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Withhold the Vote 2018: Failure to Sunset Perpetual Dual-Class Stock

We encourage Red Rock Resorts shareholders to withhold authority to vote on their proxy card for the company’s board of directors – Frank J. Fertitta III, Lorenzo J. Fertitta, Robert A. Cashell, Jr., Robert E. Lewis, and James E. Nave, D.V.M. – at the upcoming annual stockholders meeting on June 14.

The many problems arising from the company’s perpetual dual-class stock make it necessary for outside shareholders to withhold their votes, especially after the company has made no attempt to address the significant shareholder discontent expressed at last year’s annual meeting.

Perpetual dual-class shares trade at a significant discount, risk index exclusion, and are opposed by major shareholder advocacy groups.

Read our report, Withhold the Vote 2018: Failure to Sunset Perpetual Dual-Class Stock

Selected Results: 2017 Corporate Governance Survey of Red Rock Shareholders

Following shareholder discontent at Red Rock’s annual meeting this July, in which 9% to 16% of equity holders withheld from the directors, we decided to survey Red Rock investors about their corporate governance issues. The survey this year measured shareholder sentiment toward Red Rock’s takeover defenses and features of its board of directors. We believe these topics are particularly important following another year of strong M&A activity in the gaming industry.

Despite the dissatisfaction expressed by shareholders and the negative voting recommendations from Institutional Shareholder Services for Red Rock’s entire board of directors surrounding the 2017 annual meeting, the company has not announced plans to remove, sunset, or put to a vote its takeover defenses. Nor has the company done anything to resolve its problematic board structure, which ISS gave its highest governance risk rating of 10 (as of June 19, 2017).[i]

The results of our survey reveal shareholder respondents expressed consensus for a hybrid format for the annual general meeting, took issue with the dual-class capital structure and other takeover defenses, and shared their preference for a more diverse board, an independent board chair, and their doubt regarding shareholder representation on the board.

See the selected results of the corporate governance survey below:

supervoting

preferred-stock tra supermajority written-consent special-meetings agms board-diversity independent-chair shareholder-representation

Notes

[i] Institutional Shareholder Services, “Proxy Alert: Red Rock Resorts, Inc.,” June 19, 2017, original publication date June 16, 2017, p. 1.

Baron’s Sunk Cost Trap: Red Rock Resorts

Over the past year, Baron has been building a position in Red Rock Resorts, Inc. (NASDAQ: RRR) and is now the second largest outside investor, owning just over 10% of the publicly listed Class A shares of RRR. Red Rock’s shares have underperformed both the market and its peers, year-to-date. Baron’s efforts to double down on Red Rock’s stagnant stock suggest its stock pickers have fallen into a sunk cost trap, unwilling to recognize the opportunity cost they’ve incurred by putting millions more of their clients’ money in RRR over the past year.

Sunken Costs
Baron filed a 13G on October 10, 2017, announcing its 10.42% ownership of Red Rock Resorts, Inc.’s Class A shares outstanding.[i] Baron began developing its position in Red Rock following the latter’s IPO in April 2016. As early as June 30, 2016, Baron reported owning 3,605,258 (or approximately 8.7% at the time) of Red Rock’s Class A shares outstanding.[ii]

Baron’s stock pickers slowly increased the firm’s holdings in Red Rock through late 2016 and early 2017, with significant increases both in the 2Q17 (29% increase in number of shares since previous 13F) and in a 13G filed on October 10th, 2017 (28% increase) (Chart 1).[iii],[iv],[v] What value do Baron’s stock pickers see in a stagnant, underperforming security such as Red Rock?

Chart 1: RRR Share Price and Baron’s RRR Class A Ownership
171109_chart-1_bamco-rrr-ownership

Red Rock’s share price has underperformed the markets year-to-date. As of the closing prices on November 8, 2017, the NASDAQ composite index is up 24.0% and the S&P 500 is up 14.3%, while Red Rock’s share price has increased by 11.0%. On the other hand, Red Rock’s peers have significantly outperformed the markets year-to-date (Chart 2).

