Starwood Books Upgrade as Hotel Demand Slows: Corporate Finance

Starwood Books Upgrade as Hotel Demand Slows: Corporate Finance
A standard king room is seen at the Starwood Hotels & Resorts Worldwide Westin New York Grand Central in New York. Photographer: Michael Nagle/Bloomberg

Dec. 14 (Bloomberg) -- Starwood Hotels & Resorts Worldwide Inc., which is selling assets and cutting interest costs to protect its investment-grade rating as it faces slowing demand for lodging, is already getting an upgrade in the bond market.

The company’s bonds yield 151 basis points, or 1.51 percentage points, more than similar-maturity Treasuries, closer to the 126 basis-point spread on debt rated A than the 209 basis points on its own BBB category. Starwood, which operates the W chain of luxury hotels, sold $350 million of 3.125 percent, 10-year bonds this month and will use the money together with some its $650 million in cash to retire $559.2 million of debt with coupons at least twice as high.

Starwood, which has been selling hotels as it seeks to increase the percentage of profit it generates from fees, has chopped its leverage ratio to a decade-low of 1.8 times from 4.51 times in the third quarter of 2009, a year in which the global economy contracted 2.4 percent. The company plans to generate 65 percent of its earnings from fees, Chief Executive Officer Frits van Paasschen said on an Oct. 25 conference call.

“They are certainly better positioned now than they were in 2008,” Chris Snow, an analyst at bond researcher CreditSights Inc., said in a telephone interview from New York. “Clearly, you would see some stress in terms of room rates and occupancies, but they have a pretty nice buffer if the cycle were to turn against them.”

Investment Grade

Starwood regained its investment-grade ranking this year after being cut to junk when revenue slumped in 2009. Yield data from Moody’s Corp. indicates the Stamford, Connecticut-based company should be rated A3 instead of its current Baa2 grade.

The hotel operator has been selling real estate in a bid to focus on management operations driven by fees, which are less susceptible to decline in economic downturns than revenue from owning buildings.

“We’ve reduced the inherent risk in our business model,” van Paasschen said during the Oct. 25 call with investors and analysts. “The fee business is far less volatile.”

K.C. Kavanagh, a spokeswoman at Starwood, didn’t respond to e-mails and telephone calls seeking comment on the company’s finances.

The company’s shares have gained 13 percent this year, trading at $54.20 at 2:41 pm in New York.

The company’s approach follows that of competitors such as Marriott International Inc., which gets about 90 percent of its earnings from fees, CreditSights’s Snow said.

Losing Steam

Starwood forecast earnings before interest, taxes, depreciation and amortization below analysts’ estimates for the last three months of this year as demand for rooms slows around the world, van Paasschen said on the conference call. A recovery in demand has “lost its steam,” he said.

The company was able to slash interest payments as investment-grade yields hover near record lows with the Federal Reserve anticipating it will hold short-term rates close to zero percent through mid-2015.

“They are smart to strike now,” Smedes Rose, a New York-based analyst at KBW Inc., said in a telephone interview.

The sale marked the first time Starwood accessed the unsecured debt market since 2009 as management has focused on cutting debt and lowering leverage, Snow wrote in a Dec. 5 report. Starwood’s debt fell from 5.7 times trailing 12-month Ebitda in the third quarter of 2003 to 2.2 times in the third quarter of 2007 before reversing during the economic crisis.

‘Bad Times’

Starwood is shifting to a business model in which it collects a percentage of revenue from hotels that it operates while another entity owns the real estate. That reduces its reliance on cash from individual hotels and cuts back on the capital needed to maintain the properties.

“In bad times, it can turn around really quickly because you still have to staff your hotels even if nobody’s there,” KBW’s Rose said. “You’d rather be exposed to 3 to 5 percent of hotel revenues but have lots of them.”

Starwood’s W chain began with one location in Manhattan in 1998 under then-chairman Barry Sternlicht, who had built the company with acquisitions that included the Westin and Sheraton chains, according to business historian Hoover’s Inc.

Sternlicht, who left the company in 2005, is chief executive officer of closely held investment firm Starwood Capital Group LLC, which he founded in 1991.

In the third quarter, Starwood reported a 9.1 percent drop in revenue per available room, an industry measure of occupancy and rate, in Europe and only a “modest” 1.3 percent increase worldwide, Nikhil Bhalla, a senior lodging analyst at FBR & Co. in Arlington, Virginia, said on the day of the earnings release.

Falling Revenue

Growth has slowed around the world, including in China, where new hotels in metropolitan areas has added to competition, van Paasschen said. Forecasting 2013 results is “quite difficult” because it’s unclear whether the slowdown will be temporary, he said.

Starwood’s revenue-per-available-room, an industry measure of occupancy and rates, at hotels it owned worldwide declined 23.3 percent to $130.5 million in the third quarter of 2009 compared with similar period of 2008 as businesses and households cut back on travel during the recession, an October 2009 regulatory filing shows. The measure climbed to $166.3 million on Sept. 30, according to an Oct. 30 regulatory filing.

Prices for the some of the best hotels in major cities have met or exceeded the prior peak in 2008, aiding Starwood’s quest to pare its assets, according to Real Capital Analytics.

Hotel Prices

Starwood sold Manhattan at Times Square, a 665-room hotel in New York, for $275 million in October. The company sold its W property in Los Angeles’ Westwood section to Pebblebrook Hotel Trust for $125 million in August, about a week after completing the sale of the 520-room W Chicago-Lakeshore to Chesapeake Lodging Trust for $126 million.

The sales put Starwood in a better position with the rating companies to weather a potential downturn amid slowing growth globally and a potential U.S. recession as lawmakers wrangle over deficit reduction, said KBW’s Rose.

“They spent a lot of time on strengthening the balance sheet,” he said. “They are now solidly investment-grade territory.”

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