It's not often that a company's management tells you the
company is grossly undervalued and it's looking to sell itself,
effectively giving investors a chance to jump into the stock
before it takes off.
This is a form of pre-emptive merger-arbitrage investing.
However, when a company has retained an investment bank to help
with the sale, it's even less speculative than the usual
This potential buyout opportunity gets even better when the
stock also has downside protection, where the company is trading
below replacement cost.
Well, that's exactly the case with
Strategic Hotels & Resorts (
, the only publicly traded real estate investment trust (REIT)
that focuses exclusively on the luxury hotel and resort
||Strategic Hotels owns a stake in the world-famous Hotel
del Coronado in San Diego.
There are several catalysts that could help expedite a sale of
Strategic, and not just the fact that the REIT has hired
investment bank Eastdil Secured to explore the possibility.
First, Strategic's founder, Laurence Geller, abruptly left the
company in November. Geller still owns 2.2 million shares of his
company, but he would like to buy other properties. A sale of
Strategic might allow him to get the most value out of his shares
so he could put that money to work.
The second catalyst is that Geller and other insiders with
notable ownership (more than 5% of the company) have a combined
23% stake. These shareholders are aligned in looking to create
the most value for themselves, and a sale of the company may be
the best way to do so.
Third, activist investor Orange Capital has a 3.7% stake in
the company. Orange Capital started pressuring the company
earlier this year to hire an advisor and explore all options,
including a sale. It appears that pressure has worked so far, and
I don't expect Orange to ease up until the company is sold.
The great thing about Strategic Hotels is that its portfolio
doesn't contain run-of-the-mill hotels, but high-end hotels and
luxury resorts. The company owns or has interests in properties
under top brands such as the Four Seasons, JW Marriott, Hyatt,
Westin, Intercontinental, Fairmont and Ritz-Carlton, among
others. The company's 18 hotels and resorts are found in markets
with high barriers to entry in the U.S., Mexico and Europe.
Strategic also owns several parcels of prime land for
Strategic does not manage any of its properties directly but
instead uses hotel management companies. Thus, the company looks
to grow through asset management and maximizing the value of each
property, and does this all with only 35 full-time and four
The luxury hotel segment was hit hard during 2008 and 2009.
Strategic was one of the companies hardest hit as it lost
hundreds of millions from low occupancy. The company was seen as
being on the verge of bankruptcy, and its stock plunged to as low
as $0.61 a share in March 2009. It's still more than 60% off its
But the companies that survived the crisis now enjoy reduced
competition. The Great Recession led major hotel builders to put
the brakes on new buildings. There are fewer competitors as a
result of a slowdown in the construction of luxury hotel
properties. Three years ago, 23 luxury hotels opened in the U.S.
Last year, that number dropped to only six. This decreased supply
is actually a tailwind for the company, as demand continues to
outpace supply, which is a positive for pricing.
Overall, the luxury hotel industry in the U.S. has seen
positive growth in revenue per available room (RevPAR) growth
since February 2010. Prior to that week, the industry saw 96
consecutive weeks of negative RevPAR growth.
One of the real benefits of the luxury hotel business is that
it tends to outperform other major hotel businesses during
economic recoveries. Specifically, lodging tends to have an 80%
correlation with GDP. During the recovery years of 1992 to 2000,
the industry saw nine straight years of RevPAR growth, 8.9%
annually. And then from 2002 to 2007, the industry had five
straight years of RevPAR growth, 8.2% annually.
As the only pure-play high-end lodging REIT, Strategic estimates
its average replacement costs, excluding land, are at more than
$750,000 per property. For 2013, growth in total hotel RevPAR is
likely to be between 5% and 6%. Strategic is also looking to
dispose of two of its non-core assets.
The other key benefit for Strategic is that it enjoys
industry-leading earnings before interest, taxes, depreciation
and amortization (EBITDA) per available room. For 2012, Strategic
generated $81 per room of EBITDA. Compare this to top comps
LaSalle Hotel (
at $74 per room and
Pebblebrook Hotel Trust (
at $71. The reason for this is that Strategic is much less
reliant than its peers on rooms, with much greater exposure to
food and beverages. Strategic earns 53% of its revenue from
rooms, while its peers get around 66% of revenues from rooms.
Orange Capital estimates Strategic could fetch $11 to $14 a share
if sold, which would equal upside of 25% to 60%. The valuation is
supported by the fact that Strategic's properties are in prime
locations that cannot be duplicated. Orange also believes that
the company has to push for a sale to ensure shareholders' best
interest. This, given its leveraged balance sheet, makes the
return of capital to shareholders in the form of dividends or
The most difficult aspect to valuing Strategic is that there
is no publicly traded competitor that owns similar hotel
properties. What has happened is a disconnection between the
public and private valuation for Strategic's hotel properties.
One Raymond James analyst noted: "The best way for them to close
the valuation gap that exists between the public valuation and
the private valuation, or what the collection of assets are
worth, ultimately is the sale of the company. The portfolio is
one of the best portfolios of hotel assets that has ever been put
together. We think there are groups out there that would love to
own the assets."
Risks to consider:
The big risk is that the economy takes a step back in its
recovery, as the luxury hotel industry is heavily tied to the
broader economy. The other risk is that a buyer comes to the
table, but the deal fails to materialize and the stock
Action to take -->
Buy this luxury hotel REIT for a buyout, but in the worst case,
you're getting the assets for less than replacement cost. The
company has taken a big step in the sale process by hiring an
advisor to help monetize its impressive asset base. In a sale,
the company could see upside of more than 25%. Regardless of how
a sale shakes out, investors should continue to enjoy Strategic's
success on the back of a rebounding economy.
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