Hilton bid puts sector in a spin

But money could be pouring into the industry just as thousands more rooms are being built and demand is showing signs of tailing off.

Robert LaFleur, an analyst with the Philadelphia office of Susquehanna Financial Group, summed up the mood when he said: "Despite the run-up in asset prices over the past few years, the appreciation of hotels has fallen short of that achieved by almost any other real-estate asset class. Therefore, we believe that private equity will continue to purchase hotels until they are properly valued by the public markets." This raises the prospect that the major hotel groups in a still-fragmented global industry will be run as finance-led operations by investment specialists with little or no direct experience in the business, a combination that has been a recipe for a string of failures in industries as diverse as engineering, films and publishing.

And the timing may be ominous. Before Blackstone Group's cash bid for Hilton, Goldman Sachs analyst Steven Kent said it was time to sell hotel shares. He said: "We are especially concerned that supply growth is starting to surpass demand growth, which historically has been a negative signal for stock performance."

Goldman is one of Blackstone's backers for the Hilton deal, which at least shows that Goldman's Chinese walls between research and banking are firmly in place.

The number of newly built rooms is predicted to rise by 1.4% while demand may grow by only 0.6%.

Several big hotel projects had been sidelined because the cost of construction materials was soaring and ruining budget plans. Now that the American housing market is cooling, and the price of materials is moderating, a spurt of hotel building has been triggered.

A global glut of rooms could slash profit margins. Add in rising interest rates and you could have the doomsday scenario that ends the private-equity bonanza.

Blackstone already owns 100,000 hotel rooms which it can bolt on to Hilton's 480,000, along with its marketing, booking and loyalty systems. Apart from the flagship Hilton chain, the group owns Embassy Suites, Doubletree, Hampton Inn and the luxury Waldorf-Astoria.

So Blackstone will suddenly become the world's biggest hotelier, even though its first foray into the business was only nine years ago with the purchase of London's four-strong and highly specialised Savoy Hotel Group. It has since sold the chain.

While Hilton owns half the hotels it manages, giving it a strong asset base, the Blackstone deal will only work if the operations continue to contribute to cashflow.

John Arabia, an analyst with Green Street Advisors in California, said: "The Hilton transaction provides a strategic data point. Blackstone is building a very successful operating platform and brand collection. They are paying a premium to get their hands on the infrastructure."

From his head office in Beverly Hills, Stephen Bollenbach, Hilton's chief executive and joint chairman, said he expected Blackstone to keep the hotel group's management to run the entire portfolio, which extends to the Boca Raton Resort & Club in Florida and New York's London NYC as well as the La Quinta chain of inns.

"We have had a lot of discussions about how the combined business will be operated," said Bollenbach, who was already due to step down at the end of this year. "Blackstone likes our assets, our people and our management. My guess is they will keep the existing management."

Bollenbach predicted that the industry would shrug off the latest terrorist attacks in Britain, just as it had overcome September 11 within a few months.

If it goes through, the deal will bring to an end the Hilton family's involvement in hotels. The 79-year-old Barron Hilton is Bollenbach's co-chairman and has headed the business for more than 40 years.

Attention now switches to the next likely takeover targets, assuming that other private-equity groups will not want to miss out on the value that Blackstone has identified.

Those immediately in the frame are Starwood Hotels & Resorts Worldwide, the Shera-ton, Westin and Le Meridien group, and Marriott International. They are of similar size to Hilton and occupy similar market positions. However, Marriott is 80%-owned by the Marriott family, who would demand a high premium to sell.

Harry Curtis, leisure analyst at JP Morgan in New York, said: "Starwood has a better balance sheet than Hilton, but no chief executive, so it's lacking leadership and I believe it has more attractive assets. I think Blackstone only preferred Hilton because of preexisting relationships with the board."

The dark horse among the big hoteliers is Intercontinental Hotel Group (IHG), the Wind-sor-based franchise operator whose shares are listed in London and New York. Its 540,000 Holiday Inn and Crowne Plaza rooms make it the world's biggest until Blackstone acquires Hilton. The enigmatic Barclay Brothers, owners of the London Ritz, have spent this year gradually building a stake in IHG which at the last count amounted to 10%.

So unless the Barclays buy it themselves, any bidder would have to factor them into the equation. But, while its £3.9 billion market value is some way behind that of Hilton, Marriott or Starwood, the Barclays' buying has taken the shares up to a price/ earnings ratio of 34, which will put off most would-be suitors.

Bjorn Hanson, hospitality expert at the management consultant Price Waterhouse Coopers, adviser to Hilton and Starwood, said: "We are in the mature phase of the cycle of privatising hotel companies, although there will be at least one more large transaction, and perhaps two or three medium-sized ones. I think Blackstone will not stop at Hilton - it will do even more, though not on that scale. I'd be surprised if we don't see more deals before the end of this year."

Hotel fever spread around the world last week, boosting the shares of Wyndham in America, Whitbread and Intercontinental in Britain, the Spanish hotelier Sol Melia and France's Accor Group.

But one of the most intriguing possibilities, identified by Curtis, is Fel Cor, which owns a large portfolio of mainly Embassy Suites and Doubletree hotels and is therefore a purer property play than a straightforward hotel operator. Listed in New York, at $26 a share it is selling on only 10.3 times earnings and yields an attractive 3.5%.

"It is the most compelling value in our lodging universe," said Curtis.

HISTORY

1919:Conrad Hilton buys his first hotel, The Mobley, in Cisco, Texas

1925:The first hotel to carry the Hilton name opens in Dallas

1949:Hilton buys the top American hotel - the Waldorf Astoria in New York

1953:The first Hilton opens in Europe: The Castellana Hilton in Madrid

1966:Barron Hilton, Conrad's second son, becomes president of Hilton Hotels

1979:Conrad Hilton dies, aged 91; Barron Hilton named chairman

1981:Paris Whitney Hilton, granddaughter of Barron, born in New York

1996:Stephen Bollenbach named president and chief executive, the first nonHilton to hold the title of chief executive

1997:Hilton Hotels Corporation and the British company Hilton Group plc reunite the Hilton brand worldwide

2007:Blackstone buys Hilton hotels in a deal worth $26 billion. Barron Hilton has a stake worth almost $1 billion