Chart 2: Share Price Performance of RRR and Industry Peers (YTD)
171108_yahoofinance_rrrpeers

Opportunity Cost
What would it look like if instead of sinking more money into Red Rock, Baron’s portfolio managers had chosen to invest in one of its peers? Baron’s reported ownership of 3,900,959 of Red Rock’s Class A shares as of December 31, 2016.[vi] The value of this number of shares at the start of 2017 was approximately $91 million.[vii] Baron’s decision to stay invested in Red Rock came with a significant opportunity cost (Table 1). If Baron had bought shares in any of these other gaming companies instead of Red Rock Resorts, it would have seen a sizable YTD gain instead of a negligible return from RRR Class A shares.

Table 1: Market Appreciation and Opportunity Cost YTD (through 11/8/17)

Company Share Price
YTD % change (through 11/8/17)
Potential Value
(as of 11/8/17)
Opportunity Cost
Eldorado Resorts 67.3% $152 mm $51 mm
Boyd Gaming 42.4% $130 mm $29 mm
Golden Entertainment 154.4% $232 mm $130 mm
Pinnacle Entertainment 81.6% $165 mm $64 mm
Penn National 91.1% $173 mm $73 mm

What makes Baron’s position in RRR even more interesting is that the firm has nearly doubled (82% increase) its ownership of Red Rock’s Class A shares from the beginning of the year until its latest filing on October 10, 2017.[viii],[ix]  Given the opportunity cost of its RRR investment, Baron’s stake will need to generate a much greater return than what can be expected from RRR’s current 12-month consensus price target of $28.50 for the firm’s position to make financial sense.[x] Whatever Baron’s internal price target for RRR might be, the firm must assume that RRR will greatly outpace its gaming peers over a reasonable investment period.

Baron’s fund managers should not be satisfied with seeing RRR reach $28.50 by the end of 2018, considering the much bigger returns it could have gotten if it had invested in one of its peers.

Notes
[i] BAMCO, Inc., SEC Form 13G, filed on October 10, 2017.
[ii] BAMCO, Inc., SEC Form 13F, Information Table, filed on August 14, 2016, as of June 30, 2016.
[iii] BAMCO, Inc., SEC Form 13F, Information Table, filed on May 15, 2017, as of March 31, 2017.
[iv] BAMCO, Inc., SEC Form 13F, Information Table, filed on August 14, 2017, as of June 30, 2017.
[v] BAMCO, Inc., SEC Form 13G, filed on October 10, 2017.
[vi] BAMCO, Inc., SEC Form 13F, Information Table, filed on February 14, 2017, as of December 31, 2016.
[vii] Red Rock’s opening share price on January 3, 2017 was $23.36.
Yahoo Finance, “Red Rock Resorts,” Historical Data, website, accessed on October 3, 2017. https://finance.yahoo.com/quote/RRR/history?p=RRR
[viii] BAMCO, Inc., SEC Form 13F, Information Table, filed on February 14, 2017, as of December 31, 2016.
[ix] BAMCO, Inc., SEC Form 13G, filed on October 10, 2017.
[x] Consensus Price Target as reported by NASDAQ’s website. Accessed on November 9, 2017. http://www.nasdaq.com/symbol/rrr/analyst-research

Opportunity Cost: The Case of Cohen & Steers’ Investment in Red Rock Resorts

Cohen & Steers, Inc. (NYSE: CNS) filed a Schedule 13G on December 12, 2016, announcing its beneficial ownership (at the time 15.94% of Class A shares) in Red Rock Resorts. This was an interesting move by Cohen & Steers, which is often praised as the “king of REITs”[i],[ii] and self-described as “pioneers in REIT investing.”[iii] The company has no other investments in the gaming industry besides the REIT Gaming and Leisure Properties.[iv] However, since Red Rock is not a REIT and has not announced any plans to convert its assets into a REIT, why did CNS take such a large stake in Red Rock and continue to hold on to it? Red Rock’s stock (the publicly-traded Class A shares) has struggled year-to-date compared to the market and its regional gaming peers. CNS investors should ask how long the firm is willing to wait for its bet on Red Rock to pay off.

Red Rock’s share price has underperformed the markets year-to-date. As of the closing prices on September 29, 2017, the NASDAQ composite index is up 19.7%, the S&P 500 is up 11.9%, and the Russell 2000 is up 9.8%, while Red Rock’s share price has declined by 0.86%. On the other hand, Red Rock’s peers have significantly outperformed the markets year-to-date (Table 1).

