Drop, Handle & Hold

Hiatus

As you have no doubt already heard, Station Casinos received an $82 per share offer from Fertitta Colony Partners LLC last week. The buyer is a partnership between company Chairman and CEO Frank Fertitta III, Vice Chairman and President Lorenzo Fertitta, and the Los Angeles-based private equity firm Colony Capital. The company's four independent directors have formed a special committee to consider the offer.

Like everyone else, we are waiting for further announcements from the company regarding the $4.7 billion bid. Meanwhile, Drop, Handle & Hold will be taking a holiday break. We wish our readers a safe and happy holiday season. Check back with us in January for more news on the latest developments in the Las Vegas locals market.

Short, Nude & Naked

With the recent run up of Station Casinos shares fueled by published reports of a possible takeover of the company, there is one group of shareholders who probably aren't cheering -- the short sellers.

Short selling occurs when an investor borrows shares and sells them, hoping to buy the shares back later at a cheaper price. At Station Casinos, there were approximately 9.2 million shares shorted as of November 6, or 18% of the company's outstanding float. That is the second highest level in the large cap gaming universe (according to Citigroup) and up over 28% from October's levels. Given the negativity surrounding the Las Vegas locals market, it isn't surprising that there are a large number of short positions on Station Casinos.

But here's where the nudity comes in. So-called "naked short selling" is a controversial (and in some cases illegal) practice in which traders with short positions take advantage of glitches in the stock settlement process to sell shares without actually borrowing the stock (or making plans to do so). Using that strategy, naked short sellers can drive down the stock price of a company by flooding the market with orders to sell shares they haven’t borrowed. Some CEOs of companies victimized by naked short selling (e.g. Overstock.com) have been complaining loudly that the Securities and Exchange Commission needs to crack down on the practice.

An indication that Station Casinos might be a target of naked short selling was its addition on November 15 to an obscure little list published by the New York Stock Exchange called the "threshold securities" list (the company was removed from the list on 11/21).  Created by the SEC's Regulation SHO -- a rule intended to discourage abusive naked short selling -- the list includes any public company in which "failure to deliver" positions on the stock for five consecutive settlement days are at least 0.5% of the company’s total shares outstanding and total at least 10,000 shares.

Essentially, this means that traders have sold shares of the company, but "failed to deliver" the shares to the buyer within five consecutive settlement days.  And of course, this is exactly the modus operandi of naked short sellers (although the SEC notes there are other explanations for failure to deliver positions).

Under the SEC rules, any new short sales must be settled within 13 settlement days. If shares haven't been delivered by that time, the brokerage involved in the sale must buy stock for delivery to the buyer. If it doesn't, Reg SHO forbids the broker from handling additional short sales of that company's shares unless it makes binding arrangements to borrow the necessary stock.

Naked short selling has frequently been linked to the trading tactics of hedge funds.  Interestingly, Station Casinos has seen an increase in hedge funds' holdings of the company's stock. Hedge funds increased their holdings in Station Casinos by over 109%, from 6.2 million shares in the 2Q06 to 13 million shares in 3Q06.  Hedge funds now control 22% of the outstanding shares of Station Casinos (according to Lionshares as of 11/27).

What makes this drama even more interesting is the fact that Station Casinos has been buying back its stock like crazy (over 12 million since the beginning of the year), undoubtedly putting some pressure on the shorts.  Are the shorts right that the stock will drop, or is Station Casinos right that the stock is a good buy? Well, if you believe one excitable analyst who slapped a $100 price target on the company after the disappointing third quarter numbers, Station Casinos is right.

Lessons from the Gaming Control Board

On the heels of third-quarter earnings announcements by major gaming operators, Nevada's Gaming Control Board (GCB) released September gaming revenue figures for the state. Even though most analysts have politely ignored these latest numbers, we believe there is interesting information to be found here.

