Description

Description:
I originally posted this idea back in December 2003 shortly after the company announced their intention to develop their 27 acre parcel of land on Las Vegas Boulevard, Las Vegas. Please refer to that report for a description of the company and its assets. I would like to provide an update to that report in light of the run up in real estate values on the Vegas Strip. I will also update the preferred status as well as some other issues.

27-acre parcel on Las Vegas Blvd.

Our earlier report was posted shortly after the company announced their intentions to develop the land on Las Vegas Blvd. They were granted approval from the Nevada gaming commission in April of 2003 and approval from the Clark County development board in February of 2004. The project is to be a $650 million casino/hotel development called “Palace of the Sea” (see earlier report for details). Since that announcement, the company has essentially provided no update to the public. Two things have happened since their announcement. One, they terminated the Wet’n Wild lease on the property which signals that the company is pushing forward with their development intentions. Two, land values have increased substantially since then. In our earlier report, we had valued the land between $4 million to $6 million per acre. Since that report, the land values have increased and we have bumped our range to $6 million to $10 million per acre adding incremental value of $52 million to $106 million (pre-tax) to the asset value.
(this was confirmed after speaking to a few large, national real estate brokerage firms in Las Vegas). Why a $4 million spread? A $6 million sale would go to a well-financed buyer with no financing requirements, no contingencies and a quick close. A $10 million value would go to a buyer who had financing contingencies etc.. making it a slower sale process.

Recent transactions on the strip have been in the upper single digits to low double digits. Why have these prices risen so quickly? Well, for a couple of reasons. First, developers are betting on another up-cycle with the last one being in 1999. What is different now is simple – there is LESS land available. The land that Archon owns is on the north end of the strip and until recently, considered of lesser quality as it was further away from the main strip. Much has changed since then. The new Wynn Las Vegas is slated to open in April 2005 on the corner of Las Vegas Blvd and Spring Mountain Rd. It is much further north than the main resorts down near Las Vegas Blvd and Tropicana Avenue and will draw traffic ever further north. Second, high-end condominiums are popping up. The Turnberry for example which is close to Archon’s property opened up to much success and others are following. Donald Trump’s Joint Venture recently won approval to construct a 1,500 condominium unit. The demographics show a real demand for second homes for baby boomers. With bigger buildings come bigger cash flows and therefore higher land values. Third, hedge funds are starting to look at casinos as a real estate play. Casinos stocks therefore are gaining higher multiples much to the same effect as lodging companies. D.E. Shaw attempted to acquire the Riviera (directly beside Archon’s property) for $12 per share or approximately $43mln. The stock has since traded up to $20. Analysts have put a $10 million per acre handle on the 26 acres that the Riviera sits on. Fourth, taxes, including both gaming and state taxes. Nevada does not have a state tax and their gaming taxes are the lowest in the country, with the exception of South Dakota. You have high gaming taxes in Illinois, as well as the threat of increased taxes in NJ and Michigan. Fifth, M&A activity. The bigger players want to get bigger. As a result, there is a rush to acquire land.

All this sounds great and you’re probably saying “that’s great, but will Archon get the financing?”. All I can say is this. The economics are ripe for such a financing. Paul Lowden (CEO) is a good deal maker, and I’ve confirmed this with people in Las Vegas.

If you were to run a cash flow model for a $650 million project such as this, you can make some general assumptions and depending on the timing on when it would be slated to open, ROIC % of approx 15% to 20% and the all important discount rate, you can come up with approx $17/share. You can come up with a similar number using an EV/anticipated EBITDA and discount it back. I don’t need to tell you that such a model is wrought with “assumptions”. Simply using an asset value approach is a good starting point on value. I’ll touch on that at the end of the report.

