by Phillip Britt
At the beginning of September 2001, expectations were running high at MeriStar Hospitality Corporation (NYSE: MHX) despite the early signs of a market slowdown. That’s because the company was building momentum with the anticipation of its impending merger with FelCor Lodging Trust Incorporated (NYSE: FCH), a move that would have united two of the leading hotel REITs.
Then terrorists attacked the U.S., further weakening the already sluggish economy and sending the travel industry, including lodging, into a tailspin. The planned merger fell apart. Reduced business travel and the lingering effects of Sept. 11, 2001 are still challenging MeriStar Hospitality today—a situation both the company and analysts alike don’t expect to change until the economy strengthens.
But despite the merger setback and the questions still surrounding the economy and the lodging sector, MeriStar executives remain
optimistic and look to 2003 as an opportunity to regain investor and analyst confidence in
anticipation of a better climate in 2004.
From Merger to Non-Merger
MeriStar itself is the product of a successful merger. In August 1998, hotel ownership management firm CapStar Hotel Company merged with hotel REIT American General Hospitality Corporation. This deal came about at a time when many within the sector thought bigger was better for hotel REITs, according to one analyst who saw the same logic in the planned merger with FelCor.
The merger with FelCor did not dissolve directly as a result of the terrorist attacks. In fact, despite the terrorist attacks the merger with FelCor still made sense, according to Paul Whetsell, MeriStar chairman and CEO. However, financing for the sector quickly dried up, so the deal couldn’t move forward.
While the FelCor deal would have created a dominant player, MeriStar is still a leading company in its industry. The company owns 106 full-service hotels and resorts with more than 27,000 rooms in 26 states, Washington, D.C. and Canada, primarily under the Hilton, Sheraton, Marriott, Embassy Suites, Westin, Radisson and Doubletree brands.
The company’s strategy is to offer first-rate, full-service hotels in areas where there are significant barriers to entry. The full-service properties depend primarily on the business traveler. Though these hotels don’t host large conventions and trade shows, they do provide lodging for many of the attendees. With convention, trade show and other business travel down sharply in the last two years, MeriStar has suffered as well.
MeriStar Hurt From Low End of Cycle
“Travel is a soft cost for companies, one they can easily cut. Cyclically what we need is a return of profitability in the corporate world,” Whetsell says. “As businesses become more confident, they will spend more on business travel. No one is really sure when that will happen. The stock market is up one day, then down the next due to all the geopolitical concerns and the threat of domestic terrorism.”
Recent history shows the cyclical nature of the business, Whetsell says. The hotel industry had its best year ever in 2000. So a small dropoff was expected in 2001, though no one foresaw the terrorist-related tailspin at the end of the year.
Additionally, some expected a quicker economic rebound and a sharp return to previous levels of profitability for the hotel industry. The recovery has been modest. The decline in business travel has put pressure on pricing as well. MeriStar properties cut prices 3 to 4 percent in the last year to stimulate demand.
Though time eventually will heal the economic wounds of September 11, MeriStar’s future success depends on the return of solid corporate profitability. Even if the economy does start to pick up in 2003, there will be a lag between the economic upturn and the time corporate officials feel comfortable in easing the purse strings on corporate travel, Whetsell says.
Some business travelers have returned in the last year, but even they haven’t returned to their previous level of spending, Whetsell says. Many trade shows have cut back on the number of days. Most have severely limited the number of staff at trade shows. Firms that had been sending four or five employees to trade shows or conferences are now sending two or three. Additionally, those two or three have more restricted expense budgets than before. So the business traveler who might have spent $75 a day on meals a few years ago might be restricted to half that amount today. That limitation hurts the revenues of the restaurants on the MeriStar properties.
As a result, the corporation has closed some of its restaurants and lounges. However, cutbacks available to MeriStar are limited, according to Jeff Donnelly, vice president in the Boston office of Wachovia Securities. Hotels, particularly full-service hotels like those in the MeriStar portfolio, have a high percentage of fixed costs, he says.
Earnings Numbers Reflect Trends
The effects of the current economic environment are evident in MeriStar’s 2003 financial results. In 2002, net loss was $161.3 million compared to $43.3 million in 2001. Diluted net loss per share was $3.59, compared to $0.97 in 2001. Funds from operations (FFO) were $42.6 million, compared to $121.6 million in 2001.
Revenues decreased 7.0 percent to $983.5 million. Earnings before interest expense, income taxes, depreciation and amortization (EBITDA) declined 19.4 percent to $215.8 million.
Same-store revenue per available room (RevPAR) declined 8.6 percent to $63.69. Average daily rate (ADR) was off 5.9 percent to $99.44, while occupancy decreased 2.9 percent to 64.0 percent.
In the fourth quarter of 2002 the company did not pay a dividend after paying a dividend of $0.01 per share in each of the previous four quarters.
“We will continue to evaluate our dividend on a quarterly basis, as we have in the past,” Whetsell says. “We will monitor operating levels and will reinstate the dividend when our operations and taxable income have improved to a level that permits us to do so.”
Donnelly doesn’t expect any near-term improvement in dividends as MeriStar also looks to pay down debt. Lenders are very cautious in the current environment and, therefore, will be reluctant to issue loan funds for the dividends REITs or other corporate borrowers will pay, Donnelly says.
MeriStar Cuts Debt
MeriStar sold four “non-core” hotels in late 2002, using the proceeds to pay down existing debt. Whetsell noted that the company currently is marketing eight to 10 additional non-core assets for sale, which, if successful, are expected to generate net proceeds of $80 million to $100 million and will be used to further reduce outstanding debt.
“We were overweighted in some [geographic] areas,” Whetsell says. For example, MeriStar had four hotels in Houston, so it sold one (a Hilton). MeriStar also sold hotels in Las Vegas (Crowne Plaza), Mahwah, NJ (Ramada) and Mt. Arlington, NJ (Four Points by Sheraton).
MeriStar is holding on to the larger properties while selling those properties that need significant capital investment to stay competitive. The company has no current plans for new acquisitions.
MeriStar refinanced its debt in late 2002 with a new, three-year $100 million senior revolving credit facility. The initial rate of the facility was LIBOR plus 388 basis points, slightly lower than the rate under the previous credit facility.
The new revolving credit facility should help give MeriStar the flexibility to operate efficiently within its business plan and to weather the current economic conditions, Whetsell says. The $14 million balance on the previous revolver was paid off in conjunction with the closing of the facility.
The company has about $50 million of availability on the revolver based on its trailing 12-month EBITDA.
MeriStar expects to generate $90 million to $100 million of cash flow before capital expenditures in 2003. Therefore, Whetsell anticipates using the revolver only sparingly.
Caution Remains
Despite the recent debt reductions, MeriStar remains leveraged at a higher level than its peers, Donnelly explains. Higher leverage means that MeriStar’s return on equity are boosted in good economic times, but also suffer more when the sector is weak.
“MeriStar was one of my highest-rated companies in the sector in 1998, but now it’s rated as a hold,” Donnelly says.
The company may use a portion of the $56.1 million it received in January 2003 on an outstanding note to reduce its overall leverage, chief financial officer Donald Olinger said in a company release.
With no apparent recovery in sight, several other analysts cut their ratings on MeriStar in the fourth quarter of 2002. Outside of a short-term upgrade just after the terrorist attacks (to catch a rebound after the initial slide in the stock price), Donnelly has rated MeriStar a hold since the second half of 2000.
On the bright side, according to Whetsell, is that the current travel industry weakness has stopped further hotel construction. So, he says, MeriStar will be well-positioned when corporate travel does return.
“When the industry rebounded after some weakness in the early 1990s, the new business was largely absorbed by new supply,” Whetsell explains.
The company isn’t counting solely on the return of the corporate travel market. To offset weakness in the transient business sector, MeriStar in late 2002 shifted its marketing efforts to lower-rated group and leisure business to boost occupancy.
“This put more pressure on profit margins, but our operator, Interstate Hotels & Resorts (NYSE: IHR), continues to focus on controlling costs to mitigate the shift in customer mix,” Whetsell says. “We expect to achieve economies of scale and other cost benefits going forward as a result of the increased size and scale of our operator.”
Unique Arrangement
The relationship between MeriStar and Interstate is important for investors analyzing the companies to understand. MeriStar Hospitality owns its hotel properties, which are in turn operated through an agreement with Interstate Hotels & Resorts.
As a result of the REIT Modernization Act, which became effective at the beginning of 2001, MeriStar was allowed to create taxable subsidiaries that could enter into arms-length agreements with companies such as Interstate Hotels & Resorts. Interstate was formed in July 2002 from the merger of MeriStar Hotels & Resorts and Interstate Hotels & Resorts.
The two companies are legally separate, but are linked under a “paperclip” arrangement. The paperclip structure includes sharing certain management and board members, and a right of first refusal agreement for acquisitions and management contracts. Their corporate offices are in the same building in Washington, D.C., and the companies share four board members. MeriStar has nine board members, while Interstate has 13 members. Whetsell is the chairman of both companies. Interstate also operates hotels outside of MeriStar Hospitality REIT.
Interstate Hotels & Resorts operates more than 400 hospitality properties with approximately 86,000 rooms in 45 states, the District of Columbia, Canada and Russia, including 55 properties managed by Flagstone Hospitality Management, a subsidiary of Interstate Hotels & Resorts. BridgeStreet Corporate Housing Worldwide, an Interstate Hotels & Resorts subsidiary, is one of the world’s largest corporate housing providers.
To help focus the two entities, MeriStar and Interstate split the management responsibilities of the two companies in November 2002. Former MeriStar president and chief operating officer John Emery was named president and COO of Interstate. Bruce Wiles was promoted to fill Emery’s role as COO of MeriStar.
Recent Changes Could Help
Rod Petrik, managing director for Legg Mason Wood Walker, says those moves and other recent personnel changes may help put MeriStar back on track.
“They made a good first step by hiring Don Olinger from Host Marriott,” Petrik says. Olinger joined MeriStar in late 2002 as CFO, enabling Emery to focus solely on Interstate rather than splitting his time between the two companies.
Though the merger with FelCor fell through, Petrik expects MeriStar to eventually become part of another company, though Interstate might continue as a separate entity.
While not saying whether MeriStar would seek another deal, Whetsell says the focus after the FelCor deal fell through remains on finding ways to enhance shareholder value—whether that is through another merger or not. The company will look at other “strategic portfolio moves,” though he was not specific what those moves would be.
“We’ve focused on improving shareholder value by weathering the down period, focusing on liquidity and making sure we maintain the quality of assets,” Whetsell says. “We’ve opted to use cash resources to put into our properties and on the balance sheets rather than paying out a larger dividend. We’ve also sold some non-core assets to reduce our debt.”
As for when the full impact of a recovery would be seen, Whetsell offered a cautious outlook. “We look at the later half of 2003 and 2004 as a moderate recovery,” Whetsell adds.
Phillip Britt is a freelance writer based in suburban Chicago.
