STRATEGIC HOTELS & RESORTS BEE.PC
October 25, 2011 - 8:24pm EST by
creditguy
2011 2012
Price: 25.18 EPS $0.00 $0.00
Shares Out. (in M): 6 P/E 0.0x 0.0x
Market Cap (in $M): 145 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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Description

Strategic Hotels & Resorts, Inc. (BEE) is a real estate investment trust (REIT) which high-end hotels and resorts in theUnited States,MexicoandEurope.  The company currently has ownership interests in 17 properties with an aggregate of 7,762 rooms.

 

I am recommending the Strategic Hotels preferreds.  I am recommending the Series C 8.25% preferreds (current price $25.18) as an illustrative example but in reality I like all three (Series A, B, and C).  I believe the Strategic preferreds represent a ~12% total return opportunity within the next 3-6 months (possibly sooner) with the imminent reinstatement of the Company’s preferred dividend and payment of the accrued interest in arrears.   On an annualized basis that represents a ~25-50% return.   In the interim, I am effectively collecting a ~10.5% accreting current yield (not cash paying) while I wait.  I believe this investment opportunity presents bond-like risk with equity like upside and is very compelling.

 

Strategic recently held an investor day where they intimated that both events (reinstatement of the dividend and payment of the accrued dividends in arrears) were likely to happen in the near term and simultaneously.  Strategic is set to announce 3Q earnings the first week in November and I believe they could choose to announce action on the preferred dividend at that time.  If not, I believe action on that topic is likely to happen sooner rather than later.

 

I believe this investment opportunity exists because of the illiquidity of the preferred market in general and the fact that it is relatively inefficient because the preferred market is dominated by retail rather than institutional investors.

 

On the Series C 8.25% preferred as an example there are 11 dividends of .516 cents in arrears or approximately $5.67.  The Company has not paid the dividend since the last quarter of 2008.  The Company has chosen not to pay the preferred since that time to preserve liquidity through the downturn and because of an overleveraged balance sheet.  That said, the balance sheet is currently in much better shape and the reinstatement of the preferred and payment of the accrued dividends is imminent in my opinion. 

 

Post repayment of the accrued dividends I believe Strategic should trade at a 9.15% current yield or better which translates to a price of $22.56 on the Series C stock -- 8.25%/($22.56/$25.00) = 9.15% current yield.  I am using another leveraged hotel preferred Ashford Hospitality (AHT) as my comp to determine where Strategic should trade post payment of the accrued dividends.  In fact, Strategic is less leveraged and has better quality assets so I think this is a conservative assumption.  So if I am right and one were to buy the Series A preferred today at $25.18 and collect $5.67 in back dividends and the preferred were to trade at $22.56 after the payment of the back dividends I am collecting $28.23 in aggregate.

 

Strategic’s business is well documented on their website and by the sell side so I will quickly provide a basic overview of the business, the balance sheet, and the Company’s commentary on the preferred.  For more details see the Company’s recent investor presentation and transcript that they presented at their investor day presentation onOctober 4, 2011. 

 

The link is here:  http://ir.strategichotels.com/phoenix.zhtml?c=176522&p=irol-irhome

 

Strategic owns world class luxury hotels.  Properties include the Fairmont Chicago, Four Seasons Punta Mita,Marriott Grosvenor Square, Four Seasons Jackson Hole, Ritz Carlton Laguna Niguel,RitzCarltonHalfMoonBay, Four Seasons Washington D.C., Four Seasons Silicon Valley, Intercontinental Chicago, and Hotel del Coronado. 

 

Average ADR is $220 per night and average RevPAR is $150 per night which positions the Company as the highest end publicly traded lodging name.  EBITDA margins are ~20%.

 

In January 2011, Strategic embarked on a comprehensive refinancing of its balance sheet.  Because almost all of Strategic’s debt was non-recourse to the Company (property level debt) they were able to aggressively negotiate with CMBS or insurance company debt holders to refinance their debt on highly favorable terms.  In other words, by threatening to hand keys back to lenders (lenders that had no interest in owning the properties) Strategic was able to achieve very good outcomes.  The net result is the recapitalized balance sheet has lowered leverage from 14.3x at01/01/10to 7.2x. 

 

Importantly, and something that many do not focus on, is that most of the Company’s debt remains non-recourse to the Company.  Specifically, as of 06/30/11the Company had only $127 mm of credit facility debt vs. $865 mm of mortgage debt and $77 mm of cash.  In short, while leverage is still high the fact that most of the Company’s debt is non-recourse substantially de-risks the balance sheet

 

What has Strategic said about the status and plans for the preferred?  They have been very explicit about their desire and intent to deal with the preferred in the near term.   Paying the dividends in arrears and going current on the preferred would also allow them to pay a common dividend to shareholders.  In the Company’s own words on p. 50 of their recent investor day presentation:

 

  • Accrued preferred dividend approximately $93 million by year-end 2011
  • Approximately $400 million corporate liquidity at year-end 2011 (excluding financeable unencumbered assets)
  • Currently able to pay accrued preferred dividend under line of credit covenants
  • Payment of accrued dividend likely accompanied by reinstatement of current preferred dividend
  • Management to monitor 2012 outlook and determine appropriate timing of payment; critical to cover quarterly dividends out of operating cash flow
  • Payment of preferred dividend positions company to reinstate a common dividend in the future 
  • Ample liquidity and no current covenant restrictions on payment of accrued preferred dividend; management is closely monitoring 2012 outlook

 

Key excerpts from the transcript of the Company’s investor day on October 4 echoed the comments from the prepared slides.  See below:

 

  • We finally achieved also, the goal of not to require bank approval to pay the accrued preferred dividend.  We had proven to the bank that we have effectively raised proceeds through asset sales and other liquidity to pay the accrued preferred dividend and did not want to have to go to the bank group for any kind of approval or waiver.  So the bank line closed at the end of June, allowing us to execute the remaining hotel level financings.
  • This leads us to the final point on what we finally refer to as our restructuring stage, or Strategic 2.0.   At year end, our accrued preferred dividend, which has been accruing for now a full three years at the end of this year, will be $93 million.  Contrast that to we do have roughly $400 million in corporate level liquidity.  So, it is not a liquidity issue to pay the accrued preferred dividend.  And we are also, again, not restricted to paying it under the line.
  • But, given the recent economic volatility and the somewhat uncertain outlook in 2012, we have stated publicly on our earnings calls and in these meeting that we want to monitor our internal operating metrics.  Again, group pace, cancellation if there were some, which again were not seeing, and then external market trends as far GDP estimates et cetera, and determine what is the appropriate time to pay the dividend.
  • It is also important to note that we intend to couple the payment of the accrued dividend with beginning to pay the [dividend] on a quarterly basis.  So that is the other factor in this decision.  We want to just make sure and be comfortable that our operating cash flow will cover the roughly $7.3 million a quarter of preferred dividends.
  • So, we know it is imperative of us to take this last step and pay the preferred dividends to get caught up, and ultimately that will position us to be able to pay a common dividend in the future.  It is clearly our corporate objective to return to paying a common dividend as soon as practical and when appropriate.
  • You have all seen our financial results year-to-date.  Let me just, again, point out, we have had a very strong first half.  Our RevPAR up -- in this first six months, was up 14.7%, our total RevPAR up 13.4%.  This far exceeds any of the brand company results or the other lodging peers.  Our EBITDA margin, again, is exceeding the competition at an increase of 410 basis points.
  • On our second quarter call we increased our guidance.  Originally, we came out with RevPAR guidance at the beginning of the year of 7.5% to 9% range.  We increased it to 8% to 9.5% and we are very comfortable at the higher end of guidance on all these metrics.  Margins are due to expand in the 200 to 300 basis points, and EBITDA to increase up to 17% this year over 2010.

Catalyst

 
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