PRIVILEGED & CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION
This memorandum constitutes a privileged and confidential attorney-client communication prepared by Calderwood & Harkness LLP at the request of Redstone Gaming Corp. It is intended solely for the use of the addressees identified below and is protected from disclosure by the attorney-client privilege, the work product doctrine, and all other applicable privileges and protections. Any unauthorized review, use, disclosure, or distribution is strictly prohibited.
MEMORANDUM
FROM: Claudia Merritt, Responsible Partner, Banking & Finance, and Marcus Leung, Lead Associate, Banking & Finance, Calderwood & Harkness LLP
TO: Thomas Kierkegaard, General Counsel, Redstone Gaming Corp., and Priya Sandoval, Chief Financial Officer, Redstone Gaming Corp.
DATE: March 6, 2023
RE: Cost-of-Capital Comparison Analysis — Impact of Equity Rally on Proposed $35,000,000 Mezzanine Financing with Pinnacle Bridge Capital Partners, LP
C&H MATTER NO.: 1033-00001
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I. EXECUTIVE SUMMARY
This memorandum analyzes the economic impact of Redstone Gaming Corp.'s ("RGC" or the "Company") significant equity price appreciation on the proposed $35,000,000 mezzanine financing from Pinnacle Bridge Mezzanine Opportunities Fund IV, LP (the "Fund" or "Pinnacle Bridge"), an investment vehicle managed by Pinnacle Bridge Capital Partners, LP, and compares the all-in cost of the mezzanine structure to alternative capital-raising strategies that are now available to RGC given the Company's materially elevated stock price. This analysis was prepared at the request of CFO Sandoval in connection with the management committee's ongoing evaluation of the Company's financing alternatives.
Key Conclusion. The mezzanine structure that was negotiated in the fourth quarter of 2022, which carries an all-in stated coupon of 13.50% per annum (consisting of 10.50% cash interest and 3.00% payment-in-kind ("PIK") interest) together with 3.00% warrant coverage on fully diluted common equity, has become uneconomical relative to alternative financing options now available to RGC. This conclusion is driven principally by the 75.6% appreciation in RGC common stock (Nasdaq: RDGM) from $8.40 per share as of October 31, 2022 to $14.75 per share as of the most recent market close on March 10, 2023. At the time the mezzanine terms were negotiated, the all-in effective cost of the mezzanine capital was approximately 14.0–14.5% per annum. Due to the deep in-the-money status of the warrants at the current trading price, the all-in effective cost of the mezzanine has increased to approximately 19.1% per annum — a level that is uncompetitive relative to a follow-on equity offering, a convertible note, or even, subject to liquidity considerations, an incremental draw on RGC's existing senior secured revolving credit facility.
This memorandum was prepared to support CFO Sandoval's recommendation at the March 3, 2023 management meeting to pause the mezzanine financing process with Pinnacle Bridge. We have reviewed the term sheet, the draft transaction documents, and the existing Senior Credit Facility, and have analyzed the comparative costs and structural implications of each alternative identified below.
Recommendation. We recommend that RGC suspend negotiations with Pinnacle Bridge on the proposed mezzanine financing. The 90-day exclusivity period under the non-binding term sheet executed on December 2, 2022 expires by its terms on March 15, 2023. No extension of the exclusivity period need be requested, and no break fee or termination fee is payable to Pinnacle Bridge under the term sheet. We further recommend that RGC's Board of Directors formally authorize the suspension of negotiations and direct Calderwood & Harkness to notify Pinnacle Bridge and its counsel, Wainwright Hess & Caldwell LLP ("WHC"), of the Company's decision.
II. BACKGROUND
A. Proposed Mezzanine Financing — Summary of Terms
Set forth below is a summary of the principal economic and structural terms of the proposed mezzanine financing as reflected in the non-binding term sheet executed by RGC and the Fund on December 2, 2022 (the "Term Sheet") and the draft Note Purchase Agreement most recently circulated on February 17, 2023.
Borrower: Redstone Gaming Corp. (Nasdaq: RDGM), a Nevada corporation.
Prospective Lender: Pinnacle Bridge Mezzanine Opportunities Fund IV, LP, a Delaware limited partnership and investment vehicle of Pinnacle Bridge Capital Partners, LP.
Principal Amount: $35,000,000.
Use of Proceeds: The proceeds of the mezzanine financing were to be applied as follows:
(i) Approximately $22,000,000 for "Project Catalyst" — the Company's planned upgrade and expansion of its digital wagering platform, including the development and deployment of the RedBet mobile application across licensed jurisdictions; and
(ii) Approximately $13,000,000 for the expansion of the Company's tribal gaming management contracts in Arizona (Gila River Indian Community and Salt River Pima–Maricopa Indian Community) and New Mexico (Pueblo of Sandia and Pueblo of Santa Ana).
