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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?

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?

 


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?