Hotel Hell: Reggie Middleton's Review of CRE and Starwood's Q3-09

BoomBustBloggers  have been on a wild CRE and residential
rollercoaster ride over the last couple of years. Starting in 2007,we
ran into Lennar and discovered things off balance sheet that the sell
side and the company itself forgot to tell us (Voodoo, Zombies, Lennar’s Off Balance Sheet Accounting and Other Things of Mystery & Myth), Ryland and their sell happy management (What does Reggie Middleton and Ryland's Upper Management have in Common?), Hovnanian and his you should by a house now (as he puts his on the market, Credibility is the Key to Success for a CEO – Hovnanian has Lost that Key: A letter to Mr. Hovnanian) and a whole host of other homebuilders. We gave

Quick note: We are finishing up our scan of REITs that will have definitive refinance and/or cash flow issues in the next quarter or two, and have narrowed them down to four, with one finalist attempting to win the prize. I have the team running a cashflow and valuation analysis on each property in the portfolio and I should have somethingto munch on for subscribers sometime late next week.

an early warning on CRE in the 3rd quarter of 2007 (about a year before it was fashionable to do so - Will the commercial real estate market fall? Of course it will), then moved on to short General Growth Properties (now bankrubpt, GGP and the type of investigative analysis you will not get from your brokerage house) and Macerich (got this one to profit right before the market went coo coo for Cocoa Puffs - Macerich Forensic Valuation - Retail 2009-10-22 01:46:14 192.71 Kb -  Macerich Forensic Valuation - Professional 2009-10-22 01:45:52 344.92 Kb -  Macerich Sensitivity Analyis - Pro 2009-10-22 01:46:36 344.92 Kb)
close to the top of their cycles (unfortunately, we're still waiting on
ALX to speak to Mr. Reality for this one has benefitted from both a
thin float and a fundamentally irrational market! -  Alexander's Actionable Research Note Retail 2009-02-19 16:16:44 -  Alexander's Actionable Research Note Pro 2009-02-19 16:20:08 and video too: February REIT Actionable Intelligence Note Update - remember, who are you going to believe, short term stock prices or your lying eyes!).

Keeping with this theme, the rabble rousing, digital rag known as
ZeroHedge recent ran a couple of posts concerning the CRE crash and its
effects on NYC hotels. 

Fcur Seasons Hotel In New York Is Latest Victim Of CRE Crash 

In addition to the Four Seasons, three other luxury hotels, which back
a loan sent to a special servicer 10 days ago include the Four Seasons
Biltmore Resort in Montecito, the ritzy Las Ventanas in Cabo, the
destination of many a banker closing dinner, and the San Ysidro Ranch
in Montecito.

The special servicing action has forced S&P
to place 15 classes of bonds backed by a $425 million loan to Ty Warner
Hotels & Resorts on "credit watch with negative implications." The
catalyst for the action and the transition to special servicing was
prompted by a staggering drop in cash flows from properties which came
46% below S&P expectations. The loan, which matures in January
2010, and which investors were hoping to recoup full principal on, may
now be looking at substantial losses. And due to the declining cash
flow, the loan would not qualify for an extension as it is in breach of
it debt service coverage ratio.

More indicative of the
collapse in the luxury hotel segment is the drop in occupancy for the
four properties from 69% in the last fiscal year to a meager 58%
recently. Alas the Ty Warner penthouse pictured insert unfortunately
does not seem to be seeing a lot of action (if any) these days.

The full blown impact of CRE deterioration on the hotel industry could
escalate rapidly: according to RealPoint there are over 1,500 loans
with a total balance of nearly $25 billion which may be in danger of
default...

The Next CRE Casualty: Union Square's W Hotel

"...
the iconic Union Square W Hotel may just be it. The hotel, which was
acquired by Dubai's troubled sovereign wealth fund, Istithmar, for $285
million in 2006 (one of the few acquisitions of a hotel at a price of
more than $1 million per room) has been bleeding cash lately after room
rates have declined by 24%. The result has been an inability for the
owner to even meet debt service obligations: a sure sign the current
balance sheet is doomed, with an outright default just a matter of
time.

... And here is why the math on every single REIT "upside case" out there is highly suspect:

The hotel’s net cash flow this year is running at an annualized rate of
$8 million, down from $14.8 million in 2008, according to the servicer
report. That barely covers the $7.5 million of annual debt service on
the senior mortgage, but isn’t enough for the mezzanine loan. Like all
luxury hotels in Manhattan, the W New York Union Square, at 201 Park
Avenue South, is struggling with a drop in revenue because of the
recession. Room rates are down $100 from a year ago, according to a
servicer report. What’s more, the hotel’s annual property tax more than
tripled, to $3 million.

If industry indications are any sign, the rebound is still far away for the troubled New York hotel segment:

The average occupancy for luxury hotels in Manhattan was 74.2% in the
first eight months of the year, down from 81.9% a year earlier,
according to Smith Travel Research. Room rates plunged 24%, driving
room revenues down 31%.

As for those about to
get whacked when and if Istithmar decided to call it a day: some very
unhappy clients of Credit Suisse:

The purchase
was financed with a $232 million debt package from Credit Suisse that
consisted of a $115 million senior mortgage and a $117 million
mezzanine loan. Credit Suisse securitized the senior loan and placed
the mezzanine debt with one or more unidentified high-yield investors.
The interest-only senior mortgage, with a 6.5% coupon, matures in
October 2011. It was securitized via a $3.4 billion pooled offering
(Credit Suisse Commercial Mortgage Trust, 2006-C5).