Instrument: Mezzanine term note, subordinated and unsecured, with a limited second-priority pledge of the equity interests in Redstone Digital Wagering, LLC (the Company's wholly owned digital gaming subsidiary) and Redstone Tribal Management, Inc. (the Company's wholly owned tribal gaming management subsidiary), together with an assignment of the Company's intellectual property portfolio associated with the RedBet brand and platform (the "RedBet IP").
Cash Interest Rate: 10.50% per annum, payable quarterly in arrears. Annual cash interest payable: $3,675,000 ($918,750 per quarter).
PIK Interest Rate: 3.00% per annum, compounding quarterly. Year 1 PIK accrual (assuming the Company elects to pay in kind the full PIK component, as is customary in mezzanine structures of this type): $1,050,000.
All-In Stated Yield: 13.50% per annum.
Maturity: Five (5) years from the date of funding, which, based on the original anticipated closing timeline, was expected to be approximately March 2028.
Warrant Coverage: 3.00% of RGC's fully diluted common equity as of the commitment date, representing 1,650,000 shares of RGC common stock (calculated based on 55,000,000 shares outstanding on a fully diluted basis as of the commitment date).
Warrant Strike Price: $9.24 per share, representing 110% of the volume-weighted average price ("VWAP") of RGC common stock for the 30 trading days ending on the commitment date of October 31, 2022, during which period the VWAP was $8.40 per share.
Call Protection: The mezzanine note is non-callable for the first 24 months following funding. Thereafter, the note is callable at the following premiums:
• Months 25–36: 103% of par
• Months 37–48: 102% of par
• Months 49–54: 101% of par
• Months 55–60: Par (100%)
Financial Covenants: The draft Note Purchase Agreement includes the following financial covenants, tested quarterly:
• Minimum Fixed Charge Coverage Ratio ("FCCR"): 1.20x
• Maximum Total Net Leverage Ratio: 4.50x
• Minimum Liquidity: $15,000,000 (defined as unrestricted cash plus undrawn availability under the Senior Credit Facility)
Subordination: The mezzanine note would be expressly subordinated to the Company's existing Senior Secured Revolving Credit Facility (as defined below) pursuant to an intercreditor agreement to be entered into among RGC, Pinnacle Bridge, and Cornerstone National Bank, N.A., as administrative agent under the Senior Credit Facility.
Governing Law: State of Nevada.
B. Existing Capital Structure
RGC's existing debt capital structure consists principally of the following:
Senior Secured Revolving Credit Facility. A $200,000,000 senior secured revolving credit facility (the "Senior Credit Facility") established pursuant to the Second Amended and Restated Credit Agreement, dated as of March 15, 2021, among the Company, Cornerstone National Bank, N.A. ("Cornerstone"), as administrative agent, and the several lenders party thereto (the "Senior Credit Agreement"). The Senior Credit Facility is secured by a first-priority lien on substantially all of the Company's assets and the assets of its domestic subsidiaries.
Amount Drawn (as of September 30, 2022): $142,000,000. As of the most recent interim reporting date for which information has been provided to this firm, $142,000,000 was drawn under the Senior Credit Facility, leaving $58,000,000 of undrawn capacity.
Senior Facility Interest Rate: Borrowings under the Senior Credit Facility bear interest at a rate equal to the Secured Overnight Financing Rate ("SOFR") plus 275 basis points, with a 10 basis point credit spread adjustment ("CSA"), as required under the SOFR transition provisions of the Senior Credit Agreement.
Key Financial Metrics:
• Last Twelve Months ("LTM") Revenue (fiscal year ended June 30, 2022): $387,600,000
• LTM EBITDA (fiscal year ended June 30, 2022): $58,100,000
• Current Net Leverage Ratio: 2.44x ($142,000,000 ÷ $58,100,000)
• Pro Forma Total Net Leverage Ratio (giving effect to the $35,000,000 mezzanine financing): 3.05x (($142,000,000 + $35,000,000) ÷ $58,100,000)
Subordinated Indebtedness Restriction. Section 7.03(b) of the Senior Credit Agreement prohibits the incurrence of subordinated indebtedness in excess of $10,000,000 without the prior written consent of the administrative agent (acting at the direction of the Required Lenders) and the execution and delivery of an intercreditor agreement in form and substance satisfactory to the Required Lenders. A flat consent processing fee of $50,000 is payable to Cornerstone upon the granting of any such consent. As of the date of this memorandum, Cornerstone has provided preliminary comments on the draft intercreditor agreement (received February 10, 2023) but has not yet granted formal consent.
