Behind The Facade

Most people assume that the hotels they stay in are actually owned by the brands that operate them, but this is far from reality. Starwood Hotels & Resorts Worldwide holds an impressive portfolio of brands, including Sheraton, St Regis, Westin and Le Méridien, yet of its 270 hotels in Europe and the Middle East it owns and directly operates just 20.

Investors own the bulk of its properties, most of which Starwood manages, while some 40 are franchised. It was not always this way. But over the last five years, high property values have prompted a sale of hotel bricks and mortar while the brand remains outside under a management contract. Last year, in a deal worth approximately $4bn, Starwood sold some 35 properties globally to Host Hotels along with management contracts.

Bill Showalter, Starwood Hotel's senior vice president of finance, EAME, says: "What we have seen in the last couple of years is a trend towards people monetising components of their portfolio because property values are so attractive. London is one of the best examples of this.

Property prices are booming and generating returns that have not been seen in quite some time. Many people have decided that now is a good time to release some of the value locked up in these properties."

The sale to Host Hotels was, says Showalter, not part of a total property divestment plan, but contributes to a balanced strategy between owned, managed and franchised properties. "We want to be asset right, not asset light. Having a balanced portfolio has a number of advantages. It helps our capital structure and it gives us a nice mix of different income streams that, in this market, are perhaps less volatile."

BOOMING MARKET

The industry is enjoying a revival after 18 extremely lean months following 11 September 2001. Its most important KPI, revenue per available room (revPAR) is now at a historic high and the industry is developing new capacity, even in crowded markets such as London, where revPAR is up to five times that of a comparable hotel in Eastern Europe, for instance.

Showalter explains that owning a core of hotels is also important for Starwood because it can then invest in developing and refining its brands. "This sends a great message to other owners, the investors in our properties. It demonstrates that we are prepared to invest in the brands, indicating our confidence that these brands will yield exceptional returns."

The majority of Starwood's hotels in Europe and the Middle East are run for the owners of the property under a management contract in which Starwood maintains strong brand control. Showalter adds: "We would like to say, and I think that it is generally true, that as owner or operator we should be driving better ROI and profitability than a franchisee because this is our core business. However, this is not always true because you can have experienced hotel operators who happen to be franchisees, and who will also be able to drive very good performance."

AGGRESSIVE EXPANSION

Starwood has not been attracted by the sale and leaseback option. Showalter says: "I think it is an expensive form of financing. In my experience, sale and leaseback is suitable for people without access to other lower-cost financing deals. Our balance sheet is very strong, our liquidity is very good and our borrowing costs are, within the hotel industry, very favourable. So in our particular case, sale and leaseback would not be the most attractive form of financing. For other companies that are less well capitalised and do not have access to lower borrowing costs, it is an option."

Starwood was founded in 1998 has since expanded aggressively, a policy it intends continue, says Showalter. Shortly after he joined, the business completed an approximately $200m acquisition of Le Méridien, which he says was accomplished with no significant corporate pain.

"Of the roughly 120 hotels in the Le Méridien portfolio, around 90 were in our division, so we had the biggest responsibility for integrating that business and delivering the numbers on which all of our financing assumptions were based. I am very pleased that we not only met those numbers, we exceeded them."

Starwood shares have risen by roughly 40% (adjusted for the Host transaction), underpinned by both operating performance and a company sharebuyback programme. With strong liquidity and access to cheap bank money, it is still acquisitive. In January 2007, it was rumoured to be looking at taking over the UK-based, 470-strong Premier Travel Inn chain from Whitbread.

Showalter says: "We have the financial wherewithal to enter into almost any kind of investment or transaction that we would wish to. We have said publicly that we have our ear to the ground for good investments.

I am not suggesting that there is another Le Méridien on the horizon, but we are looking for opportunities, be it the purchase of another brand or individual properties, or equity investment in individual or groups of hotels and the like."

One thing he has noticed is that big acquisitions often do not yield the expected value. "It is so easy to overpay for an acquisition. One thing that continues to amaze me is when acquirers are prepared to pay for a synergy they will get from the business, but that the vendor has no impact on and cannot facilitate. Any company, including us, could make this mistake."

FUNDING THE FRANCHISEES

When Starwood's business partners need access to financing, the hotel chain often steps in. Showalter explains: "In terms of providing direct finance to owners and franchisees, we have a number of different deal structures to assist these important business partners. We give mezzanine loans from time to time and we provide key money, which is a form of upfront capital injection to help them with financing the project.

"We also have several managed hotels where we own a minority equity position for two reasons: it is a form of financing for the majority owner and our belief in the long-term appreciation potential of the property is sometimes so strong that we want a piece of the action too. But in a franchised arrangement we are materially detached from the franchisee."

Franchisees, says Showalter, tend to be investors who know their business well. But there have been cases where they fail to keep up with the brand or allow standards to drop. Starwood has strict standards, and the services of its architecture and design team are mandatory. "Before a managed or franchised hotel can come into the system, we do a comprehensive review and explain the steps required to comply." Brand owners do not generally want to lose any links in their international chain, but withdrawing a franchise is an option.

Starwood has various approaches to occasional failures. Showalter explains: "The first option is to work with the owner to find a solution, giving him a reasonable period of time to comply. If that does not work, then a number of options arise. One is to terminate the franchise contract. Our pipeline is robust enough to allow us to be selective as to which owners we go into franchises with. On the other hand, if we really believe in the quality of the property, another recourse is to offer to buy it from the franchisee. It is unusual, but not unheard of, for a franchisee to convert to a management contract."

ROLLING OUT NEW PRODUCTS

Starwood plans to roll out the W brand in five to ten markets in Europe, Africa and the Middle East over the next three years. Showalter says that Starwood will be evaluating the rollout in EAME of its successful US Vacation Ownership product whereby complexes are linked to existing hotels, allowing cross-sharing of services such as house-keeping and boosting food and beverage sales.

Europe's varying country legislation complicates the product's introduction, as does the tarnished reputation of timeshare. "'Timeshare' is not a word that appears in our lexicon," mutters Showalter. Starwood intends to continue its relentless pace of expansion while constantly adapting to a changing market.

And with Showalter safeguarding its finances, it certainly has no fears for the future. So next time you climb into bed in a hotel, remember that behind the polished exterior lies a hive of activity.