Over-rich
It takes a lot to get Bill Marriott and Steve Bollenbach rattled. After all, their respective companies, Marriott and Hilton Hotels Corporation, have led the way in the massive consolidation that has swept the US hotel industry in recent years, and their appetite - and financial ability - to carry on expanding seems undimmed.
But despite the formidable firepower at their disposal, these same men recently joined forces to complain to the US Congress that they were increasingly being outgunned by what the influential US business magazine Forbes recently described as "the unstoppable REIT juggernaut". Here, astonishingly, were perhaps the two most powerful figures in the hotel industry complaining about an uneven playing field.
The backdrop to their complaint to Congress was last year's bitterly fought battle for control of the ITT Corporation, owner of the Sheraton brand. Here was a company that, to Bollenbach's mind, had been resting on its laurels for far too long. In much the same way that Granada homed in on Forte two years ago, Bollenbach decided he could do better than Rand Araskog, the veteran head of ITT, and launched a hostile takeover bid.
For much of last year, the takeover followed the usual pattern of mud-slinging by both sides, with Wall Street observers predicting eventual victory for Hilton, provided Bollenbach was prepared to raise his offer. What the super-confident Bollenbach hadn't reckoned on was the late arrival on the scene of Starwood Lodging, a REIT led by the equally confident Barry Sternlicht. It came in as a "white knight" - a friendly suitor brought in by ITT to see off Hilton by offering a higher price.
Suddenly, Bollenbach had a fight on his hands, and he was eventually forced to throw in the towel in the face of a knockout bid from Starwood valuing ITT at a staggering $14b. To have raised his own bid any higher would have put a huge strain on Hilton's financial stability and put Bollenbach's reputation on the line.
But how, people have been asking, could Starwood afford to pay so much without putting its own future in jeopardy? The answer lies in the complicated tax breaks enjoyed by REITs such as Starwood and Patriot American Hospitality, the latter of which last week announced its entry into Europe through its £92m takeover of Arcadian International.
In essence, REITs came into being in the early 1980s as part of an attempt by the US government to revive the fortunes of the country's property sector after years in the doldrums. The tax status they were given allows them to avoid paying any corporate taxes provided they distribute 95% or more of their taxable earnings to shareholders in the form of dividends.
Normal REITs are simply property owners or landlords which collect rent from tenants, and their tax status prevents them from operating the businesses that are run from their properties. But the big advantage enjoyed by a handful of REITs, such as Starwood and Patriot, is that they have "paired-share" status, which allows them to act as both landlord and operator. They are so-called because they are effectively two separate companies whose shares are traded in tandem.
The beauty of this tax loophole, which has long since been abolished by Congress, is that the operating company can also avoid most federal taxes by passing the majority of its profits to the REIT in the form of rents or mortgage payments. The preferential tax structure means share prices skyrocket, enabling them to pay far more for companies. This is the uneven playing field of which Bollenbach and Marriott have been complaining.
The $14b ITT buy is just the latest in a series of multi-billion-dollar deals that have taken the hotel industry by storm, as Starwood and Patriot have focused on the strong rebound in the US lodging sector since the depths of the recession. Patriot, for example, has taken its total spending on recent deals to more than $5b, snapping up such brands as Wyndham and Grand Heritage along the way. And in the past few weeks, a third paired-share REIT, Meditrust, has strayed from its normal sphere of operations in healthcare by snapping up Texas-based La Quinta Inns in a $3b deal. Meditrust is also rumoured to be interested in Inter-Continental Hotels.
Stephen Potel, international hotel specialist at agent Knight Frank, says that the extraordinary speed and scope of the deals suggests that REITs are afraid that Congress might listen to the hotel industry lobby and pass legislation to abolish paired-share status. "If they see something, they'll go for it," says Potel. "My understanding of Starwood is that they're opportunistic. They have no specific strategy, but just react to opportunities as they come up. Barry Sternlicht is a deal-a-minute man. He's just insatiable."
In fact, recent pointers from the White House suggest that President Clinton is already addressing the paired-share issue. This could mean that the loop-hole will be closed, reining in the REITs' deal-making abilities. However, even if the changes do become law, they are unlikely to be implemented retroactively.
As a result of the REITs' frenetic buying spree, opportunities in the USA are becoming scarcer, so it is no surprise that the likes of Patriot, Starwood and Meditrust have been looking at Europe. Arcadian chief executive Robert Breare says: "There is a recognition that buy-side opportunities in the USA are reaching maturity."
While the comparative infancy of hotel consolidation in Europe is viewed as an opportunity by REITs, the relative lack of bigger targets with a suitable international spread also makes it difficult for them to adopt the same tactics as they do at home.
Marten Foxon, the former Forte Hotels property director who oversaw the Exclusive Hotels sell-off, says: "I don't think we'll see the mega-deals seen in the USA because there isn't really a mega-deal to be done. I wouldn't be at all surprised if Arcadian turns out to be one of the biggest. The REITs will probably seek to get companies at the embryonic stage and either work with management to develop the company or build up the portfolio on a piecemeal basis."