Build it...and they'll go elsewhere. Typically, the three areas of North Las Vegas, Boulder Strip, and Balance of the County, as defined by GCB, are a good proxy of the overall Las Vegas locals market when they are considered together. In September, the gaming revenue for the three areas showed a net gain of $4.55 million, a mere 2.50% year-over-year growth. The combined $15.45 million decline in North Las Vegas and Boulder Strip was barely offset by the $20 million growth in the Balance of the County, where Red Rock Resort and South Point Casino are located. Rather than growing the locals market, the two new resorts seem to have simply induced many customers from existing casinos to try out these brand-new properties (can you say "cannibalization"?)

The pie is not growing as fast as the casinos are. South Point (2,378 slots) and Red Rock Resort (3,225 slots) together added 18% in slot capacity to the locals market (again, the three areas of North Las Vegas, Boulder Strip, and Balance of County combined). Yet the gaming revenue of these areas grew only 10.2% in the third quarter, the first full quarter when both of these new resorts were in operation.  With the new capacity, the daily win per slot in these areas also dropped 1.51% in the third quarter. Revenue growth is clearly lagging behind unit growth in the locals market.

Would the Green Valley Ranch regulars return from South Point after having given the new property a try? Would the Suncoast be able to get business back from Red Rock after the billion-dollar resort's newness wears off? And when will slot revenue growth catch up with the new supply growth? Only time can tell.

Enter the Dragon

Last week, the Clark County Commission heard a preliminary application for the Dragon City Hotel and Resort near Las Vegas's Chinatown.  Plans on file  with the planning department show that the proposed hotel-casino will have 67,000 square feet of gaming space and 2,200 hotel rooms in a 280-foot tall tower.  According to In Business Las Vegas, the property will have 50—count 'em, 50—restaurants.  Developers of the casino say they hope to draw middle-class tourists from all over Asia (last year, one of the developers actually pointed out to the Las Vegas Review-Journal that if they can draw just one percent of all Chinese people, they could get 14 million visitors).

Yeah, we get that the developers of Dragon City seem to really want to target Asians in particular, not just any old customers, but come on—who are they kidding?  While we think this may all be a little over the top (especially the part about the 50 restaurants), we do think Dragon City could make for a decent locals casino.  Its off-Strip location is similar to that of the Gold Coast or the Orleans, and while one percent of the entire population of China sounds to us like a stretch, we do think it's possible that Dragon City could find a niche among Asian locals (after all, as the Las Vegas Sun points out, Chinatown is the "hub for that community").  Who knows, it could even become a hybrid tourist/locals property like the Palms or the proposed M Resort.  But regardless, given the fact that it is so close to homes and near Chinatown, if the project gets approved, we think it’s likely to draw at least some locals customers.

The big question, of course, is what would this mean to the other locals operators in the area?  If built, Dragon City would be within one mile of both the Gold Coast and the Palms and within a mile-and-a-half of the Orleans, Palace Station, and the land that Station has bought to redevelop its Wild Wild West site.  And it's not like other locals operators don’t also chase after the Asian clientele.  Last year, the Sun reported on how both the Gold Coast and Palace Station specifically target Asian customers.  They take out ads in "local Asian-language publications", offer special restaurants and games that appeal to Asian customers, and Palace Station even hosts special events for the Asian community.  If Dragon City gets approved, it could give these operators a run for their money. 

So who is developing this ambitious project?  Well, it seems like one of the people who has a stake in Dragon City is Robert Mendenhall.  The same Robert Mendenhall who used to be a one-third partner in the Cannery in North Las Vegas.  His company, RTM Legacy LP, is one of the owners of the land under the proposed casino.  The County Commission is scheduled to vote on the final gaming approvals for Dragon City on December 20th.

Meanwhile, on the south side of town, the Resort at Southern Highlands is changing its plans  a bit.  Olympia Gaming has submitted an application that says that the first phase of the project will have almost a thousand fewer hotel rooms than originally planned (the number has gone down from 2,400 to 1,413).  The project is moving forward though with a casino floor of almost a whopping 120,000 square feet.  You can check out the designs  here.  The County Commission will vote on the new design next week.