C. Transaction Timeline and Current Status
The following timeline summarizes the key milestones in the proposed mezzanine financing from inception through the current date:
As of the date of this memorandum, the draft transaction documentation is substantially advanced but remains unexecuted. The Note Purchase Agreement has been through two rounds of revision and a number of open business points remain, including the scope of the negative covenants (particularly the restricted payments basket and the permitted indebtedness basket) and certain representations relating to the Company's gaming licenses. The Warrant Agreement is in a less advanced state, with WHC's initial comments still under review by this firm. The intercreditor agreement with Cornerstone remains in a preliminary comment stage, with Cornerstone having provided its first round of substantive comments on February 10, 2023 but no in-person or telephonic negotiation session yet scheduled with Cornerstone's outside counsel.
III. RGC EQUITY RALLY — PRICE MOVEMENT ANALYSIS
A. Stock Price Trajectory
RGC common stock has experienced a substantial and sustained rally since the inception of the mezzanine financing process. The following data points track the price appreciation of RDGM shares over the relevant period:
Total Appreciation: $14.75 − $8.40 = $6.35 per share, representing a 75.6% increase from the base price at the time the mezzanine terms were negotiated.
The rally appears to be driven by a combination of factors, including stronger-than-expected Q2 FY2023 earnings (the Company reported revenue of $103.4 million for the quarter, exceeding consensus estimates by approximately 8.2%), favorable regulatory developments in Arizona (expansion of the authorized scope of digital wagering operations on tribal lands), and a broader market rally in the gaming and leisure sector during the first quarter of 2023. While we express no view on the sustainability of the current trading level — that analysis is beyond the scope of this memorandum — the magnitude and duration of the appreciation is sufficient to warrant a fundamental reassessment of the mezzanine structure's economics.
B. Market Capitalization Impact
The stock price appreciation has produced a corresponding increase in RGC's total equity market capitalization:
• Market Capitalization at Engagement (October 31, 2022): Approximately $462,000,000 (55,000,000 shares × $8.40/share)
• Market Capitalization at March 10, 2023: Approximately $811,250,000 (55,000,000 shares × $14.75/share)
• Increase in Market Capitalization: Approximately $349,250,000, representing a 75.6% increase
The Company's market capitalization has grown from a mid-cap valuation of approximately $462 million to an enterprise value approaching $1 billion (when debt is included), fundamentally repositioning RGC within the capital markets and expanding the range of financing alternatives available to the Company.
C. Implications for the Mezzanine Structure
The mezzanine financing terms were negotiated and benchmarked against RGC's capital structure and equity valuation as of the fourth quarter of 2022. Several aspects of the structure are directly affected by the equity price appreciation:
Warrant Strike Price. The warrant strike price of $9.24 per share was established at 110% of the 30-day VWAP of $8.40 as of the commitment date of October 31, 2022. At that time, the strike price was out-of-the-money relative to the prevailing market price, meaning that the warrants had no intrinsic value and represented only a contingent future cost to RGC. As of March 10, 2023, with RDGM trading at $14.75 per share, the warrants are deeply in-the-money, carrying an intrinsic value of $5.51 per share and a total implied dilution cost of approximately $9,091,500. This represents a material shift in the economics of the warrant component that was not contemplated at the time the terms were agreed.
All-In Cost Recalculation. The all-in cost of the mezzanine structure must be reassessed in light of the materially different equity valuation. When the warrants were out-of-the-money, the effective all-in cost of the mezzanine was approximately 14.0–14.5% per annum — competitive for subordinated mezzanine capital in the gaming sector. With the warrants deeply in-the-money, the effective all-in cost has risen to approximately 19.1% per annum, a level that is well above the cost of alternative financing sources now available to the Company.
Alternative Financing Viability. At a stock price of $8.40, a follow-on equity offering to raise $35 million would have required the issuance of approximately 4.2 million shares, representing approximately 7.6% dilution to existing holders — a level that the Company's management and board determined was unacceptably dilutive. At the current stock price of $14.75, the same $35 million raise would require only approximately 2.5 million shares, or approximately 4.4–4.6% dilution, making a public equity offering a viable and attractive alternative.
IV. COST-OF-CAPITAL ANALYSIS — MEZZANINE STRUCTURE
This Section presents a detailed analysis of the all-in cost of the proposed mezzanine financing with Pinnacle Bridge, incorporating each component of economic cost: cash interest, PIK interest, warrant dilution, transaction costs, and call protection constraints.
A. Annual Cash Costs
The mezzanine structure's direct annual cash costs are summarized as follows:
Cash Interest. $35,000,000 × 10.50% = $3,675,000 per annum ($918,750 per quarter, payable in arrears). This represents the Company's primary ongoing cash obligation under the mezzanine note and would be a fixed charge for purposes of the FCCR covenant in both the mezzanine note and the Senior Credit Facility.
