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Arnold M. Knightly

Mergers and acquisitions: Rock and a good place

5 February 2007

LAS VEGAS, Nevada -- "Relieved."

That was the word Morgans Hotel Group Chief Executive Officer and President Ed Scheetz used to describe the end of the company's nearly nine-month journey to take over the Hard Rock Hotel.

The $770 million deal closed late Friday afternoon. A public announcement is planned for today.

With the purchase, the boutique hotel operator gains entrance into the world's largest hotel market while acquiring a share in one of the city's most recognizable and marketable brands.

"Vegas is a very important," Scheetz said following the deal's closing. "We targeted Las Vegas as a very critical growth market for us. We know our customers go to Vegas. Maybe a decade or so ago it wasn't as important to our business, but now it's a key market along with New York, Miami and London."

Morgans announced last May that it was buying the Hard Rock Hotel, which includes the 11-story, 647-room tower, the Hard Rock Café on the property's southeast corner, and the adjacent 23 acres.

With the deal, Morgans also gains intellectual control of the trademarks "Hard Rock Hotel" and "Hard Rock Casino" for use west of the Mississippi River and certain areas overseas.

"The Hard Rock is a very strong brand," Scheetz said. "It has a very strong image in Vegas. The Hard Rock is well known throughout the world, and in Vegas it has a great presence."

Wall Street analysts have speculated that the Las Vegas property's excess acreage and intellectual property could be leveraged or sold to pay off some of the purchase debt. But Scheetz said the company is fairly far along with its expansion plans, and there will be announcements about the plans shortly, maybe as soon as a couple of weeks.

He added that although the deal just closed, his company already has been working on plans to upgrade and expand the property.

In May, Wall Street analysts and investors worried that Morgans, which has only a handful of operations in the United States, mostly focused in New York, Miami and Los Angeles, and two properties overseas, had leveraged itself too heavily to buy the Hard Rock Hotel.

Although Morgans had said in May that it would seek a joint venture partner for the purchase, the company didn't immediately name one. The lack of a named investor helped propel the company's stock downward from a May 8 closing price of $18.62 to a 52-week low of $11.94 by Sept. 25.

However, after Morgans announced a joint-venture agreement in November with private-equity investor DLJ Merchant Bank. The stock has rebounded, closing at $18.17 Friday.

"I think Wall Street is starting to recognize that what we set out to do we did," Scheetz said. "We knew there was a number of challenges for us. We've done everything we said we were going to do. I think when people see our expansion plans, what that will mean for us economically, it will be very positive."

DLJ invested $100 million toward the purchase for a two-thirds investment in the property. Morgans agreed to contribute a $50 million to $60 million equity contribution for a one-third stake.

Morgans will collect a management fee believed to be 5.5 percent of nongaming revenue -- estimated to be $6.9 million in 2007 and climbing to $8.4 million by 2010 -- before expenses from the joint venture to run all the nongaming operations of the hotel, a Morgan Stanley stock analysis released in early January shows.

Credit Suisse will carry $600 million in nonrecourse debt for the joint venture.

Morgan Stanley analyst Celeste Mellet Brown wrote in a stock note that if the partner had been announced earlier, investors may "have thought twice before selling shares." Brown said Morgans could realize a 10 percent to 12 percent return in 2007.

However, Morgans will have to realize the early returns without access to gaming revenue. Morgans filed paperwork for a Nevada gaming license in December. But until the paperwork is approved, Morgans will be leasing the 30,000-square-foot casino to local gaming and slot route operator Golden Gaming.

On Jan. 25, the Nevada Gaming Commission approved an initial two-year lease for the Las Vegas-based company to operate the casino while Morgans goes through licensing, a process that could take a year to complete.

Golden Gaming CEO and President Blake Sartini said the company could operate the casino beyond the two-year agreement even if Morgans gains licensing approval.

"We really felt very comfortable with Blake and his team," Scheetz said. "We've spent a lot of time with him over this (closing) period as well as with planning. We have a great relationship."

Scheetz added that Morgans and Golden Gaming are "in sync" when it comes for plans for the property. He agreed with Sartini that the relationship could go beyond the initial two years.

Meanwhile, 75 percent of the property's gaming revenue after expenses will be held in escrow awaiting Morgans' licensing. During an early January hearing, Nevada Gaming Control Board Chairman Dennis Neilander termed the deal "somewhat unusual."

Golden Gaming will receive the other 25 percent and a management fee analysts estimate to be about $3 million per year. However, Golden Gaming will pay an estimated $9.4 million in leasing fees the first year with slight increases every year, Morgan Stanley Research reported.

Approximately 520 of the Hard Rock's gaming employees are being loaned to Golden Gaming to operate the casino. The employees will be transferred to Morgans when, or if, the operator gets its license.

Although Morgans is coming into the Las Vegas market for the first time, the company is tapping a former Hard Rock executive to help smooth the transition into the market.

In October, former Hard Rock Hotel Vice President for Operations Randy Kwasniewski was hired away from Starwood Capital Group, where he oversaw the daily operations of 220 hotel and resorts in North America. He left the Hard Rock in 2003.

"It was important that they brought somebody on like myself who is familiar with the vibe, the soul of the hotel and casino, as well as the employee base" Kwasniewski said. "It is so crucial to the success of our hotel to have someone here who understands it very well and gets along well with the folks here. They didn't want anyone who would come in here and disrupt the successful things that have been going on."

Kwasniewski will return as president and chief operating officer to the property where he was previously responsible for all hotel, food and beverage, retail, and employee operations. He will also oversee Morgans' 50 percent joint venture with Boyd Gaming Corp. to develop two boutique hotels, Delano and Mondrian, as part of the $4 billion Echelon Place scheduled for completion in 2010.

"It's wonderful to come back," Kwasniewski said. "The hotel and the employees are wonderful. They've welcomed me with open arms. It's been great to come home after a couple of years."

Peter Morton opened the Hard Rock Hotel in 1995, at a construction cost of $80 million. The property was expanded four years later for an additional $100 million.