A year into the coronavirus pandemic that upended the hospitality industry, opportunistic real estate heavyweights have begun their assault on the sector to bet on market dislocation.
Valued at approximately $6 billion, global private equity firms Blackstone and Starwood Capital Group’s joint acquisition of Extended Stay America, the region’s largest owner and operator of extended stay hotels, will be the largest hotel transaction since the coronavirus pandemic outbreak when completed.
A transaction of this size – in a property sector that many had initially written off as one of covid-19’s biggest casualties – has unsurprisingly come under the spotlight, both with regards to its timing and pricing. At a broader level, the deal also speaks to the growing positive investor sentiment surrounding the hospitality sector, despite all the pandemic-related headwinds.
“The market is saying in an emphatic way that it thinks the covid-19 pandemic is temporary in nature and there does not seem to be any concern in pricing about any potential long-term implications,” said Lukas Hartwich, managing director at Green Street, a commercial real estate analytics firm. “It is interesting because this basically means the market believes the hotel industry has effectively been unaffected, once covid is in the rear-view mirror, even though it is hard to gauge what the world would actually look like in the next couple of years.”
Premium or discount?
Both Blackstone and Starwood are prior investors in Extended Stay America. In 2020, Starwood reportedly acquired an 8.5 percent stake in the company. Blackstone’s relationship goes much further; having bought and sold the company on two separate occasions – first acquiring it in 2004, exiting in 2007 and then buying it again in a bankruptcy process in 2010 before taking it public in 2013.
For Blackstone, the latest transaction is part of its growing push into the travel and leisure sector, which the firm has publicly called one of its highest-conviction investment themes. Extended Stay, as a brand, has also “demonstrated resilience over the past year despite persistent challenges due to government lockdowns and travel restrictions,” as Barry Sternlicht, Starwood Capital’s CEO, noted in the press announcement.
Blackstone-Starwood’s 50:50 JV has agreed to pay $19.50 per paired share for the transaction. The offer represented a 23.3 percent premium over a 30-day volume weighted average share price ending March 12, the last trading day before the deal was announced on March 15. As of press time for this story, ESA’s shares were trading at $19.79.
The offer has been described as fair by the analysts who spoke to PERE.
“The pricing is not indicative of distress at all, within the extended stay segment,” said Rich Hightower, managing director and research analyst at Evercore ISI. “This was the best-performing lodging sub-sector in 2020 and pricing versus pre-covid EBIDTA [reflects] a pretty full multiple in terms of enterprise value versus, compared to where the company has traded historically.”
He added: “It is a company that traded roughly at 9-10 times EBIDTA on an average throughout its history and this is roughly an 11-times-EBIDTA deal if you look at 2019 levels.”
A few of Extended Stay America’s current shareholders, including Tarsadia Capital, a New York-based investment management arm of a family office, believe otherwise. In a letter to shareholders last week, the firm opposed the deal, saying its timing and pricing was wrong and not in the best interest of ESA’s public shareholders.
“The proposed transaction price of $19.50 per share values ESA at a 11.6x 2022 EBITDA, a 37 percent discount to the current average trading multiple of its lodging peers (18.5x) and a 24 percent discount to the next lowest peer, Apple Hospitality REIT,” the letter said. “On a forward EBITDA basis, the proposed price is the lowest transaction multiple in the US lodging space in more than five years.”
However, there are some challenges with comparing ESA’s trading multiple to its peers. As Hightower pointed out, ESA is a hybrid between a REIT and a C-corp, and as such it is difficult to compare it to a pure play hospitality brand company. In a summary note, Green Street also highlighted how “quality differences between Extended Stay’s portfolio and the lodging REITs limit any direct read-through on valuation.”
In a statement published last week, ESA’s chief executive Bruce Haase defended the transaction, saying it “provides a compelling and certain return” for its shareholders.
Another executive involved in the transaction, who spoke to PERE anonymously given the transaction is yet to be closed, pointed to the premium Blackstone-Starwood are paying.
“It is shocking to me that people have an issue with that valuation and price, and the multiple that is being paid. It speaks to the competitive environment we are in now to invest capital,” the executive said.
The executive added that they were “extremely surprised” interest in hospitality has rebounded as quickly and extensively as it has, given sector fundamentals are still challenged: “It is startling to me that there would be questions around [the] desire to pay $19.50 for a company trading at around $13 pre-covid, when it had 40 percent more cashflows than it does today.”
The factors driving the uptick in sentiment in the hospitality sector are befuddling to others too. Is this purely sentiment, buoyed by the vaccine rollout, pent-up domestic travel demand and fiscal stimulus? Or are hotel fundamentals improving too?
John Worth, executive vice-president for research and investor outreach at NAREIT, said the transaction only “confirms what can be seen in the equity markets in terms of the valuations of hotel REITs.”
He pointed to the “incredible rebound” in hotel stocks, starting last November when the Pfizer vaccine’s efficacy was first announced. In the initial months of the pandemic, the hotel stocks were down almost 65 percent at one point. From the values in November 2020, hotel REITs are understood to have increased 85.8 percent as of mid-March 2021, when PERE interviewed Worth.
“When you analyze the period from February 21, 2020 to March 19, 2021 – essentially 13 months of trading days – hotels are up 1.2 percent,” he said. “These are extremely modest gains. But had you asked analysts back in April whether hotel REITs would end up positive or negative on a YOY basis, no one would have said they would see a green number.”
While Hightower agrees there is some level of fundamental recovery underway, with improvement in occupancy levels, he also believes “the sentiment has probably overshot fundamentals as they are on the ground currently.”
“The market is pulling forward quite a steep recovery over the next two to three years, compared to what stock prices today might be implying,” he noted.
Moreover, the hybrid nature of the extended stay sector puts it in a different ballpark than what most people typically associate with the hotel industry. As the person involved in the ESA transaction explained to PERE, it is the blend of hospitality and apartment in the extended stay sub-sector that has resulted in greater stability.
The deal, if approved by the shareholders, is expected to close towards the end of the second quarter. A successful closing of the transaction will be a key indicator of where investors believe the hospitality sector stands in its recovery trajectory.