The hotel REIT space could become smaller if Pebblebrook Hotel Trust succeeds in convincing LaSalle Hotel Properties to accept a new offer for the company after its initial proposal was rejected.
After a $3-billion offer was spurned by LaSalle in late March, Pebblebrook has now reportedly sweetened the pot to the tune of about $3.6 billion, the equivalent of around $31.75 per share. The offer includes the option for LaSalle shareholders to elect to receive cash up to a maximum of 15 percent in aggregate.
LaSalle turning down Pebblebrook's initial offer is unsurprising. It's normal for a targeted company to flat out reject a first offer and even feign disgust for being lowballed. LaSalle called the initial bid "insufficient in both price and mix." But in the case of this deal, disapproval of the deal may, in fact, not be totally simulated.
Pebblebrook's offer to acquire LaSalle has both a biblical and Shakespearean quality about it. The prodigal son returning.
There is no reported love lost between Pebblebrook CEO Jon Bortz and LaSalle CEO Michael Barnello. Bortz served as president and CEO of LaSalle Hotel Properties from its inception in April 1998 until he left the company in September 2009. Upon Bortz's departure, Barnello, who had been COO and EVP of acquisitions, was named CEO. Only a year later, Bortz formed Pebblebrook and became chairman of the board, president and CEO.
One hotel REIT executive framed the tense situation this way: "This is, 'I don't want to sell to the guy who started this company, who he thinks can fix what I have done.'"
Ultimately, Barnello may not have the choice to fend off a buyer for long. LaSalle is firmly in play now that an acquisition for it has gone public. From a strategic standpoint, Pebblebrook acquiring LaSalle makes sense. The two companies have very similar asset portfolios, a mix of full-service, branded and lifestyle-oriented properties. Both REITs have a strong concentration of Kimpton hotels.
Should LaSalle sell to a public REIT, it's highly likely that it will be Pebblebrook. "What's unique to Pebblebrook is they have a cost of capital advantage. They can use their currency accretively to do a deal, even where there stock is trading at roughly 14.5x or 15x EBITDA. Most other REITs are in the 12x or 12.5x camp and the math just doesn’t pencil out," said Michael Bellisario, VP and equity research senior analyst at Robert W. Baird & Co.
There has been a tendency toward M&A within the REIT space, a trend that follows the progressions of the overall hotel industry. Examples include RLJ Lodging Trust's $7-billion acquisition of FelCor Lodging Trust and Marriott International's deal for Starwood Hotel and Resorts, which created the largest hotel company in the world.
In today's fragmented market, bigger is better and size and scale matters when dealing with brands and third parties. Specific to a possible Pebblebrook and LaSalle tie-up, investors look for liquidity in stock, which a deal of this shape would provide. The overriding opinion is that there are too many small hotel REITs operating today. (In total, there are around 30 publicly traded hotel REITs.) "There are more than need to exist," one hotel REIT executive said.
Bellisario says Pebblebrook is being "opportunistic," with the "market giving a green light to acquire." More companies are hunting for deals now as RevPAR slows and margins come under pressure. Moreover, as Bellisario pointed out, there are not a lot of assets for sale and with the debt markets wide open, people can bid up prices. "You don’t get opportunities like this every day," he said.
A note by SunTrust Robinson Humphrey made clear what it thought about Pebblebrook's revised deal for LaSalle: "Take the deal," it read. The note continued to say that the revised offer represented a 15.6x EBITDA multiple on its 2018 estimated EBITDA, "by our calculations, [the] shares of LHO have never traded at these multiples in the past."
Bortz is famously an "in the weeds" CEO, one that enjoys being part of day-to-day company minutiae. He reportedly is a regular participant in budget meetings and frequently involves himself in hotel CapEx decisions. He is someone who knows the ins and outs of each hotel that is part of his company's portfolio.
If LaSalle doesn't capitulate to Pebblebrook, there are some outs. Since LaSalle is now firmly in play, it is likely reaching out to private-equity firms, since it is highly unlikely that another public company could swoop in over the top of Pebblebrook. This could mean a Blackstone, a Starwood Capital, a LoneStar, to name but three.
According to Bellisario, private equity is highly likely to end up acquiring LaSalle. "From day one, we had been saying the range of outcomes had a REIT as lowest on our list," he said. "We knew there was private-equity interest."
While Pebblebrook's offer is now in the public sphere, there are machinations going on behind close doors. Since LaSalle has not given Pebblebrook exclusivity to "get under the hood" of its assets, as Bellisario put it, this remains a running process.
"This is a private-equity buy wholesale, sell retail type of transaction. The reason is because private equity is well capitalized and can use leverage—and that is what Pebblebrook does not have," Bellisario said.
"Pebblebrook's offer is highly dependent on its stock price and unless its stock price significantly outperforms, its offer does not change that much. Whereas the debt market is white hot, debt capital is widely available and is attractively priced—the math just works a lot easier from a private-equity buyer's perspective that looks at levered returns; REITs are much more unlevered focused in their return underwriting."
A last option could be a deal struck with a sovereign wealth fund or some type of high-net-worth family, which could allow LaSalle to continue its operations normally with Barnello at the helm.