Never let it be said that MarketTamer.com is anything less than a “full service” provider of the best in investor education and information! A case in point is this very article, which is a timely follow-up regarding two articles we published back in September – when Blackstone Group (BX) the world’s largest private equity company[1] first announced it was preparing to take the iconic Hilton Worldwide Holdings (HLT) public via an Initial Public Offering (IPO). In light of what you’ll read below, as well as the stock market activity during the day of its IPO launch (December 12th), you may want to go back and review those articles!
https://www.markettamer.com/blog/does-blackstones-sale-of-hilton-hotels-suggest-a-market-top-part-i
https://www.markettamer.com/blog/does-blackstones-sale-of-hilton-hotels-suggest-a-market-top-part-ii
Prior to the actual IPO date, the announced “price range” for the stock IPO had been $18-21. However, BX and its IPO underwriters were so impressed (and overwhelmed) by the incredible advance demand for shares of this IPO[2] that a decision was made to “jumpstart” the IPO by one day! This is particularly striking during a week that saw the S&P 500 (SPY) experience a significant downside “swoon” through several layers of support (see below):
Pretty ugly chart, eh? (Talking “ugly”, you should have seen my “P/L Day” metrics!)
Here is a price chart for HLT on its first day of trading:
Taking into account the drop off within the entire market durin the last hour of Thursday (12/12) trading, I’d say HLT had an outstanding day!
Let’s quickly review[3] the story that intertwines BX with the historic “Hilton” brand.
Around 2006-07, Blackstone was on the hunt for a major brand it could take private, spruce up, and “add value”[4]. It spotted the Hilton chain and pursued a buyout.
In July of 2007, Blackstone succeeded in its goal of taking Hilton private, which brought to mind my own tattered and torn Book of Wisdom to Heed When Trading, a tome that includes: “Be careful what you set your heart upon, for it will surely be yours!”[5] With the advantage of retrospective vision and insight, we know that Blackstone’s purchase of Hilton came almost at the high water mark of the S&P 500![6] Adding to the human interest inherent within this story is the fact that BX paid $47.50/share for Hilton – which was a 40% premium to the price at which the Hilton stock had been trading prior to the announcement!
To be fair to BX’s 2007 management team, in those “salad” days of real estate, expectations were almost universally positive and the economy was strong. Few opinion makers were giving voice to any recognition of what we now understand was (by then) a mounting financial tsunami of historic proportions![7] [8] Needless to say, as business travel plummeted and leisure travel revenue tumbled in the months/years that followed, BX realized that its timing could have been better.[9] The initial aggregate price BX paid for the chain was $6.5 billion, and it has since thrown in an additional $20 billion of investment/debt to upgrade the chain’s infrastructure and streamline operations.[10]
To the credit of BX management, it did not waste much time with handwringing or finger pointing. Instead, it went to work creating the finest, most profitable hotel/resort chain it could. Looking back on these past 6 years, then, the result of these efforts by BX management has been impressive! Obviously, it started with what was already a solid brand – sporting the iconic Waldorf Astoria[11] and Conrad Hotels & Resorts luxury brands and an international montage of hundreds of thousands of hotel and resort rooms located throughout ninety countries and territories!
At this point, HLT manages the world’s largest hotel group – now consisting of over 665,667 rooms around the world, a full 36% more than in 2007. Within that range of facilities, there is quite a pricing spread from location to location. For example:
Batang Ai Longhouse Resort, Lubok Antu, Malaysia[12] — lowest cost room is $69.58 (210 MYR)
Hilton Hawaiian Village Waikiki Beach Resort — from $129
Waldorf Astoria in New York — from $329
Transcorp Hilton Abuja (Nigeria) – from $367
London Hilton on Park Lane[13] – from $359
The Batang Ai location (see photo to left and below) is a fortuitous example of the Hilton business plan for a number of reasons – each of which illustrate a strength of the “new” Hilton. One of the reasons for “hope” within the hotel industry looking forward is that, as the economy has slowly (but rather steadily) picked up since 2007, the major hotel operators have resisted the temptation to engage in major building programs to expand room supply. As we know from Econ 101, that means that the hotel industry has enjoyed more pricing flexibility (leverage) than would have been the case if hotel room supply actually had expanded.
So right about this moment, you should be asking yourself: “Wait a minute here! You just said that the Hilton chain has expanded by 36% since 2007! What do you mean the “room supply” has not exploded?!”