Placement Agent Fee. Ashford Peak Advisory Group, LLC is entitled to a placement agent fee of $525,000, equal to 1.50% of the $35,000,000 principal amount, payable upon the closing of the mezzanine financing. When amortized over the 5-year term of the note, this equates to approximately $105,000 per year.
Lender's Counsel Fee Cap. Under the Term Sheet, RGC is responsible for the legal fees of Pinnacle Bridge's outside counsel, Wainwright Hess & Caldwell LLP, up to a cap of $175,000, payable at closing.
Cornerstone Consent Fee. The flat consent processing fee payable to Cornerstone National Bank, N.A. in connection with the granting of consent under Section 7.03(b) of the Senior Credit Agreement is $50,000, payable upon the execution of the consent letter.
Total One-Time Transaction Costs (excluding C&H fees):
C&H Legal Fees Incurred to Date. Calderwood & Harkness's estimated fees incurred through the date of any dormancy election total approximately $287,400, as set forth in greater detail in Section VII.C below. These fees are a sunk cost that has been incurred regardless of whether the mezzanine financing closes and therefore should not factor into the forward-looking cost-of-capital comparison. They are noted here solely for completeness.
B. PIK Interest Accrual
The 3.00% per annum PIK component of the mezzanine note's interest rate does not require current cash payments but instead compounds quarterly and is added to the outstanding principal balance. While this feature preserves near-term cash flow, it increases the total amount of principal that must be repaid at maturity (or upon any earlier prepayment following the expiration of the call protection period).
Year 1 PIK Accrual: $35,000,000 × 3.00% = $1,050,000 (accrued and added to principal, assuming the Company elects to pay the full PIK component in kind, as is customary under mezzanine structures of this type).
Compounding Effect Over the Full Term. Assuming the full PIK election is made throughout the 5-year term, and reflecting quarterly compounding of the 3.00% PIK component, the outstanding principal balance at maturity would increase from $35,000,000 to approximately $40,565,000. The total PIK accrual over the full 5-year term is therefore approximately $5,565,000, representing additional "phantom" interest cost that does not appear as a cash expense but is economically real.
The following table illustrates the approximate growth of the principal balance due to PIK accrual on an annual basis:
Note: Figures are approximations reflecting quarterly compounding and rounding.
C. Warrant Dilution Cost — Original vs. Current Analysis
The warrant component of the mezzanine structure is the element most significantly affected by the equity rally. The analysis below compares the economic cost of the warrants at the time the terms were negotiated to the cost at the current trading price.
At Engagement ($8.40/share — October 31, 2022).
• Warrant shares: 1,650,000 (3.00% of 55,000,000 fully diluted shares)
• Strike price: $9.24 per share (110% of the 30-day VWAP of $8.40)
• Market price: $8.40 per share
• Intrinsic value per warrant share: Negative ($8.40 − $9.24 = −$0.84); warrants were out-of-the-money
• Implied economic cost at engagement: Zero intrinsic value; no immediate dilution cost. The warrants had time value (which could be estimated using a Black-Drubeck or similar option pricing model), but at the time the terms were agreed, the conventional view among the parties was that the warrants represented a modest contingent cost to the Company — a "sweetener" for the lender that would only produce economic value for Pinnacle Bridge if the Company's equity price appreciated, a scenario in which both parties would benefit.
At Current Market Price ($14.75/share — March 10, 2023).
• Market price: $14.75 per share
• Strike price: $9.24 per share (unchanged)
• Intrinsic value per warrant share: $14.75 − $9.24 = $5.51
• Total implied dilution value: 1,650,000 shares × $5.51 = $9,091,500
• Dilution as a percentage of current market capitalization: $9,091,500 ÷ $811,250,000 ≈ 1.12%
• Additional dilution to existing shareholders on a post-exercise fully diluted basis: 1,650,000 ÷ (55,000,000 + 1,650,000) = approximately 2.91%
The $9,091,500 implied dilution value represents the aggregate intrinsic value that would accrue to Pinnacle Bridge if the warrants were exercised at the current market price. Even if the warrants are not exercised immediately (they are typically exercisable over a 5- to 7-year period following issuance), the market value of the warrants at issuance — calculated either by reference to intrinsic value or through a more rigorous option pricing methodology — represents a real economic cost to the Company and its existing shareholders. It is this cost that has fundamentally altered the economics of the mezzanine structure.
D. All-In Effective Cost of Mezzanine Capital
Combining the components analyzed above, the all-in effective cost of the mezzanine capital can be estimated as follows:
Implied All-In Effective Annual Rate: Approximately 19.1% on $35,000,000 of capital.
