Checking Out of the Public Market

Are public hotel companies becoming an endangered species? Through the first six months of 2007, five hotel companies went private in deals valued at $7 billion, more than double the $3 billion total during the same period last year. The brisk level of M&A activity through mid-year was just a warm-up for the fireworks that followed on the deal front.

On July 3, the Blackstone Group bought Hilton Hotels Corp. for $20.1 billion in cash, or $26 billion including debt. Blackstone agreed to pay a 40% premium to Hilton's closing share price of $33.87 before the deal was announced. The acquisition still hinges on Hilton shareholder approval.

What's more, the deal has raised speculation that three other publicly traded hotel operators — InterContinental Hotels, Starwood Hotels & Resorts and Wyndham Worldwide Corp. — are mulling over buyout offers.

“Everything is up for grabs,” says analyst Amit Kapoor of Rye, N.Y.-based Gabelli & Co., who expects more hotel privatizations this year. “There's enough liquidity in the capital markets, and the public-private market valuation gap puts all major lodging companies in the crosshairs of private equity.”

Blackstone Group has cobbled together a formidable lodging empire (see table) through a series of acquisitions over the past few years. One driving force behind these deals, sources say, is the perception that the public market undervalues hotel companies. Most analysts agree that public hotel companies are trading at a substantial discount to their net asset value. As a result, private buyers are willing to pay more than public shareholders for these listed companies.

The Blackstone purchase represents approximately 15.2x management's 2007 EBITDA guidance. This is a rich multiple, considering that large-cap hotel companies had been trading at multiples closer to 11x to 12x EBITDA. Not surprisingly, many hotel stocks posted strong gains the week of July 4, including Starwood and Marriott, which popped by roughly 10% soon after the Hilton deal was announced. Trading in both stocks has since quieted down as of July 20, but shares in each company were still trading above their early July levels.

Blackstone's hotel portfolio is now considered to be the world's largest. Even before the deal was announced, Blackstone's portfolio included more than 100,000 hotel rooms in the U.S. and throughout Europe. Hilton owns, manages and franchises hotels under the Hilton, Conrad Hilton, Doubletree, Embassy Suites, Homewood Suites, Hampton Inn, Scandic and the Waldorf-Astoria Collection brands.

The entire Hilton portfolio consists of 2,800 hotels with 485,000 rooms. Hilton directly owns only 6.5% of those hotel rooms, and 60% of the total portfolio is franchised. “This is a very strategic acquisition for Blackstone because the company already owns so many hotel rooms, and can therefore convert many of those rooms under the Hilton flag,” explains Ralph Block, author of Investing In REITs and editor of the Essential REIT newsletter.

Blackstone can accelerate the growth of the Hilton brand while leveraging its existing strengths in the hotel market, adds Block, who finds the privatization trend a bit disturbing. “It is a very troubling question when the best and the brightest companies are going private,” concludes Block. “Maybe the folks running the public companies are bearish, but I don't think anyone really knows the answer why.”

INSATIABLE APPETITE FOR HOTELS

Blackstone has expanded its empire over the past few years by spending nearly $39 billion to acquire public hotel companies.