That view may explain the sudden interest in Arcadian, one of the UK's smaller quoted companies, with 11 historic-style hotels in the UK and Jersey, some development projects on the Continent and joint ventures encompassing timeshare, the Great Eastern Hotel redevelopment in London, and Malmaison Hotels. The £92m purchase price is loose change to a REIT, yet it is significant that Starwood is also believed to have looked carefully at Arcadian in case Patriot decided not to proceed with the deal.
Until the deal was announced, City analysts had tended to cite the much larger Thistle Hotels, which has had its problems recently, as a more obvious target for REITs, but such speculation ignored the fact that Thistle does not have the strong brand profile that these US predators look for. While Patriot clearly believes that Malmaison and Wyndham can be rolled out in every major European city and beyond, Thistle's potential for development beyond these shores seems less obvious.
Breare explains: "It would be foolish to think these REITs are so gung-ho they will be the answer to every asset-seller in Europe. That is wholly wrong. They are expected to be aggressive, but they are going to very selective and very focused on brands."
In the case of Starwood, the brands seen as having big potential in Europe are Sheraton and Westin, though again a piecemeal approach looks the likely way forward. Just before Christmas, for example, Starwood forked out $51.5m for the prestigious Turnberry Hotel and golf courses, as a flagship for its Westin Hotels & Resorts brand, while in London it is involved with a £125m luxury hotel development at Bloomsbury Square that will be operated by Westin.
The Arizona-based group is also looking to add another 10-15 Sheraton hotels to its current total of six in the UK, and has voiced its desire to bring its three-star Four Points brand to Britain. Bob Cotter, head of Sheraton in Europe, says that expansion in Europe will be a mixture of joint ventures, management contracts and franchises, although he does not rule out acquiring a small group to kick-start Four Points.
Despite the arrival in Europe of the "unstoppable REIT juggernaut", Sternlicht and his colleagues would be unwise to believe they are going to have things all their own way. At the recent Arthur Andersen hotel investment conference in London, Arne Sorenson, senior vice-president, business development, at Marriott International, said that the group still believed wholeheartedly in the benefits to be derived from increasing distribution and leveraging further economies of scale. He told the audience: "There will be continuing consolidation and we will participate in it."
Dominic Walsh is a business correspondent on The Times
IT TAKES a lot to get Bill Marriott and Steve Bollenbach rattled. After all, their respective companies, Marriott and Hilton Hotels Corporation, have led the way in the massive consolidation that has swept the US hotel industry in recent years, and their appetite - and financial ability - to carry on expanding seems undimmed.
But despite the formidable firepower at their disposal, these same men recently joined forces to complain to the US Congress that they were increasingly being outgunned by what the influential US business magazine Forbes recently described as "the unstoppable REIT juggernaut". Here, astonishingly, were perhaps the two most powerful figures in the hotel industry complaining about an uneven playing field.
The backdrop to their complaint to Congress was last year's bitterly fought battle for control of the ITT Corporation, owner of the Sheraton brand. Here was a company that, to Bollenbach's mind, had been resting on its laurels for far too long. In much the same way that Granada homed in on Forte two years ago, Bollenbach decided he could do better than Rand Araskog, the veteran head of ITT, and launched a hostile takeover bid.
For much of last year, the takeover followed the usual pattern of mud-slinging by both sides, with Wall Street observers predicting eventual victory for Hilton, provided Bollenbach was prepared to raise his offer. What the super-confident Bollenbach hadn't reckoned on was the late arrival on the scene of Starwood Lodging, a REIT led by the equally confident Barry Sternlicht. It came in as a "white knight" - a friendly suitor brought in by ITT to see off Hilton by offering a higher price.
Suddenly, Bollenbach had a fight on his hands, and he was eventually forced to throw in the towel in the face of a knockout bid from Starwood valuing ITT at a staggering $14b. To have raised his own bid any higher would have put a huge strain on Hilton's financial stability and put Bollenbach's reputation on the line.
But how, people have been asking, could Starwood afford to pay so much without putting its own future in jeopardy? The answer lies in the complicated tax breaks enjoyed by REITs such as Starwood and Patriot American Hospitality, the latter of which last week announced its entry into Europe through its £92m takeover of Arcadian International.
In essence, REITs came into being in the early 1980s as part of an attempt by the US government to revive the fortunes of the country's property sector after years in the doldrums. The tax status they were given allows them to avoid paying any corporate taxes provided they distribute 95% or more of their taxable earnings to shareholders in the form of dividends.
Normal REITs are simply property owners or landlords which collect rent from tenants, and their tax status prevents them from operating the businesses that are run from their properties. But the big advantage enjoyed by a handful of REITs, such as Starwood and Patriot, is that they have "paired-share" status, which allows them to act as both landlord and operator. They are so-called because they are effectively two separate companies whose shares are traded in tandem.
