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Why did UBS start lending to Fertittas and stop lending to Red Rock? [updated]

Note: Since publishing this article on February 8, 2021, we discovered the financing statement for the UBS loan to the Fertittas was terminated on March 23, 2020.  Notwithstanding, the pledge and margin loan were still identified as in effect in Red Rock’s April 22, 2020 Form DEF 14A. We have updated to reflect this new information. 3/10/2021

The controlling owners of Red Rock Resorts Inc. (NASDAQ: RRR), Frank Fertitta III and Lorenzo Fertitta, pledged six million or 13% of Class B Red Rock shares to UBS AG in September 2018 for a margin loan worth up to an estimated $155 million.

In February 2019, Red Rock disclosed the termination of a $50 million UBS commitment that had been identified as in effect in its Form 10-Q for the quarter ending September 30, 2017.  In February 2020, it disclosed the termination of an $18.5 million commitment that had been identified as in effect in an amended credit agreement dated February 8, 2019.

On March 23, 2020, the financing statement for the UBS loan to the Fertittas was terminated. But the pledge and the margin loan were identified as in effect in Red Rock’s April 22, 2020 Form DEF 14A.

Why did UBS end up by lending to the Fertittas personally but not to the public-traded company they controlled? And what caused the Fertittas to take on the margin loan in the first place? Why did UBS terminate the financing statement for the margin loan on March 23, 2020?

[See our letter to the SEC and Nasdaq requesting a closer look at pledged shares at Red Rock here.]

Red Rock has not explained what prompted the changed relationship with UBS. And why the Fertittas secured liquidity through a margin loan is also of potential interest to public shareholders given the Fertitta’s control of Red Rock.

On one hand there appears to be cash, lots of it. The Fertittas reportedly cleared $870 million each in the 2016 sale of the Ultimate Fighting Championship, and in August 2020 spent $74 million to purchase five million Red Rock shares (see here, here, here, here and here).

On the other hand, they have borrowed money—$64 million from a related party to buy Red Rock shares in August 2019—and, between one or the other of them, they have acquired a number of luxury assets:  two superyachts, a support yacht, and a penthouse near Manhattan’s Central Park.

Two Fertitta yachts have been delivered since 2018, with a third on its way: the 285-foot Lonian ($160 million estimated); the 217-foot Hodor support yacht ($55 million estimated); and the 308-foot Viva (due in 2021).

Two helicopters share the initials of Frank and Lorenzo Fertitta and the Las Vegas area code (N702FF, N702LF) and are owned by entities that share the superyacht names (Viva Eagle LLC, Lonian Raven LLC).

Hodor Holdings Limited is named as a secured party in an August 2017 financing statement related to the construction of an “equipped submersible” by Seamagine Hydroscape Corporation. Hodor Holdings, Ltd.’s address is identified as the same Las Vegas address as Fertittas Enterprises, Inc.

UBS promotes its securities-backed loans as useful for purchasing yachts, among other things.  But as it stands, Red Rock investors have no basis to know what the loan proceeds were used for.

Red Rock’s securities pledging policy, a summary of which was first disclosed in April 2020, does not appear to cap pledging even though it requires certain insiders to “pre-clear” transactions in company securities.

Moreover, it is not clear which persons would review and approve such “pre-clearances.” And Red Rock has not disclosed whether the 2018 margin loan transaction was subject to the current policy.

Investors are in the dark about the details of pledged shares at Red Rock. They deserve sufficient information to decide whether such pledges benefit the company.

Amidst chaos at Palms, Fertittas’ UBS margin loan collateral fell 38%

The now-closed KAOS day/nightclub at Palms was canceling shows the same month shares in Palms’ parent company Red Rock Resorts hit their lowest since the company’s IPO. When in that same month Red Rock controlling owners Frank and Lorenzo Fertitta borrowed $64 million from a related party to fund the purchase of 3.4 million Class A shares in the company (see here, here and here), some claimed the purchases were a show of confidence in the company.

But that is not all that happened in August.

Almost a year prior to these transactions, Frank and Lorenzo Fertitta pledged 6 million Class B shares in Red Rock to secure a margin loan from UBS AG in September 2018 (see UCC here). We estimate the loan was up to $155 million, assuming the ability to borrow 95% of the pledged share value and that the Class B shares were valued the same as Class A shares.

At the time of loan’s filing on September 27, 2018, RRR’s Class A shares traded at about $27.21. When the company’s stock price dropped to $16.76 per share on August 7 this year, the value of the Fertittas’ Class B share collateral for the margin loan would have lost over 38% of its value.

While RRR has not disclosed why the Fertittas needed the UBS margin loan in the fall last year, UBS promotes its securities-backed loans as useful for purchasing yachts, among other things.

Since the UBS loan to the Fertittas, two of the three new Fertitta yachts have launched. Lorenzo Fertitta’s 285-foot Lonian (estimated cost of $160 million) was ready to launch one month prior to the UBS loan, the 216-foot “crazy custom catamaran” Hodor launched in February, 2019, and the 308-foot Viva (Feadship project 817) is scheduled to launch for 2020.

Fertitta Capital’s sports betting deal highlights disclosure dilemma at Red Rock Resorts

Investors in Red Rock Resorts (NASDAQ: RRR) lack the necessary information to know if they lost a business opportunity to Fertitta Capital, the investment firm founded in 2017 and run by Red Rock Resorts controlling owners, according to letters sent by the Culinary Union to the U.S. Securities Exchange Commission (SEC) and NASDAQ Stock Market.

See press release here.

In the letters to regulators (available here), the Culinary Union asks for a determination if potential conflicts of interest for those with dual roles at Red Rock Resorts’ and Fertitta Capital should be disclosed to investors, and questions whether Fertitta Capital’s investment in The Action Network, a sports betting media company, means the family firm receives opportunities owed to shareholders and now competes with Red Rock Resorts’ sports betting business.

To date, Red Rock Resorts has not informed investors that its principals, brothers Frank and Lorenzo Fertitta, and its Senior Vice President of Government Relations, Michael Britt, have dual roles at a firm whose business interests are similar to Red Rock Resorts, including in gaming, sports betting, leisure, live events, wellness, and food and beverage. The company’s proxy statement, released this week on April 29, makes no mention of Fertitta Capital at all.

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?