Second group knocks Station stock options

By Liz Benston

Monday, May 12, 2003 | 11:15 a.m.

An independent proxy research firm has become the second party to criticize a Station Casinos Inc. stock compensation plan that faces an upcoming shareholder vote.

The Culinary Union, which has wanted to organize Station Casinos' work force of roughly 10,000 for years, issued a report last month arguing that shareholders should vote against a compensation plan that rewards top executives.

The union is now promoting a separate report by Institutional Shareholder Services -- a firm that issues research and independent vote recommendations for shareholder groups -- that says the plan's cost is too high relative to other gaming companies.

In its proxy analysis, ISS said the cost to shareholders was determined based on several factors including the effect on future earnings.

The Rockville, Md., firm has been thrown in the spotlight during contentious proxy battles, such as when it recommended that Hewlett-Packard Co. shareholders vote for last year's controversial purchase of Compaq Computer Corp.

The Culinary Union is not a client of ISS and didn't pay for the report, which was compiled for institutional shareholders of Station Casinos, ISS Vice President of Marketing Cheryl Gustitus said.

At the company's annual meeting May 21, Station executives will recommend that shareholders vote in favor of extending a 10-year stock compensation plan for another decade. As of Dec. 31, the company's compensation program allowed the board of directors to authorize granting another 410,905 shares to executives, according to the company's latest proxy statement. As of year-end, options to purchase about 12.2 million shares of common stock were outstanding, of which about 6.9 million were exercisable.

Station Casinos Chief Financial Officer Glenn Christenson defended the company's compensation plan, saying other reports have shown that executives are "undercompensated" based on the company's stock performance.

"We're talking about 400,000 options in a universe of 61 million shares outstanding," he said. "The union is using distorted information for their own purposes. An objective analysis of compensation in our industry (would show) our compensation statistics are as good as or better than anyone in the gaming industry. Yet the Culinary Union chooses only to focus on Station Casinos and not on their own union-represented companies."

Christenson declined to comment on the ISS recommendation, saying ISS hasn't returned repeated calls to discuss the analysis. The company wasn't aware of the analysis until the union distributed the information, he said.

The Culinary Union's report argues that the stock compensation program gives controlling stockholders the power to shift a significant amount of future earnings away from outside shareholders.

Option grants, in particular, have overwhelmingly benefited the Fertitta family, who already control the largest percentage of shares and sit on the company's board of directors, the union report says.

Station Casinos Chief Executive Frank Fertitta III; Fertitta's brother, President Lorenzo Fertitta; and the Fertittas' sister and brother-in-law, Delise and Blake Sartini together control about 28 percent of company stock and about 50 percent of the company's outstanding options, according to a Culinary Union analysis of the company's proxy and 2002 annual report. All four -- as well as Christenson -- also sit on the company's eight-member board of directors.

"It's one thing to align executives' interests with shareholder interest," said Courtney Alexander, research director of the Culinary Union. "It's another thing to take millions of options and grant them to insider shareholders. Then you are simply taking the potential for earnings in the company from the outside shareholder and giving it to the inside shareholders."

Expensing those options would have reduced 2002 earnings per share by 26 percent and lowered 2001 earnings per share by 25 percent, according to the Culinary Union report. The report calculated the difference between the company's earnings as reported in its income statement and its "pro forma" earnings including stock-based compensation expenses.

The union forwarded the report to ISS, which cited the report in its proxy analysis. Rather than supporting the union's contentions, ISS concluded that the compensation plan failed to measure up because it was costlier than those of Station competitors.

Some research analysts contacted last week said the Culinary Union ultimately aims to whip up support for the union and has not subjected other companies' stock-based compensation plans to the same scrutiny.

"In consumer businesses, we value very high stability of management because that generally means consistency of strategy," said Larry Haverty, a managing director of State Street Research, which manages two mutual funds containing Station Casinos stock. "This is a company that has had enormous management stability. Contrast that with Park Place (Entertainment Corp.), which has been a revolving door and whose stock is about where it was four years ago.

"(Station executives) have made our shareholders a bunch of money. I'm not a philosopher to say whether these guys are taking out too much for themselves. I care about what this stock is making for public shareholders."

Many gaming companies use stock options and restricted stock as part of compensation plans that are tied to financial performance, Deutsche Bank Securities analyst Marc Falcone said. "Each company has a different plan. But we don't view Station as being overly aggressive versus any other company we cover."

"In my view they have one of the best growth stories in gaming right now," Falcone said. "They've executed on a business plan, they have created shareholder value and they should continue to given their strong growth profile."

Executives' cash compensation as a percentage of total compensation is lower than the four largest casino operators -- MGM MIRAGE, Park Place, Mandalay Resort Group and Harrah's Entertainment Inc., said Joe Greff of Fulcrum Global Partners.

Station Casinos' stock-based compensation as a percentage of total executive compensation is about 25 percent compared to 18 to 23 percent at larger peers such as MGM MIRAGE, Park Place and Mandalay Resort Group, according to another stock analyst who declined to be named. The average is closer to 30 percent for companies in the Standard & Poor's 500 Index, the analyst said.

