early to mid-2000s. Moreover, Las Vegas is unlikely to see the same kind of population boom like it did in the 2000s, according to expert projections.

From 2010 to 2015, the Las Vegas population grew 5.46% (Figure 1), compared to 26.5% population growth from 2002 to 2007 (Figure 2).

160802_RRRIPOdissected_fig1

160802_RRRIPOdissected_fig2

Annual population growth from 2010 to 2015 averaged 1.2% with a peak of 2.7% in 2013. From 2002 to 2007, annual growth averaged more than 4 times higher at 4.9% with a peak of 6.4% in 2004.

This kind of population explosion is not likely to return, according to projections by experts. Population forecasts show low, single-digit growth for the Las Vegas metropolitan area. The Nevada State Demographer’s Office predicts 0.9% annual growth rates or lower for 2017 through 2033 and UNLV’s Center for Business and Economic Research (CBER) estimates annual growth rates of 1.7% and lower from 2017 through 2050 (Table 1).

160802_RRRIPOdissected_tab1

With little population growth ahead, the Las Vegas locals market looks like a mature market that is unlikely to expand significantly. As 90% of the existing population already lives within five miles of one of the RRR properties, growth in the company’s core Las Vegas business would need to come from more customer visits and greater customer spending, not population expansion.

Local gaming behaviors

A useful source of information to gauge the health and growth potential of the Las Vegas locals market is the Clark County Residents Study commissioned by the Las Vegas Convention and Visitors Authority (LVCVA). These biennial studies are conducted with a random sample of 1,200 local participants and provide useful insights into locals’ gaming behavior and their overall entertainment spending patterns.

A comparison of the 2006 and 2014 Resident Study shows a significant decline in locals’ gaming activity, frequency, and budgets (Table 2).

160802_RRRIPOdissected_tab2

As we noted earlier, almost half (46%) of Las Vegas residents did not gamble in 2014, a percentage that rose significantly from the one-third (33%) who said they did not gamble back in 2006. In addition, how locals rank gambling among both their most frequent and favorite leisure activities, how often people gamble, and how much they budget for gambling are down across the board. These declining gauges of locals’ gaming behavior are consistent with what we have observed in the stagnant slot handle for the Las Vegas locals market, which we described in a previous report.

Since locals are gambling less and population growth is slow going forward, it is unclear how Red Rock can grow its core Las Vegas business.

 

Download this report

More Questions about the $460-Million Valuation of Fertitta Entertainment

A key feature of the Red Rock IPO is the use of proceeds, plus additional debt, to acquire Fertitta Entertainment for $460 million in a related-party transaction. Investors should ask the company how it arrived at and agreed to this price.

First of all, here is some perspective on the price tag of this insider deal. $460 million equals:

  • 93% of the estimated IPO net proceeds of $495.9 million (assuming the mid-point of the offering price range and that the underwriters do not exercise their options to purchase additional shares)
  • 20% of the IPO valuation of Station Casinos’ equity of $2.26 billion (with the same assumptions as above)
  • 8.7 times Fertitta Entertainment’s 2015 management fee revenue from Station Casinos
  • 31 times Fertitta Entertainment’s 2015 pro forma EBITDA of $14.8 million (which we calculated by comparing the financials of the consolidated Station Holdco LLC and Station Casinos)

In addition, we believe prospective investors should ask Red Rock management the following questions:

  • Is Red Rock projecting $34 million of incremental annual EBITDA and therefore only $18 million in annual corporate expenses on a going-forward basis after buying Fertitta Entertainment and internalizing management?
  • If yes, does that projection include potential equity-based compensation expenses?
  • And what is the plan to keep corporate expenses at $18 million a year for 13.5 years?

Even though the company’s IPO prospectus filings do not describe any specific financial benefits of the Fertitta Entertainment acquisition, Red Rock management explained the valuation basis of the Fertitta Entertainment deal what they presented to Nevada gaming regulators on January 21. During the special meeting of the Nevada Gaming Control Board meeting to approve the IPO, CFO Marc Falcone said:

With the transaction and the acquisition of Fertitta Entertainment, we actually improve, EBITDA will go up by $34 million, approximately. So we are basically taking the management fees that were historically paid to Fertitta Entertainment, those now will remain within Red Rock Resorts, Inc., and Station Casinos LLC. We are also adding back some expenses that related to salaries and wages for the employees that are currently employed at the Fertitta Entertainment level that will now be employed at the Station Casinos LLC level [emphasis added].*

That is, the company believes that internalizing Fertitta Entertainment would lead to incremental annual EBITDA of $34 million because that’s the amount it would “save” by (1) not paying out management fees ($52 million in 2015) anymore but (2) paying corporate expenses covering its executives and corporate employees directly, who are currently employed and paid by Fertitta Entertainment. If $34 million incremental EBITDA is the basis for the $460 million price, a 13.5x multiple was used. It thus appears the company has agreed to transfer 13.5 years of potential EBITDA “savings” as an immediate lump-sum cash payment to the owners of Fertitta Entertainment as part of the IPO.

Mr. Falcone’s statement implies that the company is expecting to pay only $18 million a year in corporate expenses going forward ($52 million minus $34 million). Is $18 million in corporate expenses a realistic number for a company the size of Red Rock/Station Casinos?

Let’s consider what Station Casinos used to do when it was a publicly-traded company. In the last three full years when it was a publicly-traded company before the disastrous insider-led leveraged buyout of 2007, the company paid on average about 4.9% of its net revenues out as corporate expenses.

($ millions) 2004 2005 2006
Net revenues $986.7 $1,108.8 $1,339.0
Corporate expenses $47.2 $57.6 $63.1
Corporate expenses as % of net revenues 4.8% 5.2% 4.7%

In 2015, Station Casinos had net revenues of $1.35 billion. If it had paid its own corporate expenses at a level like it used to during the three-period listed above, it would have spent $61 million in corporate expenses. We believe it would be unrealistic to expect to pay only $18 million in corporate expenses after Red Rock internalizes Fertitta Entertainment.

Another concern investors should be aware of is how the company accounts for equity-based compensation. According to section 3.08 of the disclosure schedule of the execution copy of the Fertitta Entertainment purchase agreement (filed as Exhibit 10.10 in Red Rock’s 2/12/16 S-1/A):

With respect to [Fertitta Entertainment LLC’s] consolidated financial statements for the years ended December 31, 2012, 2013 and 2014 and for the six months ended June 30, 2015, the Company did not record share-based compensation expense associated with equity incentives issued to current and former executives of the Company from FI Station Investor LLC.  FI Station Investor LLC is an entity that is owned by the parent entities of the Company.  Pursuant to GAAP, this non-cash share-based compensation is required to be recorded as a component of the Company’s statement of operations since these executives were employees of the Company and FI Station Investor LLC is a common-controlled entity of the Company’s equity holders.  The Company’s auditor, Ernst & Young LLP, has determined that each of the foregoing financial statements would require to be restated and has withdrawn its opinions for each audit period that are dated March 25, 2015, May 14, 2014, April 16, 2013 and May 15, 2012, respectively.

This disclosure should lead investors to ask whether Station Casinos has an accurate handle on historical, current and projected costs of equity-based compensation, which could be an expensive component of cost for any company. (We have sent a letter to the SEC asking some other questions based on this disclosure, too.)

* The transcript of the Jan. 21, 2016, special meeting of the Nevada Gaming Control Board can be ordered by calling Sunshine Litigation Services at 775-323-3411. The quote is from pp. 32-33.


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

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: