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Back INN Style? HYLodging2002.qxd 1/16/02 12:54 PM Page 3 High Yield Lodging Research January 2002 High Yield Lodging Outlook 2002 Back INN Style? Jason N. Ader (212) 272-4257 Jason M. Kroll CFA (212) 272-9621 Trip McCoy (212) 272-8821 High Yield Lodging Outlook 2002 January 18, 2002 Table of Contents Investment Thesis .............................................................................................. 4 Is the Lodging Industry Poised for a Turnaround?.................................................... 5 What is the Credit Outlook?................................................................................ 10 How Are Current Trends? ................................................................................... 13 Relative Value Analysis...................................................................................... 15 Company Updates Boca Resorts, Inc.............................................................................................. 17 Extended Stay America, Inc................................................................................. 24 FelCor Lodging Trust .......................................................................................... 34 Host Marriott, LP .............................................................................................. 45 MeriStar Hospitality Corp. ................................................................................... 56 Prime Hospitality Corp........................................................................................ 66 Starwood Hotels & Resorts Worldwide, Inc.............................................................. 74 Appendix ........................................................................................................ 86 High Yield Lodging Jason N. Ader Research (212) 272-4257, [email protected] Jason M. Kroll, CFA (212) 272-9621, [email protected] Trip McCoy (212) 272-8821, [email protected] Lodging Outlook 2002 Special thanks to: John Mulkey Glen Reid Corey Benjamin Dina Treanor John F. Foy Managing Editor: Mark Albright Copy/Production: John Foy, Colleen Pickett, Miles Becker, Maya Singer, Reno Bo Cover Design: Ann Kim Bear Stearns® is the registered trademark of The Bear Stearns Companies Inc. Lodging Outlook 2002 — January 18, 2002 Investment Thesis We are commencing formal high yield coverage of the lodging industry with an overall market weighting. In general, we believe that companies in this sector face a challenging near-term environment as a result of the travel fall-out following September 11 and generally weak economic conditions. However, in our view, the long-term outlook remains sound because the economy appears to be slowly rebounding (January consumer confidence rose to its highest level in 12 months) and the prospect of new supply remains limited. Additionally, most lodging companies in our universe have readjusted their cost and capital structures to better withstand the current challenging operating environment. Meanwhile, scaled-back capital expenditure plans, targeted asset sales and significantly reduced dividends (where applicable) should allow lodging companies to preserve capital and liquidity. We believe that these proactive steps position the lodging industry to potentially realize significant EBITDA expansion in 2003–05 and a strengthening of credit measures that were weakened after September 11. While most lodging bonds have rebounded considerably since their post- September 11 lows, we believe that modest upside remains for investors with a 12–24 month investment horizon. Although we expect lodging bonds could be somewhat volatile over the course of the next several months as a result of unfavorable quarterly earnings comparisons, results should stabilize, in our view, during the second half of the year. Based on our projections, credit measures are expected to weaken, in some cases considerably, over the first half of 2002, but will likely stabilize from that point and improve by year-end. In addition, we believe that most of the difficult issues, such as rating downgrades and covenant amendments, have already been resolved and priced-in by the investment community, thus allowing companies to focus on the future. In terms of top picks, we favor Extended Stay America and FelCor Lodging Trust, in terms of risk adjusted total return potential. We view the ESA bonds as one of the more stable credits in the lodging space given the current challenging landscape. We believe that the extended-stay business model (when compared to the full-service model) is better insulated from both the economic downturn and travelers’ fears of flying. In addition, the company’s liquidity is ample, as it completed a new round of financing last summer. Among the three lodging REITs, we believe FelCor’s bonds offer the best relative value, particularly for those investors willing to absorb some near-term volatility. We believe FelCor entered the downturn in the best financial condition among the lodging REITs, and its strategy of being well-diversified geographically with limited exposure to top U.S. markets has become a comparative strength in the post- September 11 period. In addition, we believe that the MeriStar Hospitality senior subordinated notes are an attractive relative value play and well-suited for CBOs, given the comparatively low dollar price at which the bonds trade (87.75 as of January 18). The balance of this report is dedicated to offering investors additional information on key trends, recent developments as well as our outlook for the industry. In addition, we provide comprehensive company reports and models on seven high yield lodging companies. Lastly, the appendix provides a wide array of key industry data and metrics that we believe may be useful in forming your investment decision. 4 Bear, Stearns & Co. Inc. Lodging Outlook 2002 — January 18, 2002 Is the Lodging Industry Poised for a Turnaround? The lodging sector was among the most impacted industries by the general reaction following the attacks of September 11. The hotel business was crippled by massive airline disruption and consumer fear of travel. Overnight, market expectations for the business went from dim to dire, as hotels ran empty and rates began to plummet. Earnings and cash flow estimates for the remainder of 2001 were slashed, and original expectations for 2002 were all but erased. In an effort to console investors, several lodging companies hosted conference calls to discuss the state of their businesses, and lay out a course for how they would manage in an unchartered environment. And a few weeks after the attack, the bottom was reached. Since that time, we have seen a significant recovery in not only the underlying business fundamentals, but also in lodging bond spreads. While America was still grieving, its leadership was taking decisive and effective military action against the perpetrators in Afghanistan, and the traveling public began to feel more assured about returning to the road. Notwithstanding several scares and a few tragic and isolated incidents, hotel operating trends began to show signs of gradual improvement and move up considerably from the post-attack troughs. Concomitant with heavy discounting implemented by nearly every major airline, hotel companies began to offer very attractive rates, put together package deals, waive restrictions, and do everything possible to stimulate new demand. Weekly Change in Total U.S. RevPAR Since September 11 (Year Over Year) 10% 0% -0.053 -10% -0.102 -0.107 -0.129 -0.137 -0.141 -0.131 -0.16 -0.149 -20% -0.175 -0.174 -0.175 -0.169 -0.189 -0.188 -0.202 -0.243 -30% -40% -0.373 -50% 1/5 9/15 9/22 9/29 1/12 10/06 10/13 10/20 10/27 11/03 11/10 11/17 11/24 12/01 12/08 12/15 12/22 12/29 Source: Smith Travel Research. As expressed in the graph above, more than four months after the tragic attacks of September 11, the hotel business has begun to show slow signs of stabilizing. While acknowledging that the operating outlook for the first half of 2002 remains challenging, in our opinion this is less a function of September 11 but stems more from continued reduced corporate spending levels and tighter travel budgeting controls that have constrained business travel. It is important to understanding the lodging industry’s traditionally tight correlation with the Bear, Stearns & Co. Inc. 5 Lodging Outlook 2002 — January 18, 2002 overall economy. As illustrated below, the lodging industry tends to follow trends in the overall economy, and for the past 25 years, change in hotel demand has closely tracked changes in GDP. While economic trends are a good industry barometer, the two do not track each other precisely. Historically, contractions in the lodging industry have been longer and deeper, while expansions have been shorter. Troughs in hotel rooms demand growth lead downturns in the economy and lag recoveries. Correlation Between Changes in GDP and Hotel Demand 0.12 Change in GDP Change in Demand 0.08 0.04 0 -0.04 75 77 79 81 83 85 87 89 91 93 95 97 99 01E 03E Source: Smith Travel Research and Bear Stearns Global High Yield Research. Comparisons Should Improve as the Year Goes On One reason we believe lodging companies should fare better as the year progresses is that comparisons become progressively easier. As the chart below reflects, January was the strongest RevPAR month of the year and the three months of the first quarter were the only months to show positive comparisons. 2001 Monthly Changes in RevPAR 10.0% 7.1% 5.0% 3.0% 1.4% 0.0% -5.0% -2.3% -4.5% -4.2% -4.8% -6.3% -10.0%
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