This compares unfavorably to the approximately 14.0–14.5% effective all-in rate that would have applied at the time of engagement, when the warrants were out-of-the-money and the warrant dilution cost was effectively zero. The equity rally has added approximately 4.5 to 5.0 percentage points to the effective annual cost of the mezzanine capital — a material increase that fundamentally changes the relative attractiveness of this financing structure.
We note that this analysis uses a simplified straight-line amortization of the warrant dilution cost over a 5-year period. A more rigorous analysis using a Black-Drubeck model or Monte Carlo simulation — which would account for the time value of the warrants in addition to their intrinsic value — would likely produce an even higher effective cost figure, as the warrants' optionality has significant additional value given the recent volatility of RDGM shares.
E. Call Protection Premium
The mezzanine note's call protection schedule imposes a significant additional constraint on RGC's financial flexibility:
• Months 1–24: Non-callable. The Company cannot prepay the mezzanine note, regardless of circumstances, for the first two years following funding.
• Month 25 (first call date): Callable at 103% of par = $35,000,000 × 103% = $36,050,000 (a $1,050,000 prepayment premium).
• Months 37–48: Callable at 102% of par.
• Months 49–54: Callable at 101% of par.
• Months 55–60: Callable at par (100%).
The practical consequence of the call protection is that even if RGC's equity continues to appreciate and more favorable refinancing alternatives become available in the near term, the Company would be unable to retire the mezzanine note for at least 24 months without incurring a significant prepayment premium. This locks in the deadweight cost of the mezzanine structure — including the ongoing cash interest, PIK accrual, and warrant dilution — for a minimum two-year period.
If, for example, RGC wished to prepay the note at the earliest possible call date (month 25), the total cost to the Company would include: (i) 24 months of cash interest payments ($7,350,000), (ii) 24 months of PIK accrual (approximately $2,121,000), (iii) the call premium ($1,050,000), and (iv) the full value of the warrants (which would remain outstanding regardless of the note's repayment), for a total economic outlay well in excess of $10.5 million before the Company could free itself from the mezzanine obligation.
V. ALTERNATIVE CAPITAL-RAISING OPTIONS
In light of the materially changed economics of the mezzanine structure, we have analyzed three alternative capital-raising strategies that are now available to RGC given the Company's elevated stock price and improved market positioning.
A. Follow-On Equity Offering
The most straightforward alternative to the mezzanine financing is a registered follow-on offering of RGC common stock.
Pricing and Share Count. At the current trading price of $14.75 per share, raising $35,000,000 through a follow-on offering would require the issuance of approximately 2,372,881 new shares (before accounting for the underwriter discount). Assuming a typical underwriter discount of 5–6% for a secondary offering of this size in the gaming sector, the gross offering size would need to be approximately $37,100,000 to $37,234,000 in order to generate net proceeds of $35,000,000 to the Company. This would require the issuance of approximately 2,515,000 to 2,523,000 new shares.
Dilution Impact. On a post-issuance basis, existing shareholders would experience dilution of approximately 4.4–4.6% (2,515,000 to 2,523,000 new shares ÷ (55,000,000 existing shares + 2,515,000 to 2,523,000 new shares)). This level of dilution is comparable to, though modestly higher than, the 2.91% fully diluted warrant dilution under the mezzanine structure — but critically, the equity offering dilution carries no ongoing servicing cost. There is no coupon, no PIK accrual, no call protection, and no warrant overhang.
Cost. The one-time underwriting fee would be approximately $2,100,000 (based on a 6% gross spread on $35,000,000). Legal fees, printing costs, SEC filing fees, and other offering expenses would likely total an additional $400,000–$600,000, bringing total transaction costs to approximately $2,500,000–$2,700,000.
Estimated Effective Annual Cost. If the one-time underwriting fee of approximately $2,100,000 is notionally amortized over a 5-year period (for comparability to the mezzanine term), the annualized cost is approximately $420,000 per year. Equity capital has no contractual servicing cost — no interest, no PIK, and no mandatory repayment. The true "cost" of equity is the opportunity cost of dilution, which is a function of the Company's future performance and is not directly comparable to a contractual interest rate.
Structural Advantages. A follow-on equity offering would:
• Generate no incremental leverage on RGC's balance sheet
• Require no subordination consent from Cornerstone National Bank, N.A.
• Eliminate the need for an intercreditor agreement
• Avoid gaming regulatory suitability filing requirements for the lender and its principals
• Provide the Company with maximum financial flexibility, as there are no prepayment, call protection, or covenant constraints associated with equity capital
Potential Disadvantages. A public equity offering carries certain risks and disadvantages that should be weighed against the cost savings:
• Market signaling. An equity issuance may be interpreted by some market participants as a signal that management believes the stock is overvalued, potentially creating short-term downward pressure on the share price.
