PEQ Private Equity

Advanced merger discussions between Morgans Hotel Group Co. and hotelier Sam Nazarian's SBE Entertainment Group have collapsed after months of negotiations, said people close to the process, after two longtime rivals at Morgans clashed over terms of the deal.

On one side was private-equity investor Ronald Burkle, a preferred equity holder in Morgans, who favored the merger. On the other side: Jason Kalisman, a Morgans board member whose investment firm, OTK Associates, is the largest shareholder.

Mr. Burkle was in line to become chairman of the combined company and would have acquired two Morgans hotels as part of the deal, according to a draft news release on the merger reviewed by The Wall Street Journal.

Mr. Kalisman, however, believed the company was giving away too much to Mr. Burkle, according to an October letter OTK sent to the Morgans board that was reviewed by the Journal.

The negotiations faltered after Mr. Kalisman's firm wrote the board to express its "strong opposition" to the transaction, according to the letter. Mr. Burkle said he wouldn't agree to a deal without full board approval, these people said.

Some large Morgans shareholders, who were uneasy with an agreement giving board control to SBE, also had concerns about a merger, said people close to the matter.

The two men have sparred for years, sometimes lashing out publicly, as when Mr. Burkle referred to Mr. Kalisman as a "spoiled child" in a regulatory filing. The feud goes back to at least 2013, when they angled for control of a historic but small boutique hotel operator with a shrinking market capitalization that now stands at about $120 million.

Both men trace their roots to the retail industry. Mr. Burkle, 62 years old, is the son of a grocery-store manager. He worked for his father as a clerk and went on to found the private-equity firm Yucaipa Cos. and became a billionaire through leveraged buyouts of supermarkets and grocery chains.

Mr. Kalisman, 37, has a background in real estate and investing, and was Morgans interim chief executive until recently. He is related to the Taubman family that created an empire of shopping malls, starting in 1950.

A Morgans merger with SBE had been in the works for months and was seen as a second chance for both companies, which have been through tough times lately.

Founded by nightclub impresario Ian Schrager in 1984, Morgans helped pioneer the boutique hotel craze that focuses on high design and social public spaces. It owns the Hudson New York and the Delano South Beach hotels, and it manages a dozen properties in the U.S. and abroad.

But as more hotel companies launched competing boutique properties, including the big chains, Morgans has had a difficult time keeping its edge.

The company in May 2014 announced it had hired Morgan Stanley to explore strategic alternatives. It has reported negative net income in recent quarters even as the U.S. hotel industry has enjoyed booming revenue and record room rates.

The busted deal also upends SBE's hope for a publicly traded stock, which people familiar with Mr. Nazarian's thinking said is something he had counted on to help grow his company. SBE has new hotels in the pipeline, including one in New York and other properties in Mexico, but the company will have to find new funding for future expansion.

The two sides reached a tentative agreement that would have called for each to own half of the new company, which was going to be called SBE-Morgans, in a stock-for-stock transaction, according to the draft news release. SBE-Morgans' market capitalization would have been about $260 million, a person familiar with the negotiations said.

The combined company would have paired SBE's SLS and other hotel brands and its nightclubs and restaurants with Morgans hotel brands like Delano and Mondrian. Mr. Nazarian, SBE's chief executive officer, would have been CEO of the combined company.

The merger called for Mr. Burkle to acquire the two hotels in a deal that valued the properties at $590 million, according to the release.

Mr. Burkle became involved in Morgans a few years ago through preferred shares as well as loans he made to the company that have been retired.

OTK Associates began assembling a stake in Morgan in 2008, and in 2013 nominated a new slate of directors aimed at blocking Mr. Burkle's recapitalization plan.

That plan involved canceling some of his holdings in the company in exchange for ownership of the Delano and other Morgans assets. OTK criticized the plan as giving control of the company to Mr. Burkle, and OTK's slate of directors won the shareholder vote that year.

After the vote, Morgans then-chief executive officer Michael Gross, a close associate of Mr. Burkle, resigned and Mr. Kalisman took over as interim CEO, a position he held until earlier this year.

Mr. Burkle fired back a couple of months after the 2013 vote through a Morgans regulatory filing, in which he said Mr. Kalisman was "acting like a spoiled child" and "playing with the company as though it's your new toy." The Yucaipa chief then said he wanted to see Morgans put up for sale.

Write to Craig Karmin at craig.karmin@wsj.com

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(END) Dow Jones Newswires

November 04, 2015 15:35 ET (20:35 GMT)

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