Hilton Worldwide Holding: Leverage Is High

| About: Hilton Worldwide (HLT)

Hilton Worldwide Holdings (NYSE:HLT) made its public debut on Thursday, December 12. Shares of the large and growing collection of hospitality companies across the world ended their first day with gains of 7.5%.

While Hilton's operations have done really well under the past ownership of the Blackstone Group, the high leverage incurred and the premium valuation leaves little potential in my opinion at these levels.

I remain on the sidelines.

The Public Offering

Hilton operates 4,041 hotels, resorts and related properties in over 90 countries. The company has been around for almost 100 years, comprising about 665,000 rooms at the moment.

Besides operating the flagship Hilton Hotels & Resorts chain, the company operates other chains as well including the Waldorf Astoria, Conrad Hotels and Hampton Inn, among others. The company employs some 300,000 workers which serve over 38 million members and other occasional guests across these properties.

Hilton sold 117 million shares for $20 apiece, thereby raising $2.34 billion in gross proceeds. The company offered some 64.1 million shares thereby raising $1.28 billion in gross proceeds, while selling shareholders offered the remainder of the shares.

Initially, bankers and the firm set an initial price range of $18-$21 per share. Shares were eventually sold just above the midpoint of the preliminary initial public price range. Some 12% of the total shares were offered in the public offering. At Friday's closing price of $22.10 per share, the firm is valued at $21.8 billion.

The major banks that brought the company public were Deutsche Bank, Goldman Sachs (NYSE:GS), Bank of America/Merrill Lynch (NYSE:BAC) and Morgan Stanley (NYSE:MS), among many others.


Back in 2007, Hilton was taken private by affiliates of the Blackstone Group LP. Ever since, the global organization has been aligned and a performance-driven culture has been established. Following this acquisition, the company has increased the total number of rooms by about 170,000, expanding the number by roughly a third. On top of that the number of rooms under construction more than doubled towards 92,000 rooms at the moment.

The firm holds a worldwide market share of about 4.5%, on the back of the leading position in North America where it holds an 8.7% market share. The market share ranges between 1.1 and 2.4% in Asia-Pacific, