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November 23, 2009

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Study: Move to take Station Casinos private was fair

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Justin M. Bowen

The Palace Station resort in Las Vegas.

By Steve Green (contact)

Published Wednesday, Sept. 23, 2009 | 11:09 a.m.

Updated Wednesday, Sept. 23, 2009 | 2:43 p.m.

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A study commissioned by Station Casinos Inc. has found the company's $5.7 billion going-private transaction in 2007 was fair and reasonable at the time and didn't include fraudulent or inequitable provisions.

The report, filed in Station's bankruptcy case Tuesday, will likely be used by the company to fend off requests by certain creditors that the deal be further examined to see whether it involved circumstances that may now benefit certain lenders and creditors at the expense of others.

The report will also likely be scrutinized by lenders critical of the company.

Among other things, they have been asking why Station doesn't sell some of its assets so it can satisfy some creditors' claims.

They are also asking why Station hasn't asked the bankruptcy court to modify a deal in which the company essentially pays $250 million per year to lease from itself four of its most valuable hotel-casinos: Red Rock Resort, Sunset Station, Boulder Station and Palace Station.

With much of the rental money earmarked for payments on a $2.475 billion mortgage, the dissenting lenders say the rental payment should be revised downward to reflect today's economic environment that has reduced the value of the mortgage's hotel-casino collateral.

The Special Litigation Committee of the Station board of directors said in its report that:

--The company was not insolvent at the time of the 2007 transaction and did not become insolvent because of the deal, the company was not left with unreasonably small capital and Station did not intend or expect to take on debt beyond its ability to pay.

--It found no evidence or indication that any party intended to defraud any creditor or that any party engaged in inequitable conduct.

--Its hired experts specifically investigated whether financial projections concerning the deal were aggressive or unduly optimistic and found they were not.

The Special Litigation Committee was formed March 31 in anticipation of questions and potential litigation concerning the 2007 buyout. The committee was authorized to investigate potential fraudulent transfer claims and other potential claims related to the going-private deal. The committee is represented by independent legal counsel and an independent financial advisor.

The committee said it and its advisors reviewed thousands of pages of documents and e-mails and interviewed 19 people including Station executives, investors and third parties including auditors, legal advisors and financial advisors.

The committee found Station's founding Fertitta family, its partner in the buyout, Colony Capital; and other participants in the deal "had a good faith belief that the transaction would succeed and that the company would enjoy continued growth."

"Unfortunately for the many parties affected, the transaction was not successful," the committee said.

"Rather than any misconduct or inherent problem with the transaction or the company's business, the committee believes that the ultimate failure of the transaction can most directly be explained by the severe, rapid and unanticipated deterioration of the local, national and global economies following the closing of the transaction," the committee said.

The committee said Station, in discussing the proposed buyout, had forecast earnings before interest, taxes, depreciation and amortization of $664.6 million in 2007 and $749.6 million in 2008. But as the recession got under way and results were trending about 10 percent below its forecast, it reduced its projection by a corresponding amount.

The company did not meet the revised projections, but the special litigation committee concluded they were reasonable when made.

The bulk of the 88-page report analyzes whether the buyout involved fraudulent transfers, including transactions that can be voided or challenged "as constructively fraudulent because the company received less than reasonably equivalent value in exchange."

In analyzing whether fraudulent transfers were made, the report noted the buyout resulted in today's Station Casinos: a complex maze of corporate entities with various financial obligations. The report stated that based on case law, the formalities of the corporate structure would likely be disregarded in buyout lawsuits and that it would instead be analyzed based on its total economic effect.

The bottom line, using that analysis, is that the deal encumbered the company with an additional $1.6 billion in debt and those funds were part of the $4.2 billion paid to shareholders, the report found.

Under this analysis, the committee reported some findings that critics may try to capitalize on.

"The net effect of the transaction was that the company incurred approximately $1.6 billion of additional interest-bearing debt without the company receiving a corresponding direct economic benefit," the report said.

"While this might seem like an over-simplification of the many separate events that made up the transaction, the committee believes that it reflects a prudent approach to the consideration of potential claims concerning a challenged LBO (leveraged buyout) transaction.

"The committee concluded that Station Casinos cannot be considered to have received reasonably equivalent value for the approximately $3.7 billion of transfers by or on behalf of Station Casinos to ... (certain) shareholders because Station Casinos itself received no value from the redemption of its stock. The committee did not conclude that the redemption of stock in connection with the transaction was inherently improper, only that Station Casinos did not receive reasonably equivalent value from it."

While not addressed in the report, Station financial records show that part of the value of the transaction was reflected in an increase in the value of its goodwill and intangible assets from $155 million to $3.9 billion.

But after the takeover and the recession set in, during the fourth quarter of 2008, the company took $3.34 billion in non-cash impairment charges to write down certain portions of its goodwill, intangible assets, investments in joint ventures and land held for development to their fair value.

Goodwill and other intangible assets are accounting measures that enable companies to reflect the value of their brands and businesses in terms of producing future cash flow.

Despite its reasonably equivalent value findings, the committee suggested potential fraudulent transfer claims would involve "fact-intensive inquiries" that would significantly add to the time and expense of any litigation.

"In this case, while some claims challenging the transaction might require resolution of issues of fact and may survive a motion to dismiss, the committee does not believe the claims have a meaningful likelihood of success on the merits," the report said.

"The committee believes that it is appropriate to state the committee’s conclusion that litigation challenging the transaction would be protracted, extremely costly and could significantly delay or disrupt the reorganization process," the report said.

The committee recommended that the company not bring litigation on its behalf against anyone over the going-private deal and that it "oppose any request by creditors or others that they be authorized to bring the claims on behalf of the company’s bankruptcy estate."

Station has previously disclosed the committee was investigating potential "derivative claims," in which a company sues -- or is forced to sue -- its own directors and officers for mismanagement. Three such shareholder lawsuits proposing that Las Vegas Sands Corp. sue its directors are pending in Clark County District Court.

The report noted Deutsche Bank, a key Station lender, declined a request that a participant in the going-private deal be interviewed by the committee's experts for the study.

The litigation committee's report reviewed the circumstances of the going-private transaction:

--Shareholders were paid $4.2 billion under the deal at $90 per share. That included nearly $294 million paid to members of the Fertitta family for some of their shares and options.

--Some $1.4 billion in debt was paid off.

--Some $130 million in buyout fees were paid.

--The Fertittas contributed more than $720 million in equity in the form of stock.

--Colony Capital contributed $2.7 billion in cash and equity.

--The deal left Station with $5.285 billion in debt, including old debt of $2.3 billion. The new debt included $510 million from a senior secured credit facility and the $2.475 billion mortgage encumbering the four hotel-casinos.

Counsel for the litigation committee have asked Station's bankruptcy judge to allow them to brief the court on the report during a Sept. 30 status hearing.

With the economic downturn sharply reducing revenue at its locals casinos, Station defaulted on debt obligations earlier this year and on July 28 filed for bankruptcy reorganization. Its hotels and casinos remain open.

For the quarter ended June 30, it said revenue of $267.2 million was down from $339.1 million one year ago; and that it lost $65.3 million vs. a profit of $18.6 million one year earlier.

Discussion: 16 comments so far…

  1. By bdover
    9/23/09 at 11:37 a.m.
    Suggest removal

    Gee, what a surprise. Hiring a company to review your shady dealings is like asking your Mother in Law what she thinks of her daughter. Funny the bank didn't want to get involved either. Maybe they're too busy sneaking around Lake Las Vegas, another smell test boondoggle.

  2. By tvegas
    9/23/09 at 12:01 p.m.
    Suggest removal

    Got to admit these guys have chutzpah.

  3. By burnemandturnem
    9/23/09 at 1:52 p.m.
    Suggest removal

    The unspeakable arrogance and avarice of the Fertittas makes one's skin crawl. Of course this deal was rotten from the start and as this winds its way through the court everyone will see it for what it is: a case of greed making people stupid!!