Table 1: Share Price % Change YTD (through 9/29/17)

Company or Index

Share price (1/3/17, open)

Share price (9/29/2017, close)

Year-to-date % change

Red Rock Resorts

$23.36

$23.16

-0.86%

Eldorado Resorts

$17.10

$25.65

50.0%

Boyd Gaming

$20.40

$26.05

27.7%

Golden Entertainment

$12.24

$24.38

99.2%

Pinnacle Entertainment

$14.65

$21.31

45.5%

Penn National

$13.90

$23.39

68.3%

Gaming and Leisure Prop (REIT)

$30.77

$36.89

19.9%

MGM Growth Properties (REIT)

$25.31

$30.21

19.4%

NASDAQ composite index

$5,425.62

$6,495.96

19.7%

Dow Jones Industrial Average

$19,872.86

$22,405.03

12.7%

S&P 500

$2,251.57

$2,519.36

11.9%

Russell 2000

$1,357.99

$1490.86

9.78%

Source: Yahoo Finance

Cohen & Steers’ 13G filed on December 12, 2016, shows the company owned 9,739,009 of Red Rock’s Class A shares. At the start of 2017, the value of these shares was approximately $228 million.[v] Red Rock’s share price has not appreciated year-to-date (through 3Q17). If Cohen & Steers had put this $228 million investment in nearly any other gaming company, including the two actual gaming REITs, it would have generated sizable returns for its investors and clients (Table 2). Holding onto Red Rock’s Class A shares had a significant opportunity cost for Cohen & Steers.

Table 2: Market Appreciation and Opportunity Cost YTD (through 9/29/17)

Company

Share Price
YTD % change (9/29/17)

Potential Value
(9/29/17)

Opportunity Costs

Eldorado Resorts

50.0%

$342 mm

$116 mm

Boyd Gaming

27.7%

$291 mm

$65 mm

Golden Entertainment

99.2%

$454 mm

$228 mm

Pinnacle Entertainment

45.5%

$332 mm

$106 mm

Penn National

68.3%

$384 mm

$158 mm

Gaming and Leisure Prop (REIT)

19.9%

$273 mm

$47 mm

MGM Growth Properties (REIT)

19.4%

$272 mm

$46 mm

Red Rock’s investment risks are very clear, such as its limited geography diversity, dependence on Las Vegas macro fundamentals, and its long-held but vacant land holdings with few shovel-ready development plans. In its S-1 filed on October 26, 2016, Red Rock states:

We depend on the Las Vegas locals and repeat visitor markets as our key markets, which subjects us to greater risks than a gaming company with more diverse operations.

Except for fees from its set-to-expire management contracts at Gun Lake and Graton ($111 million in 2016)[vi], Red Rock relies on the Las Vegas valley for all of its revenues. In 2016, 92% of the company’s consolidated net revenues were from its Las Vegas operations.[vii] This should be a red flag for investors skeptical about the Las Vegas locals market recovery. (A notable economist and gaming analyst recently cast doubt on the strong growth narrative surrounding the Las Vegas economy.[viii],[ix]) By comparison, Red Rock’s peers are much more geographically diverse (Table 3).

Table 3: Geographic Diversification of Gaming Companies

Company

U.S. States with Operations

Red Rock Resorts

1

Eldorado Resorts

10

Boyd Gaming

7

Golden Gaming

3

Pinnacle Entertainment

9

Penn National

16

*Management contracts excluded

Source: SEC filings and company websites

Red Rock is also the only company among its peers to have a dual-class capital structure – providing 10-to-1 super voting stock to the Fertitta insiders – as well as numerous other anti-shareholder provisions that have been the subject of governance alerts by Institutional Shareholder Services and the Council of Institutional Investors. Given the abundance of better performing securities in the gaming space, why did Cohen & Steers bet on Red Rock?

The decision by Cohen & Steers fund managers to invest in Red Rock comes at a time when active managers are facing increased pressure to both outperform their passive counterparts and reduce fees. Nearly $500 billion shifted from active to passive funds in the first half of 2017 and Morgan Stanley estimates that global asset managers’ revenue could drop as much as 30% by 2019.[x],[xi]  According to S&P Dow Jones Indices’ SPIVA® scorecard, actively-managed large-cap, mid-cap, and small-cap funds have underperformed their respective indices over the 1-, 3-, 5-, 10- and 15-year periods (Table 4).[xii]

Table 4: Percentage of U.S. Equity Funds Outperformed by Benchmarks

Fund Category Comparison Index

1-year

3-year 5-year 10-year

15-year

All Large-Cap Funds S&P 500

66.00

93.39 88.30 84.60

92.15

All Mid-Cap Funds S&P MidCap 400

89.37

94.21 89.95 96.03

95.40

All Small-Cap Funds S&P SmallCap 600

85.54

95.69 96.57 95.64

93.21

Source: S&P DJI, SPIVA U.S. Year-End 2016 report

 

Notes

[i] Larry Swedroe, “Cohen & Steers: The King Of REITs Poised To Provide Investors 42% Annualized Returns,” Seeking Alpha, May 15, 2014, https://seekingalpha.com/article/2218583-cohen-and-steers-the-king-of-reits-poised-to-provide-investors-42-percent-annualized-returns

[ii] Arturo Neto, “Cohen & Steers: King Of REITs Moving In The Right Direction But It Will Take Patience For The Big Payoff,” Seeking Alpha, September 16, 2014. https://seekingalpha.com/article/2497685-cohen-and-steers-king-of-reits-moving-in-the-right-direction-but-it-will-take-patience-for-the-big-payoff

[iii] Cohen & Steers, Inc., “About Us,” website, accessed on October 5, 2017. https://www.cohenandsteers.com/company

[iv] Cohen & Steers, Inc., SEC Form 13F, Information Table, filed on August 14, 2017. https://www.sec.gov/Archives/edgar/data/1284812/000114036117031503/xslForm13F_X01/form13fInfoTable.xml

[v] Cohen & Steers, Inc., SEC Form SC 13G, filed on December 12, 2016.

[vi] Red Rock Resorts, Inc., SEC Form 10-K, filed on March 13, 2017, p. 21.

[vii] Red Rock Resorts, Inc., SEC Form 10-K, filed on March 13, 2017, p. 48.

[viii] Wade Tyler Millward, “Southern Nevada economy still growing, UNLV economist says,” Las Vegas Review-Journal, June 13, 2017, https://www.reviewjournal.com/business/southern-nevada-economy-still-growing-unlv-economist-says/

[ix] Howard Jay Klein, “Boyd Gaming: Has It Expanded Its Locals Market Base At The Expense Of Bigger Possibilities,” Seeking Alpha, September 18, 2017, https://seekingalpha.com/article/4108010-boyd-gaming-expanded-locals-market-base-expense-bigger-possibilities

[x] Charles Stein, “Active vs. Passive Investing,” Bloomberg, July 6, 2017, https://www.bloomberg.com/quicktake/active-vs-passive-investing

[xi] Sarah Jones, “Asset Manager Revenue May Fall 30% by 2019, Morgan Stanley Says,” Bloomberg, March 17, 2017, https://www.bloomberg.com/news/articles/2017-03-17/asset-manager-revenues-could-slump-30-percent-by-2019-ms-says

[xii] S&P DJI, “SPIVA U.S. Year-End 2016,” report, April 12, 2017, p. 8, http://us.spindices.com/search/?ContentType=SPIVA

Outside Shareholders Dissent at Red Rock Resorts’ Annual Meeting

Outside shareholders of Red Rock Resorts demonstrated their dissatisfaction with the company’s directors at its July 6th meeting of stockholders, with the most opposition shown toward the independent directors.

Assuming all insiders voted their Class A and Class B shares in favor of management’s recommendation, then the total outside Class A shareholder vote “for” the directors was between 59% and 71%.[i] That means between 29% and 41% of outside shareholders did not vote “for” the company’s directors

Outside Class A Shareholder Support for Red Rock’s Directors

Director Outside Class A “For” Outside Class A “For” %
Frank J. Fertitta III 47,606,865 71%
Lorenzo Fertitta 46,912,406 70%
James E. Nave 40,389,581 60%
Robert E. Lewis 40,425,855 60%
Robert A. Cashell, Jr. 39,415,189 59%


Ernst & Young reports
that only 3.8% of Russell 3000 directors received less than 80% support from all shareholders (combined inside and outside) in 2017 (YTD, 5/31/2017). Therefore, a significant number of Red Rock’s outside shareholders expressed discontent with the entire board.

