Kerrisdale Capital Management Issues Letter to Morgans Hotel Group, Urges Board to Sell Company
NEW YORK, June 20, 2013 /PRNewswire/ -- Kerrisdale Capital Management, a private investment management firm and beneficial owner of 1.4 million shares of Morgans Hotel Group ("Morgans Hotel" or "Morgans") (NasdaqGM: MHGC) and 4.3% of the company, issued the following letter on Thursday, June 20th to the Board of Directors of Morgans Hotel:
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Dear Directors, Management and Other Stakeholders of Morgans Hotel Group,
We wish to congratulate all parties on a well-fought and value-creating proxy contest over the past few months. Shares of Morgans Hotel closed Wednesday, June 19 at $7.59, near 3-year highs. While the debate over the future direction of the company has been heated and adversarial, shareholders collectively have benefited.
Concerning Michael Olshan and his colleagues at OTK Associates LLC, it's abundantly clear that shareholders have profited significantly from his team's tireless efforts. When management's initial recapitalization plan was announced on April 1, 2013, the company's shares closed the day at $6.16. They languished at approximately that level for more than a month, and shares may have continued to trade at that range if the originally proposed recapitalization plan was consummated. However, as a result of OTK's persistent and intelligent activist campaign to appoint a new slate of directors, shares of Morgans Hotel have risen more than 20%. Yucaipa's May 17, 2013 disclosure of an unsolicited bid of $7.50/share and management's initiation of a sale process were direct consequences of OTK's activism. With their work on Morgans Hotel, the Olshan and Taubman families have earned themselves a sterling reputation for creating shareholder value.
But if Kerrisdale were satisfied with the current state of affairs at Morgans Hotel, we would not be writing this letter and inserting ourselves into the public discussion over the future direction of the company. Certain language used by OTK in its activist campaign leave us concerned, and unclear about the OTK board's future intentions. Judging by the 10% intraday decline in the share price of MHGC immediately following the announcement of the OTK proxy victory, it's clear that we are not alone in our concerns.
To best understand Kerrisdale's reservations, it's important to recognize that actions and communications by both the Yucaipa / management bloc and the OTK bloc during the proxy contest were driven not only by desires to maximize shareholder value, but also by a degree of mutual mistrust. Throughout the campaign, language used by both sides bordered on unprofessional. In particular, we believe that neither side has presented a sufficiently realistic portrayal of the historical sequence of events at Morgans. Lost in the vitriol are the incredible contributions of management in building Morgans into what the company has become today, as well as OTK's actions in triggering the recent rise in the company's stock price.
Having already discussed the contributions of OTK, it's equally important to recognize the contributions of the current management team. Management has been unfairly portrayed as self-dealing destroyers of value throughout the OTK activist campaign. This is inaccurate. Activists need to be careful when they begin to discredit the very real and tangible progress that hard-working corporate executives often make in an effort to improve the long-term value of their businesses. The OTK activist campaign, for all its value-enhancing aspects, went too far in its criticism of Morgans management.
We believe that Morgans management has taken diligent steps to make the company appealing to a strategic acquirer. Unsurprisingly, these steps have required investments, not only in the form of capital investments but also in the form of investments through the expense line items of the income statement. Recent SG&A at the company has been irregularly high, but much of it has likely been necessary in order to strengthen the talent and competence of the employees at both the corporate and unit hotel level. Any strategic acquirer will be able to realign Morgans' cost structure, especially in terms of SG&A, and use its own selling and administrative infrastructure to further build out the company's iconic brands. As a result, historical and current SG&A expenses are among the least important line items in the company's financial statements. Revenue has suffered because of ongoing renovations at the Hudson and Delano, but then again a strategic acquirer would not desire dilapidated hotels as the cornerstones of brands it expects to leverage across the world. In numerous ways, recent historical results have been depressed because the Morgans management team recognized that the end-game is a sale to a strategic acquirer, and short-term sacrifices had to be made to make Morgans as valuable as possible to an acquirer.
