Hilton: Sleeping With The Enemy?

It may have no choice but to join forces with a REIT giant

It couldn't have made Stephen F. Bollenbach terribly happy. At a conference of the hotel-and-casino industry at the Beverly Hilton Hotel, beneath a banner reading "When you're still hot--you're really hot!" the Hilton Hotels Corp. CEO was forced to sit on a panel with Barry Sternlicht, the 36-year-old chairman of Starwood Hotels & Resorts Trust who had two months earlier beaten Bollenbach in an $11.7 billion takeover battle for ITT Corp. "Other than missing out on just one small deal, we had a great year," Bollenbach said when it came time for him to grab the microphone.

And what a deal it would have been, making Hilton the most powerful player in the fast consolidating business. Now, with rivals such as Sternlicht using real estate investment trusts (REITs) to raise huge amounts of money on the stock market and snap up properties at inflated values, Bollenbach is uncharacteristically quiet. "We see every deal that comes along," he says, sitting in his Beverly Hills office. "But I'm not going to bid more than something's worth just to have it, and I don't want to be in a bidding war with those guys."

In fact, Wall Street has been abuzz in recent weeks with talk that Hilton may do just the opposite: join ranks with a REIT or become one itself. There have been merger talks, sources say, between Hilton and Patriot American Hospitality Inc., an up-and-coming giant in the REIT industry. So far, nothing has come of them, and Hilton execs estimate that a conversion would saddle Hilton with a one-time tax bill of some $250 million. "I just don't see it in the cards for us," says Bollenbach. "But I have learned that you never say never."

DO OR DIE? A conversion may seem unlikely, given Bollenbach's hyperbolic lobbying war last fall against REITs and their tax advantages--a crusade that helped persuade the White House to include a restriction in its proposed budget on future acquisitions by some REITs. But rivals and other industry observers say Hilton may have little choice. "This is a company built on acquisitions," says Bear, Stearns & Co. analyst Jason N. Ader. "And to acquire, it may have to become a REIT or merge with one." Neither Hilton nor Patriot American would comment publicly on the talks.

In any case, Bollenbach must find something to fuel the 20%-a-year earnings growth he has promised investors. Although Hilton reported on Jan. 20 a tripling of its 1997 net income, to $250 million on revenue of $5.3 billion, more than half that growth came from acquisitions that Bollenbach engineered within months of his appointment in early 1996. Hilton's stock, meanwhile, has dropped to around $29 a share, from about $35 last year, hurt by languishing casino operations and a fourth quarter that missed analysts' expectations. "He has a lot of cash and could do a stock buyback," says money manager Mario J. Gabelli, who holds a significant Hilton position. "But if he continues to be put in a box and can't make acquisitions, he may have to get imaginative. Maybe he acquires a REIT, or maybe he looks to get acquired."

Of course, Hilton is hardly without options. It still boasts some of the choicest properties in either of its businesses, including the trophy Waldorf-Astoria in New York and the Flamingo Hilton along the Vegas Strip. Yet with REIT mania lifting hotel and casino prices, Bollenbach seems to be locked out of some of the juiciest new deals. Hilton lost out on Station Casinos Inc. in Vegas last month, estimating its value to be far below the $1.7 billion paid by Richard E. Rainwater's Crescent Real Estate Equity Inc.

REITs have a big advantage because they pay no corporate taxes. Wall Street has driven their stock prices to around 11 times cash flow, compared with about 8.5 times for hotel companies like Hilton. That lets REITs make stock-based acquisitions for 10% to 15% more than Hilton can pay, while getting the same return on investment, says Mark Greenberg, manager of Denver's Invesco Leisure Fund, which holds 295,000 Hilton shares. Adds Steven Hash, an analyst at Lehman Brothers Inc. in New York: "It's like a Volkswagen racing against a Porsche."

With splashy new deals increasingly out of reach, Bollenbach has little alternative but to milk those he managed to swing before prices zoomed out of sight. Bally Entertainment Corp., which he bought for $3.1 billion four months into his tenure, accounted for nearly all of Hilton's $306 million growth of operating cash flow in gaming.

EIFFEL POWER. Squeezing more growth out of those properties could be problematic. To combat a slew of new casinos that will soon hit the Vegas strip, Hilton nearly doubled the size of its $760 million Eiffel Tower-shaped Paris casino. But that isn't expected to open until 1999, and even then it could take business away from other nearby Hilton properties.

Hilton's 10 largest hotels, which provide 65% of its operating cash flow from lodging, face little competition in their markets and had a strong 1997. But can Hilton continue to raise room rates by 9%, as it did last year? "I can see them doing it for five years, maybe," says Charles Skelton, president of Hospitality Advisers Inc., an industry consultant in Ann Arbor, Mich. "But you can't keep raising like that forever."

That's why Bollenbach must find a way to keep adding to his asset lineup. Hilton is looking at $500 million of deals, including $400 million to buy from Prudential Insurance Co. the half of the Hilton Hawaiian Village in Honolulu that it doesn't already own. "There'll be deals in the next six months or so," Bollenbach says. Only this time, he'll have to fight it out asset by asset. Certainly not as dramatic--or as much much fun--as ITT would have been.