• Permanent Dilution. Unlike a mezzanine note that is repaid at maturity, equity dilution is permanent. However, this permanent dilution carries no fixed servicing cost, and the Company retains maximum flexibility to deploy capital as it sees fit.
• Execution Risk. A follow-on offering is subject to market conditions at the time of pricing. If the stock price declines between the announcement date and the pricing date, the Company may need to issue more shares or accept lower net proceeds. This risk can be mitigated through an "overnight" or "bought deal" structure.
• Timeline. A registered follow-on offering would require the preparation and filing of a prospectus supplement under the Company's existing shelf registration statement (assuming the shelf is current and the capacity is sufficient), with a typical timeline of 2–4 weeks from board authorization to pricing.
B. Convertible Note
A convertible note represents a hybrid alternative that combines elements of debt and equity, potentially offering lower cash coupon rates than the mezzanine while deferring equity dilution to a higher stock price.
Conversion Premium. With RGC trading at $14.75, a convertible note could be structured with a conversion premium of 25–35% above the current market price. This would result in a conversion price of approximately $18.44 per share (at a 25% premium) to $19.91 per share (at a 35% premium). Conversion would occur only if RGC's stock price reaches or exceeds the conversion price, providing a natural buffer against dilution.
Coupon Rate. Based on current market conditions for gaming sector convertible notes and discussions with market participants, we estimate that a $35,000,000 convertible note for RGC could be placed with a coupon of approximately 4.50% to 6.00% per annum. Taking a midpoint of 5.00%, the annual cash interest expense would be $1,750,000 — less than half the $3,675,000 annual cash interest under the mezzanine note.
Conversion Dilution. At a conversion price of $18.44 to $19.91, the conversion shares would total approximately 1,758,000 to 1,898,000 shares, which is modestly higher than the 1,650,000 warrant shares under the mezzanine. However, the convertible shares would only convert at the higher price point, meaning that the economic dilution to existing shareholders would be materially less than the mezzanine warrant dilution unless the stock rallies substantially further. Moreover, if the stock does not reach the conversion price during the term of the note, conversion may never occur and the note would simply be repaid at par at maturity — with the only cost to the Company being the coupon payments.
Structural Features. A convertible note would typically include:
• A 5-year maturity, comparable to the mezzanine
• A cash coupon significantly below the mezzanine rate
• No PIK component (most convertible notes pay a cash coupon only)
• No separate warrant coverage (the conversion feature replaces the warrant)
• Limited or no call protection (most investment-grade or near-investment-grade convertibles are callable after 3 years at par, and many include a "soft call" provision allowing early call if the stock trades above 130% of the conversion price for a specified period)
• No financial maintenance covenants (most publicly placed convertible notes are covenant-lite)
Cornerstone Consent. Whether a convertible note would require consent under Section 7.03(b) of the Senior Credit Agreement depends on its structuring. If structured as subordinated unsecured indebtedness, the same consent requirement and $50,000 fee would apply. However, if the convertible note is structured as senior unsecured indebtedness and placed under a separate indenture, a different analysis under the Senior Credit Agreement's negative covenants may apply, and consent may not be required or may be available under a different permitted indebtedness basket.
C. Incremental Senior Secured Debt
As a third alternative, RGC could draw down additional amounts under its existing $200,000,000 Senior Credit Facility with Cornerstone.
Available Capacity. As of September 30, 2022, $142,000,000 was drawn under the Senior Credit Facility, leaving $58,000,000 of undrawn capacity. Drawing an additional $35,000,000 (bringing total drawn amounts to $177,000,000) would consume approximately 60% of the remaining availability, leaving only $23,000,000 of undrawn capacity.
Interest Rate. Borrowings under the Senior Credit Facility bear interest at SOFR + 275 bps + 10 bps CSA. Based on current SOFR rates (approximately 4.55–4.60% as of early March 2023), the all-in interest rate on incremental draws would be approximately 7.40–7.45%, which we round to approximately 7.5–8.0% to account for potential rate fluctuations over the draw period. This compares extremely favorably to the 13.50% stated yield (or 19.1% effective yield) of the mezzanine.
Annual Cash Interest. An additional $35,000,000 drawn at approximately 7.5% would generate annual cash interest of approximately $2,625,000, compared to $3,675,000 of cash interest under the mezzanine — a cash savings of approximately $1,050,000 per year. Moreover, there would be no PIK accrual, no warrant dilution, and minimal incremental transaction costs (as the draw would be made under the existing facility).
