Description

Company Description:
Host Marriott Corporation operates as a real estate investment trust(REIT) that primarily engages in the ownership and operation of hotel properties in North America. It operates its hotels under various brand names, including Marriott, Ritz-Carlton, Hyatt, Four Seasons, Fairmont, Hilton, and Westin. As of February 28, 2005, the company’s lodging portfolio consisted of 107 upper-upscale and luxury full-service hotels consisting of approximately 55,000 rooms. Its hotels are located in 26 states and Washington, D.C., in the United States; Toronto and Calgary, Canada; and Mexico City, Mexico.

Investment Thesis:
HMT owns the largest and highest quality lodging portfolio in the REIT universe and has substantial leverage to the continued recovery in the lodging industry given its high exposure in the urban luxury and upper upscale segments. Pro forma for the purchase of 38 hotel and resort properties from Starwood Hotels and Resorts (HOT), HMT will have a global room base of 73,653 rooms that should outperform the industry for the next two years due to the strong demand trends and low net supply growth in the luxury and upper upscale segments. Based on HMT’s replacement value and current transaction multiples I arrive at a fair value of $23+ per share.

Lodging Environment:

Supply-
As a result of the economic downturn at the turn of the century and the 9/11 attacks, since 2001 the room supply growth in US has trended below the historical long-term average of 2.5% and is forecasted to remain so through 2007 due to rising building costs. In today’s lodging environment hotel owners and developers recognize higher returns on investment by buying assets versus building them due to the rising cost of capital and higher construction and operating costs, which has lead to the modest pipeline in room supply growth. The tepid room supply growth forecast is affirmed by analyzing the current active pipeline for new hotel rooms and those under construction, which as of October showed the active pipeline and current construction represented only 5.5% and 2.1% of current room supply, respectively. As a result, industry-wide room growth forecasts see supply increasing by only 1.7% and 1.9% in 2006 and 2007, respectively.

Luxury and Upper Upscale Supply-
The supply forecast for the luxury and upper upscale segments of the lodging industry is expected to be even more benign over the next two years than the overall industry due to the higher construction costs and longer lead times. According to Smith Travel Research, the increases in room supply for the luxury segment in 2006 and 2007 should be a 1.5% and 2.5%, respectively, and in the upper upscale segment in the same period room supply growth should be a lethargic 1.4% in both years. The net new supply coming on in these segments is likely to be even lower as there has been sharp rise in capacity being taking out in major metro areas, like New York City, where hotels are being converted condos. The slow growth in the overall industry and in the luxury and upper upscale lodging segments should continue to benefit HMT as pro forma for the purchase of the HOT portfolio, HMT’s room mix by segment will be 87% upper upscale and 13% luxury.

US Total Lodging Unit Growth Forecast
Growth
2000 2.6%
2001 1.9%
2002 1.6%
2003 1.2%
2004 0.7%
2005 1.4%
2006 1.7%
2007 1.9%

US Lodging Luxury Room Supply Growth Forecast
Growth
2000 7.7%
2001 9.7%
2002 8.9%
2003 4.6%
2004 2.3%
2005 1.0%
2006 1.5%
2007 2.5%


US Lodging Upper Upscale Room Supply Growth Forecast
Growth
2000 2.0%
2001 3.0%
2002 2.0%
2003 2.3%
2004 1.7%
2005 1.3%
2006 1.4%
2007 1.4%

Demand-
In conjunction with today’s firm economy, the supply constrained environment has lead to increased occupancy levels across the industry that in-turn has allowed lodging owners and operators to significantly raise rates over the past two years. As a result, industry-wide revPAR growth forecasts call for continued improvement in 2006 and 2007 when industry-wide revPAR should improve 6.1% and 5.6%, respectively. However, the slower than industry room supply growth in the luxury and upper upscale segments is expected to lead to higher than industry revPAR growth, which should significantly benefit the revenue and cash flow of hotel owners and operators in the segment. In 2006, revPAR growth in the luxury and upper upscale segments should both grow 8.6% followed by growth of 8.5% and 7.3% in 2007, respectively. Based on forward looking guidance by the major hotel owners and operators there is definitely room for upside to industry revPAR growth estimates as both HLT and HOT issued initial guidance that their revPAR growth could reach as high as 10% in 2006.


US Total Lodging Industry RevPAR Growth Forecast
Growth
2000 6.3%
2001 -6.9%
2002 -2.7%
2003 0.1%
2004 7.7%
2005 8.1%
2006 6.8%
2007 6.0%

US Lodging Luxury RevPAR Growth
Growth
2000 8.9%
2001 -14.1%
2002 -5.0%
2003 1.6%
2004 11.2%
2005 12.6%
2006 8.6%
2007 8.5%

US Lodging Upper Upscale RevPAR Growth
Growth
2000 7.0%
2001 -11.6%
2002 -3.4%
2003 -1.6%
2004 8.1%
2005 10.2%
2006 8.6%
2007 7.3%

Starwood Hotels and Resorts Portfolio Acquisition:
In November 2005, HMT announced that it had signed a definitive merger agreement to acquire 38 luxury and upper upscale hotels from Starwood Hotels and Resorts for $4.04 billion. The portfolio consists of 25 domestic and 13 international properties and a total of 18,964 rooms managed under the Westin, Sheraton, W Hotels, The Luxury Collection and St. Regis brands. As part of the transacation, HMT is expected to assume approximately $700 million of debt and issue $2.3 billion of equity (133,529,412 common shares at the exchange price of $17.00 per share) to Starwood shareholders. The balance of the purchase will be paid in cash. The transaction is expected to close in the first quarter of 2006.