"They are marginally ahead (of peers), but I emphasize marginally," the analyst said.

The cost of expensing options is useless unless the figure can be compared to other companies, the analyst said. Companies aren't required by law to expense those costs, requiring investors to dig further for such information.

According to an analysis of total compensation packages in 2001 by In Business Las Vegas, a sister publication of the Las Vegas Sun, five executives at Station Casinos were among the 10 highest compensated Las Vegas gaming executives -- in many cases beating out casino chiefs at bigger companies -- primarily due to large awards of restricted stock.

Still, executives at the world's largest casino companies came out ahead of the pack when ranked by annual compensation alone.

The Fertitta brothers and Christenson ranked 2nd, 3rd and 4th in total compensation in 2001, topping former Park Place chief executive Tom Gallagher and MGM MIRAGE chief Terry Lanni.

Philip Satre, former chief executive of Harrah's, was Las Vegas' best-paid casino executive, reporting $7.8 million in total compensation that year. That included annual compensation of $2.2 million, long-term compensation -- including stock-based compensation -- of $5.1 million and other compensation of about half a million dollars.

Harrah's Chief Executive Gary Loveman, then-chief operating officer of the company, ranked 5th with $3.7 million in total compensation. Nearly half came from exercised stock options and $1.8 million was annual compensation and salary.

Station Casinos' stock has climbed about 25 percent from two years ago.

Top executives have reaped the greatest benefit of that appreciation, Alexander said.

The Culinary Union lambasted Station in 2001 for rewarding top executives more than 2 million stock options the year of the Sept. 11 terrorist attacks that devastated tourism and jobs in the city. Those options are now worth about $25 million, about $17.4 million of which went to Frank and Lorenzo Fertitta, Alexander said.

Station has purposely chosen to grant more stock options and less cash compensation than its peers in order to align long-term executive performance with company performance, Christenson said.

The company typically grants options in the latter part of the year, he said. Half of the 2001 options vested over a five-year period and the other half vested over 10 years. Prior to Sept. 11, executives took pay cuts of 12 and 22 percent due to the limping economy, lowering base salaries that haven't been reinstated until last month, he said.

"When thousands of union-represented employees were laid off (after Sept. 11), we didn't lay off anyone," he said. "When union employees are not getting a raise this year, our employees are."

The union has singled out Station Casinos because its compensation plan is up for renewal and because the company is known for rewarding its controlling shareholders with lucrative options at opportune times, Alexander said.

"There is a history of picking moments of depressed (stock) prices to reprice options or issue new options and that puts a direct conflict between the interests of outside shareholders and inside shareholders," she said. "They are taking advantage of moments when outside shareholders are suffering to issue potentially lucrative options."

According to the Culinary Union report, Station repriced or reissued options to insiders in 1995, 1997 and 2002 after management "failed to generate value for outside shareholders."

Unlike Station Casinos, MGM MIRAGE and Wynn Resorts Inc. didn't issue options to their controlling shareholders, Kirk Kerkorian and Steve Wynn, respectively, Alexander said.

"That's a key difference" between Station and competitors, she said. "When those options are exercised ... company outsiders will have a smaller piece of the pie and the Fertitta family is going to gain what they are diluting for the outside shareholders."

The company hasn't bailed out executives with better option deals, Christenson countered.

None of the Fertitta family members or outside directors have ever repriced options, he said. Some company executives have repriced shares, but the number of options re-granted were lowered so that the value of the options remained the same, he said.

Repricing options is one of the most controversial performance issues to emerge in recent years as investors have become more critical of corporate governance.

In 2001, MGM MIRAGE offered 400 of its top executives and managers an opportunity to reprice millions of stock options, arguing that the incentive was critical to retaining successful management.

In 1998 and amid flagging performance, Hilton Hotels Corp. said it would grant President Steven Bollenbach 6 million options -- 2 million exercisable at above-market prices -- upon the company's split into separate gaming and lodging entities. The gaming entity became Park Place Entertainment.

The union report isn't a prelude to an organizing campaign at Station properties, nor is it actively organizing at company casinos, Alexander said.

Still, she said the union is "very clearly keeping an eye on this company."

"Station Casinos is a large employer in this industry."

The Culinary Union, the largest local in the Hotel Employees & Restaurant Employees Union nationwide, represents more than 45,000 workers on the Las Vegas Strip.

It has launched on-again, off-again efforts to organize Station Casinos workers.

After winning a 1993 vote to unionize workers at Santa Fe Station in northwest Las Vegas, the Culinary Union failed to reach a contract with owners Santa Fe Gaming Corp. before the property was sold to Station Casinos in 2000. The union claims Station terminated the property's roughly 1,000 employees, only rehiring about 150 workers. As the new owner, Station reserved the right to hire its own employees, executives said at the time. Officials also argued that they wanted the ability to transfer Station employees to new properties to reward long-time workers with better shifts, more convenient locations and promotion opportunities.

The union also criticized Station for similarly making workers at the Fiesta casino in North Las Vegas reapply for their jobs after the company purchased the property from the Maloof family in 2000.