Leverage Impact. Pro forma total net leverage would increase to 3.05x ($177,000,000 ÷ $58,100,000), which is within both the senior facility's leverage covenant and the proposed mezzanine covenant of 4.50x maximum leverage. However, this alternative presents significant drawbacks:
• Reduced Liquidity. Drawing $35,000,000 on the revolver would reduce undrawn capacity from $58,000,000 to only $23,000,000. Depending on the Company's unrestricted cash balance, this may cause the Company to fall below the $15,000,000 Minimum Liquidity threshold that was proposed as a covenant in the mezzanine note and that is likely also relevant to the Company's internal financial planning parameters.
• Operational Flexibility. The Senior Credit Facility serves as the Company's primary source of working capital and liquidity. Consuming the vast majority of remaining availability for a discrete capital project (Project Catalyst and tribal expansion) would leave the Company with insufficient revolver capacity to address unforeseen operating needs, seasonal cash flow fluctuations, or opportunistic acquisitions.
• Amendment or Waiver Risk. Depending on the specific financial covenant levels in the Senior Credit Agreement (which include minimum liquidity and maximum leverage tests), drawing down an additional $35,000,000 may require an amendment or waiver from the Required Lenders, which carries its own timeline, cost, and uncertainty.
For these reasons, while the incremental senior secured draw represents the lowest-cost alternative from a pure interest rate perspective, it is likely not the optimal solution for RGC on a risk-adjusted, holistic basis.
D. Summary Comparison Table
The following table provides a side-by-side comparison of the four financing alternatives across the key economic, structural, and regulatory dimensions:
VI. IMPACT ON TRANSACTION ECONOMICS — DECISION FRAMEWORK
A. Original Rationale for the Mezzanine Structure
At the time of engagement in October 2022, the mezzanine structure was selected by RGC management as the preferred financing vehicle for Project Catalyst and the tribal gaming expansion for sound strategic reasons. RGC common stock was then trading at $8.40 per share, producing a market capitalization of approximately $462 million. The Company's board and management team evaluated the available financing alternatives at that valuation level and reached the following conclusions:
Equity was excessively dilutive. A follow-on equity offering at $8.40 per share would have required the issuance of approximately 4,166,667 shares (before underwriter discount) to raise $35 million. After accounting for a 5–6% underwriting discount, the share count would have increased to approximately 4,415,000–4,424,000 shares, representing approximately 7.4–7.6% dilution to existing shareholders. The Company's principal institutional shareholders, including Thornbury Capital Management and Overland Pacific Advisors, had communicated informally to management that dilution in excess of 5% would be disfavored. The mezzanine structure, with its 3.00% warrant coverage, was specifically chosen to minimize equity dilution at the then-prevailing stock price.
The mezzanine cost was competitive. At a stock price of $8.40 and a warrant strike of $9.24, the warrants were out-of-the-money, and the effective all-in cost of the mezzanine was approximately 14.0–14.5% per annum. While this rate is elevated in absolute terms, it was within the range of prevailing market rates for subordinated mezzanine capital in the gaming sector in Q4 2022, particularly given RGC's mid-cap size, limited free float, and the inherent complexity of gaming regulatory requirements.
Senior secured capacity was limited. The Company determined that drawing down additional amounts under the Senior Credit Facility would excessively consume liquidity reserves and was inappropriate for funding discrete, multi-year capital projects of the nature contemplated.
Each of these considerations has been materially altered by the equity rally.
B. Revised Analysis at Current Valuation
At the current stock price of $14.75 per share and market capitalization of approximately $811 million, the decision framework that supported the mezzanine structure in October 2022 no longer applies:
Equity dilution has been dramatically reduced. A follow-on equity offering at $14.75 would result in dilution of only approximately 4.4–4.6%, which is within the parameters previously identified as acceptable by the Company's institutional shareholders and is comparable to the 2.91% warrant dilution under the mezzanine — but without any ongoing coupon, PIK, or call protection burden.
The mezzanine has become prohibitively expensive. The total 5-year cost of the mezzanine financing — including cash interest, PIK accrual, warrant dilution, and transaction costs — is estimated at approximately $33,000,000 to $34,000,000, a figure that is nearly equal to the $35,000,000 principal amount itself. The Company would, in effect, be paying nearly $1 for every $1 of capital received over the 5-year term. By contrast, a follow-on equity offering's total cost would be approximately $2,100,000 to $2,700,000 in one-time underwriting and offering expenses, with no ongoing servicing cost.
Net present value comparison. Even on a discounted cash flow basis, the alternatives are substantially more favorable. Using a discount rate of 10% (representing RGC's estimated weighted average cost of capital), the net present value of the mezzanine's total payments (cash interest, PIK repayment, principal, call protection risk, and warrant dilution) significantly exceeds the net present value of the cash flows associated with a follow-on equity offering or a convertible note. We have not prepared a detailed NPV model for purposes of this memorandum but would be pleased to do so if the Board requests a more granular quantitative analysis.