For a look at the locations of the major casino resorts (Archon’s is referred to as the Wet’n Wild), go to www.lasvegastourism.com/maps/vegasmap1sml.gif


Archon Preferred Stock (ticker: ARHNP)

The preferred stock is trading at approximately $2.40 per share. There are about 4.5 million shares outstanding and the company continues to repurchase them in the open market. They accrue but don’t pay a cash dividends. As of October 2003, they began accruing at 16% per annum. The aggregate liquidation preference as of June 2004 stands at $4.07 per share.
The dividends are payable only when declared by the BOD and the liquidation preference is payable only upon liquidation, dissolution, or the winding up of the company. Because dividends have accrued for more than 2 years, holders of the preferreds were entitled to elect 2 BOD members. They have done so since our last report. Howard Foster and Jay Parthemore were elected to the Board. Their terms expire in 2006 and 2007 respectively.
The best way to think of the preferred stock is as a perpetual preferred that will either be paid off in full, or converted to a debenture (at the company’s option)

The Pioneer Casino

Archon had been leasing the Pioneer in Laughlin Nevada but decided to purchase it outright in December of 2003 due to the unfavorable lease it was under. The purchase price was $35.6 million which consisted of $12.6 million in restricted cash, $2.5 million in marketable securities, $2.5 million from a note and approximately $18 million in debt secured by the land held for development in Las Vegas as well as a personal guarantee from Paul Lowden.
As of the first 9 months for fiscal year 2004, the Pioneer did approximately $2.2 million in EBITDA. The pro forma interest expense on this is $120,000 per month or $1.44 million per year. As management indicated, they just want to generate enough EBITDA to cover interest expense and some minor capital expenditures. Their ultimate goal, I believe, is to sell this thing and not lose any more money on it.


Duke’s Casino

They ceased operating this cash burn in December of 2003. The company subsequently wrote off their investment in Duke’s and recorded a reserve for its receivable from Dukes in the amount of $1.4 million. In addition, they agreed to purchase the real property from the senior lender for $3.7 million no later than June 1, 2007. The only good news out of this was that 190 slot and video poker machines in Duke’s Casino is owned by Archon and they subsequently moved this stuff to the Pioneer, alleviating some future additional cap-ex requirements for the Pioneer.


Lone Mountain Rd Property
The company ended up selling the 20-acre parcel for $5.7 million ($0.7 million more than the original option called for).

Investment Properties

Nothing has changed here. The properties continue to kick off decent cash flows. Archon paid $145 million for the two properties and purchased them under a 1031 exchange. I don’t have an exact appraisal on these properties, but we could probably say with some margin of safety that they are worth at least $150 million. Mortgage debt against it stands at approximately $110 million.

Valuation (using June 30/2004 B/S)
Tables don’t work very well when converted to PDF so I’ll summarize it as follows:
Assets
Cash - $9.8mln including marketable securities
Land held for development (27 acre parcel in Vegas) - $23.1mln
Investment properties - $134.45mln
PP&E and other assets (including current and long term) - $41mln
Total Assets = $ 208.5mln

Liabilities
Current Liabilities (including current portion of non-recourse debt) -$37.1mln
L.T.Debt - $18.4mln
L.T. Investment Property debt - $81.4mln
Deferred taxes - $28.7mln
Other Liabilities - $20.6mln
Preferred Liq. Preference - $18.5mln
Total Liabilities -$204.7mln

Equity
$3.08mln
Low-end Adjustments include:
$5mln to investment properties.
$138.9mln to Land Held for Development(Vegas strip) at $6mln/acre
Pro forma equity (low-end) - $146.98mln or $23.63 per share
High-end Adjustments include:
$7.5mln bump to investment properties
$246.9mln to Land Held for Development (Vegas strip) at $10mln/acre.
Pro forma equity (high-end) -$257.48mln or $41.40 per share.
Assuming a 40% tax hit to the gains on the Vegas strip land, you get down to a range of $14.70 to $25.52 per share.

Catalyst

Financing announced which is likely to happen by year end given the fact that the economies are ripe for these types of deals and the fact that the company terminated its Wet'n Wild lease on the 27 acre parcel of land.