Baird analyst outlines three outcomes for Starwood future

1Hotel news this week has been dominated by Starwood Hotels & Resorts Worldwide's admission that it is looking at what to do with the company—strategic alternatives, it calls it—including a possible sale.

The disclosure came to light during the company's Q1 call. Other hotel companies discussed the revelation during their own earnings calls.

The question now becomes: What will ultimately happen to Starwood? Here's what we know now:

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Starwood is in flux. It dismissed its CEO Frits van Paasschen in February and is currently in the midst of spinning off its timeshare business. Now, shareholders are not to pleased with what they view as underperformance.

To find out a possible endgame here, HM turned to R.W. Baird analyst Michael Bellisario for his take on the situation. He notes three potential outcomes:

1) Do nothing: "Continue strategy to spin off timeshare business, further the asset-light strategy—selling $800 million of assets this year, perhaps another $800 million-$1 billion next year to get to their 2016 target—cost cutting and improving customer brand perception and relationships with owners. After the review, which could be 45 days or more, they may say they are on the right track. Will the market dislike that?"

2) Sell the company: "But to whom?" Bellisario ponders. "It's hard to tell. Private-equity buyers, foreign capital, domestic hotel brands would all love to own Starwood." Bellisario acknowledged a couple likely candidates. "Wyndham and IHG are both interesting. Do they have the capacity to do that in terms of their balance sheets? Marriott talked it down, as did Hilton on their calls. I don't see Hyatt doing it."

3) Do something beyond a sale: "That's pretty likely...do something, but not an outright sale. Maybe spin off a REIT or do a larger real estate transaction, or debt recapitalization. Or buy a brand or company."

"Those are the three big buckets, but it's hard to put percentages on them," Bellisario said. "The market is clearly pricing in some big value creating transaction, most people think this sets up for a sale, but it's too early to tell."

WHY NOW?
Bellisario, and The Street for that matter, said he wasn't "overly surprised," by the Starwood news, and that it is "good to get that imprint in the public domain." He said investors are frustrated about the stock's performance (Starwood's stock jumped to a record $88 on the news; it's hovering around $86 currently), and with the new interim CEO, Adam Aron, in place, it felt like this announcement would happen.

But why this, why now? Bellisario pointed to the aforementioned investor frustration and the board reacting to that. "Some board moves have been reactive," he said.

Meanwhile, while Starwood's Q1 net income dropped, overall, Bellisario said, numbers were in line with analyst expectations. Bellisarioa said EBITDA and EPS are better indications of a company's performance, net income is "skewed because of real estate and depreciation expenses," he said.

There's no doubt that if Starwood is sold, it's a "once-in-a-generation type of trade," as Bellisario called it. "And at this point in the cycle would get premium pricing for it."

And anything is possible with the buyer. No doubt the likes of Marriott and Hilton are poring over the books now to figure if a deal works and makes sense. Meanwhile, both hotel giants have been growing organically of late, launching new brands of their own and also making smaller acquisitions—such as Marriott acquiring Spain's AC Hotels and Africa's Protea Hotels.

Is Blackstone lurking? It paid a record $26 billion for Hilton back in 2007, and is still Hilton's largest shareholder. "It would have to be a very good deal qualitatively and quantitatively," Bellisario said. "They don't want to muddy the waters." Marriott, of late, has been buying back stock back; Hilton, meanwhile, is paying down debt and discussing a the potential of paying a dividend.

Bellisario is absolutely convinced that more M&A will continue in the industry. "We are at that point in the cycle," he said. "The debt markets are better and valuations are higher. Maybe not a mega deal, but the velocity and size of transactions will increase."

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