  4. By ddwest
    9/23/09 at 2:47 p.m.
    Suggest removal

    bdover - don't be ignorant. Hindsight is always perfectly clear and 20/20. Being a Monday morning quarterback is the easiest job in the world. If you had a problem with the deal, you should have spoken up then. The truth of the matter is in 2007, the gaming industry was booming and the company had something like 25 consecutive quarters of cash flow growth so the cash flow growth supported the deal but the economy started to turn which no one forecasted. If the deal was shady as well, the Fertittas would not have left $900 million in stock in the deal to make it work because they certainly could have cashed it out at the closing price of the transaction. You need to get your facts straight before you make stupid off-handed comments.

  5. By chazbean
    9/23/09 at 3:38 p.m.
    Suggest removal

    I agree with bdover this is not an INDEPENDENT report. The only people making money are the Attorneys and Accountants.

  6. By CynicalObserver
    9/23/09 at 3:47 p.m.
    Suggest removal

    Comment Part 1:

    I cannot comment on the merits report described in the story above, because I have not read it. However, it is fair to say that prior to the serious crash of the economy which occurred on the Friday to Monday period ending with Lehman Brothers bankruptcy filing on September 15, 2008, leveraged buy out transactions like the Stations deal occurred all the time, for at least 15 years.

    The general principle under which all debt buyers (i.e. bond buyers, mezzanine loan lenders, mortgage lenders, and line of credit lenders) bought their loans was "Buyer beware. You need to read all of the relevant documents and if you buy a piece of this debt, you are stuck with it."

    That is the principle the U.S. Supreme Court followed in not stopping the bankruptcy court's sale of Chrysler to a partnership composed of Fiat, the UAW Health and Welfare Fund and the U.S. and Canadian governments, despite the whining of Chrysler's unsecured bond holders which included Indiana State Pension funds.

    So the bottom line from the point of the "sophisticated business community" and legal community is that if you buy a piece of a loan or a corporate bond, you are stuck with the consequences of the whole financing structure, as long as no outright fraud, i.e hiding of material factual information from the underwriters who organized the bond deal or the loan deal were involved.

    A corollary to that principle was and always had been, if you are so stupid as to buy a bond or a piece of a loan you don't fully understand, don't buy it. If you do buy it, that's your problem.

    The problem with those general principles is that there is a law on the books in most states, including Nevada, called the Uniform Fraudulent Transfer Act. Now that the recession/near depression has occurred, lawyers are starting to realize that it is badly written, allowing unpaid creditors to attack these big deals as including "illegal transfers", based on a hind sight look at the numbers, even though there was nothing wrong with the complex financing deal when it closed.

  7. By CynicalObserver
    9/23/09 at 3:48 p.m.
    Suggest removal

    Comment Part 2:

    The creditors in the Mervyn's bankruptcy case are using that law to sue Target, which spun off and sold Mervyn's as well as two groups: the group who bought Mervyn's buildings (now occupied by Kohl's in many cases) and the group who bought Mervyn's operating business which leased those buildings. Mervyn's creditors want to unwind that deal, get the money back from Target, take the Mervyn's buildings away from the group that bought them, and lump those recoveries into the Mervyn's bankruptcy for redistribution to all creditors. The case hasn't gone far enough to allow anyone to judge whether this sort of "unwind the leveraged buy out" under the Uniform Fraudulent Transfer Act will actually work in bankruptcy court.

    Essentially, what this report on behalf of the Station Casinos, Inc. Litigation Committee is, is a prove up that at the time the leveraged buy out deal was made, there was nothing extra ordinary about it.

    However, it's tough for such a committee or its consultants to prove a negative, i.e. that no fraud on the underwriters occurred. That's why the Bankruptcy Code pretty well guarantees that if creditors demand the appointment of an "independent" Examiner, to look for pre-bankruptcy fraud, misconduct by people running a Chapter 11 debtor, or self-dealing by those people, the bankruptcy court judge is obligated to appoint the Examiner, as long as the creditor who wants the Examiner appointed is willing to pay for it. So no one should be shocked if an Examiner is appointed in the Stations case, because it is the creditor's right to have one appointed.

    That's why Station Casinos is trying, in effect, to create new case law saying "No examiner is needed" and have the judge refuse to appoint the examiner. I don't think that argument will fly. However, the Examiner will have to read this report and take it into consideration in writing his own report to the bankruptcy judge.

