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Behind The New Deal Mania

News: Analysis & Commentary: MERGERS & ACQUISITIONS


The latest consolidations are for growth, not cost-cutting

The valuations may seem staggering. Acquirers may seem to be overreaching. But week in and week out, deal mania continues. The latest crop: the merger of KPMG Peat Marwick and Ernst & Young, forming the world's largest professional services firm; the white knight rescue of ITT Corp. by real estate investment trust king Barry Sternlicht to create the world's mightiest hotel operator; and the return to prominence of media mogul Barry Diller, who is acquiring the television assets of Seagram Co.'s Universal Studios.

Meanwhile, what could turn out to be the largest deal in American history, the battle for MCI Communications Corp., continues. The players--WorldCom, GTE, British Telecommunications, and MCI--were expected to start a series of discussions by Oct. 24.

Unlike the last wave of consolidations earlier this decade--inspired by the need to slash costs--many of today's dealmakers are buying for growth. Assuming a continuing growth cycle, acquirers and merger partners alike are looking for new customers, complementary businesses, fresh markets, and the chance to leverage existing strengths with new ones. BUSINESS WEEK takes a closer look.Return to top


It has become a game in the hotel industry to guess where Barry Sternlicht might check in next. Over the past 2 1/2 years, the brash, 36-year-old vulture investor has averaged close to one acquisition a month as he dealt his way from a tiny Los Angeles-based hotel real estate investment trust into a hotel giant worth $4.5 billion, including September's purchase of Westin Hotels. Still, no one understood the extent of his ambition. On Sept. 29, Sternlicht sent ITT CEO Rand Araskog a four-word note stating: "We have to talk." Three weeks later, Sternlicht forced Hilton Hotels Corp. to drop its hostile bid for ITT Corp. with a $9.8 billion friendly offer to buy the hotel giant. If the deal goes through, Sternlicht's Starwood Lodging Trust will be the biggest hotel operator in the world.

Where does Sternlicht get off elbowing past the world's largest hotel company? Starwood is a REIT that, because of a grandfathered provision in its charter, can both own and operate its properties. To keep their corporate tax-free status, modern-day hotel REITs are forced to lease out operations to third parties, which can erode profits. Sternlicht's REIT consists of two companies--one that operates the hotels and pays tax, and one that owns the real estate and does not. But the two are paired together, with the same shareholders and the same management. "This way we don't have to give up control to some guy who says we need gold doorknobs and crystal chandeliers," says Sternlicht.

AN ONGOING BOOM? That structure has helped Sternlicht's REIT return more than 50% a year. And that in turn has been enough for Wall Street to boost his takeover resources by bumping his stock to 12 times operating cash flow, or 20% higher than Hilton's.

Buying a trophy and running it are two different things. ITT has already outlined $55 million in cost savings. Sternlicht aims to cut some $50 million more by combining operations. And he will group his existing hotel holdings under the Sheraton or Westin names. Analysts predict substantial ongoing tax savings.

Starwood's cost of capital could climb, derailing the transaction if Wall Street starts to sour on the deal. A bigger risk is that the 9%-a-year sales growth the full-service hotel sector is experiencing may not continue. And Sternlicht is assuming a lofty 20% increase in cash flow per share even after he more than doubles his shares outstanding. He will have to deliver this, and more, to stay on a roll.

With low debt levels, Sternlicht should easily meet interest payments. But a lot depends on that stock price. A REIT, which is required to pay out 95% of its taxable income to shareholders each year, has to return frequently to the stock market for capital. And ITT was anything but a Wall Street darling before Hilton came along. The question now will be whether Sternlicht can swallow ITT and keep his magic touch.By Kathleen Morris in Los AngelesReturn to top

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