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The Tax Receivable Agreement of the Red Rock Resorts IPO

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:

The IPO and the Fertitta Entertainment Airplane

In September 2015, Fertitta Entertainment LLC, the entity that Station Casinos LLC is proposing to acquire for $460 million using Red Rock Resorts, Inc. IPO proceeds and additional debt, borrowed $30 million to buy “an asset.”  As the company says in its IPO filings, “Fertitta Entertainment entered into a $22.0 million secured promissory note and drew an additional $8.0 million under its revolving credit facility to finance an asset purchase.” The company has not disclosed the nature of the asset purchased.

Loan documents we have found show that Fertitta Entertainment bought a 2011 Bombardier Global Express jet in September with a $22 million loan from Guggenheim Aircraft Opportunity Master Fund LP.  The five-year loan from Guggenheim was made with a Fertitta Entertainment subsidiary, FE Aviation II LLC.

Deciding How to Pay $30 Million

Red Rock Resorts will at least pay off some of the financing used for the purchase.  According to the IPO filings, “All amounts outstanding under the [Fertitta Entertainment] Credit Facility are expected to be repaid, and the FE Credit Facility is expected to be terminated, upon consummation of the Fertitta Entertainment Acquisition.” Red Rock Resorts will therefore pay off at least the $8 million Fertitta Entertainment borrowed from its revolver to finance the private jet purchase.

What about the $22 million loan? The IPO filings do not make clear if the company will also pay off the $22 million loan Fertitta Entertainment took for the private jet.  What the filings do make clear is that paying off this $22 million loan will not be part of the $460-million purchase of Fertitta Entertainment.

Other than the date and the asset’s $30 million price tag, this is the extent of the details disclosed by the company about the $22 million loan: “The promissory note has a term of five years and requires Fertitta Entertainment to make monthly principal and interest payments. The promissory note bears interest at LIBOR plus 5.25% and contains a number of customary covenants and events of default.”

Meanwhile, the company states that, “an airplane will be transferred by Fertitta Entertainment to one or more of its members or their affiliates prior to the consummation of the Fertitta Entertainment Acquisition.”  No further details about this transfer are disclosed in the IPO filings.

53 Flights in One Month

The same month Fertitta Entertainment borrowed $30 million for a private jet, two other private jets owned by the Fertitta family made 53 flights in September alone.  Both private jets are registered through entities that list Frank J. Fertitta III, and Lorenzo J. Fertitta as managing officers (see here and here).  One private jet made thirteen round-trips between Las Vegas and southern California, and the other private jet made three round-trips between Las Vegas and Indiana, and also flew to Pennsylvania, Virginia, California, and New Mexico.

Red Rock Resorts, whose primary business lies in the Las Vegas locals market, claims “that one of [their] competitive strengths has been the ability of our highly experienced management team, led by the Fertitta family, to identify, develop and execute innovative and value-creating opportunities.”  The company has not disclosed what out-of-Las Vegas opportunities its owners might have been pursuing with their frequent travel.

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?

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

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?

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:

What is Red Rock Resorts, Inc.?

On Wednesday, the Nevada Gaming Control Board released the agenda for a special meeting to be held on January 21. A new company, Red Rock Resorts, Inc., will go before the board to seek approval for a public offering while becoming the sole manager and sole voting member of Station Casinos LLC. Yesterday, Red Rock Resorts, Inc. filed an S-1/A with the SEC.

Red Rock Resorts Inc. is the new name of Station Casinos Corp. and the vehicle for Station Casinos’ return to the public market. Station Casinos registered the domain nameredrockresortsinc.com”, but it does not currently direct to a live website. (The more obvious domain name for the company, “redrockresorts.com”, has been taken by someone else.)

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(Page image captured 1/15/2016)

In a related vein, Fertitta Entertainment LLC, which has managed Station Casinos properties since 2011, also seems lacking in terms of its online presence. Its website, at www.fertittaentertainment.com, which has been live since April, 2011, is still unfinished with dummy text on some pages. See herehere and here. Recall that Station Casinos LLC has agreed to buy the company for $460 million concurrent with the Station Casinos Corp. IPO. It is unclear from the related SEC filings so far whether the Fertitta Entertainment purchase will include the transfer of this website to Station Casinos.

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(Page image captured 1/15/2016)

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

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:

Our Response to SEC Request for Comment on the Effectiveness of Financial Disclosures about Entities Other than the Registrant

Read our full letter to the SEC here.

On Nov. 30, we sent a letter to the SEC in response to the commission’s request for comment on “Effectiveness of Financial Disclosures About Entities Other Than the Registrant”. We ask the Commission to consider three specific amendments to Rule 3-05. We have arrived at our suggestions after reviewing recent filings by Station Casinos LLC and Station Casinos Corp.

An excerpt from our letter:

We think investors would find it difficult to evaluate the proposed $460-million purchase price of Fertitta Entertainment LLC as neither registrant has provided historical financials of the target. The purchase agreement filed in an 8-K by Station Casinos LLC on Oct. 13 does not include any exhibits showing historical financials of Fertitta Entertainment. And these are not disclosed in Station Casinos Corp.’s IPO filings, including an S-1 filed on Oct. 13 and an S-1/A filed on Nov. 24, either.

Investors are thus left in a quandary: they cannot know whether the Fertitta Entertainment acquisition is “significant” because they do not have the necessary information to check the significance of the purchase using the tests provided for under Rule 3-05. They therefore cannot assess and evaluate whether the purchase of an affiliate under common control is a good one for Station Casinos LLC and its proposed new parent Station Casinos Corp.

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

How much is Station Casinos worth?

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: