Description

Sometimes you never forget what people say:  Over twenty years ago Alan Leventhal, the extremely successful Boston real estate developer, excitedly described the Embassy Suites he was then building:  “What a value”!  Felcor, a hotel REIT, is the largest owner of Embassy Suites, which comprise 47 of its 83 properties and account for 57% of its cash flow.  Other “upper upscale” hotels (Sheraton, Doubletree, etc.) account for much the balance:  Felcor has just completed a major disposition program over the last three years which has made it a much more focused company.  The stock currently sells at 10.7X 2008 EBITDA and a 7.4% cap rate (after a standard 5% maintenance allowance for routine capital spending).  Numerous recent hotel company transactions—5 lodging REITs have been taken private so far in 2007—suggest a NAV of 1 Sometimes you never forget what people say:  Over twenty years ago 2X EBITDA and a 6% cap rate, or the mid $30s is appropriate.  Either Felcor will work its way higher on its own or I think there is an excellent chance that the company will be acquired.

M&A Environment

The Blackstone proposal for Hilton last week is only the latest in a major wave of private equity deals over the last three years or so.  None of these deals have been at less than 10X forward cash flow and, over the last two years (almost 20 $1 billion+ portfolio deals) the multiple band has been 11-15X and trending up.  The reasons are pretty simple:  Industry fundamentals are excellent, there is an unprecedented amount of dedicated real estate private equity and ample debt financing, and cap rates are more attractive for hotels than other property classes.  Three of the five lodging REIT deals this year have had very successful and sophisticated buyers:  Apollo, JER, and Goldman/Whitehall.  (I don’t know much about the others; they could be very sharp also.)

Company Background:

Felcor went into the recent downturn as an overlevered and poorly focused company.  Over the last three years the company has slimmed down, selling 45 “non-strategic” hotels—all of its Crown Plazas and most of its Holiday Inns—for over $700 million.  Interestingly, the average sales multiple was 12X  trailing cash flow for these less compelling properties.  Currently, Felcor owns 83 hotels (22,000 net rooms), focused on the upper upscale segment and the following regions:  Northeast (20%), California (19%), Florida (15%), Southwest (15%) and Georgia/Carolinas (15%).

Late last year the company set forth on an ambitious renovation program covering all of its properties, which will be completed by early 2008, at a cost of $430 million, or roughly $20,000/room.  The disruption, of course, penalizes this year’s profitability but should enhance 2008 and beyond:  Management projects a 9% return on 75% of the total spending, or a lift of nearly $30MM, roughly 10% of this year’s cash flow.  Results thus far from the eight hotels renovated in 2006 suggest this is a realistic objective. 

In addition, the company plans on spending $150MM over the next three years on 14 development projects at existing hotels (meeting space, spas, etc.) which management projects will yield an 18% ROI.  Management purports to be interested in selective acquisitions but the company has not acquired a hotel in three years.

Industry Conditions

The key thing to watch is supply.  Since 1968 supply growth has averaged 2.5%.  After a bulge in the late 1990s supply has trended under this level for the last 6 years; although the rate of growth has picked up recently it should stay under this level for at least the next 12-18 months according to the authoritative Price Waterhouse survey.  Overall REVPAR (revenue/available room) continues to climb nicely although at the buoyant levels of mid-decade.

Other Information

I am happy to provide more information but the stock traded up 5% today and I wanted to post quickly.  There is a very concise recent presentation available on the website (www.felcor.com)

Catalyst