Hotel Perspectives: Merger Mania

Lodging experts say that even after the Marriott-Starwood merger closes, there will be plenty of other flags across all brand categories. Thayer Lodging operates the Diplomat Resort & Spa in Hollywood, FL, part of the Curio by Hilton collection.

In recent years, Airbnb and its explosive growth, the emergence of the select service sector and the hotel business’ seemingly unending, record-breaking strong performance have been the key topics of concern for owners and investors. Those trends continue to dominate discussions but hotel company consolidation—a blast from the past that re-emerged in 2015—has the industry agog. Among the deals that were done, as reported by Real Estate Forum sister publication GlobeSt.com, Strategic Hotels & Resorts was purchased for $6 billion in September by prolific hotel owner the Blackstone Group. In December, FRHI Holdings—parent of the Fairmont, Raffles and Swissôtel brands—was sold to AccorHotels by a partnership of the Qatar Investment Authority, Kingdom Holding Co. and Oxford Properties. The deal was valued at US$2.9 billion. But the biggest of them all, and the one creating a whole lot of buzz, was Marriott International’s pending acquisition in November of Starwood Hotels & Resorts. The mega-deal was valued at $12.2 billion and will create a combined organization that will operate or franchise more than 5,500 hotels spread across 31 brands, with 1.1 million keys worldwide, according to GlobeSt.com. So what, if anything, will be the impact of all this hospitality company convergence on buyers and sellers? And is the merger and acquisition activity out of hoteliers’ systems, or are they just getting started? “Marriott’s acquisition of Starwood was a good financial deal and a great strategic one,” declares Lee Pillsbury, chairman, Thayer Lodging Group. For one thing, it will give the combined company greater leverage with online travel agencies, whose commissions eat into a hotel operator’s room revenue with each booking. “In the consolidation of the airline industry, the carriers have pulled back on providing fare information, making it difficult for meta sites like Expedia.com to access information,” Pillsbury says. “It’s not about the commission, it’s about taking the transparency out of pricing.” Still, those OTA commissions are no small matter, notes Geoff Davis, president and senior principal, HREC. “In the merger, if Marriott got its Expedia commission knocked down to 18%—and the average is 20% to 25%—that cost reduction can have considerable impact if you’re an owner.” Analyst Evan Weiss, executive managing director and principal, LW Hospitality Advisors, sees additional benefits of the merger. “The combined company will be able to use Marriott’s best-in-class reputation, its central reservation system and other factors, as well as value engineer Starwood’s key components from its more than 1,200 assets.” He continues, “The merger appears to be extremely accretive to both firms, and to the ultimate combined firm from a brand, reputation, rewards, CRS and organizational perspective. The interesting part will be what other firms will do to compete with a 1.1-million-room company that controls multiple category killer brands, access to all brand categories and two of the most renowned meeting and group and guest rewards databases in the world.”

“If you look at the top 10 or 20 management companies in our space, some of them will be active in 2016 in terms of either acquiring companies or consolidating theirs.”—Leslie Ng, Interstate Hotels & Resorts  

Of course, the impact of the merger isn’t entirely known, and some industry players can foresee negative ramifications. “The only negative, from an owner’s perspective, is less competition,” observes Mitchell Hochberg, president and COO, Lightstone Group. “So when an owner is talking to multiple brands and they play off of each other, there will be less competition. It remains to be seen if Marriott will allow the brands to competitively negotiate off each other.” But even this can be offset, says Davis. “There are still plenty of brands an owner can look to as an alternative, such as Hyatt, Hilton, IHG, Wyndham and others, so competition will remain strong.” No matter the outcome, every hotel owner, investor or analyst contacted by Forum expects other firms to respond to the Marrriott deal with more M&A activity. “You will see management company consolidations this year,” predicts Leslie Ng, CIO, Interstate Hotels & Resorts. More specifically, he adds, “If you look at the top 10 or 20 management companies in our space, some of them will be active in 2016 in terms of either acquiring companies or consolidating theirs. Larger firms will buy smaller ones either to gain scale or to better concentrate their areas of focus.” Ng explains, “It helps deliver the execution of the business plan more quickly than launching a platform from scratch, which takes a lot more time and doesn’t guarantee success.” From a seller’s perspective too, there’s value in doing such a deal, reveals Monty Bennett, founder, chairman and CEO of Ashford Hospitality Trust. “Ashford Prime, our high-end REIT, is pursing strategic alternatives, which may include it being sold,” he tells Forum. “The board felt that the current stock price wasn’t trading at full value and so the company needed to go through an analysis of strategic alternatives.” But some smaller firms aren’t on board with becoming an acquisition target. “For us to compete, we don’t have to be party to a consolidation strategy,” says S. Kirk Kinsell, president and CEO, Loews Hotels & Resorts. “We have a superior, competitive offer and a lot of organic growth on our own and to build our own returns for investors. Today, frankly, there are things in our model that I’d want to retain versus becoming part of something big. Our size is an advantage in the interest of being nimble, having a focused agenda and relationships I can maintain with just a few owners as well as clients and customers.” Still, Loews has its eyes on strategic expansion of its holdings, Kinsell tells Forum. “We are continuing to focus on gaps in distribution and hope to add more hotels during the year. We’ve said publicly that our goal is to double in size over the next five years; we’re at 25 properties going on 26.” He elaborates, “Within North America, we want to be in 20 or more cities where we aren’t currently. On the West Coast, we’re not in Seattle, Portland, Orange County, CA and we could probably have something in Los Angeles. We’re not in the Phoenix resort area or Denver, and moving to other parts of the country, we could have a hotel in Texas—whether that’s Houston, Dallas, San Antonio or Houston. We’re not in St. Louis, MO, Kansas City, Cincinnati or Cleveland.” Growth in secondary markets also is on the radar screen at Lightstone, reports Hochberg. “We’re doing a lot of investing nationally; we will buy 20 to 30 properties in the next year. We’re focused on secondary markets because they provide the greatest opportunity for growth, and we like university towns for the stability.”