And while the maturity is only two years in the future (as are many
other scheduled CRE maturity rolls), the likelihood that the loan will
continue paying current income for the next 24 months is virtually nil.

So if this is the fate of one of the sovereign fund's landmark properties, what will happen to its two other trophy hotels?

Istithmar’s real estate holdings include two other Manhattan
properties: the Mandarin Oriental at Columbus Circle and the office
building at Six Times Square. Istithmar has been converting Six Times
Square into a hotel, but work on the project appears to have slowed
dramatically."...

That lengthy preamble brings us to our Q3 review of Starwood Hotels (HOT). A
full forensic analysis and preview was released to subscribers right at
the onset of this most historical of bear market rallies - see:

 Starwood Hotels (HOT) Intelligence Note_072009 - 2009-07-22 03:45:18 927.84 Kb

 HOT Report 290709 Retail 2009-08-03 01:52:38 420.81 Kb

 HOT Report_290709 Pro 2009-08-03 01:53:54 635.54 Kb.

Let's see how well we did in terms of our fundamental accuracy. 

Starwood Hotels (HOT) Results Review & Opinion - 3Q09

As
the world turns, the global downturn continues to clinch the
international hotel industry, with the luxury and upper upscale
segments claiming the title as leading role in being the worst hit.

Click any and all of these graphics to enlarge...

Further,
the two significant factors - substantial supply-demand mismatch of
rooms in this segment and corporate profits growing largely on the back
of cost cutting rather than top line growth - are likely to undermine a
cyclical upturn for these segments in the near-to-medium term. 

 

Performance
of Starwood Hotel, a major global player in the luxury and upper
upscale hotel segment, continued to deteriorate in 3Q09. System wide
double digit decline in REVPAR (revenue per available room) is clamping
down on revenues in ALL segments. REVPAR for the comparable system-wide
hotels, which include worldwide owned, managed and franchised hotels,
declined 20.3% with sharp declines recorded across all geographies.
Revenues (excl other revenues from franchised and managed properties
which are reimbursements of costs incurred on behalf of managed hotel
properties and franchisees) declined 31.0% (y-o-y) to $703 mn in 3Q09
from $1,019 mn in 3Q08.

Decline
in REVPAR at owned hotels, resulted in 31.1% (y-o-y) decline in
revenues from owned, leased and consolidated joint venture hotels to
$396 mn in 3Q09 from $575 mn in 3Q08. REVPAR for comparable owned
hotels worldwide declined 23.7% (y-o-y), with hotels in North America
witnessing a decline of 24.0% and international hotels recording 23.3%
decline. Starwood's management and franchise fees declined 17.0%
(y-o-y) to $181 mn in 3Q09 from $218 mn in 3Q08 as the revenues at the
managed and franchised hotels continue to plunge. Further, the revenues
from vacation ownership declined 44.2 %( y-o-y) to $126 mn in 3Q09 from
$226 mn in 3Q08.

In
spite of widespread cost cutting measures being implemented at the
owned hotels, the margins continue to squeeze as the steep decline in
revenues is outpacing decline in costs. Gross margin of the owned
hotels declined to 16.7% in 3Q09 from 24.0% in 2Q08. On TTM basis, the
gross margin of the owned hotels squeezed sequentially to 17.5% in 3Q09
from 19.7% in 2Q09 with the decline being more severe in the owned
hotels in North America.

 

The
Company is also cutting down on SG&A expenses to salvage the
sagging operating margin, but the impact of lower gross margins at
owned hotels and lower management fees is outweighing the cost cuts and
the Company's operating margin contracted significantly to 7.0% in 3Q09
from 13.6% in 3Q08. The operating income declined 59.3% (y-o-y) to $85
mn in 3Q09 from $209 mn in 3Q08.

As
in 2Q09, the bottom line in 3Q09 was impacted by a number of special
items. However, the net positive impact of $15 million (after tax) was
much lower than in 2Q09. The special items included $44mn of tax
benefit primarily related to hotel sales, partially offset by net
impairment charges of $27 mn and restructuring charges of $2 mn.
Excluding these special items, the net profit declined 80.6% (y-o-y) to
$25 mn in 3Q09 from $129 mn in 3Q08. Diluted EPS (excluding special
items) was $0.14 in 3Q09, against $0.71 in 3Q09.

Comparison of the actual with our forensically derived estimates

Starwood
continues to underperform vis-à-vis our estimates. The actual revenues
(excluding other revenues from franchised and managed properties) in
3Q09 were about 5.6% lower than our estimates. Also, the margins
contracted much more than our expectations. resulting operating income
which was 30.9% lower than our estimates. Adjusted EBITDA was $179 mn
against our estimates of $216 mn. Excluding the special items of $15
mn, the actual net income was $25 mn against our estimates of $48 mn.
EPS (excl special items) was $0.14 against our estimates of $0.26.

Although
for 4Q09, the company is expecting adjusted EBITDA within the range of
$190-$200 mn which is higher than our estimates of $183 mn, the
Company's full year estimates of adjusted EBITDA within the range of
$735-$745 mn is lower than our FY09 projection of $766 mn owing to
lower than expected EBITDA reported over the last two quarters. If I
deem it necessary, I will issue a revised valuation matrix, to subscribers particularly if I see the market moving to respect the fundamentals again.

Comments

[Anonymous]

A freshly weakened dollar will render this thesis bankrupt.

Try again.