Morgans Hotel: A Zombie Company Bleeding Cash and Defaulting on Loans

Aug.17.09 | About: Morgans Hotel (MHGC)

Morgan Hotel Group (NASDAQ:MHGC) “owns” several heavily mortgaged hotels, operates a few more, and is involved in several others as joint ventures. These properties are generally high end independent hotels, which is the single worst performing segment of the very weak lodging industry. In the most recent quarter, MHGC’s Revenue per Available Room plummeted 39.5%, by contrast for the overall hotel industry this metric was around -20%. MHGC’s hotels are suffering from severe double whammy: less overall travel and substitution from high-end to mid-priced and business class hotels.

MHGC, because of its heavy debt load and reckless bubble-era buying spree, has never made money, even during the boom. Its reported net loss was around $30 million in 2005, $14 million in 2006, $15 in 2007, and $57 million in 2008.

Unsurprisingly, with this weak performance when the economy was growing, now MHGC is hemorrhaging cash. This most recent quarter, it announced that it had stopped making payments and was in default on the loans against two of its hotels, and even worse was forced to renegotiate its line of credit backed by its three best properties. The interest rate on the credit line was increased while its size was slashed from $220 million to $125 million. Previously the line of credit was at LIBOR + 1.35%, now it’s LIBOR + 3.75% with a LIBOR floor of 1%. This is a strong indication the company is getting squeezed.

Valuation of the Stock: $0

One method of valuing a stock is the string of dividends is based on its earnings, most commonly price to earnings and price to earnings growth. But MHGC simply lacks the ability to make money given its huge debt load. It even lost money during the best of the boom years, and is losing even more now. As it blows through even more money and takes on even more debt, there is basically no prospect of it making money in the future. It will go out of business before it makes any money (see more on its impending bankruptcy below). So by this metric the stock has a value of 0.

Indeed, since it was incorporated all MHGC has done is lost money: adding up all of its profits since incorporation and subtracting all losses produces a figure of negative $103.4 million.

Another method is to look at its balance sheet. MHGC reported a book value as of 6/30/09 of $47.6 million, or $1.60 a share. This paltry figure contrasts with its ridiculous $5 a share current price.

But MHGC’s highly questionable accounting practices hide an even worse truth. The biggest red flag on MHGC’s balance sheet is its gigantic $74.94 million “deferred tax asset.”

As the company lost money quarter after quarter it has understated these losses by creating this tax asset. This is perfectly justifiable, like most questionable accounting practices, in certain circumstances. Lots of companies swing from profit to loss and back again, and adding the value of current losses to the balance sheet because they can become future deductions makes sense. But MHGC simply is not going to make enough money, and probably not any money, before it files for bankruptcy.

Subtracting out this phantom asset drops book value from $1.60 a share to negative 92 cents per share. The company’s books also contain a phantom “goodwill” asset, which it reports as worth $73.7 million. Goodwill, however, is an accounting fiction, and one that can only be justified when a company purchases assets that by other accounting conventions cannot be booked at market values.

This fairly rare situation does not present itself here. Instead, it is just to cover up that MHGC overpaid for many of its properties during the real estate bubble. On an open market, $73.7 million in goodwill is worth precisely zero dollars and zero cents. Subtracting this out brings MHGC’s book value down to negative $101.01 million, or -$3.41 per share.

Ticking Time Bomb Convertible Note Debt Will Lead to 2014 Bankruptcy

As bad as all this sounds, MHGC actually is sitting on a decent amount of cash, and still has part of its line of credit open. In other words, while its future will only consist of quarter after quarter of losses, and it is deeply in debt, and it will continue to have to walk away from certain of its hotels because the revenue can’t cover its interest payments, the company itself will survive until October 1, 2014, at which point it will, without doubt, declare bankruptcy.

The reason why is its ticking time-bomb convertible notes. Way back in 2007 some very foolish people lent MHGC $172.5 million at the absurdly low interest rate of 2.375% (the conversion rights are beyond worthless). This loan is due on 10/1/14, and there is absolutely no way MHGC will be able to pay it back. Here is my rough forecast of MHGC’s future available cash and credit:

  • 1/1/10 $215 million
  • 1/1/11 $185 million
  • 1/1/12 $160 million
  • 1/1/13 $135 million
  • 1/1/14 $110 million
  • 10/1/14 $89 million (the day the bill for $172.5 million comes due).

Note that I am predicting the company continuing to burn money in 2010 and beyond, but at a much slower than its current rate of about $50 million a year. This is partly because I think eventually the hotel industry will recover, but not enough for MHGC to actually turn a profit with all of its debt. If and when a lodging recovery occurs a few years from now, MHGC will have more debt it is paying interest on and less cash earning interest than it did during those good years, a period in which it nonetheless kept losing money.


The stock of MHGC has no economic value. Even during some of the best years ever for luxury hotels MHGC still consistently lost money. Even under an unlikely and extremely optimistic scenario in which the company turns a small profit two or three years out, it simply has no way of paying back its convertible notes. It was a nice ride while it lasted for the company’s pampered management and board (including guru author Deepak Chopra), but in the end a company that is unable to make money will not last. The foolish people who purchased the convertible notes extended MHGC’s simulation of corporate life for years by funding these losses, but this zombie company’s hour of death is completely foreseeable, and is ticking away five years, one and a half months from now.

In the mean time shares of MHGC are dead money. My target for MHGC is $0.00. If you own it, all you have to look forward to is no dividends and the stock drifting up and down on a random walk to its eventual destination of zero five years from now.

Unfortunately, I clearly not the only one to see that MHGC is worth $0.00, and MHGC is heavily shorted with no shares currently available for new short positions. My solution to this has been to short MHGC calls.

Disclosure: Short MHGC calls