Description

Trading at $6.25/share with a BV of $11.11 (0.57x book), over $9 a share in cash, and daily trading volume of 400,000 plus; on both an absolute and relative basis MHX is a LONG opportunity in a Company and industry that reached it’s trough in 2002. At trough EBITDA MHX should trade at 11x or $8/share. As cash flow begins to ramp and the dividend is reinstated the stock will trade between 11x-12x or a stock price of $13-$15/share.

Lodging is a high fixed cost business and highly cyclical in that room rates (rents) are reset on a daily basis. This model produces considerable leverage in an improving economy. Currently, at trough cash flow levels there is significant operating leverage and quite simply an added dollar in revenue will flow incrementally to the bottom line. A rebound in business travel coupled with MHX’s strong properties, post dispositions, MeriStar will benefit significantly from the dynamics of the model.

MeriStar Hospitality (NYSE: MHX), hotel REIT owner of 100 hotels with 26,219 rooms. The Company is repositioning the portfolio by selling non-core assets to de-leverage the balance sheet and provide funding for future acquisitions. The strategic focus is on top-quality hotels in major metropolitan markets and destination resorts. The dispositions will leave the Company with proceeds estimated to be between $280-$320MM along with a portfolio of 65 hotels consisting of 18,220 rooms, these dispositions will be completed by the end of 1Q04.

The company is selling non-core/tertiary hotel assets to local buyers and investment groups at attractive prices to MHX. MHX’s hotels represent an attractive investment opportunity for the local buyers given the ability to finance at low rates coupled with the leverage hotel owners can achieve as the economy continues to rebound.

Post dispositions MHX will hold quality/core assets, have an improved balance sheet, and the potential for significant leverage as RevPAR improves in 2004. Lodging managements have faced a terrible operating environment post the stock market bubble and the terrorist attacks in 2001. Managements have faced negative rhetoric from the investment community and thus management’s communication to the investment community has remained cautious/measured with regards to Company and industry specific guidance.

Valuation:
MHX’s occupancy in 2004 is projected to be 69% and assuming flat ADR RevPAR will be in the 3-4% range. The leverage comes as ADR improves, a 1% improvement in ADR will yield RevPAR in the 3.5-4.5% range. As operating statistics improve so will the stock price. MHX in 2001 was trading at 12x peak EBITDA or $22.5 per share.

MHX currently has $1.7B in debt, $275MM cash, and 2003 Company forecasted EBITDA is $162-$165MM. Upon completion of hotel dispositions anticipate lost cash flow of about 9% thus the Company’s EBITDA on the remaining portfolio would be about $150MM, and MHX’s net debt would drop to $1.1B. If the stock traded at 11x 2004E EBITDA, in line with peers, the stock would be $7.75 or 24% upside from current levels.

MHX: Pre dispositions Post dispositions
Stock Price $6.25 $6.25
Sharesout 63M 63M
Equity Value $394MM $394M
Cash $275 $575
Debt $1.7B $1.7B
Minority Interest 38MM 38MM
TEV 1,857MM $1,557MM
TTM EBITDA $173 -----
Post disp EBITDA ----- $150

The best comps to MHX are Felcor (FCH) and Host Marriot (HMT). FCH is trading at 12.8x TTM EBITDA and 12.2x 2004E EBITDA, while HMT is trading at 11.7x TTM EBITDA and 11.6x 2004E EBITDA.

COMPANY MHX FCH HMT
Total Enterprise Value $1,857 $2,956 $9,627
TTM EBITDA 173 253 753
TEV/TTM EBITDA 10.8x 11.7x 12.8x
EBITDA ’04E 150 254 788
TEV/EBITDA ‘04E 10.4* 11.6x 12.2x
*TEV of $1,557 considers disposition of assets and further debt reduction in early 2004

Liquidity position is improving with no significant maturities till August 2007 of $175MM (per 3rd quarter 10Q), with a cash position of $575MM post dispositions. (The company announced today that the 8.75% ’07 bonds have been reduced to $80MM) All of MeriStar’s publicly traded debt is trading over par.

Relationship with Interstate Hotel and Resort (NYSE: IHR)
IHR is the manager and operator of most of MHX’s real estate portfolio. Within the lodging industry this is not an uncommon relationship and the two Companies, in 2003, have been working through and eliminating potential conflicts of interest.

Throughout 2003 much has been done to separate the MHX and IHR management and board member overlap. Paul Whetsell on October 22, 2003 resigned as the Chief Executive Officer of IHR and is now the only board member to hold duel office within both companies. Mr. Whetsell remains Chairman and CEO of MHX and Chairman of IHR.

The story of de-leveraging and selling off non-core assets is a continued theme among many of the hotels stocks. MHX represents an over looked opportunity within this sector to purchase a stock trading at a discount to peers at trough cash flow multiples. The supply growth in upscale hotels is projected to be 1% in 2004. Thus, as MHX continues the successful sale of non-core assets reducing debt load and adding further liquidity to the balance sheet the Company will be well positioned to benefit from the continued recovery of the hotel sector.

On December 18, 2003 MHX announced the sale of 1,224 rooms for an average price of $25,700 per room. Looking at the brand and location of the 7 hotels this is a fair price. Prior to this sale the Company sold 7 hotels in 2003 consisting of 1,362 rooms for an average price of $66,740 per room. For the Company to achieve the mid point of their target the remaining 28 hotels or 7,999 rooms at a per room price of $33,700 which is more than achievable.

The value call on the industry is to buy stocks at 10x trough cash flow vs. 12x peak cash flow as in 2001. MHX is the cheapest lodging stock and positioned well for the up-tick in business travel and the economy;
trading at 10x 2004E (post asset sales) vs. peers trading at 11.5x-12.5x.

Stock price sensitivity:
Multiple 10X 11X 12X
EBITDA
150 $6.35 $8.73 $11.11
175 10.32 13.10 15.87
200 14.29 17.46 20.63

Catalyst

Short term: $6.35-$8.73/share
1) Asset sale announcements in 1st quarter of 2004
2) RevPAR improvement in 2004
3) Continued debt reduction
Long term: $8.73-$15.87/share
1) Reinstatement of dividend- a 2005 event
2) Publicly stated willingness to sell the Company once it is cleaned up