Case Study: A Look Back On Hilton’s LBO By Blackstone

(Alisha Gragya & Nikhil Sahdev)

Financial markets are dynamic and hence characterised by the term VUCA: Volatility, Uncertainty, Complexity and Ambiguity. Rightly so, it keeps providing examples that contradict most investor expectations and yet turn out to result in archetypes of financial profits and success. One prominent example is the acquisition of Hilton Hotels, a leading market player in the hotel industry, by Blackstone Group, an American multinational private equity investment firm.

Background

After a third consecutive profitable year for the lodging and hotel industry, Hilton Hotels, traded on the New York Stock Exchange, became an appealing investment prospect for private equity investors. From the beginning of the century up until 2006, Hilton witnessed remarkable growth in business, sales and operations, offering high returns on investment. However, an expanding business transcending borders and rising profit margins called for a strong partnership with an established firm in the real estate sector in order to fund Hilton’s aggressive growth strategy. Blackstone Group, which had incorporated almost 5 hotel chains in its investment portfolio including MeriStar RIET and Boca Resorts, seemed to be the ideal option due to its unparalleled financial expertise.

The conditions for a Leveraged Buyout (LBO) were favourable for both parties. Both the industry and the company were mature, yielding high returns on a constant basis and had a potential for expense reduction. Apart from an increase in the company value, the acquisition granted feasible exit options, since making Hilton private would have made way for another IPO, once the company had grown in valuation. Furthermore, Blackstone could have sold the Hilton properties in case there was a necessity to cover the debt issued for the acquisition and the asset could have been used as collaterals to secure the debt too. Despite the fact that Hilton Hotels didn’t have a clean balance sheet and their outstanding debt stood at a massive $6556 billion (Scarantino, 2018), a traditional LBO seemed inevitable. Another broad risk assessment taken into consideration was that hotel services are considered to be a luxury good, and hence demand is income elastic. Both the companies were key players in their field and the synergies of their expertise created ripples in the global market.

Cracking the Deal

Ultimately, without committing much capital expenditure, The Blackstone Group decided to make a large acquisition under the umbrella of Leverage Buyouts. There were primarily three reasons: the use of leverage debt enhances expected returns on investment in terms of a high Return on Equity (ROE) and Internal Rate of Return (IRR), bank debt is a low-cost capital when interest rates are low in comparison to equity, and debt financing is liable to tax shield effects.

The deal was finalised in June, 2007 at $47.5 per share amounting to a price of $26 billion (Gillian Tan, 2018). Over 78.4 percent of the deal i.e. $20.5 billion was financed by debt and the remaining $5.6 billion was injected via equity. The LBO became one of the largest debt-financed acquisitions in the world. The debt quota was furnished by a syndicate of seven highly reputable financial institutions including Bank of America, Goldman Sachs, Lehman Brothers and Morgan Stanley. Despite the high risks associated with magnanimous debt funding, the deal was well-structured and many instruments were employed to hedge risks such as procurement of a syndication loan from prominent financial bodies and lower interest rates on a real estate collateral.

Source: Data from Hilton’s Financial Statements, Graph by Orchid. Date: 04/02/2008

However, this successful LBO soon landed in a tumult with the offset of the Real Estate Bubble in late 2007, and consequently, the financial crisis of 2008. As the hospitality industry plummeted, investors around the world expected nothing less than an inevitable bankruptcy of the Hilton Hotels.

Market Repercussions

Hilton’s profits are cyclical; in the last recession, revenue available per room dropped by 12% in one year, taking earnings before interest, tax, depreciation and amortisation (EBITDA) down 20% (FT, 2008). With this, Blackstone’s initial investment, that gave the group an enterprise value of $26bn, was worth a lot less in 2008; during the financial crisis, the private equity house wrote down its investment by about 70 per cent (Tan, 2018). Given the circumstances, it is reasonable to question how Blackstone made profit, let alone complete one of the most profitable private equity deals of all time.

At the time of completion, the financing market for leveraged deals such as Hilton had already started to collapse. Essentially, this meant the banks could not get loans off their balance sheets; typically banks break up debt into smaller, securitised assets and sell it to many hundreds, if not thousands, of investors (Sender, 2013). But because this had not occurred, only a handful of banks held the debt, making it easier to renegotiate the terms of it. In this restructuring process, Blackstone eliminated almost $4bn worth of debt and pushed back debt maturities by two years to 2015 (Sender, 2013; Roumeliotis, 2013). This was notable for its scale and impact as it allowed Hilton to keep more of its cash flow, which was projected 58 per cent upward compared to 2009 (Roumeliotis, 2013).