The beauty of this tax loophole, which has long since been abolished by Congress, is that the operating company can also avoid most federal taxes by passing the majority of its profits to the REIT in the form of rents or mortgage payments. The preferential tax structure means share prices skyrocket, enabling them to pay far more for companies. This is the uneven playing field of which Bollenbach and Marriott have been complaining.
The $14b ITT buy is just the latest in a series of multi-billion-dollar deals that have taken the hotel industry by storm, as Starwood and Patriot have focused on the strong rebound in the US lodging sector since the depths of the recession. Patriot, for example, has taken its total spending on recent deals to more than $5b, snapping up such brands as Wyndham and Grand Heritage along the way. And in the past few weeks, a third paired-share REIT, Meditrust, has strayed from its normal sphere of operations in healthcare by snapping up Texas-based La Quinta Inns in a $3b deal. Meditrust is also rumoured to be interested in Inter-Continental Hotels.
Stephen Potel, international hotel specialist at agent Knight Frank, says that the extraordinary speed and scope of the deals suggests that REITs are afraid that Congress might listen to the hotel industry lobby and pass legislation to abolish paired-share status. "If they see something, they'll go for it," says Potel. "My understanding of Starwood is that they're opportunistic. They have no specific strategy, but just react to opportunities as they come up. Barry Sternlicht is a deal-a-minute man. He's just insatiable."
In fact, recent pointers from the White House suggest that President Clinton is already addressing the paired-share issue. This could mean that the loop-hole will be closed, reining in the REITs' deal-making abilities. However, even if the changes do become law, they are unlikely to be implemented retroactively.
As a result of the REITs' frenetic buying spree, opportunities in the USA are becoming scarcer, so it is no surprise that the likes of Patriot, Starwood and Meditrust have been looking at Europe. Arcadian chief executive Robert Breare says: "There is a recognition that buy-side opportunities in the USA are reaching maturity."
While the comparative infancy of hotel consolidation in Europe is viewed as an opportunity by REITs, the relative lack of bigger targets with a suitable international spread also makes it difficult for them to adopt the same tactics as they do at home.
Marten Foxon, the former Forte Hotels property director who oversaw the Exclusive Hotels sell-off, says: "I don't think we'll see the mega-deals seen in the USA because there isn't really a mega-deal to be done. I wouldn't be at all surprised if Arcadian turns out to be one of the biggest. The REITs will probably seek to get companies at the embryonic stage and either work with management to develop the company or build up the portfolio on a piecemeal basis."
That view may explain the sudden interest in Arcadian, one of the UK's smaller quoted companies, with 11 historic-style hotels in the UK and Jersey, some development projects on the Continent and joint ventures encompassing timeshare, the Great Eastern Hotel redevelopment in London, and Malmaison Hotels. The £92m purchase price is loose change to a REIT, yet it is significant that Starwood is also believed to have looked carefully at Arcadian in case Patriot decided not to proceed with the deal.
Until the deal was announced, City analysts had tended to cite the much larger Thistle Hotels, which has had its problems recently, as a more obvious target for REITs, but such speculation ignored the fact that Thistle does not have the strong brand profile that these US predators look for. While Patriot clearly believes that Malmaison and Wyndham can be rolled out in every major European city and beyond, Thistle's potential for development beyond these shores seems less obvious.
Breare explains: "It would be foolish to think these REITs are so gung-ho they will be the answer to every asset-seller in Europe. That is wholly wrong. They are expected to be aggressive, but they are going to very selective and very focused on brands."
In the case of Starwood, the brands seen as having big potential in Europe are Sheraton and Westin, though again a piecemeal approach looks the likely way forward. Just before Christmas, for example, Starwood forked out $51.5m for the prestigious Turnberry Hotel and golf courses, as a flagship for its Westin Hotels & Resorts brand, while in London it is involved with a £125m luxury hotel development at Bloomsbury Square that will be operated by Westin.
The Arizona-based group is also looking to add another 10-15 Sheraton hotels to its current total of six in the UK, and has voiced its desire to bring its three-star Four Points brand to Britain. Bob Cotter, head of Sheraton in Europe, says that expansion in Europe will be a mixture of joint ventures, management contracts and franchises, although he does not rule out acquiring a small group to kick-start Four Points.
Despite the arrival in Europe of the "unstoppable REIT juggernaut", Sternlicht and his colleagues would be unwise to believe they are going to have things all their own way. At the recent Arthur Andersen hotel investment conference in London, Arne Sorenson, senior vice-president, business development, at Marriott International, said that the group still believed wholeheartedly in the benefits to be derived from increasing distribution and leveraging further economies of scale. He told the audience: "There will be continuing consolidation and we will participate in it." n
Dominic Walsh is a business correspondent on The Times
