Description

Archon Corp (symbol: ARHN) is the Sahara Gaming/Santa Fe Gaming stub. In Q3 of 1995, ARHN sold the Hacienda and the Sahara Hotel/Casino to Circus Circus for $204 million. ARHN kept a 27 acre parcel of land next to the Sahara which is currently occupied by a Wet’N’Wild water park. In March of 2001, ARHN sold its Santa Fe Hotel to Stations for $205 million.

On 12/5/2003 Archon announced their intentions to develop the land. Information is scarce, but the company intends to issue more information “in a week or so”. Here’s what we know. In April of 2003, the company received approval from the gaming commission to develop the land which at the time was expected to cost $650,000,000. They plan to build a 600 ft. (Stratosphere is 1,149 ft.) Ferris Wheel, 3,250 rooms, a fifty story hotel, time shares, and a man made lake with 78 suites located on moored boats. We have yet to learn how the company plans to finance this deal (which leaves room for skepticism). If it’s all debt, we will hold a highly leveraged asset with the chairman/CEO owning 80% of equity. If equity financing is involved, it will likely be at higher levels than the current stock price. My analysis looks at the situation from an NAV standpoint as opposed to a net present value of the future cash flow of the Hotel Casino. Although, we don’t know how this new venture will be financed, I am assuming that management are looking for value in excess of, or at least equal to, the intrinsic value of the company. We’re waiting for more data. And I thought the sooner I got this out the better. Disclosure: we are long common and preferreds.

Stub Assets

27 acres on Vegas strip – property is on the balance sheet at approximately $800K per acre. It is currently worth approximately $4 million to $6 million per acre, adjacent land was recently sold to a Hilton timeshare project for approximately $5,000,000 per acre.

Currently on the Balance Sheet at approximately $21 million.
At $4 mln per acre x 27 acres = $108 mln
At $6 mln per acre x 27 acres = $162 mln

The company is continually interviewing candidates to partner and help finance development of the land. Any such transaction would be the catalyst in beginning to clarify ARHN’s apparent discount to NAV. ARHN has a gaming license covering the operation of any casino built on the property which adds instant value to any partner.

20 acres outside of Vegas on Lone Mountain Road – tied to sale of Santa Fe Casino in which the purchaser has an option to acquire it for $5 mln by October ’03. We are waiting for further information.

Pioneer Casino in Laughlin, NV- The company currently leases this casino and is tied to a bad lease in which they are incurring approximately 14% or $4.8mln in interest expense as of fiscal year ‘02. The company has the option to purchase the casino for approximately $35 mln at the end of ’03. According to management, the company is barely cash flow positive given its current lease and will likely purchase the casino by putting down approximately $15 mln in cash and taking out a first mortgage for the balance at approximately 8%. The cash flow generated from the casino will cover the interest expense on the mortgage.

Investment Properties - Upon closing of the Santa Fe sale, ARHN purchased two investment properties intended to qualify as like-kind exchanges of real property under section 1031 of the Internal Revenue Code and to defer a portion of the federal corporate income tax on the sale. ARHN paid $145 mln, consisting of $12.6 mln in cash and $132.4 mln in debt. These properties are generated by $630K in cash flow and depreciation charges against income of $3.6 mln as of the end of ’02.

Duke’s Casino – In October of ’02, the company loaned $1.1 mln at 15% which matures in 2009 to Duke’s-Sparks, a Nevada limited liability company that is developing Duke’s Casino. The company has the option to acquire 70% of the equity in the entity that owns Duke’s. The company also advanced Duke’s $400K in the form of a promissory note. As a note, the son of ARHN’s CEO is a limited partner in Duke’s.

Archon Preferred Stock (symbol: ARHNP)
This small issue (approximately 4.7 million shares) is also a nice piece of paper. It trades at $2.25 per share, has a liquidation preference of $3.57 or approx. $18 mln. The company had been paying PIK dividends up until Oct 31,1996. Thereafter, the company decided to accrue dividends at a rate of 8% starting in ’97 and increasing semi-annually to a maximum of 16%. As of the end of fiscal year end 2002, $9.5mln in dividends has accrued. As of September 30, 2003, the liquidation preference was $3.73 per share).
The dividends are payable only when declared by the BOD and the liquidation preference is payable only upon liquidation, dissolution, or winding up of the company.
Because dividends have accrued for two years, holders of preferred stock are entitled to elect 2 directors (The next Board meeting is scheduled for sometime in April). The company has the option to convert these preferreds to an 11% debenture. To date however, management has not made a decision to convert.

Legal Issues
Pioneer debt has provisions prohibiting payment of dividends on preferreds. It also keeps ARHN from incurring additional debt (which is probably why they haven’t converted the preferred stock to debentures).

Management
Paul Lowden, ARHN’s Chairman/CEO owns 80% of the common stock. Lowden is a “Vegas Man”. He met his wife Susan Lowden (ex- Nevada senator, ARHN director and EVP) during his early days as a lounge singer. William Ruggio (NV Senator) is antoher prominent board member.

Valuation
The company currently has a book value of approximately $2.11 per share. If you value the land on the Vegas strip at the current market value, the book value bumps to $18.70 to $27.40 per share. (Assuming that the company does not develop the land and sells it at $4 to $6mln per acre and assuming a 40% tax rate, the net proceeds would be $51.8mln to $84.24 or $8.33 to $13.54 per share. (See pro forma balance sheet at back of report).

December 31/02 Pro Forma Balance Sheet ($mlns)
Low High
Cash & equiv. $20.8
Restricted cash $13.0
A/R $3.4
Inventories $0.3
Prepaid expenses $.98
$38.5
Land held for
Development $110 $164
Property held
For Investment $140
Land used in ops $8.2
Bldgs & improve $35.7
Machinery $11.9
Accum depreciation ($21.6)
$284.2
Other Assets $6.4
Total Assets $329.1 $383.1

Liabilities
A/P $1.9
Int payable $2.3
Accrued liab $2.4
Current LT debt $.10
Current Non-
recourse debt $5.7
Total Current $12.4

LT Debt $0.27
Non-recourse debt $117.4
Lease obligations $35.4
Deferred taxes $34
Other liabilities $11.3
Pfd stock $18.1
Total liablities $228.9

Equity $100.2 $154.2
Per share $16.1 $24.8

Catalyst

Development details to be issued by the company "in a week or so."