Alternatively, we can look directly at the “withhold” vote. Commenting on a 2012 study commissioned by the Investor Responsibility Research Center Institute, GMI’s Ratings director of research Kimberly Gladman said: “The average level of withheld votes in a director’s election is 5 percent; companies should be concerned when the level in an election exceeds 10 percent.”

To measure shareholder dissatisfaction this way at the recent Red Rock meeting, we reduce the super voting shares held by insiders to a one share, one vote standard. This adjusted votes figure more accurately reflects the desires of all equity holders, not just the Fertitta insiders. If all shareholders of Red Rock had equal voting rights and assuming no Class B shareholders withheld their votes, then the vote results show between 9% and 16% of shareholders withheld from the company’s directors.

Adjusted Votes Withheld from Red Rock’s Directors

Director Adjusted Votes Withheld Adjusted Votes Withheld %
Frank J. Fertitta III 10,593,246 9%
Lorenzo Fertitta 11,287,705 10%
James E. Nave 17,810,530 15%
Robert E. Lewis 17,774,256 15%
Robert A. Cashell, Jr. 18,784,922 16%

Red Rock’s closing share price on July 5th (the day before the annual meeting) was down 3.1% year-to-date compared with NASDAQ Composite Index’s gain of 13.3%. As of May 8th, Class A shareholders held 58.4% of the equity but only controlled 12.9% of the vote.[ii]

Read the letter and report we sent to Red Rock’s public investors, criticizing the company’s independent directors for anti-shareholder corporate governance measures and related-party transactions and encouraging investors to withhold votes from its independent directors.

ISS recommended withholding on all of the company’s directors, which we fully supported.

See table below for how we calculated inside, outside, and adjusted votes.

Inside and Outside Votes

Share Class Number of Shares Votes
Class A Shares Outstanding 67,778,152 67,778,152
Insider Class A Shares 516,326 516,326
Outside Class A Shares 67,261,826 67,261,826
Class B Shares Outstanding 48,327,396 456,799,632
Insider Class B Shares (1 vote per share) 2,941,592 2,941,592
Insider Class B Shares (10 votes per share) 45,385,804 453,858,040
Class A + B Outstanding 116,105,548 524,577,784
*Number of adjusted votes equals the number of Class A + B outstanding

[i] At the July 6th annual meeting, Richard Haskins, President of Red Rock Resorts, said as of record date (May 8, 2017) there were 67,778,152 Class A shares outstanding, 48,327,396 Class B shares outstanding, and 45,385,804 Class B shares with 10 votes per share. These figures were used to calculate the number of Class B shares with one vote per share, the voting power and equity of each class, and to estimate the number of insider and outsider “for” votes. The number of insider Class A shares comes from Red Rock’s DEFR14A, filed on May 26, 2017, p. 47.

[ii] See note i

Why It Is Necessary to Withhold Your Vote

In a new report we argue that it is necessary for Red Rock Resorts’ shareholders to withhold votes from the company’s three independent directors – James E. Nave, D.V.M., Robert E. Lewis, and Robert A. Cashell, Jr. – on their proxies for the company’s July 6, 2017 annual stockholders meeting.

Read our report encouraging shareholders to withhold votes on Red Rock’s independent directors.

We fully support ISS’ recommendation to withhold votes on all of Red Rock’s directors.

These long-serving directors have failed to advocate for the sunsetting of the company’s myriad of poor corporate governance features since its IPO last year, and they have not acted to prevent the enrichment of company insiders and related parties. We believe it is essential to send an unambiguous message to management that investors expect a higher standard of corporate governance at a publicly-traded company, especially now that outside shareholders own a majority of the economic interest in the company.

In taking the company public, Red Rock’s board of directors implemented several antitakeover measures, including a dual-class ownership structure with 10:1 super voting stock for insiders.

Red Rock’s three independent directors are the sole members of its Nominating and Corporate Governance Committee, which is responsible for monitoring the company’s governance matters. Furthermore, Red Rock’s independent directors have a history of approving transactions that are not in the best interest of the company or its outside shareholders.

For these reasons, we encourage Red Rock’s Class A shareholders to withhold their votes from the elections from Directors Nave, Lewis, and Cashell at the company’s upcoming annual meeting of stockholders.

Red Rock Corrects Violation of Securities Law in Proxy Statement

On June 8, 2017, we sent a letter to the SEC regarding Red Rock Resorts proxy statement filed on May 1, 2017 and its amended proxy statement filed on May 26, 2017. We noticed that Red Rock did not provide shareholders with the ability to withhold votes on its director elections even though the company uses a plurality voting system.

