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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?

 

More Growth Questions about the Las Vegas Locals Gaming Market

Station Casinos has not entered any commercial gaming market outside of Nevada since it had to leave Missouri in 2000, while the gaming industry has expanded into many more new states since then. If investors seek a gaming company that can expand into multiple commercial markets outside of Las Vegas, be sure to ask Red Rock management what happened in Missouri. Station also aborted its online gaming venture within 2 years. But for tribal gaming, Station has been landlocked in Nevada.

All of these facts seem to warrant the classic warning for prospective investors: Do you want to put all your eggs in one gaming basket?

There has been little growth in overall gaming revenue in the Las Vegas locals gaming market since 2009. And Station Casinos has not noticeably gained market share.

Download our new report on growth questions about the Las Vegas locals market here.

Marc Falcone, Red Rock’s CFO, told the Nevada Gaming Control Board in January 2016 that

I do think we are encouraged by the backdrop of the economy. We do expect to experience additional growth. We think we are in the early stages of recovery, particularly in the locals business, and we are enthusiastic and excited about the backdrop, what we see economically and how that can translate into further growth across all revenue categories in our business today.

Yet economic data from federal agencies and gaming data from the Gaming Control Board suggest the current recovery in the Las Vegas area is moving slower than a previous post-recession recovery.

According to the National Bureau of Economic Research, there have been two recessions so far in the 21st century: one in 2001 and another that ended in June 2009. Four years after the first recession, Station Casinos opened its Red Rock Casino Resort & Spa.  Four years after the second recession, Station Casinos’ founding family is cashing out $460 million through the Red Rock Resorts IPO.

Comparing Recoveries in Las Vegas Economy

Post-Recession Growth Population ↑ Average Weekly Wages ↑ Number Employed ↑
2002 – 2006 22.3% 19.2% 24.5%
2011 – 2015 9.4% (through Aug.) 3.6% (through 3Q15) 13.5% (through 3Q15)

Recovery after the 2001 recession meant that, from 2002 to 2006, the population of the Las Vegas Valley grew by 22.3%, the average weekly wages of Clark County residents grew by 19.2%, and the total number of employed Clark County residents grew by 24.5%.  During the current recovery, from 2011 to 2015, the population of the Las Vegas Valley grew by 9.4%, the average weekly wages of Clark County residents grew by 3.6%, and the total number of employed Clark County residents grew by 13.5%.

Post-Recession CAGR Population ↑ Average Weekly Wages ↑ Number Employed ↑
2002 – 2006 5.2% 4.6% 5.6%
2011 – 2015 2.3% (through Aug) 0.3% (through 3Q15) 3.2% (through 3Q15)

Another way to compare these two sets of indicators would be to look at the growth rates.  Following the 2001 recession the population grew at a compound annual rate of 5.2% and the number of people employed grew at a compound annual rate of 5.6%.  In the four years after the more recent recession, not only did wages grow at a slower rate, but Las Vegas area population and the number of people employed grew at compound annual rate of 2.3% and 3.2%, respectively.

Recoveries and Tighter Slots in Las Vegas Locals Market

Post-Recession Growth Slot Unit Count Slot Handle Slot Handle
Avg Monthly Growth
Dec. 2002 – Dec. 2006 18.7% 36.2% $19.8 million
Dec. 2011 – Dec. 2015 11.5% ↑  1.1% $0.66 million


In the Las Vegas locals gaming market, from December 2002 to December 2006, slot unit count grew by 18.7%, while slot handle climbed by 36.2% at an average of $19.8 million per month over the four-year period. In the current era, from December 2011 to December 2015, slot unit count declined by 11.5%, while slot handle climbed by 1.1% at an average of $660,000 per month.

Furthermore, we identify a potential limit to the current recovery in terms of the slot win percentage, i.e., how tight the slots are.  From December 2011 to December 2015, total slot revenue amount grew 23.5%, while the slot unit count declined and slot handle was stagnant.  This growth in market-wide gaming revenue was made possible because slots got tighter.  Overall slot win rates (by the house) in the market went from 4.39% in December 2011 to 5.36% in December 2015, while slot win per unit per day rose 40%, from $75 per unit per day in December 2011 to $105 per unit per day in December 2015.

Growing casino revenue through tighter slots has its limits.  The addition of more slot units, by comparison, indicates confidence in expanding demand.  As noted in a previous report, when casino operators see their customers spend more on slots, they put more slots out on the floor.  This was the case between 2004 and 2006 when slot wagers in the locals market rose by 20%, and owners added 7,343 slots to the market.

If the Las Vegas locals market has reached an inflection point and is about to take off, why is Red Rock selling its specially zoned casino development sites? You have no doubt read in the prospectus and heard from the company that Station Casinos has taken advantage of a Nevada law that restricts new neighborhood casinos from being developed and has bought up the only available future casino sites so that they “own and control” their own destiny. So why are they selling some of these sites now? Is it a reflection of what those economic numbers could be telling them about the future of their core business?

 


“Too-Big-To-Regulate”

We recently sent a letter to Nevada Governor Brian Sandoval  to provide the governor with “specific examples of problems related to the approval of the Station Casinos/Red Rock Resorts IPO by the Nevada Gaming Commission on January 21, 2016 in order to illustrate the challenges Nevada faces in regulating a ‘too-big-to-regulate’ significant owner of one of the major gaming companies in Las Vegas.”

The entire letter can be viewed here.

In the letter, we discuss the rushed nature of the approval of the IPO by the Gaming Control Board and Nevada Gaming Commission, Deutsche Bank’s accountability as the parent company and affiliate of a felon, federal regulators’ reactions to the bank’s misconduct, and the relationship between the bank and its designated director at Station Casinos, Mr. Robert A. Cashell, Jr. We also ask whether Nevada’s gaming regulators are too permissive toward “too-big-to-regulator” investors.

Our letter concludes with the following:

We cannot help but worry that Nevada gaming regulators appear unwilling to confront head-on the admittedly complex issues related to a “too-big-to-regulate” investor like Deutsche Bank, which is affiliated with a felon. We are fearful that this apparent unwillingness on the part of our state regulators might invite unwelcome scrutiny from federal officials, especially as federal regulators and investigators continue to work to hold Deutsche Bank accountable for its actions. Some might even begin to question whether Nevada is capable of upholding the “gold standard” of gaming industry regulation when our regulators continue to look the other way and refuse to ask hard questions about why the affiliate of a felon continues to own and profit from casinos in our state.

The entire letter can be viewed here.


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

The IPO Is Postponed, Per Deutsche Bank

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.