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Red Rock Resorts’ deficient board diversity claims [updated]

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Updated: Red Rock Resorts Inc. disclosed a revised diversity policy on April 26, 2022. Based on those changes, Red Rock Resorts seems to make the goal of diversifying the Board even harder to reach. In the revised policy, Red Rock Resorts stated that, while it is open to recruiting diverse candidates, it would continue to evaluate the benefits of adding new Board members against the additional costs and impact on efficiency that may result from a larger Board—a consideration that it had not stated in its prior policy. See those revisions here and the 2022 policy here. We originally published the content below on January 31, 2022.

Red Rock is the only one of the nine publicly traded Nevada-based casino gaming companies with zero women on its board of directors. Its five-person board has been the same white men since its 2015 IPO and its justification to shareholders for its board composition relies on deficient claims.

See our letter to the SEC about Red Rock’s deficient board diversity claims here here.

In the Corporate Governance – Diversity section in its 2020 and 2021 proxy filings, Red Rock tells investors that it considers gender among its diversity characteristics and then explains that:

“Gaming regulatory agencies in certain of the jurisdictions in which we operate may require our directors to maintain licenses. The licensing process is onerous, invasive, time consuming and expensive. Because of this, it is difficult to identify well-qualified candidates willing to subject themselves, as well as their families, to the rigorous and intrusive process necessary to obtain a gaming license. As a result of the limited pool of potential directors and the strong qualifications of our present Board, we believe that the current composition of our Board is in the best interest of the Company. We remain continuously open to recruiting well-qualified diverse candidates to our Board.”

There isn’t a limited pool of potential directors for Nevada-based gaming companies

There are several indicators that suggest there is not a limited pool of potential directors for Nevada-based gaming companies. Every publicly traded Nevada-based casino gaming company except Red Rock has at least one woman serving as a director, amounting to 20 out of 76 directors, or 26%, with half of them joining these boards since 2018 [1].

Nationally, women now make up 30% of all directors in the S&P 500, which is up from 28% last year and 16% a decade ago. And in the Russell 3000 index, women of all races account for 27 percent of all directors, up from 24 percent.

The pool of female directors for Nevada casino gaming companies appears to be no smaller than national averages so it is concerning Red Rock justifies its board composition through the problematic idea that if only there were a larger pool of candidates then the Board might look different.

[CHART JANUARY 27, 2022]

A gaming license is not a justifiable obstacle to board diversity

Red Rock’s claims about board diversity also rely on the problematic assumption that the pool of potential directors is too small because of the gaming license process. The gaming license process is not a justifiable obstacle to board diversity, as evidenced by the presence of women on the boards of every publicly traded Nevada-based gaming company except Red Rock.

In fact, at least in Nevada, the licensing process should present no obstacle. Nevada gaming regulation 16.415 does not require licensing of every director of a publicly traded corporation, only of directors who are actively and directly engaged in the administration or supervision of gaming activities. The regulation identifies the board chair and chair of the audit committee as among the directors who must normally be licensed.

Meaning Red Rock can elevate directors to the Board without their undergoing the rigors of the licensing process where they do not require licensing.

Red Rock has an obligation to assess the effectiveness of its diversity policy

Red Rock shareholders deserve to know whether the Company’s diversity policy is effective or not. SEC rule 229.407(c)(2)(vi) states that “if the nominating committee (or the board) has a policy with regard to the consideration of diversity in identifying director nominees, describe how this policy is implemented, as well as how the nominating committee (or the board) assesses the effectiveness of its policy.”

So, what does Red Rock mean when it states in its diversity policy that “we remain continuously open to recruiting well-qualified diverse candidates to our Board”?

Red Rock’s three independent directors, Mr. Robert Cashell Jr., Mr. Robert Lewis, and Mr. James Nave, have been on the Red Rock board since its IPO, comprise the Nominating and Corporate Governance Committee, and were board members of Red Rock’s predecessor company since 2011.

What can the Company disclose to back up the claim that the recruitment of diverse candidates is active and ongoing?

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NOTE 1:

COMPANY DIRECTOR YEAR JOINED
Full House Resorts Inc. 1 Kathleen M. Marshall 2007
Golden Entertainment Inc. 2 Ann N. Dozier 2019
Monarch Casino & Resort Inc. 3 Yvette Landau 2010
Las Vegas Sands Corp. 4 Micheline Chau 2014
5 Nora M. Jordan 2021
6 Yibling Mao 2021
Caesars Entertainment Inc. 7 Bonnie Biumi 2020
8 Jan Jones Blackhurst 2019
9 Sandra Douglass Morgan 2021
Boyd Gaming Corp. 10 Marianne Boyd Johnson 1990
11 Christine J. Spadafor 2009
12 Veronica Wilson 2003
MGM Resorts International 13 Mary Chris Jammet 2014
14 Alexis M. Herman 2002
15 Rose McKinney-James 2005
16 Jan Swartz 2018
Wynn Resorts Ltd. 17 Betsy S. Atkins 2018
18 Patricia Mulroy 2015
19 Margaret J. “Dee Dee” Myers 2018
20 Winifred “Wendy” Webb 2018

Red Rock Resorts Public Shareholders Vote for Change

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Submitted by the New York State Common Retirement Fund and co-filed by SEIU Pension Plans Master Trust, Proposal 4 at Red Rock Resorts’ most recent annual meeting asked the board of directors to take steps to eliminate the company’s dual-class share structure. We argued that there were good reasons to support the proposal. Now, despite the proposal’s defeat, we assess that approximately 87% of the publically-held (non-insider) shares that were voted were cast in favor of it.

