Starwood Debt Rating Lowered

S&P says the move stems from the hotel company's lack of progress in improving credit measures

On May 6, 2003, Standard & Poor's Ratings Services lowered its corporate credit rating for Starwood Hotels & Resorts Worldwide (HOT ) to 'BB+' from 'BBB-' . The ratings were removed from CreditWatch where they were placed on Dec. 20, 2002. The outlook is stable. Total debt outstanding as of Mar. 31, 2003, was $5.5 billion.

The rating actions stem from Starwood's lack of progress in improving credit measures during the last several quarters amid a challenging lodging operating environment. In addition, Standard & Poor's expectations are that credit measures will not improve to levels more consistent with the ratings in the near term, despite significant planned asset sales.

Performance of U.S. travel and leisure companies continues to be affected by such factors as a weak economy and an unstable global political environment. Revenue per available room (RevPAR) for the U.S. lodging industry declined for a second consecutive year in 2002, and was down again in the first quarter of 2003. In addition, higher expenses in areas such as insurance, energy, health care costs, and property taxes, have squeezed margins, resulting in declining EBITDA for most companies.

In line with these trends, Starwood provided guidance on Apr. 29, 2003, that RevPAR for its same-store owned hotels in North America would likely decline about 4% in its second quarter ended June 30, 2003, and that EBITDA would likely be in the $230 million to $240 million range. In addition, Starwood cited its expectation that full 2003 RevPAR will decline by 1% to 2% resulting in EBITDA of $930 million to $950 million. This new guidance is below Standard & Poor's previous expectations.

The company has moved forward on its plan to sell assets in order to reduce debt, and has announced that it has entered into agreements to sell certain assets for 565 million euros, or about $617 million, based on exchange rates as of Mar. 31, 2003. These transactions are expected to close in mid-2003. The company also announced its intention to sell an 18-hotel portfolio in North America. While no agreement has been consummated relative to this portfolio, the company expects to enter into an agreement in the coming months and to close these sales in the second half of 2003. If Starwood successfully closes each of the transactions, it will generate total proceeds of about $1.1 billion, most of which are expected to be used to reduce debt.

While this level of asset sales would have met Standard & Poor's expectations, the operating environment has weakened further than anticipated in the first quarter, and only a modest improvement is expected in the remainder of 2003. As a result, Standard & Poor's foresees that Starwood's debt to EBITDA ratio will remain in the high-4x area, even after taking into account asset sales.

Starwood's hotel portfolio, which is primarily comprised of upscale properties in urban locations, has been meaningfully affected by the weak lodging operating environment. EBITDA declined by 21% during 2001, 10% in 2002, and an additional 17% in the three months ended March 31, 2003. Debt balances declined somewhat in 2002, but as of Mar. 31, 2003, have risen back to year-end 2002 levels of $5.5 billion. As a result, credit measures have weakened considerably with total debt to EBITDA in the mid-5x area for the 12 months ended Mar. 31, 2003.

The primary cause of Starwood's EBITDA drop stems from a significant economy-related falloff in business travel during the past two years. The composition of Starwood's portfolio typically helps the company to grow faster than the sector during healthy economic environments, but underperforms the industry during weak periods. Therefore, Standard & Poor's expects that Starwood will experience solid internal growth once the economy begins to grow more quickly, particularly given a very modest anticipated increase in hotel supply in the next few years. However, Standard & Poor's does not expect the lodging industry to begin to grow quickly again before 2004, as there are few catalysts to spur a quick positive turnaround. This is expected to limit Starwood's ability to materially improve credit measures through internally generated cash flow in the near term.

The ratings for White Plains, N.Y.-based Starwood reflect its large, high quality and geographically diversified hotel portfolio with many well-established brand names, offset by a still-challenging lodging environment and high debt leverage. Starwood's hotel portfolio consists of nearly 750 hotels in about 80 countries, flagged under the Westin, Sheraton, St. Regis, Four Points, and W brand names. The company's geographic diversity, lack of significant asset concentration, and increasing management and franchise income are expected to provide a more steady source of cash flow once economic conditions stabilize.

Liquidity: In October, 2002, Starwood refinanced its previous senior credit facility with a new four-year $1.3 billion senior credit facility. The new facility is comprised of a $1 billion revolving credit facility and a $300 million term loan. This substantially improved the company's liquidity position. As of Mar. 31, 2003, Starwood reported having about $497 million available under its domestic and international revolving credit facilities. Unrestricted cash balances totaled $158 million on this date, although this is expected to primarily represent operating cash. After considering dividend payments and approximately $450 million in capital expenditures, Starwood is expected to have minimal discretionary cash flow available for debt reduction in 2003 beyond that amount generated through asset sales.

Despite significant refinancing success in 2002, Starwood's upcoming debt maturities remain fairly significant. About $870 million in debt is scheduled to mature in 2003, $410 million in 2004, and $615 million in 2005. A portion of the 2003 debt maturities are expected to be repaid through asset sale proceeds, which along with revolving credit facility availability, are expected to provide Starwood with adequate liquidity to meet its 2003 maturing obligations, and its capital spending objectives.

Outlook: The stable outlook reflects an expectation that a significant portion of the anticipated asset sale proceeds will be applied toward debt reduction. This is expected to enable the company to meaningfully improve credit measures in 2003, despite the challenging lodging environment, although to levels that are still somewhat weak for the new ratings. Further de-leveraging is anticipated beyond 2003.

From Standard & Poor's RatingsDirect

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