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An Update on Station Casinos Valuation, as Implied by Fidelity Filings

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Last November, we noted that a Fidelity fund’s SEC filing implied that it valued Station Casinos’ equity at approximately $1.12 billion at the end of August. On January 28, the same Fidelity fund filed a new quarterly report and presented the values of its holdings as of November 30. The value of its Station Casinos stake dropped by over 5%.

Value as of 8/31/15Value as of 11/30/15Change
1,194,419 shares of Station Holdco LLC$4,384,000$4,157,000-5.2%

Source: Fidelity Puritan Trust Form N-CSR filed 10/28/15 and Form N-Q filed 1/28/16

The implied valuation of Station Casinos would have thus dropped to $1.06 billion at the end of November.

Fidelity, whose funds collectively own 8.7% of economic interest in Station Casinos, did not disclose its valuation methodology. A Fidelity spokesman did say in a statement to the Wall Street Journal last October that the firm has “a rigorous and thorough fair market valuation process for mutual fund holdings.”

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

The IPO Is Postponed, Per Deutsche Bank

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Deutsche Bank announced on January 28 that the Station Casinos (Red Rock Resorts) IPO had been postponed. According to Co-CEO John Cryan, the decision was made in the previous week “due to market conditions.” On January 21, Station Casinos CFO Marc Falcone had made a presentation of the company’s “$450 million of primary offering of shares” at a special meeting of the Nevada Gaming Control Board.”

Two questions come to mind:

1. Will the Fertitta family and other insiders seek other ways to fund the $460-million Fertitta Entertainment deal even before the IPO goes to market?

Last March, the company sought approval from holders of its $500 million bonds to issue another $300 million of bonds to fund a special distribution to its owners. It cancelled those plans by May for “off-the-record” reasons. In the third quarter last year, it paid distributions of $106.4 million to Station Casinos LLC members, which was more than the company’s EBITDA of $90.0 million in the quarter. According to CFO Marc Falcone’s comments at the Gaming Control Board meeting on January 21, the company currently has $350 million available under its revolving credit facility. Will the company tap the revolver to fund the Fertitta Entertainment acquisition or make other cash distributions to the owners now that the IPO is on hold?

2. Will the terms of the IPO be modified?

We have pointed out various issues with the way the public offering has been structured since it was first announced in October. See more of our analysis of the Red Rock Resorts/Station Casinos IPO:

We also sent a letter to the SEC on January 26 to draw attention to certain information missing from the prospectus filings by Red Rock Resorts.

We will keep you updated with more in-depth analysis of the Red Rock Resorts/Station Casinos IPO. Sign up for updates here or follow us on Twitter at @UHGamingRe.

The Tax Receivable Agreement of the Red Rock Resorts IPO

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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:

Do You Want to Be a Second-Class Shareholder of Red Rock Resorts?

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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:

Selling Growth While Cashing Out

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Read our updated report, “Selling Growth While Cashing Out”.

Is the Las Vegas locals market in decline? Data from the Nevada State Gaming Control Board show a continuing decline in the number of slot machines in the Las Vegas locals market since 2009. This is accompanied by a similar decline in the total amount wagered by customers in the locals market. Both total slot units and amounts wagered have declined to 2003 levels. Station Casinos derives “approximately 80% to 85%” of its gaming revenue coming from slot play.

Why is Red Rock Resorts selling hard-to-come-by casino sites? Historically, Station Casinos built its leading position in the Las Vegas locals gaming market by acquiring a portfolio of competing locals casinos and undeveloped land shielded from competition thanks to Nevada’s SB 208 legislation. The company touts its gaming-entitled land holdings in its IPO prospectus, but it has not disclosed that some of its casino sites are now on the market or explained why it is ceding some of its “highly desirable” and “strategically located” gaming-entitled locations in Las Vegas.

When will Red Rock Resorts grow again? Station Casinos has seen little growth in its core Las Vegas business over the last several years. Casino revenues from its properties in Las Vegas barely increased from 2009 to 2014, with a compound annual growth rate of only 0.07%. A significant portion of the company’s EBITDA growth over the past three years has come from its tribal casino management agreements, but the company has not signed a new tribal casino development agreement in over a decade.

