Friday, January 13, 2006

Hilton Hotels--Like Paris Hilton Better.

On December 29, 2005, Hilton Hotels Corp. (HLT-$25.00) said it would buy the hotel assets of Britain's Hilton Group PLC for 3.3 billion pounds ($5.7 billion) cash. Under the terms of the deal, Beverly Hills-based Hilton Hotel will only acquire the British company's lodging operations, totaling 40 hotel properties in Britain and Europe, along with 200 leased hotels. Hilton Group will change its name to Ladbrokes PLC and focus on its online and in-store betting operation, which has hundreds of locations in Europe.

The transaction, which is expected to close early this year, will be financed with cash on hand at the time of the closing (estimated to be approximately $1.2 billion) and a new bank facility.

The deal is being viewed favorably on Wall Street by many analysts. Prior to the transaction, the flagship Hilton brand was primarily vested in the U.S., Canada, and Mexico. Now, with a global lodging industry footprint, which also includes other Hilton Family brands like Embassy Suites, Hampton Inns & Suites, and Doubletree [that had previously been confined to North America], management is looking to expand its presence to places like India and China.

Management said it expects to save about $30 million per year going forward from consolidating technology, billing and other functions. The Company also anticipates realizing a number of revenue enhancing synergies, such as the worldwide implementation of Hilton's proprietary customer information system, called "OnQ."

This new business is a switch from the Company's previous strategy of selling off real estate to generate management fees and distribute the cash to investors. And... other non-industry-related activities: In 2004, the Company invested in a synthetic fuel facility--YES... we wrote that correctly: In August 2004, the Company acquired a 24% minority interest in a coal-based synthetic fuel facility for approximately $32 million. The facility produced operating losses, and Hilton's proportionate share of which totaled approximately $13 million for the nine months ended September 30, 2005. [BUT--the venture generated tax-credits.]

Hilton stock currently trades at a lower valuation [P/E, P/S, etc.] than its rivals because of its previously limited global presence. Contrary to analysts' sentiments, the 10Q Detective remains neutral on Hilton stock as an investment going forward.

On January 6, 2006, Moody's Investors Service cut Hilton Hotels debt-rating by two notches, from the lowest investment-grade rating to the second highest junk rating of "Ba2."

Paris Hilton may have to cut up her AMEX card to make this deal work. Prior to this acquisition, at 136.9%, total debt smothered shareholder equity. Adding in the additional financing needed to close the deal, the long-run solvency of Hilton Hotels Corp. is clearly a risk. This is not to say debt is bad, for on a trailing twelve-month basis, the Company is said to be trading on the equity at a gain. To illustrate, Hilton's rate of return on total assets is 5.76%, whereas the rate of return on the stockholders' equity was 16.22 percent. In other words, though highly leveraged, management has a history of using its debt profitably to earn such a higher ROE. Our concern is that SEC filings indicate that management is generating some of these returns by playing with derivatives. For example, for the first nine months of 2005, the Company is sitting on pre-tax gains of $7 million from derivative contracts covering 2.5 million barrels of oil!

As if the Company did not have enough debt to service, SEC filings also disclose that management has offered "franchise financing programs" with third party lenders to support the growth of its Hilton Garden Inn, Homewood Suites by Hilton, Hampton and Embassy Suites brands. As of September 30, 2005, Hilton had provided guarantees of $41 million on loans outstanding under the programs. In addition, there was guaranteed $36 million of debt and other obligations of unconsolidated affiliates and third parties, bringing the total guarantees to $77 million. Hilton Hotels also has commitments under letters of credit totaling $56 million as of September 30, 2005.

The Company also provided performance guarantees to certain owners of hotels under which Hilton operated under management contracts. Reclassifications, IRS audits--after reading some of Hilton Hotel's SEC filings we needed to take aspirin. We think it would be much more fun to follow the antics of Paris Hilton than Hilton Hotels Corp. stock.


NO DooDahs said...

The synfuel credits first came to my attention about 6-8 months ago, when I was researching Rex Stores as a possible "value" purchase. You might have fun looking at their Q's and K's if you get a chance.

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