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October 29, 2009

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

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

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.

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.

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

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