    It is also important to point out that in my own personal experience, I have never seen a bankruptcy court Examiner who wasn't biased towards the person paying him. So, that's another reason Colony Capital and the Fertittas probably don't want the Examiner.

  8. By CynicalObserver
    9/23/09 at 3:51 p.m.
    Suggest removal

    Comment Part 3:

    There are three steps after an Examiner issues his written report. Stations gets to rebut it, in writing, filed with the judge. The judge will decide whether or not to take management of Stations away from its current owners and appoint a Chapter 11 Trustee (my guess no). Regardless of the outcome of those first two steps, Stations angry creditors will be able to file a lawsuit against Colony Capital and the Fertittas under the Uniform Fraudulent Transfer Act, and other laws, if the creditors' lawyers think the information the Examiner found merits filing that lawsuit. Filing such a lawsuit won't mean winning such a lawsuit. However, creditors who sue, and their lawyers, relying on such an Examiner's report will largely be free for liability for malicious prosecution if they lose their lawsuit.

    Bottom line: There is a very long road for all participants in the Stations Casinos case to follow before Colony Capital and the Fertittas are found to have done anything unlawful. I still strongly believe in the presumption of innocence under our Constitution, and that people should not be convicted of wrongdoing by the press or by internet pundits.

  9. By vc
    9/23/09 at 4:14 p.m.
    Suggest removal

    This report is worth less than the paper its written on.

  10. By belinda
    9/23/09 at 4:26 p.m.
    Suggest removal

    I generally agree with CynicalObserver, except in this case serious questions surround how Stations handled the "old debt" of $2.3 billion referenced above. As the article notes, "the deal left Station with $5.285 billion in debt, including old debt of $2.3 billion...[t]he new debt included $510 million from a senior secured credit facility and the $2.475 billion mortgage encumbering the four hotel-casinos." Stations borrowed the "old debt" in 2004, when it was financing Red Rock Station, Aliante and pipe dreams like Durango Station...well before any talk of going private. RR & Aliante alone cost $1.6 billion. At the time, a reasonable debt investor would have relied on those assets being available in the event of default, since there were no other assets or costs to justify the need for $2.3B. Station effectively said as much during the "old debt" issuance. By (1) encumbering the prime casinos to a senior loan in going private and (2) transferring raw land to the "old debt" with inflated values and no formal appraisals (only a weak "professional opinion" rendered by CB Richard Ellis) -- all without a supermajority vote of all "old debt" holders -- Station effectively engaged in defalcation of the "old debt" holders. Now that may or may not be a violation of the UFTA, but it is certainly long-standing case law in bankruptcy court at the federal level.

  11. By belinda
    9/23/09 at 6:12 p.m.
    Suggest removal

    One last point. This is not about fraud, but defalcation, and the federal bankruptcy courts have upheld that one can be guilty of defalcation without any intention or knowledge of doing so. Intent or awareness of the debtor is irrelevant to proving that valuable assets were moved to the ultimate benefit of the debtor and the injury of a creditor(s).

    This is important because an unsecured creditor never truly lends money without expectation of repayment of principal, nor does a debtor accept money without expectation of a claim on assets for the amount of that principal. Security notwithstanding, a $2.3B creditor whose lending is substantially prior in time to that of a subsequent $2.985B creditor has a reasonable claim to injury when the later debt arrangement is shown to have directly benefited the debtor and effectively removed or reduced the assets available to the original creditor. At the time of the 2004 lending, any reasonable creditor would have viewed the construction of casino assets such as RR as part of Station's "general corporate purposes" and therefore open to claim in case of default (along with all other wholly owned properties of the company).

    Stations may have viewed it this way as well, as evidenced in presentations and comments made by company executives before and during the construction of RR, expansion of Palace Station, design of Durango Station, etc. prior to the going-private transaction. If true, one could argue that defalcation was knowingly committed in that the facts show (1) the company leveraged away the prime casino properties for the subsequent going-private transaction and (2) failed to formally appraise the raw land that formed (a) the balance of the company's creditworthiness argument in its materials for the new "privatized" financial structure and (b) a substantial part of the assets the company would ultimately leave for the original creditors. (The land holdings were never formally appraised; Stations only solicited a "professional opinion" on their value from CB Richard Ellis, a fact acknowledged in materials from the time.)

