|Shares Out. (in M):||35||P/E||0||0|
|Market Cap (in $M):||63||P/FCF||0||0|
|Net Debt (in $M):||562||EBIT||0||0|
In what should be the final chapter in a seemingly endless saga replete with proxy fights, board reshufflings, public bickering, and even a failed midnight coup attempt at one of the company's Manhattan properties, Morgans Hotel Group is finally ready to be sold....or is it?!
Many on VIC are likely familiar with the issues that have plagued the company since the financial crisis, and MiamiJoe's 2015 writeup does a nice job summarizing the company's assets (owned hotels and management contracts). Rehashing the complete background to the current merger agreement in place is not worth it (and would take a very long time), so I will summarize by saying that after years of various shareholder factions vying for control of the board, the board formally began to explore alternatives in Septemeber 2014, with the stock at $7.52. On 5/9/2016, almost two years later, the board announced a deal to be acquired by Sam Nazarian's SBE group for $2.25/share in cash. By the time of the deal announcement, poor results and investor skepticism about a deal materializing had driven the share price down to $1.33.
Post-deal activity -
The definitive proxy statment (https://www.sec.gov/Archives/edgar/data/1342126/000119312516670960/d208371ddefm14a.htm#tx208371_20) revealed a flurry of activity, both leading up to and following the announcement of the deal with SBE. Most important was the emergence of two bidders (Bidder U and Bidder V) after the deal announcement offering $2.40/share and $2.75/share, respectively, with both parties representing adquate financing to close.
When Morgans dislcosed the $2.75/share offer in an amendment to the proxy, shares traded as high as $2.67. However, a poor Q2 print coupled with a NY Post article claiming Bidder V had walked gradually sent shares back to ~$2.25/share.
Latest developments -
On 9/7/16, one week ahead of the shareholder vote on the SBE deal, Morgans filed another amendment to the proxy, disclosing three material pieces of information:
1) While Bidder V has yet to sign a non-disclosure agreement, as recently as 9/2/16 Bidder V requested that Morgans' advisers speak with Bidder V's advisers regarding financing Bidder V's proposal.
2) The mortgage lenders have not yet consented to SBE's assumption of MHGC's mortgage debt, which is a condition to the merger.
3) SBE has not yet finalized agreements for financing the deal.
The dislcosure of (2) and (3) above has sent the stock down to where it is currently - $1.81/share.
The opportunity -
At $1.81/share, the deal with SBE represents a gross return of 24%, which, on an annualized basis, would be 165%, assuming a closing date of 11/9/2016, which is last day to close, per the merger agreement. To the extent investors believe MHGC holders will vote for the deal and that SBE can close, this represents a compelling opportunity. Additional activity on the part of other bidders provides further upside optionality.
Shareholder vote - the vote is scheduled for 9/14/16 and 29% of shareholders have pledged support for the SBE deal as part of the merger agreement. Given that no other bidder has gone public with an offer at this point, I believe shareholders will vote the SBE deal through.
While financing risk is unpleasant, it is not unusual for financing to take some time before coming together, particularly given the rather complicated capital structure of MHGC (preferred securities, warrants, etc.). Should SBE fail to close either because of a failure to finance the deal, or because of a failure to receive consent from lenders to assume MHGC's mortgage debt, then MHGC will be entitled to a reverse break fee of $6.5m, or $0.19/share.
Base case: the SBE deal gets done before the "out date" of 11/9/16. In their most recent amendment to the proxy, MHGC warns the deal could take "several weeks" after the shareholder vote to close if the mortgage/financing conditions are met - 11/9/16 is exactly 8 weeks after tomorrow's vote - likely enough time.
Bull case: If shareholders vote against the deal or if SBE fails to close, new bidders would have an open window beginning 11/9/16 fo sign an agreement. In the end, the provisions of the merger agreement with SBE have been the primary obstable to Bidders U & V conducting due diligence. There is clearly interest in the assets. Upside here is hard to pin down, but should negotiations reopen with any other bidders, odds of losing money from today's level are quite low, and there is a real possibility one could see a bid at or above the current deal's value given the number of interested parties.
Bear case: Should SBE fail to close and no other bidders emerge for the assets, the $6.5m reverse break fee would likely be cold comfort for shareholders, many of whom are likely scarred by all the drama at MHGC over the years. What does downside look like in this scenario? MHGC was trading at an unaffected price of $1.33 before the SBE deal was announced. This represents 26% downside from the current quote. However, given the number of bidders involved and the fact that Bidder V was in talks with MHGC's advisors re financing as recently as last week, and that both bidders V & U have expressed a willingness to go hostile in the past, I would ascribe fairly low odds to this scenario.
My expected value is as follows:
Base case: $2.25/share to be received on 11/9/16 - 60% probability
Bull case: $2.40/share to be received on 12/31/16 - 20% probability
Bear case: $1.33/share - 20% probability
I peg downside in the bear case at $1.33, assuming that the reverse break fee of $0.19/share is offset by weak results since last year and a pending dividend increase on their preferred securites (which are held by Ron Burkle, who has pledged his support for the SBE deal and who himself offered to buy MHGC for $8.00/share a few years back).
$2.25 x 60% = $1.35
$2.40 x 25% = $0.60
$1.33 x 15% = $0.20
= $2.15/share, or 19% gross return from here. With an assumed resolution on the above by 12/31/16, this would represent a weighted expected annualized return of 65%.
- Shareholder vote on 9/14/16
- SBE completes financing/mortgage agreements
- Bidders V or U (or other parties) make a public offer after failed shareholder vote or SBE failure to close
- Improved operating results