From the April 22 proxy filing, we estimate that the company’s named executive officers and directors, including controlling owners Frank and Lorenzo Fertitta, had approximately 464.4 million votes thanks to the fact that each of the approximately 45.4 million B shares owned by the Fertittas was entitled to 10 votes. Assuming all the insiders voted against Proposal 4, approximately 6.7 million votes controlled by public holders were cast against the proposal, while more than 43.7 million votes were cast for it. (See the official tally here.) This means that 86.7% of the publically-held shares that were voted were cast in support of the proposal to change and improve the company’s corporate governance.

Proposal 4 Voting Results by Publically-Held Shares

Votes Percentages
FOR 43,758,349 86.7%
AGAINST 7,309,136 13.3%

This is the second time in three years public shareholders of Red Rock Resorts have voted to support a shareholder proposal to improve corporate governance. In 2019, CalPERS submitted a proposal to adopt majority voting for director elections (“Red Rock’s All-White, All-Male Board Draws Calpers’ Attention”, Bloomberg, 6/5/2019). We calculate that CalPERS’ proposal was supported by approximately 83.3% of the publically-held shares that were voted. Nevertheless, the company has not changed its plurality voting standard for director elections.

While Red Rock Resorts traces its history to the founding of Bingo Palace (which later became Palace Station), it cannot hold on to an anachronistic view of itself as a family business and continue to deny public investors a fair say in corporate governance. Red Rock Resorts can do better, and public shareholders of Red Rock Resorts deserve better. It should listen to public shareholders and adopt majority voting for directors and take steps to eliminate the dual-class share structure.

Three Reasons to Eliminate Red Rock’s Dual-class Voting Structure

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Lagging Performance

Since Red Rock Resorts went public 5 years ago, its Class A share price has underperformed its peers and the market.

As of 5/26/21, RRR’s Class A shares have gained 116.61% over a 5-year period. Over the same timeframe, the share prices of other regional gaming operators Golden Entertainment, Inc. (GDEN), Boyd Gaming Corp. (BYD), Monarch Casino & Resort, Inc. (MCRI), and Penn National Gaming, Inc. (PENN) share prices went up 231.16%, 243.55%, 241.32%, and 463.43%, respectively. The NASDAQ also went up 180.27.91% over the same period.

Doing away with the dual-class share structure would be a good first step toward maximizing the value of Class A shares of Red Rock Resorts. In the words of a recent Wall Street analyst report: “RRR’s dual-class share structure is suboptimal for most investors and has historically been an impediment to valuation optimization.” (1)

An Entrenched Board

Two years ago, CalPERS raised the issue of board diversity with Red Rock. See Red Rock’s All-White, All-Male Board Draws Calpers’ Attention (Bloomberg, June 2019). At the time, Red Rock said “because the casino business requires an extensive licensing process for board members,” it is “difficult to find qualified candidates.”

Two years later, Red Rock continues to nominate the same five white men to its board and again blames the gaming licensing process for making it difficult to find diverse candidates in this year’s proxy. The company, however, fails to mention that other public-traded Nevada gaming companies have all somehow managed to seat women on their boards.

Doing away with the dual-class share structure is a smart step toward reforming an entrenched, all-white, all-male board at Red Rock Resorts.

Greater Transparency

Family office investments and share pledging by Red Rock’s controlling insiders raise questions about potential conflicts of interest.

Red Rock’s chairman and vice-chair, Frank and Lorenzo Fertitta, have dual roles at Fertitta Capital, their family office founded in 2017 that has overlapping business interests with Red Rock in gaming, sports, betting, leisure, wellness, and food and beverage.

In 2019, Fertitta Capital led a $17.5 million funding round for a sports betting media company, The Action Network.  It remains unclear if Red Rock’s board vetted the deal and whether the family firm receives opportunities owed to shareholders and now competes with Red Rock.

Also, Frank and Lorenzo Fertitta pledged six million or 13% of Class B shares in Red Rock in September 2018 for a margin loan worth up to an estimated $155 million from UBS AG, a bank that was a lender to Red Rock but stopped doing so. The loan pledges appear no longer to be in effect.

To date, Red Rock has not made any disclosures about Fertitta Capital, nor has it explained why UBS started lending to company insiders and stopped lending to the company.

Doing away with the dual-class share structure is a smart step toward transparency and fully protecting Red Rock from potential conflicts of interest.

(1) J.P. Morgan, “Red Rock Resorts: Takeaways from Investor Meetings. Story Still Has Legs. Reaffirm Overweight. PT to $48 (+$1),” North America Equity Research, p. 6 (May 14, 2021).

Why did UBS start lending to Fertittas and stop lending to Red Rock? [updated 4.28.21]

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Note: On 3/10/21, we published the following update: “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.” Now we can report that there is no pledge and margin loan identified as in effect in Red Rock’s April 22, 2021 Form DEF 14A. We have updated the report to reflect this new information. 4/28/2021.

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. No pledge and margin loan are identified as in effect in Red Rock’s April 22, 2021 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 delivered in 2021: the 285-foot Lonian ($160 million estimated); the 217-foot Hodor support yacht ($55 million estimated); and the 308-foot Viva ($175 million estimated).

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%

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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

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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?

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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?