Under 17 C.F.R. § 240.14a-4(b)(2), a proxy that provides for the election of directors must provide means for security holders to withhold authority to vote for each nominee.  The proxy may do so by providing: (1) a box indicating that authority to vote is withheld; (2) an instruction that indicates a vote may be withheld by striking out the name of any nominee; (3) a blank space in which the voter may enter the names of nominees for whom votes are withheld; or (4) any similar means, provided that clear instructions are provided about how to withhold authority.

By not providing shareholders with the ability to withhold votes, the company was effectively preventing investors from registering their dissatisfaction with director nominees.

On June 16, 2017, Red Rock filed an amended proxy statement that corrected the voting options by providing shareholders with the ability to withhold their authority to vote.

The Myth of the Las Vegas Locals Market Recovery

Red Rock Resorts is heavily dependent on the health of the Las Vegas locals gaming market. In this report, we examine key gaming metrics in the Las Vegas locals market – going beyond simple measures of gaming revenue – in order to gauge the company’s potential to grow back up to the peak levels of 2007.

We challenge the myth that growth in the Las Vegas locals market will lead to recovery of the 2007 heights anytime soon. As we focus on slot handle and slot payout trends, we find there is little increase in slot handle while higher gaming revenue has come from tighter slots.

What we see is that the slot handle has been increasing at a slow pace in the Las Vegas locals market. From January 2012 to January 2017, slot handle in the locals market increased by only 1.88% with a CAGR of 0.37%. These monthly handle numbers show a relatively stagnant market with little growth.

In contrast, the monthly handle numbers leading up to the Las Vegas locals market’s historic peak in 2007 paint a very different picture. From January 2002 to January 2007, monthly handle increased by 33.8% with a CAGR of 5.99%.  As of March 2017, total slot handle in the Las Vegas locals market was down 20.6% from its historic peak in March 2007.

Las Vegas Locals Market Handle Increase CAGR
Run up to peak (Jan 2002 – Jan 2007) 33.8% 5.99%
Current (Jan 2012 – Jan 2017) 1.88% 0.37%

Our analysis of historical slot handle and win percent numbers for the Las Vegas locals market shows that one reason for the increases in gaming revenue in the Las Vegas locals market (and the myth about the locals market recovery), is tighter slot machines. Investors should ask management when Red Rock will be able to grow to pre-recession levels of business in this stagnant and saturated Las Vegas locals market.

Read Part I: How Will Red Rock Grow in a Saturated and Stagnant Market?

Read Part II: The Myth of the Las Vegas Locals Market Recovery 

 

(Picture source: https://commons.wikimedia.org/wiki/File:Sandro_Botticelli_021.jpg)

Why is Red Rock Resorts’ Share Price Underperforming the Market and Its Peers?

Why is Red Rock Resorts’ Share Price Underperforming the Market and Its Peers?

In the first quarter of 2017, Red Rock Resorts’ Class A share price declined by 7% while the S&P 500 index went up by 4.65%.

rrrvsp500-1q17

(Source: Yahoo Finance)

RRR’s share price dropped while other regional gaming operators’ share prices rose in the quarter:

rrrvregionals-1q17

(Source: Yahoo Finance)

What explains this significant underperformance of RRR stock? We believe investors are likely concerned with the Palms acquisition and the uncertainty in the company’s growth pipeline:

Is the Palms acquisition meeting management expectation?

When the $316-million Palms acquisition was first announced last May, the company said that “[f]actoring in anticipated synergies, the Company estimates that the Palms will generate $35 million in EBITDA during the Company’s first full year of ownership.” Is the company on track to meet this goal?

When Station Casinos officially took ownership of the Palms on Oct. 1, Michael Jerlecki, who had been the general manager of Palace Station, became the resort’s GM. However, Jerlecki was replaced by Anthony Faranca by early February without any public announcement from the company. (The new GM is mentioned in passing in a local columnist’s write-up on new assistant manager Jon Gray.) We do know from the company’s recently filed 10-K that Palms had a net pretax loss of $1.3 million in the fourth quarter on net revenues of $38.5 million.

