Forty acres and a casino

Did Morgans Hotel Group overpay for the Hard Rock Hotel & Casino? How will it make the numbers pencil out? And what will become of the oldest profession?

Those are some of the questions swirling in the wake of Morgans‘ USD 770 million buyout of the hipster hangout on Harmon Avenue.

„‚Overpaid‘ is kind of a nebulous term,“ said resort broker David Atwell, president of Resort Properties of America. „Overpaid on comparable sales in the area for similar usages? Yes. Overpaid, considering that they want to develop this into a 1,800-room property (it currently has 647 rooms) producing USD 140 million (cash flow) eventually? Maybe not.“ Wall Street reacted negatively to the news. „The stock never stuck above its offering price of USD 20 per share after its February launch,“ wrote, „and with the Hard Rock announcement, it has hit a new low,“ bottoming out at USD 15.49 a share.

Higher prices, less staff

„We are going to extract every drop of value from those 40 acres,“ Morgans CEO Ed Scheetz vowed to stock analysts. „We will ultimately dominate the most attractive segment in Las Vegas.“

His deal breaks down as follows:

USD 421 million for the hotel-casino proper.

USD 259 million for 23.8 acres of developable land.

USD 69 million for intellectual property rights.

USD 20 million for the nearby Hard Rock Cafe.

USD 1 million for owner Peter Morton’s condo-development plans.

That’s a lot of nickels in the jukebox. Given the Hard Rock’s 2005 cash flow of USD 40 million, Morgans paid an EBITDA multiple of 10.5 for the hotel-casino. That’s compared to a recent industry average of eight times EBITDA, which would have seen the resort go for USD 320 million. Morgans has stated that it thinks it can get that multiple down to 8 or 9.

Jeremy Aguero of Applied Analysis believes that Morgans is computing the value of the underlying land into the cash flow, thereby obtaining a lower multiple. Whether Morgans overpaid, he added, depends on how it exploits its excellent new asset and brand. Of the latter, Scheetz said he’d be sticking with the Hard Rock imprimatur „for now.“ He also vowed to improve cash flow by flipping as much as two-thirds of the overall purchase to joint-venture partners and by creating internal efficiencies.

According to a recent briefing for analysts, the Hard Rock’s on-site reservation, marketing, merchandising and accounting departments will be given the sack under the new regime. Morgans expects to push room revenues higher through a mix of higher rates, a new management culture and upgraded room product. A corporate spokesperson added that Morgans would „utilize our revenue management system and customer lists to attract a more affluent clientele, which will spend more money throughout the property.“

During his analyst huddle, Scheetz further explained that the older, more affluent clientele could be transitioned to Morgans‘ Mondrian and Delano brands when those open as part of Boyd Gaming’s Echelon Place.

Moolah for Morton

Morgans believes one way it can improve cash-flow margins is by unloading almost USD 13 million paid to the elder Morton annually for management services and personal expenses.

Scheetz downplayed the importance of gaming revenues and in a conference call with investors, characterized the Hard Rock’s casino as an „amenity.“ Operations will be farmed out on a fixed-payment basis. This tactic is largely to expedite the takeover, although Morgans said it will seek a gaming license further down the road.

Despite Morgans partnership with Echelon Place, when asked if Boyd Gaming would be running the Hard Rock casino, company spokesman Rob Stillwell’s response was succinct: „Nope!“

Scheetz defended the Hard Rock’s price tag by stressing the uniqueness of the opportunity; the volatility of Vegas real estate as witnessed by the frenzied bidding war over the Tropicana; the chance to build a customer base for Echelon Place; and having a foothold on Harmon Avenue when development eventually ramps up there. As Scheetz told analysts, by making one high-impact purchase instead of several smaller ones, Morgans has achieved the first two years of its growth plan in one fell swoop.