Interstate Hotels & Resorts’ Bourbon Orleans Hotel in New Orleans; the firm’s Leslie Ng sees more consolidation ahead among management companies.

The firm is focused on select service, Hochberg notes, and is particularly keen on Marriott’s Moxy Hotels brand. “Select service is continuing to grow because consumers have embraced it; it provides an affordable price with many of the amenities of a full-service property. If you can provide the same guest room and level of service, without a banquet facility, doorman, or certain amenities, and deliver the room for 30% less, that’s incredibly appealing. “We’re working on seven Moxy properties, four in New York City, two in Los Angeles and one in the South Beach area of Miami. It brings lifestyle to select service, which was a big gap,” he continues. “Being able to offer that is a big opportunity.” Others in the industry see a clear impediment to growth, and its name is Airbnb. “A $25.5-billion value has been pegged to the company,” notes Weiss. “Anyone thinking it won’t have an effect on the market, especially in the major cities, is crazy.” Agrees Bennett, “A couple of the major markets, such as New York and San Francisco, are where conditions are choppy mainly because of Airbnb. There are 110,000 hotel rooms in New York City and that supply is growing by 3% to 4% per year, but over 30,000 Airbnb hosts have emerged in the last few years—with supposedly 10,000 to 15,000 of them being active. That’s a dramatic increase in inventory and a huge sucking away of demand.” In fact, a report by analysts Ryan Meliker and Michael Kodesch of Canaccord Genuity states, “Airbnb has an impact on pricing power in major leisure-oriented urban markets during compression nights [when the city is virtually sold out of hotel rooms]. We estimate that across the top-25 US markets, compression nights have increased by 49% since 2013 but rate growth during those nights is 10.8%, down 250 basis points from the 13.3% growth in similar nights that year. We attribute this more limited pricing power to the impact of home-sharing services like Airbnb.” Other factors worrying some owners and developers—and emboldening others—are supply growth, lending trends and overseas markets. “There are 450,000 rooms in the pipeline, that’s an enormous number,” declares Weiss. “At the same time, national occupancy is around 66% and average daily rate is about $120. These are massive increases from the depth of the recession, when we were at 53% and $100, respectively, and I don’t see how that’s sustainable.” But for Bennett, a key change in the lending environment for developers is likely to help hotel investors. “A number of banks are being asked by regulators to curb real estate lending, particularly for new construction, so the new supply market should be lower in 2017 and 2018 than it otherwise would be. “Six months ago,” he continues, “debt proceed levels were attainable where the debt yield to EBITDA was maybe 8% but now you probably can only get 9%, so that’s 10% less proceeds.” Notes Pillsbury, “There still are attractive investment opportunities. We’ve always been value-add players but we’re even more focused on that now because performance has improved and valuations have risen.” For sellers, the market offers optimal conditions too, says Davis. “We have a lot of clients who want to sell before the cycle ends. Anyone who bought between 2008 and 2011 is probably a seller. There are still profits to be taken and if you wait too long, you may miss the window.” He forecasts, “Properties valued at $10 to $50 million will trade actively for the next few years. You might see less activity in major $100-million assets or portfolio sales because those already have occurred or the buyers, such as REITs, are less active.” Ng has similarly optimistic expectations. “There’s a lot of uncertainty going into 2016 but most prognosticators are still saying we’ll see 5% to 6% RevPAR growth. At Interstate, it’ll be a year for both acquisitions and dispositions. We have owners who will try to harvest profit from hotels they acquired four to five years ago but others look to buy, particularly Asian investors.” Ultimately, buyers and sellers alike are making a gamble, Pillsbury notes. “Howard Marks, CFO and co-chairman of Oaktree Capital, wrote a year-end letter in 2012 titled ‘It’s All a Big Mistake.’ His point was anytime a real estate transaction happens, someone has made an error. If you’re the buyer you’re assuming you’ll be getting a big return while the seller is assuming it wouldn’t, so someone misjudged what’s going to happen in the future.”