Given these numbers, investors might wonder whether the Palms is on track to make $35 million in EBITDA through September 30 this year. While the company did not provide property-level breakout of Palms’ EBITDA for the fourth quarter, investors should demand greater clarity going forward so they can better understand whether the expensive, debt-financed purchase is paying off as management had anticipated.

What happened to the Palms Place hotel rooms?

The company’s 10-K shows there were 713 hotel rooms at the Palms, but makes no mention of the condo-hotel units at Palms Place. Back in September, the company’s investor presentation showed that, at Palms, in addition to 713 rooms across two hotel towers, there were “approximately 448” condo units at the stand-alone Palms Place tower in the “room rental program, pursuant to which the Company receives 50% of the room rate and 100% of the resort fee on any such rentals.”

What happened to these 448 hotel units at Palms Place? They would account for about 39% of total available hotel units at the company’s new acquisition. The 10-K does not say anything about this Palms Place condo-hotel program. Has the company decided not to manage Palms Place’s hotel pool anymore? If so, how might that affect the goal of making $35 million in EBITDA at the Palms through September 30?

Why is no one adding significant capacity in the Las Vegas locals market?

We recently took a closer look at the company’s new development pipeline in Las Vegas and found little that was “shovel ready.” Given the lack of discussion on this issue during the analyst call, we believe some further questions are warranted.

For example, when will the company tell investors more about the planned second hotel tower at Palace Station, which received planning approval in September? The planned tower is absent from the discussion of the on-going $115-million “upgrade” of Palace Station in the company’s latest investor presentation from March 20.

While the company continues to tout its “Existing Development Sites” in Las Vegas such as “Durango” and “Viva” in its March presentation, it has not announced any concrete plans to build out those sites. Moreover, there are ten “Gaming Enterprise Districts” in the Las Vegas Valley which are not owned or controlled by Station Casinos.

non-rrr_geds

(See our interactive map of casinos and casino sites in the Las Vegas locals market.)

The existence of these non-Station future casino sites should make investors skeptical of any claims of barriers of entry to the Las Vegas locals market. Moreover, if the Las Vegas locals market is growing significantly, why have these other developers not seen fit to build out new Las Vegas locals casinos?

What will happen in the company’s tribal casino management segment in 2021?

Outside of Las Vegas, there are looming challenges in the company’s tribal casino segment. Its two existing management agreements expire in February, 2018, and November, 2020, respectively. The company estimates that its only other tribal casino project will require another 36 to 48 months to begin construction and 18 months after construction begins to complete and open.

This means the earliest opening date would fall around September, 2021, and that the company most likely will not have a tribal casino management fee revenue stream in 2021. To be clear, the tribal casino management segment accounted for 7.6% of the company’s net revenues and 18.0% of adjusted EBITDA in 2016.

It should be noted that the company’s $225-million Term Loan A and $685-million Term Loan B both mature in June 2021, and its $500 million of 7.5% senior notes are due March 1, 2021. That is a total of approximately $1.4 billion of debt coming due when the company will likely not have any tribal casino management revenue. Will the company be able to roll over that debt given this potential lack of tribal casino management revenue in 2021?

Fidelity Would Have Valued Station Casinos at $9.19 at the End of January

If Fidelity bond funds valued Station Casinos at an estimated $9.19 per share at the end of January, what will Fidelity equity funds value the company at if they decide to participate in the upcoming Red Rock Resorts IPO?

As a result of Station Casinos’ Chapter 11 bankruptcy reorganization in 2011, Fidelity owns approximately 8.7% economic interest in the gaming company in the form of Station Holdco LLC units held by several of its bond funds. These funds disclose the value of their Station Holdco holdings regularly.

Most recently, 22,418,968 Hold LLC units in the Fidelity Capital and Income Fund (FAGIX) were given a value of $78.018 million as of 1/31/16 in a 3/30/16 N-Q filing.

Using the same methodology as before, we estimate that this implies a valuation of Station Casinos’ equity at approximately $1.06 billion, which would translate to about $9.19 per share based on the fully-diluted number of shares outstanding of Red Rock. That is, Fidelity would have valued Red Rock at $9.19 at the end of January.

What valuation will Fidelity give Red Rock if the mutual fund giant decides to participate in the IPO, which has an offering price range of $18 to $21 per share? Will Fidelity ask itself, internally, how Station Casinos could have doubled in value in less than three months?