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The $460-Million Fertitta Entertainment “Internalization Fee”

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See our follow-up post, “More Questions about the $460-Million Valuation of Fertitta Entertainment”.

Based on the company’s presentation at the Nevada gaming regulators’ meeting on Jan. 21, Red Rock Resorts’ acquisition of Fertitta Entertainment is to be understood as the internalization of an external manager. How does the $460-million Fertitta Entertainment “internalization fee” compare to those commonly found in REIT internalization transactions?

REIT internalization fee from 1997 to 2013Fertitta Entertainment internalization fee
As % of acquirer equity2.7% – 10%43.0%
As % of acquirer’s invested capital0.9% – 6.0%14.4%
As multiple of manager’s TTM EBITDA2.9x – 14.0xNA

The historical REIT internalization fee figures in the table above are from a September 2014, study of REIT internalization fees by Sherry Cefali and Nick Tarditti of Duff & Phelps, which shows the range of REIT external manager valuations from 1997 to 2013.

The $460-million Fertitta Entertainment internalization fee is much higher compared to these figures:

Three more observations:

  1. The internalization fee will be paid entirely in cash instead of equity or a combination of cash and equity. Red Rock will pay the $460 million “internalization fee” entirely in cash instead of equity or a combination of equity and cash as has been done in the REIT sector. For example, common shares were used in January 2016 to finalize the internalization of management of Starwood Waypoint Residential Trust, merging them with Colony American Homes inside the larger company known Colony Starwood Homes.
  1. Some REITs have internalized external managers with no fee. The Duff & Phelps study excludes transactions with no internalization fees. While some REITs have been criticized for large internalization fees, some “have stopped paying their management companies any money to bring them in-house.” In 2008, Healthcare Trust of America was one of the first to “transition into a self-managed company without an internalization fee” and many have followed suit. Philips Edison – ARC Shopping Center REIT waived the internalization fee of its external managers in 2010, and Chamber Street Properties “internalized its management structure, with no separate fee paid” in 2012 before announcing its IPO in 2013.
  1. The non-insider cost for acquiring Fertitta Entertainment should be closer to $50 million, not $460 million, based on termination provisions in the casino management agreements. The $460 price tag is 8.9x the $51.7 million trailing-twelve-month management fee Fertitta Entertainment received from Station Casinos as of September 30, 2015. According to the Fertitta Entertainment management agreement covering 13 of the 19 Station Casinos properties, termination of the agreement upon sale of the managed properties to a third party would only cost Station Casinos a fee equal to the trailing-twelve-month management fee. See Exhibit “D” Financial Terms of this management agreement, which can be found as Exhibit 10.21 of Station Casinos LLC’s 10-K, filed 3/10/15.

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

What is the Red Rock Resorts IPO?

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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: