Description

Thesis / Idea:

This is not a screamingly attractive expected return, but if you are looking for a genuinely great (albeit somewhat cyclical) business that can continue to compound intrinsic value in the mid to high teens for many years to come, at a reasonable price, this may be for you. It is large, liquid and well-run meaning that we think it can serve as a nice piece of the portfolio separate from more 'event-y' or otherwise spicy names.

Business Overview:

Hilton is an asset light franchisor of hotel brands that is levered to the secular growth of global travel. The company has a storied history, beginning with its founding in 1919 by Conrad Hilton. Key events in the company’s history include its 1947 IPO, acquisition of Promus in 1999 (Embassy Suites, Homewood Suites, Hampton Inn, Double Tree), LBO by Blackstone in 2007 and re-IPO in 2013, and then subsequent spin-off of the timeshare business (HGV) and owned real estate (Park Hotels) in early 2017. It is one of a few businesses that have only had 4 CEOs over a 100+ year history: Conrad (1919-1966), Barron (1966-1996), Stephen Bollenbach (1996-2007), and most recently Chris Nassetta (2007-present).

HLT has a brand portfolio of 21 brands, the largest being Hampton Inn (28%), Hilton (20%), DoubleTree (13%) and Hilton Garden Inn (13%). Between 1992 and 2009, Hilton did not introduce any new brands. Under new management, since 2009 there have been 12 new brands launched to address white space in HLT’s portfolio. Those new brands now account for 12% of rooms but a sizeable proportion of the pipeline.

The Hilton brand is no longer a growth driver (rooms have grown at ~1% CAGR). The biggest growth drivers over last 3 years are Hampton Inn (29% of cumulative growth / 6% CAGR), Home2Suites (15% of cumulative growth / 22% CAGR), Hilton Garden Inn (12% of cumulative growth / 5% CAGR), Tru (10% of cumulative growth) and DoubleTree (9% of cumulative growth / 4% CAGR).

HLT is the 2nd largest player after Marriott, accounting for ~5% of global rooms but 18% of rooms under construction (3.6x differential), across 7.1K properties and 1.1M rooms. In the US (HLT’s largest market), HLT accounts for 14% of rooms but 20% of rooms under construction. HLT’s share is poised to rise in all geographies.

In terms of business mix, franchised rooms are the vast majority of mix (76%) and the fastest growing, followed by managed (22%) and owned & leased (2%). Geographically: the US is the largest market (69%), followed by AsiaPac (13%), Europe (9%), Americas Non-US (6%), and MEA (3%). From a product type, the largest segment exposures are Upper upscale (29% of mix), Upscale (33% of mix) and Upper Midscale (33% of mix). Midscale and Upper Midscale have been the fastest growing segments.

HLT is benefiting from a shift away from independent hotels to branded hotels, both in the US and internationally. Brands enable hotel developers and operators to earn a higher return than independents because of the power of the brand and customer loyalty programs, best operating practices and lower financing costs. Greater customer loyalty results in higher RevPAR (HLT has consistently generated ~15% RevPAR premium), a lower mix of OTA bookings (~14% vs ~40% for an independent), a lower take rate on OTA bookings (~12% vs 20% or more). HLT has 158M loyalty members that have been growing at mid to high-teens CAGR, and these members account for 60% of room nights (up from 40% in 2007). Even with the additional franchise fee (5.5% of room revenue) and other fees, the above creates more absolute profit dollars with a branded hotel. The attractiveness of this is exemplified by just ~1% brand churn for HLT and the fact that HLT’s market share of the hotel pipeline is much higher than their current market share. As a result of the advantage above, branded hotels have been gaining share at the expense of independents. Brands represent 54% of global supply today (73% in the US) but ~80% of the pipeline of new rooms. US branded share mix has been steadily rising, going from 46% in 1990 to 73% in 2020. Internationally, we have seen a similar trend but starting from a much lower base than in the US (AsiaPac is the next most branded geo with only ~32% share vs 73% in the US). We believe Hilton will continue to benefit from this.

Economic Model

Franchises pay ~5% of revenue (as well as another ~5 to 10% of revenue that gets put back into technology, marketing & loyalty program) and HLT generates 29% EBITDA margins. The incremental economics are even better as: 1) there is negligible incremental capital involved to grow units (net unit growth has averaged 5-6% and is expected to continue going forward), 2) capex needs are minimal (~1% of revenue), 3) NWC is a positive inflow as the business grows (A/P > A/R, sizeable benefit from deferred revenue in loyalty program). The only other cash outflows are contract acquisition costs (aka key money) which are incentive payments to owners to sign with Hilton. These are used in unique circumstances (10% of all rooms) and, while lumpy, are negligible at ~1% of revenue. In simple terms, there is 3rd party investment of $50B behind HLT’s 428K room pipeline (38% of existing rooms), that will ultimately create ~$800M of stabilized EBITDA for HLT. HLT’s capital investment is just $300M (0.6% of 3rd party investment), or a 270% pre-tax ROIC.

Thesis and expected returns:

Given HLT’s franchisee profitability, share gains vs independents, and impressive pipeline, we believe there is a long runway for unit growth (~5% per year). This, combined with typical through-the-cycle RevPAR growth (slight premium to global nominal GDP growth), and slight increases in franchisee fee splits, should produce a ~10% revenue CAGR. There is very little incremental expenditure needed to grow, and so we expect margins can continue to expand, producing a 12% EBITDA CAGR.

When combined with a decent amount of financial leverage (currently 2.9x net debt / EBITDA and target of 3x to 3.5x) and all free cash flow devoted to share repurchases, this equates to high-teens FCF per share growth.

The mgt team is excellent and unlike other teams in the travel & leisure industry, have never engaged in value destructive M&A. There is a clear preference to build brands organically rather than acquire, and mgt has made it clear that excess free cash flow will be used to reduce share count. The CEO, Chris Nassetta, owns $645M of stock outright ($770M including RSU and shares) and has never sold a share, and Blackstone’s Jon Grey is the Chair of the Board and also owns $110M of stock. From a capital allocation perspective, they have done all the right things such as selling Waldorf for $2B in 2014 for a record price per room, and spinning off the real estate and time-share businesses.  

Even assuming moderate multiple compressing, the above setup would pencil in mid to high teens IRR, which we view as attractive in the context of a business with this risk, visibility and liquidity. 

Catalyst

• Continue growth in net units
• Margin expansion
• Ongoing capital returns and share count reduction