    But it doesn't matter whether Stations did this knowingly or not. You don't need proof of intent to prove defalcation occurred and defalcation is critical because it trumps all other creditor claims. Victims of defalcation are entitled to have their claims paid first. Given there is about $2.3B of those, it would force Stations and Deutsche Bank to do what they should have done in the first place -- make a reasonable offer to repay the unsecured creditors what they are owed instead of trying to walk away without paying anything.

  12. By CynicalObserver
    9/24/09 at 1:20 a.m.
    Suggest removal

    Belinda, what you call defalcation is a grounds to prevent an individual fiduciary from being discharged from a debt in what is most often his own personal bankruptcy. No person is bankrupt in the Station Casinos case.

    I call the same conduct a breach of fiduciary duty, and that is the cause of action normally plead and proven against a controlling shareholder or officer of a corporation.

    I ran the word defalcation through the 9th Circuit bankruptcy cases, read the first 50 most recent ones, and did not see an actual cause of action for defalcation. I am curious, do you have any 9th Circuit federal case citations for a "defalcation cause of action" brought in the main bankruptcy proceeding of a corporation, or as an adversary proceeding as part of a corporate bankruptcy? I would enjoy reading them.

    The other problem is what the "old" unsecured bond documents say or don't say. Obviously, if the old bond documents do not prohibit mortgaging of the company's assets, then shareholders like Colony Capital and the Fertittas are going to raise a business judgment rule defense to any breach of fiduciary duty or defalcation cause of action by the old unsecured bondholders.

    As the bankruptcy case law is developing in Delaware, there is no pre-bankruptcy "zone of insolvency" in which corporate directors, or officers are rendered fiduciaries for creditors of the company prior to the company's bankruptcy filing. Delaware's Supreme Court specifically negated the existence of such a duty to creditors. The question has to be asked if that same body of case law exists in the 9th Circuit. Last time I went looking for any zone of insolvency cases in the 9th Circuit, they didn't exist. Perhaps this may be the case where that issue is decided by the 9th Circuit.

    Similarly, there's the question of what state law governed the conduct of Station Casinos' officers and directors when the leveraged buy out occurred. Is it Nevada law, because the company is incorporated and operated here, or is it New York law assuming that is the governing law of the "old bonds"?

    The content of Nevada's laws versus another state's could make a significant difference in the details of the "code of conduct" to which the controlling shareholders are held.

    Unless the case settles, all these issues mean a significant pleading battle on more than just these fundamental question of whether there was a fiduciary duty to the "old bondholders" prior to the leveraged buy out, what state law applieds if there is such duty, and then a trial before a jury to judge whether the conduct of the controlling shareholders of Station Casinos, Inc. was a breach of fiduciary duty, or as you call it defalcation. No walk in the park by any means for either side.

    Interesting choice of Reno as the place for the bankruptcy and such a trial.

    Too bad Nevada won't allow prop bets on whether Fertittas have to payback the money. There would be a lot of action on that one.

  13. By formervegas76
    9/24/09 at 3:07 a.m.
    Suggest removal

    think station's just trying to influence final outcome

  14. By boomeranddalejr
    9/24/09 at 5 a.m.
    Suggest removal

    who cares???? go gamble some place else -

  15. By Boxer47
    9/24/09 at 12:03 p.m.
    Suggest removal

    Funny how that little report they commissioned failed to mention that the Fertittas and Colony were sued by multiple shareholder groups claiming fraudulent transfer and settled one case with the Palm Beach Firefighters' Pension Fund. This LBO was leveraged for the Fertittas and their close associates, not for the good of the company and the sustaining of any period of prosperity. They showed a clear and convincing habit of borrowing on top of debt to pay themselves and maintain their own lavish lifestyle. They learned it's cheaper to pay lawyers than to do things on the up and up. They destroyed their father's company, screwed lots of innocent hard-working folks in the process, and will probably get away with it unscathed. This is your America, folks. The crooks have all the power.

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