C. Risk of Further Equity Appreciation
The current analysis is based on a stock price of $14.75 as of March 10, 2023. If RGC's stock continues to appreciate — as the consensus analyst estimates would suggest is possible given the Company's improved operating performance and favorable regulatory tailwinds — the economics of the mezzanine become even more unfavorable, as the intrinsic value of the warrants increases dollar-for-dollar with each increment of stock price appreciation above the $9.24 strike. Simultaneously, a follow-on equity offering becomes increasingly attractive, as each dollar of stock price appreciation reduces the number of shares required to raise the target $35 million.
Conversely, if the stock declines from $14.75 back toward $9.24 or below, the mezzanine economics would revert to something closer to what was originally negotiated, and the relative attractiveness of the mezzanine versus an equity offering would shift. However, in that scenario, the window for a favorable equity raise at the elevated price would have been lost. This asymmetric risk profile argues in favor of acting promptly to capitalize on the current favorable equity market conditions.
VII. ADDITIONAL CONSIDERATIONS
A. Exclusivity Expiration
The 90-day exclusivity period under the Term Sheet executed on December 2, 2022 expires by its terms on March 15, 2023. Under Section 4(a) of the Term Sheet, during the exclusivity period RGC agreed not to solicit, negotiate, or enter into any agreement with respect to mezzanine or subordinated debt financing from any party other than Pinnacle Bridge. The exclusivity provision is one of the three binding provisions of the otherwise non-binding Term Sheet (the other two being confidentiality and expense reimbursement).
Upon the expiration of the exclusivity period on March 15, 2023, RGC will have no contractual obligation to extend the exclusivity or to continue negotiations with Pinnacle Bridge. No extension need be requested, and the expiration of the exclusivity period does not trigger any break fee, termination fee, or other penalty.
We recommend that RGC allow the exclusivity period to expire by its terms without requesting or agreeing to any extension. This will preserve the Company's flexibility to pursue alternative financing arrangements without any contractual constraint.
B. Placement Agent Fee
The engagement letter with Ashford Peak Advisory Group, LLC, dated October 14, 2022, provides for a placement agent fee of $525,000, equal to 1.50% of the $35,000,000 principal amount, payable solely upon the closing of the mezzanine financing. The engagement letter contains no minimum fee, break fee, or expense reimbursement provision payable in the event that the transaction does not close.
Accordingly, if the mezzanine financing does not proceed to closing, no fee is owed to Ashford Peak under the terms of the engagement. We note, however, that the engagement letter contains a 12-month "tail" provision pursuant to which a fee would be payable to Ashford Peak if RGC enters into a financing transaction with Pinnacle Bridge or any other party introduced by Ashford Peak during the engagement period within 12 months following the termination of the engagement. If RGC elects to retain Ashford Peak in connection with an alternative capital-raising transaction (such as a convertible note placement), the terms of the engagement should be renegotiated to reflect the different transaction structure and market.
C. Sunk Legal Costs
Calderwood & Harkness's estimated fees incurred through the anticipated dormancy date are approximately $287,400, based on the following time and rate summary:
The interim invoice has been rounded to $287,400. These fees represent the cost of legal services rendered in connection with the mezzanine financing from the opening of the engagement on October 31, 2022 through the anticipated date on which the matter would be placed on dormant status.
These costs are sunk costs that have been incurred regardless of whether the mezzanine financing proceeds. They should not factor into the forward-looking decision regarding whether to continue or suspend the mezzanine process. We note, however, that a significant portion of the work product generated in connection with the mezzanine financing may be repurposed and applied to alternative capital-raising transactions, including:
• The corporate authorizations analysis (board resolutions, charter and bylaw review, stockholder approval requirements)
• The regulatory analysis (Nevada, Arizona, and New Mexico gaming regulatory requirements for various financing structures)
• The IP diligence memorandum (RedBet intellectual property portfolio review)
• The capitalization table and dilution analysis (which may be updated for an equity offering)
D. Document Preservation
All draft transaction documents remain unexecuted and in draft form as of the date of this memorandum, including:
• Note Purchase Agreement (second revised draft, circulated February 17, 2023)
• Warrant Agreement (first draft, circulated January 27, 2023)
• Intercreditor Agreement (preliminary draft, with Cornerstone's initial comments received February 10, 2023)
• Pledge and Security Agreement (first draft, circulated January 27, 2023)
If the matter is placed on dormant status, all documentation, correspondence, and work product should be preserved in accordance with Calderwood & Harkness's document retention policies and the Company's own record-keeping requirements. The matter file may be reactivated if circumstances change — for example, if the Company's stock price declines and the mezzanine structure once again becomes economically attractive, or if Pinnacle Bridge approaches the Company with revised terms that address the warrant pricing issue.
E. Gaming Regulatory Considerations