Blackstone Group's agreed deal to buy Hilton Hotels Corp. this week showed that buyout firms will happily layer big premiums on the right target and can still feel confident about debt financing.
That's particularly true when the target owns appealing properties, allowing the deal to be funded through commercial mortgage-backed securities (CMBS) as well as corporate debt.
Add to the mix assets that line up well next to others accumulated in the current buyout boom, and the case can be made for Blackstone paying 25 percent above the record high for a stock that had already roughly tripled in the previous five years.
Hotels appear cheap relative to other real estate asset classes, Susquehanna Financial Group analysts wrote in a research note on Thursday. We believe that investors see hotels as a risk-adjusted 'bargain' relative to other asset classes, such as office buildings, malls, and apartments.
Its holdings of more than 50 properties, including New York's Waldorf-Astoria hotel, may allow Hilton to finance a leveraged buyout (LBO) on good terms by tapping the tightening CMBS market. Secured by relatively stable properties, these loans are often far cheaper than general corporate debt.
Enthusiasm for this paper had given investors unprecedented access to cheap debt -- lifting both leverage levels and prices paid per square foot for office space and other properties. Lenders recently became more selective amid wider concern about debt quality triggered partly by the subprime mortgage crisis.
But Blackstone isn't just buying Hilton as a standalone asset. Blackstone already has a portfolio of more than 100,000 hotel rooms in the United States and Europe -- including La Quinta Inns and LXR Luxury Resorts and Hotels -- and likely sees synergies in acquiring Hilton's nearly 30,000 rooms that are not usually associated with private equity deals.
PAYING A HIGH PRICE
Even Hilton seemed unusually comfortable with Blackstone's gambit; $47.50 per share is about 40 percent above the closing price a day before the deal was unveiled, valuing Hilton at about $20 billion excluding debt.
We think the price on this deal maximizes shareholder value, said Stephen Bollenbach, Hilton's co-chairman and chief executive, during a conference call on Thursday. They're paying a high price so I think that demonstrates their desire to grow the company.
Buyout firms are flush with funds earmarked for real estate. The Hilton bid comes as a newly public Blackstone is raising a $10 billion real estate fund, according to reports.
And they aren't the only quasi-strategic buyer among private equity players. Other real estate opportunity funds such as Goldman Sachs Group Inc.'s Whitehall unit -- which last month agreed to buy hotel REIT Equity Inns -- are positioned to take advantage of similar synergies.
CATALYST FOR TRANSACTIONS
Still, not all lodging companies can lean heavily on real estate financing, said JPMorgan investment banking managing director Glenn Carlin, because some get cash flows from operations they do not own, such as time share earnings and fee income.
The big hotel companies are not as easy to finance in an LBO as one would think, Carlin said. The traditional corporate debt markets are typically not as aggressive as the real estate markets.
Yet buyouts may prove increasingly likely for those companies that can utilize real estate debt markets. Shares of Starwood Hotel & Resorts Worldwide Inc. (HOT.N: Quote, Profile, Research), though flat in Friday trade at $74.16, had jumped 8 percent on Thursday.
Starwood looks a whole lot like Hilton, said Susquehanna analyst Robert LaFleur. Stylistically and scale-wise it makes the most sense as a potential target.
Access to CMBS is also a catalyst for gaming company buyouts, LaFleur said.
Indeed, gaming companies recently targeted for buyouts, such as Harrah's Entertainment Inc. and Station Casinos Inc., own substantial properties.
Real estate companies -- including those in lodging and gaming -- have access to additional capital markets like CMBS that other industries do not, said JPMorgan's Carlin, adding: Although retail companies have begun figuring out how to utilize the CMBS market.
Big retailers Macy's Inc. and Target Corp. -- whose shares were each up about 5 percent late on Friday -- may be attractive buyout targets due to the embedded value of their real estate. Such deals would be similar to the 2005 buyout of Toys 'R' Us, which leveraged off its properties for financing.
(Additional reporting by Chris Reiter)