Additionally, Blackstone’s thesis with Hilton was to pursue organic growth – their President, Johnathan Gray, believed that Hilton was a company that the firm could really transform. They capitalised on a ton of white space in Europe and China and launched new brands to capture more customers, which included Curio, Tru and Canopy. Additionally, the firm pursued a high-margin franchising strategy to spread the company’s lucrative brands and entice new travellers from the world’s emerging middle classes, rather than acquire new brands (Raval, 2013). Under Blackstone, the number of hotel rooms in Hilton’s system almost doubled to 900,000, with 350,000 in the pipeline (Tan, 2018).

Blackstone’s success with Hilton can thus be attributed to clever financial engineering to free cash flow and strong execution of Hilton’s vast expansion.

The firm executed 12 separate transactions to gradually sell off its holdings in Hilton, including an IPO. Often private equity firms use IPOs exit from large-scale investments (Roumeliotis, 2013) and in 2013, Blackstone raised $2.35bn in an IPO. It sold 117.6 million shares at $20 and its underwriters included Deutsche Bank, Goldman Sachs, Bank of America Merrill Lynch and Morgan Stanley. This gave Hilton an EV of $32bn (Raval and Massoudi, 2013) but since then Hilton’s share price has increased by a significant amount. Blackstone sold 15.8 million shares, valued at $1.3bn, in 2018 to exit Hilton Worldwide; with this the firm realised a total profit of $14bn, meaning it more than tripled its initial investment (Tan, 2018).

Definitions

Leverage Buyout– One company’s acquisition of another company using a significant amount of debt to meet the cost of acquisition.

Return on Equity (ROE)– A measure of the company’s annual return or net income divided by the value of its total shareholder equity. A high ROE indicates a profitable company.

Internal Rate of Return– The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis.

Leverage Ratio (Debt to Asset Ratio)– A leverage ratio is a  financial ratio that indicates the level of debt incurred by a business entity against its total assets.

EBITDA– Net income excluding interest, tax, depreciation and amortisation – a measure of profitability

EV- Measure of a company’s total value (common shares + preferred shares + market value of debt + minority interest – cash and equivalents)

White space– Market opportunities a company may wish to pursue

Bibliography

Tan, G. 2018. Blackstone Exits Hilton, Earning $14 Billion After 11 Years. [online] Bloomberg. Available at: <https://www.bloomberg.com/news/articles/2018-05-18/blackstone-is-said-to-plan-sale-of-remaining-stake-in-hilton>[Accessed 28th August 2020].

2018. Blackstone’s overall profit from Hilton deal? A whopping $14B. [online] The Real Deal. Available at: <https://therealdeal.com/2018/05/18/blackstones-overall-profit-from-hilton-deal-14b/>[Accessed 28th August 2020].

Scarantino, F. 2018. Leveraged Buyout in the Hotel Sector: the analysis of the Hilton Hotels Acquisition Made by The Blackstone Group. [online] Luisse. Available at: <http://tesi.luiss.it/23410/1/690711~1.PDF>[Accessed 28th August 2020].

FT, 2008. Revisiting Hilton’s IPO. [Online] FT. Available at:

https://www.ft.com/content/47c10a0c-d28a-11dc-8636-0000779fd2ac [Accessed 28th August 2020].

Sender, H. 2013. How Blackstone revived the Hilton brand. [Online] FT. Available at: https://www.ft.com/content/1bfae21e-04c8-11e3-9e71-00144feab7de [Accessed 28th August 2020].

Raval, A. 2013. Successful Hilton Worldwide IPO would be a Blackstone landmark. [Online] FT. Available at: https://www.ft.com/content/e2674f02-5160-11e3-b499-00144feabdc0 [Accessed 28th August 2020].

Roumeliotis, G. 2009. Analysis: After mega-LBO boom, a massive private equity cleanup. [Online] Reuters. Available at: https://www.reuters.com/article/us-lbohangover-analysis/analysis-after-mega-lbo-boom-a-massive-private-equity-cleanup-idUSBRE97R08E20130828 [Accessed 28th August 2020].

Raval, A. Massoudi, A. 2013. Hilton IPO prices near top of the range to raise $2.35bn. [Online] FT. Available at: https://www.ft.com/content/43613af6-6279-11e3-bba5-00144feabdc0 [Accessed 28th August 2020].

Featured image: Hilton logo


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