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

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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%.

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(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.

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(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?

Fallow Land, Hollow Claims

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Red Rock Resorts has been talking up its Las Vegas development sites and master-planned expansions in its presentations to investors and SEC filings. However, after a review of local real estate listings and planning agency documents, we found development sites for sale and no approvals on file for some of the company’s master-planned expansions. We present our findings in a new report that you can download here.

Our report on Red Rock’s Las Vegas growth pipeline raises some important questions for investors:

  • Why does the company continue to describe the Cactus and Castaways parcels as “development sites” when they are listed for sale?
  • After over a decade of delays, what is the timeline to build out the Durango development site?
  • Does the company still see value in developing a resort hotel on the Flamingo site, which lies between Red Rock Casino and the Durango site?
  • When will the conditions of Inspirada’s master-planned community improve enough to warrant building a resort hotel?
  • When will the company submit plans for the new hotel tower and meeting space at Red Rock Resort or the meeting space expansion at Sunset Station?

See our report for more information from our review into RRR’s development sites and master-planned expansions.

Check out our map of existing properties and future casino development sites in Las Vegas, including those not controlled by RRR.

Why is Station Casinos Selling Valuable Casino Sites?

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See also: More growth questions about the Las Vegas locals gaming market.

In Red Rock Resorts’ most recent S-1/A, the company says it “control[s] approximately 398 acres of developable land comprised of seven strategically-located parcels in Las Vegas and Reno, Nevada, each of which is zoned for casino gaming and other commercial uses” (3/15/16 S-1/A, p. 116). The filing then lists seven such parcels: Durango/I-115 (70 acres), Wild Wild West/Viva (96 acres), Flamingo/I-215 (58 acres), Via Inspirada/Bicentennial Parkway (45 acres), Boulder Highway (30 acres), Mt. Rose Property (Reno) (88 acres), and South Virginia St/I-580 (Reno) (8 acres).

Two of these sites caught our eye, because they are actually on the market. There is no guarantee that IPO investors will be able to participate in any potential growth tied to these parcels, if they are soon sold off.

The large Mt. Rose site in Reno has been on the market since at least November 3 last year, less than a month after the company made its initial IPO filing on Oct 13.

A 25.5-acre portion of the company’s 30-acre Boulder Highway site in Las Vegas has also been on the market for a while. The parcel for sale is not itself entitled for gaming development, leaving a 5-acre rump for a future casino. The earliest listing we saw was from October 28.

It is unclear why Red Rock does not disclose in its prospectus that these two parcels are currently listed for sale. This lack of disclosure is all the more puzzling given that the company does say that another gaming-entitled parcel in its land bank is for sale – immediately after it lists off the seven parcels mentioned above: “We also own an additional development site in Las Vegas that is zoned for casino gaming and other commercial uses and which is currently for sale.”

This likely refers to what one might call the “Cactus/I-15 site”, which is located off the new Cactus Avenue ramp of I-15 south of the Las Vegas Strip. This parcel has also been on the market since at least October 28, and it is being sold “with a deed restriction precluding any gaming on entire site.” (Station Casinos had announced a “Cactus Station” project at this location back in November, 2008, before the highway exchange was built.)

Gaming-entitled land has been a scarce commodity since Nevada State Senate Bill 208 (“SB 208”) was enacted in 1997 to significantly limit the construction in large urban communities such as Las Vegas/Clark County and Reno/Washoe County. As Red Rock tells prospectus investors, one example of the ability of its “highly-experienced management team, led by the Fertitta family,” to create value has been their “capitalizing on the opportunity created by Nevada’s passage of SB 208 through a series of strategic acquisitions and new developments” (S-1/A, 3/15/16, p. 4). Furthermore, the company believes that “the development of new casino facilities will continue to be limited due to SB 208, which limited casino gaming in the Las Vegas valley to specified gaming districts and established more restrictive criteria for the creation of new gaming districts” (S-1/A, 3/15/16, p. 8). One would thus expect any large, gaming-entitled parcels – such as the ones the company has put on the market – to continue to be quite valuable.

Investors should ask Red Rock Resorts/Station Casinos and its IPO underwriters:

  • Why is the company selling valuable casino sites?
  • Where will growth come from if the company is selling off future casino sites?
  • Does the Fertitta-led management team not see value in these parcels?
  • Do they not see growth opportunities that can be realized by developing these sites?
  • Do the Fertittas and other executives of Red Rock have confidence in the company’s core Las Vegas locals business?

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

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: