Daily Trouble |
PAH Chart
|
Related Items |
|
<DAILY TROUBLE>
Tuesday, December 8, 1998
Patriot American Hospitality Inc.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PAH)") else Response.Write("(NYSE: PAH)") end if %>
Phone: 214-863-1000
Website: www.patriotamerican.com
Price (12/7/98): $7 15/16
HOW DID IT FIND TROUBLE?
Last year there were only three hotel real estate investment trusts (REITs) that had the right to manage their own properties and still benefit from a REIT's ability to avoid corporate taxation. They were among the five "paired-share" REITs, and they were hot stocks.
The really blistering paired-share, Starwood Hotels <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HOT)") else Response.Write("(NYSE: HOT)") end if %>, got so fiery it went up 67%. Starwood used its hefty stock price multiple to win a tough takeover war for ITT/Sheraton. The second hottest was Patriot American, which also climbed dramatically, but only 32%, ending at $28 3/4. During 1998, Patriot American expected to make use of that special niche in the tax law and its own high multiple to acquire more hotels, issue more stock, and generally compete with Starwood. Many observers (me included) expected that in 1998 Patriot would even outperform Starwood.
Then several things happened. Congress, heavily lobbied by non-REITs like Marriott, changed the law and eliminated the advantages held by paired-share REITs. Hotels came back in favor with private investors, and the prices of good hotels rose. Starting in January '98, Wall Street mutual fund managers, most of whom never really understood REITs in the first place, suddenly realized that real estate is not a long-term go-go growth industry.
All REITs were hurt as the funds started bailing out, but with (premature) fears of recession and maybe deflation in the wind, hotel REITs were hurt the worst. By last month, despite a 3.4% growth in U.S hotel revenue per room year-to-date, lodging REIT stock prices were down hard -- by a weighted average 41%.
In the middle of this suddenly unfavorable climate, Patriot thoroughly screwed up its flagship acquisition of Interstate Hotels. Patriot found itself in a duel to the death with Marriott over Marriott's claim that it had a right of first refusal on many of the Interstate assets. Patriot began missing quarterly earnings estimates, and the stock began to dive.
Feeling the need to keep the price up (Patriot insiders own around 23% of the shares), management had doubled up its bets. To buy more hotels for its Wyndham and Grand Bay brands, Patriot had entered into a derivative financing called "equity forwards." This was somewhat risky, as Patriot had almost $1 billion in debt maturing in the next 12 months. Its line of credit was about maxed out. Patriot borrowed $350 million from Wall Street houses, promising to either pay off in cash or issue more stock at whatever price it would take to make the lenders whole.
In addition to having a lot of short-term debt, Patriot entered 1998 somewhat over-leveraged. By Q3 1998 it had EBITDA interest coverage of 2.7x, while the average hotel REIT is 4.0x. Patriot had started to arrange for $850 million in longer-term bond financing earlier in the year, and bought an interest rate cap. Then in August, as Patriot stock was in free fall, debt investors on Wall Street belatedly came to agree with the equity guys. Suddenly there was no new Wall Street debt money available for most real estate, much less troubled hotel company workouts. By November it recognized that the cap would be useless, and Patriot had to write off $49 million.
BUSINESS DESCRIPTION
Patriot American Hospitality is a real estate investment trust focused on owning, managing, franchising, and leasing some 490 hotels in North America, the Caribbean, and parts of Europe. Patriot proprietary brands include Grand Bay, Carefree Resorts, Wyndham, and ClubHouse. The operations of its hotels are going very well, with the exception of the (repairable and mostly insured) damage from a hurricane that hit its Puerto Rican properties.
FINANCIAL FACTS
Income Statement
12-month sales: $1,606 million
12-month funds from ops: $255.4 million
12-month net income: ($73.3 million)*
12-month EPS: ($1.48)*
Profit Margin: N/A
Market Cap: $1370.8 million
*includes extraordinary items
Balance Sheet
Cash: $118.3 million
Total Assets: $7.5 million
Total Liabilities: $4.8 million
HOW COULD YOU HAVE SEEN IT COMING?
Well, as you know by now, I did not see it coming. I did not expect the lodging REIT sector to be crushed by investor sentiment while the industry continued its very healthy upswing. If the same thing happened tomorrow, I would probably miss it again.
If I had to ask myself what I missed at Patriot American specifically (and I do), I probably should have been more suspicious that Congress might take away the "paired-share" status when the ITT acquisition became so much of a hot potato. Then there was a clear sign management was not dotting its I's and crossing its T's when Marriott was able to hang up the interstate merger in court.
But the clearest sign, which I ought to have caught, was the entering into "equity forwards" and the total debt level Patriot had taken on. The excess debt did not make Patriot's crash inevitable, but it did remove its wiggle room at a time when real estate was approaching the top of its cycle and the economy is thought to be weakening. With another year of no bad news, maybe the stock would have been a winner, but the risk of facing unhappy lenders was clearly unjustified.
The big lesson I learned at this point in the real estate cycle is that managing the balance sheet is equally as important as managing the properties, and that the real risk of derivatives is hard to reflect accurately in the balance sheet. As soon as some Wall Street wizard invents a new financial tool, investors should be very cautious.
WHERE TO FROM HERE?
Patriot must restructure its debt, and soon. It just agreed to sell some $200 million of its "non-core" hotels and the Interstate management operation to an affiliate of its financial advisor (and largest lender) PaineWebber. The disposition was subject to suggestions of insider dealing -- the deal structure did not look at arm's length, and perhaps as a result, the company replaced PaineWebber as its financial advisor. In any case, the market was not impressed by the deal combined with another unhappy earnings surprise, and the stock price declined further.
Patriot still needs a major restructuring of its debt. That cannot be an easy task. At the present stock price, and including the equity forward obligations, Patriot has a debt/total market cap ratio of approximately 75%. It is unlikely that many lenders would throw cash at such a highly leveraged company unless they can charge pretty hefty rates. New stock sales will not be easy either. The company issued its equity forwards commitments when the stock was up near $25. Today it is around $7 1/2. If it has to dump $350 million in new shares on the market all at once, it could go lower.
That leaves Patriot American with more asset sales as a key part of the work-out strategy, but Patriot is dragging its feet on that. Institutional investors who have been approached by the company say that Patriot is mostly trying to sell second tier assets encumbered with management and franchise agreements. Don't expect great news on that front soon.
The company has finally taken one aggressive step though. On November 23, it said it will cut out the dividend ($1.28 annual) for this quarter -- possibly longer. With 168.8 million shares outstanding (including some "OP units" used to acquire hotels), that move can generate $216,064,000 a year in cash flow. Add in $150,000,000 from the PaineWebber sale and something additional for whatever else it can sell and several potential strategies open up.
Patriot could throw some principal payment bones to its creditors. For the balance it could offer a secured position with mortgages against some of the hotels in lieu of the unsecured debt they now hold (though the line of credit and some other loans probably have covenants that would require renegotiation). It could also issue preferred stock to swap for some of the debt, or offer its creditors warrants on some additional shares in return for their forbearance.
There is something like 250% excess security and value to play with. Using quite reasonable assumptions, the noted real estate boutique Green Street advisors estimates Patriot American's net asset value is $17.25 per share. That assumes the avoidance of bankruptcy and that the company will resolve its liquidity problems by "selling assets, issuing preferred equity and securing higher interest debt."
There is some evidence that a little confidence is returning. Since November 23rd Patriot has been trading at double to triple its recent 1,500,000 share daily volume. There have been two major block trades totaling 376,000 shares since the dividend announcement. Still, the stock is up about 25% from its low on the 24th.
My own guess is that Patriot will survive without going through any bankruptcy proceeding. It will need some luck, though, and much more disciplined focus than it has displayed in recent months. It's not by any means a stock that should be played by the unwary, though. No longer a hot stock, it's a hot potato. Maybe it's even a mashed potato, but despite a bad year I'm pretty sure it's not a whipped potato.
-Michael Dowd ([email protected])
Check out the Daily Trouble Message Board!
|
|||||||||
<% if request.querystring("source") = "yhoolnk" then referer = Request.ServerVariables("HTTP_REFERER") if referer = "" then referer = "http://finance.yahoo.com/" response.write " " end if %> <% function YahooWelcome if gsCookieUsername = "" and request.querystring("source") = "yhoolnk" then %> |
Welcome, Fool! |
|
Be a Fool and get free, unlimited access to our site.
What we offer: |
© Copyright 1995-2000, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. The Motley Fool is a registered trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us |