His views are supported by and CB Richard Ellis Senior Vice President Carlton Geer. The former posited that the Hard Rock gives Morgans an instant Vegas revenue stream while it builds at Echelon Place. The latter pointed to the Hard Rock’s boutique-like character, contending that it’s an ideal vehicle for Morgans‘ Vegas debut.

„Yes, they paid an aggressive price for that property,“ Aguero said. „They’d certainly be hard-pressed to construct a property at the same price.“

Geer, however, scoffed at Aguero’s analysis. „The transaction is not as easy as putting a multiple on it. This is not a simple multiple deal,“ he said, noting that it also involves intellectual property that includes rights to the Hard Rock brand west of the Mississippi and internationally. That has little value, Geer added, unless you use it outside the Vegas market.

Majestic Research analyst Matthew Jacob seconded Geer’s view, saying that the 8-times casino-industry average reflects the lower multiples achievable in regional markets, where taxes are higher. „Nevada is much more stable. You know what you’re getting,“ Jacob remarked, adding that Las Vegas assets tend to be valued at 10 times cash flow, „so that does make sense. I was more surprised by the value they applied to the (adjacent) land, because it is off-Strip.“ He noted that he hadn’t seen comparable land prices away from the Strip but it’s good news for companies like Wynn Resorts and MGM Mirage that have similar off-Strip acreage that’s underutilized.

Seven years ago, Atwell said, he had those 24 acres — the Paradise Bay Club — in escrow for $ 41 million, or USD 1.7 million an acre. In September 2004, Morton bought them for USD 85 million (USD 3.6 million per acre). Their value has increased exponentially since then.

Morgans‘ breakdown puts it at USD 11 million per acre, while Aguero’s and Atwood’s analyses would place it higher.

„We valued the land at USD 10 million to USD 20 million in our bid offering,“ said Geer, whose company represented another would-be Hard Rock buyer. „Land values are based on scarcity. Land is irreplaceable. They pegged the value about right, based upon what is happening in Las Vegas right now.“

„The question,“ offered Aguero, „is whether these guys‘ crystal ball is that clear.“ Over the next decade, USD 30 billion worth of construction is slated here, he noted, including as many as 37,000 new hotel rooms.

Same cow, more milk?

One of the first things Scheetz plans to do, to hit his target of increasing Hard Rock earnings by 25 percent in the short term, is raise room rates, which currently average USD 169. „That’s a shame but probably almost inevitable, given who’s taking over,“ said „Las Vegas Advisor“ publisher Anthony Curtis. „If all of a sudden they try to start pricing it like their other properties, people aren’t going to go for it.“

Of Morgans‘ approach to its new Vegas acquisition, he said, „they don’t want to fiddle too much with that machine. They bought the machine and now they want to tinker it to death.“

„That’s unrealistic to believe you’re going to make it up just out of room rates,“ Aguero said of Scheetz’s USD 50 million revenue target. Pointing out that hotel rooms only account for 21 percent of casino revenues in Clark County, Aguero said that believing significant additional revenue could be achieved by tweaking yield management in the rooms is naive. „That’s the $ 20,000 question: How do they get more milk out of the same cow?“

Broaden appeal

Aguero speculated that Morgans might try to broaden the brand appeal of the Hard Rock or synergize with Echelon Place. „It’s possible (to hit that 25 percent mark) but it’s not going to be easy.“

Although Morgans hasn’t decided whether to redevelop the Paradise Bay Club site itself, with a joint-venture partner or re-sell it, Scheetz said the condominium project aborted by Morton last winter could be resumed almost immediately … and more efficiently. Scheetz might also cannibalize the Hard Rock’s surface parking to facilitate expansion. Implosion of the Hard Rock, however, was ruled out.

So, too, might be prostitution. Morgans is rumored to be planning to evict the ladies of the evening. „Unbelievable!“ Curtis exclaimed when informed of this. „If you start taking the girls out of the place, it’s going to affect the property in general. There’s not a casino in town that doesn’t have them somewhere in the joint.“