The answer is at once simple and ingenuous! Since the 2007, the biggest hotel operators have awakened to the economic realities of how brand, capex costs, and financial statements intersect in optimal ways. Namely, the big hotel operators specialize in hotel management, efficiencies of supply and cost management, and brand promotion/expansion. As any economist will assure you, companies perform best financially when they focus upon that which they know and do best!
Therefore, it is a huge plus that chains like Hilton and Marriott International (MAR) have awakened to the wonders of expanding their hotel businesses via what some call “asset light” – namely, bringing many new hotels (primarily overseas) into the Hilton chain as franchise properties. This choice results in providing HLT with a number of financially advantageous features, including: 1) no heavy upfront capital costs; 2) simpler accounting; 3) steady stream of revenue flowing in each year; 4) (if properly managed) improved metrics during “earnings report” season! The fact is that the 36% room growth since 2007 is primarily the result of BX recognizing the growth opportunities available through franchising!
If an investor asked herself (himself) why one might invest in a hotel company in 2013, here are some pluses:
1) Economic cycle: traditionally, the “mid-point” of an economic recovery is the “sweet spot” for hotel firms. As job growth picks up and corporations shift from cash hoarding to spending for sales growth, room demand tends to pick up, offering hotels some improved pricing power and financial leverage;
2) Forecasts of impending hotel growth: Chad Mollman, an equity analyst at Morningstar, identifies 5.5% as the growth level expected for “per available room” revenue during 2014. When one add adds in a 1% factor for “room growth”, market participants are expecting 6.5% growth for both 2014 and 2015. Esther Kwon (S&P Capital IQ) suggests that muted room growth over the past 6 years means: “You’ll see rates tick up along with occupancy.”
In a similar vein, if one asked why BX decided o initiate its IPO in December of 2013, that answer is embarrassingly easy to provide:
1) Simply put, IPOs have been “hot” this year. Demand for IPOs has seemed practically insatiable during 2013.
a. Companies have generated almost $50 billion during the past 11.5 months through IPOs.
b. That is up an amazing 19% from 2012!.
c. That qualifies as the best year for IPO issues during the past ten years![14]
2) The U.S. stock market has focused much this year on various “index” returns.
a. The FTSE Renaissance US IPO Index, measuring returns from IPO issues, has been up by 54% during 2013.
b. That compare with a “mere” 25% from the S&P 500 Index!
c. The 218 IPOs issued thus far in 2013 is the most since 2000.
The result has been one that pleases management and impresses experts! The $2.35 billion of investment dollars buying into HLT is (by far) the largest hotel IPO ever![15] In fact, HLT outdrew even the much-ballyhooed TWTR IPO (that attracted only $2.1 billion!).
HLT currently carries about $12.5 billion in “Net Debt”. Since “Enterprise Value” consists of “Market Cap” and “Net Debt”, a conservative “Enterprise Value” for the company can be estimated at anywhere between the following figures (based on the market cap criteria specified):
Low End of IPO Price Range ($18): $21.168 Billion + $12.5 Billion = $33.67 Billion
Average IPO Price ($20): $23.520 Billion + $12.5 Billion = $36.02 Billion
Share Value at 12/14/13 ($22.10) $25.990 Billion + $12.5 Billion = $38.49 Billion
That market scale is impressive when one knows two additional facts:
1) The first figure ($33.67 billion) is more than 27 % higher than the leveraged buyout (LBO) value of Hilton (by BX) in 2007!
2) The market cap of Hilton’s competitors pale in comparison:
a. Starwood Hotels & Resorts Worldwide Inc. (HOT): $14.29 billion
b. Marriott International Inc. (MAR): $14.12 billion
c. Hyatt Hotels Corp. (H): $ 7.33 billion
What this means is that, on paper, BX is now able to claim an $8.5 billion value on its 2007 LBO.
You may join me in finding that it is remarkable that, even after this IPO, BX retains 750 million shares![16] It is fair to say, then, that BX has done well by itself in its handling of the 2007 Hilton LBO. It would appear that, financial crisis and bad timing not withstanding, no one is going to feel any obligation to hold a “tag day” for BX! Through financial and management discipline, BX kept diligent, focused, and determined, and proved to the rest of us that there is always hope for (more than) full recovery!
INVESTOR TAKEAWAY: On the surface, the hotel industry seems poised for significant growth, and the oversubscribed demand for HLT could convince the average investor that purchasing shares of HLT is an undeniably great idea.