The acquired portfolio has high quality, luxury and upper upscale hotels with an average size of approximately 500 rooms and an expected revPAR of $117 in 2005. Approximately 80% of the portfolio revenues are from properties in urban, convention or resort locations, six of which are city-center hotels with over 750 rooms.

This transaction benefits HMT both strategically and financially as it further diversifies the company’s brands and geographical footprint and is expected to be immediately accretive to FFO per diluted share and effectively delevers the balance sheet.

Estimates-
New
HMT Assets Adj. Pro Forma
2006 EBITDA $1037mm $360mm $1397mm
Interest (423) (80) (64) (567)
Preferred Div. (24) (24)
Income Taxes (7) (7)
Partnership Adj. 10 10
Minority FFO (36) (36)
Convert Div. 51 51
Other (25) (25)
FFO 590 273 (64) 799

Shares 414 134 799
FFO/Share $1.42 $1.46
Accretion $0.03
% Accretion 2.0%

Balance Sheet
LT Debt 5501 700 1070 7271
Preferred Stock 716 716
Equity 2320 2233 4553
Capitalization 8537 2933 1070 12540

Credit Stats-
Debt/Total Cap 64.4% 23.9% 58.0%
Debt + Prf/EBITDA 5.9x 1.9x 5.6x
Debt/EBITDA 5.2x 1.9x 5.1x
EBITDA/Interest 2.5x 4.5x 2.5x

Benefits of Acquisition-
1. reduces leverage
2. accretive to 2006 FFO per diluted share
3. brand diversification
4. increased international exposure
5. further economies of scale

Risks of Acquisition-
1. technical pressure from equity issuance to HOT shareholders
2. delay in closing that could decrease accretion
3. pro forma the company will have a higher percentage of its room base that has expiring labor contracts in 2006

Union Contract Expirations:
A top issue facing the lodging industry in the US in 2006 is the expiration of labor contracts between select hotels and the union in over half a dozen major cities. The impact to HMT in the event of a strike or business interruption will likely have only a slight impact on HMT’s operations in 2006 because only 9,463 rooms, or 13% of the pro forma room base, will be impacted. The impact to HOT and HLT will likely be more severe as 18% and 30% of their room bases will have contracts expiring in 2006, respectively.

Replacement Value Analysis:
Brand Rooms $/Key Value ($MM)
Marriot 43,175 $250,000 $10,794
Sheraton 11,572 250,000 2,893
Westin 5,755 300,000 1,727
Ritz-Carlton 3,826 450,000 1,722
Hyatt Regency 3,522 275,000 969
W Hotels 1,114 500,000 557
Swissotel 1,127 375,000 423
Fairmont 450 750,000 338
Other 1,229 225,000 277
Four Seasons 608 450,000 274
Hilton 678 225,000 153
St. Regis 232 500,000 116
Westin 365 225,000 82

Asset Value 73,653 367,308 20,321

Long-Term Debt 7,271
Preferred Stock 716
Courtyard JV Equity Interest 16
Cash 400

Equity Value 12,750
Rooms 548

Replacement Value/Share $23.28


Catalysts:
• Addition to the S&P 500 Index
• Closing of the acquisition of the HOT asset portfolio in Q1
• Rising costs, including labor, insurance, and energy has stymied the pace of new supply growth, especially in the urban upper upscale segment
• Rising construction costs should also dampen supply forecasts
• Rising interest rates/cost of capital
• Weak US dollar


Risks:
• Lodging ownership model is more volatile.
• HMT is a consolidator of assets, making acquisitions a key driver. If increased levels of capital chasing lodging assets result in higher transaction multiples this could hamper the company’s ability to grow via acquisition or cause yields on acquisitions to be lower than expected.
• A resurgence in capital spending to fund new developments would likely cause higher than expected future supply growth, which in turn would decelerate revPAR growth and operating profit improvements.
• Economic and event risk
• Higher utility costs impacting margins
• Higher labor/benefits costs
• Shortening booking window

Catalyst

• Addition to the S&P 500 Index
• Closing of the acquisition of the HOT asset portfolio in Q1
• Rising costs, including labor, insurance, and energy has stymied the pace of new supply growth, especially in the urban upper upscale segment
• Rising construction costs should also dampen supply forecasts
• Rising interest rates/cost of capital
• Weak US dollar