M&A Wave

During the first quarter of 2006, hotel mergers and acquisitions are heating up internationally. In the words of hospitality industry observers and musical group Bachman-Turner Overdrive, “You Ain't Seen Nothing Yet.”

On the heels of strong investor interest in 2005, this year began with Hilton Hotels Corp.'s proposed $5.7 billion acquisition of the lodging unit of Hilton Group PLC, headquartered in the UK, a deal that would reunify the brand worldwide.

A few weeks later, Los Angles-based Colony Capital LLC, along with Saudi Arabia's Kingdom Hotels International, bought the Fairmont Hotels & Resorts for $3.3 billion. It will be combined with the Raffles luxury chain, which the pair of investors bought last year.

And in late February, New York-based Blackstone group, one of the most aggressive hotel buyers last year, came to bat again with a deal to buy MeriStar Hospitality for $940 million.

“This year will continue to be a very strong one for hotel M&A activity,” predicts William Marks, managing director of San Francisco-based JMP Securities. “There's more to come because the climate for these deals is exactly right. To start with, compared to other asset classes, hotels still aren't so pricey, if you believe growth projections for the industry, and clearly a lot of investors do.”

Then there's the persistence of cheap debt. “REITs are buying, since they have access to inexpensive capital. But private companies are even better positioned to play the hotel acquisition game,” Marks says. Whereas a public company is able to borrow 30% to 60% of the asset value for an acquisition, a private borrower often can borrow 75% or more, using the higher leverage to enable it to goose up returns, he adds.

Much depends on continued strong global hotel fundamentals, points out Mark Woodworth, executive vice president of Atlanta-based PKF Consulting. “Capital markets have viewed lodging in a favorable light lately because demand is outpacing supply worldwide, and that probably won't change,” says Woodworth.

Domestic markets are strong because of heavy demand and high barriers to entry for new product, particularly in the upscale segments. Meanwhile, foreign markets in fast-growing nations can't build fast enough to keep up with demand.

Global platforms are the driving force behind much of the M&A activity. “Analysts are pushing hotel ownership to go global, because returns outside the United States tend to be higher than domestic returns,” says Jack Corgel, professor at the Cornell Hotel School. “Countries such as India and China are seeing GDP growth that far outpaces average U.S. growth of about 3% annually. Concurrently, demand for hotels is through the roof in those places.”

Then there's the matter of portfolio diversity, which seems to a goal for large acquirers such as Blackstone, says Woodworth. The Colony-Fairmont deal is an example of another sort of diversification, a geographically-oriented one, he adds. “With a portfolio like that, you aren't as tied to the ups and downs of a particular economy,” he says.

In theory, with worldwide hotel holdings also comes worldwide economies of scale. “Another part of the rationale in merging hotel operations is to gain the efficiencies of scale, especially in terms of reservation systems or loyalty programs, or other marketing,” says Corgel. “It might not be the main driving factor in a deal, but it's probably quite important.”

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