I will be the first person to admit to a total absence of omniscience regarding the price of HLT one year from now. However, I will submit these thoughts to you for consideration:
1) In my experience, virtually every IPO is overhyped. In fact, “overhyped” comes with the very nature of the IPO process.
a. A financial firm is promised a fee for underwriting and promoting the IPO
b. Lots of incentives are provided for that firm
c. The firm offers lots of incentives to brokers (the sales force) to promote (hype) the shares
d. Brokers in other firms are similarly well-motivated to help generate interest in the shares
2) An investor would be foolish to ignore the fact that BX is retaining over 75% of the company’s shares.
a. The implications of that fact include the possibility that, relative to competitors, HLT is currently over-priced.
b. If nothing else, those 750 million shares represent a very significant (some might say “overwhelming”) “supply” of shares in the years to come that may prove to have the effect (however unintended) of creating a “ceiling” on the stock price.[17]
3) If HLT offered a free night of lodging or a regular discounted room rate to shareholders, I would become much more interested in buying here!
a. I am drawn to Malaysia (pictured earlier)
b. Elara: Hilton Grand Vacations Hotel (Las Vegas)(below) $98 advance/non-refundable).
c. The Morrison, a Double Tree by Hilton Hotel (Dublin) (below) 159 EURO; $218.
4) I would never recommend to anyone that she/he buy a particular stock. However, if one coveted some shares of HLT in the months ahead, I could be persuaded to agree that waiting a while for the stock price to settle back down closer to the original range of $18-20 is a very logical strategy!
a. HLT currently has no options available.
b. However, if options were available, I would look to sell $16 puts within whatever spread, in whatever month, an investor felt comfortable.
DISCLOSURE: To absolutely no one’s surprise, I do not own shares of HLT. Nothing in this article is intended as a recommendation to buy or sell anything. Always consult with your financial advisor regarding changes in your portfolio – either subtractions or additions.
Submitted by Thomas Petty MBA CFP
[1] BX is also among the largest forces within the real estate investment space.
[2] The “order book” showed that this Hilton IPO was over subscribed by a factor of approximately five!
[3] “Reader’s Digest”-style; you will definitely find a lot more detail in the two September articles!
[4] “Spruce up” covers a wide-range of PE (private equity) strategies – from streamlining administration and adding operational efficiencies to cutting unnecessary staff numbers and infusing the organization with tighter, more energized focus.
[5] Attributed to James Baldwin.
[6] My calculation shows it came within 60 basis points of the market top!
[7] I find it eternally amusing how many more “experts” claim in their vitae that she/he foresaw the financial crisis than there are written accounts of such foreboding prescience in the 2005-08 era!
[8] Soon after the buyout, revenue per available room tumbled 15% and hotel stock prices collapsed by 15% or more!
[9] Besides an Eminem song entitled “Be Careful What You Wish For”, there is a children’s album with that title that includes a track called “Walkie, Walkie, Walkie”… which by 2009 may have described what BX management wished it could have done regarding its purchase of Hilton!
[10] A variation on Baldwin’s “wise saying” applies to BX’s purchase: “Ambition is a Dead Sea fruit and the greatest peril to the soul is that one is likely to get precisely what he is seeking!” – Edward Dahlberg
[11] While I was growing up, my parents gushed whenever they talked about the Waldorf Astoria… which (by the way) inspired the “Waldorf Salad”. A Waldorf Salad is a salad traditionally made of fresh apples, celery, and walnuts dressed in mayonnaise … usually served on a bed of lettuce as an appetizer or a light meal. It was first created between 1893 and 1896 at the Waldorf Hotel in New York City.
[12] Provides the modern comforts and convenience in the Borneo rainforest. Enjoy a home away from home in this traditional native Iban design 71m²/764sq.ft duplex with separate working and living rooms. The spacious duplex, on 2 levels, has 1 queen bed. Special touches include tea and coffee making facilities. Sleeps 2 adults, 1 child. Special “Bed and Breakfast” rate includes breakfast – 447 MYR, or $138.00/night. The cheapest rate in a normal room is actually $69.58.
[13] Set in the heart of Mayfair overlooking Hyde Park, this hotel is perfectly located near Knightsbridge and Buckingham Palace.
[14] Per the IPO research firm, Renaissance Capital.
[15] The next biggest hotel IPO was the $1.1 billion Hyatt Hotels Corp. IPO in 2009 (per Dealogic).
[16] That equates to approximately 76.5% of the HLT shares.
[17] Simply due to the immutable economic law of “Supply and Demand”!
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