Of course, not all of management's actions have been blameless. Have certain executives granted themselves excessive stock options? Probably. Was Yucaipa attempting to juice its returns through the proposed recapitalization? Sure. But it's unfair and misleading to use certain measures of self-dealing to discredit the far more consequential body of tremendous work that the Morgans management team has accomplished over the past several years. Yucaipa and the current management team have been unfairly criticized for taking a long-term view towards building an enterprise that can become as attractive as possible to a strategic acquirer.
Having explained our frame of reference, it's time to turn to the appropriate prognosis. Morgans Hotel needs to be sold. A thorough and carefully coordinated sale process, spearheaded by a reputable investment banking firm, is the very obvious way forward for the company at this time.
Morgans Hotel Group is far more valuable to a strategic acquirer than operating as a standalone company. To a capable acquirer, Morgans represents a scalable platform upon which to build a high-margin international luxury boutique hotel chain. As we saw Starwood do brilliantly with its Le Parker Meridien acquisition, a strategic acquirer can make many multiples off its investment by combining a prestigious hotel brand with its international expansion expertise. Marriott's recent acquisition of the Gaylord Hotels further illustrates the substantial cost synergies that a global hotel chain can achieve by leveraging its existing reservation systems, procurement, and marketing, substantial costs a boutique brand management company bears on its own.
Current management's success in signing numerous property management contracts for its Delano and Hudson brands is a testament to their hard work and to the marquee value of Morgans' brands. Using Starwood's W hotel chain as a benchmark, it is quite possible that Morgans could expand its brands to over 50 hotels globally. This would represent an annual management fee revenue base in excess of $100 million versus only $20 million today. A well-capitalized and proven global operator can effectuate this expansion far faster than the currently undercapitalized Morgans.
Though Morgans has potential as a standalone entity, when accounting for the time, costs and risks associated with executing its plan, we believe that well-financed global hotel chains can achieve a significantly higher value from Morgans Hotel than it can on its own. By selling the company today, shareholders can achieve a far higher value, adjusted for time value of money, than by waiting for Morgans to grow organically.
Recent disclosures by Morgans have indicated that the number of parties that have sent an expression of interest in acquiring Morgans has swelled to nine. This signifies that the sale of Morgans would benefit from a robust auction, one in which Morgans Hotel shareholders will likely be able to extract a sizeable amount of any synergy value. Global hotel management companies are currently trading for 10x to 12x EBITDA and can easily finance an acquisition of the entire company, including the Delano and Hudson hotels.
Finally, the tension between the new Board and current management team makes us concerned about execution issues if Morgans remains independent. To the extent that the OTK board is considering a change in management, we note that it's highly difficult to replace management at any company in an effective manner, let alone at a fast-growing boutique hotel operator whose future lies in newly signed management contracts. Continuity is typically the hallmark of well-run businesses.
We believe the time to sell Morgans Hotel is now.
That sale process should be run by the current management team, with the current bankers that the management team has been working with over the past few weeks. Appointing new management would be highly disruptive at this point in the process, and Kerrisdale fiercely opposes any delay or disruption to the recently initiated solicitation and evaluation of bids. Once a company has put itself on the block, there is no credible turning back. Signing new partnership agreements and contracts will become significantly more difficult, and uncertainty around future ownership can lead to deteriorating operations and irreparable damage to the Mondrian, Hudson and Delano brands.
Our advice to the incoming board is clear: keep the current management and move forward with the ongoing sale process. The OTK board must explore the nine expressions of interest in a full and transparent process, and aggressively solicit additional bids. OTK should congratulate itself on being the catalyst that has brought about the current state of affairs, and adopt the course of action that is in the best interest of all shareholders. Sell Morgans Hotel Group.
Sincerely,
Sahm Adrangi
Chief Investment Officer
Kerrisdale Capital Management, LLC
About Kerrisdale Capital Management, LLC
Kerrisdale Capital Management, LLC is a fundamentally-oriented investment manager that focuses on long-term value investments and event-driven special situations. Kerrisdale has $225 million in assets under management and is based out of New York City.
For further information please contact:
Sahm Adrangi
Chief Investment Officer
Kerrisdale Capital Management, LLC
1212 Avenue of the Americas, 3rd Floor
New York, NY 10036
Telephone: 212.792.9148
SOURCE Kerrisdale Capital Management, LLC
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