Morgans Hotel Group Co. (NASDAQ:MHGC) owns several luxury hotels in top markets such as New York City, San Francisco, and South Beach. Morgans currently has a market cap of $264 million.
Morgans Hotel Group reported an adjusted EBITDA of $9 million in the third quarter. This was a $6.1 million increase due to strong performance from the Hudson hotel in New York City.
Morgans' presence in major travel markets means that the company will continue to see strong EBITDA growth going forward. However, I am not writing this article to get investors to purchase the common stock, but rather buy the bonds that are maturing this year.
Morgans has $154 million worth of bonds coming due this October. These are senior bonds that are essentially tied to real estate. This is why the bonds have such a low coupon of 2.375% since the real estate is collateral.
The bonds are currently trading below par value by $4. So investors would realize a $4 gain at the time of maturity. In addition to this, the bonds are paid semi-annually. So if we factor in the interest we get about a 5%+ return between now and the time of maturity, which I consider to be a decent return given the large amount of safety here.
So why do I believe the bonds are safe?
Well for the one thing, the hotels are seeing an increase in EBITDA. Also interest rates are not likely to rise much before October meaning that Morgans should be able to refinance its debt fairly easily then.
Now it's also time for me to address the 300lb elephant in the room. Morgans Hotel Group had a tough time with the recession. There was a steep decline in room demand for luxury hotels. Consumers were cutting back heavily. In 2009, Morgans was under significant pressure and decided it needed a capital infusion.
Morgans was able to secure $72 million of capital from Ronald Burkle. Burkle owns the investment firm, Yucaipa Companies. However, this was a very costly move for Morgans. Part of the agreement calls for Burkle to receive preferred shares. These shares have a "death spiral" feature. The preferred initially has an interest rate of 8%, which increased to 10% this year. The rate will rise to 20% in 2016 if the preferred is not repaid.
So while this is an issue, the bonds are going to be maturing well in advance of this and there is another big plus. Burkle also happens to own $88 million of the debt coming due this October. This means he is incentivized to see the debt get refinanced properly.
I believe these bonds provided a near guaranteed 5% return in the next 9 months. The debt is secured by real estate located in top markets and investors will be investing along side Burkle as well. While Morgans Hotel Group does have some issues regarding its warrants and preferreds with Yucaipa Companies, this won't impact bond investors due to the near maturity.
This bond has a CUSIP of 61748WAB4.
Additional disclosure: I plan on purchasing a position in Morgans Hotel Group bonds.