Investors deserve better analysis of Las Vegas economic conditions. We reviewed how the company in its IPO filings describes certain of its own key metrics for understanding the Las Vegas economy and the potential for growth in the Las Vegas locals gaming market (e.g. average weekly wages and home value appreciation). When Station Casinos says that it believes the Las Vegas locals gaming market is one of the most attractive in the U.S. because of, among other things, “its strong economic and demographic fundamentals,” what is the company talking about? How confident is the company in its claims?

 

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:

Public Comments by UNITE HERE Culinary Local 226 at Nevada Gaming Commission Meeting on December 17, 2015

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In October of this year, Station Casinos filed registration documents with the SEC to take the company public. These filings make it clear that Deutsche Bank will hold both voting and economic rights in Station Casinos following the offering. You will soon have to review and decide whether to approve the company’s application for a public offering.

We have previously communicated our concern that it is dangerous to allow a parent company of a felon to go unlicensed while profiting from Nevada casinos and have asked the Board and Commission to call Deutsche Bank forward for a suitability review. Now that Deutsche Bank is set to own voting rights, we believe this only furthers the need for a suitability review.

In May 2011, the Gaming Commission approved the restructuring of Station Casinos without requiring Deutsche Bank to go through licensing despite its 25% ownership. At the time, Robert Cashell, Jr. was appointed by Deutsche Bank to hold its voting interests in Station Casinos. The Board and Commission made it clear that Deutsche Bank could not interfere with the management or voting rights of its at-will designee, Mr. Cashell.

Station Casinos’ IPO filings appear to demonstrate possible direction from Deutsche Bank. The board of Station Casinos Corp., including Mr. Cashell, has agreed to set limitations on executive compensation based on Deutsche Bank ownership. Specifically, management salaries cannot exceed 105% in the second post-IPO year as long as Deutsche Bank owns at least 5% of Class A shares.

Now that Deutsche Bank is set to own voting rights in Station Casinos through its subsidiary and given the question as to whether the bank may have exercised control over its at-will designee and whether Mr. Cashell may have not acted independently, we believe this only underscores the need to call the bank forward for a suitability review. We believe this should be done even before you formally consider Station Casinos’ application for a public offering.

(For more details, see our Dec.23 letter to Nevada Gaming Commission on Deutsche Bank’s Ownership of voting rights and interference in the proposed Station Casinos IPO.)

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

How much is Station Casinos worth?

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Last week, news broke that Fidelity, the mutual fund giant, had lowered its valuation of Snapchat Inc., the video messaging app company, by 25%. (See, for example, here, here, and here.)

The story got us thinking about how much Fidelity values Station Casinos LLC, of which it owns 8.7%. Fidelity’s valuation would provide a useful baseline for prospective investors in the Station Casinos IPO.

Here is what we found: a Fidelity fund’s filing implies that it valued Station Casinos’ equity at approximately $1.12 billion at the end of August.

  • Station Casinos LLC’s last 10-K, filed on 3/10/15, shows that Fidelity affiliates owned a total of 26,613,550 of Station Holdco LLC units, which constituted 8.7% of ownership interest in the company. This means there were approximately 305,902,874 Holdco LLC units overall.
  • The N-CSR filing by Fidelity Puritan Trust, filed on 10/28/15, shows that the Fidelity Puritan Fund valued 1,194,419 Station Holdco LLC units at $4.384 million on 8/31/15. This implies a valuation of $3.67 per Station Holdco LLC unit.
  • Total value of Station Holdco LLC units is therefore: $3.67 * 305,902,874 = $1,122,787,062.

Station Holdco LLC holds 100% of the economic equity interest in Station Casinos LLC. Therefore, Fidelity’s filing implies that it valued Station Casinos’ equity at approximately $1.12 billion at the end of August.

This also means that Deutsche Bank’s indirectly-owned 25% stake in Station Casinos is worth about $280.7 million.

Will Station Casinos be able to raise enough money through the IPO to buy out Deutsche Bank, whose regulatory troubles could have implications for new investors in the highly regulated gaming business, and pay $460 million to insiders to buy the company’s exclusive management company? (We will take a closer look at the value of the management firm, Fertitta Entertainment LLC, in a coming report.)

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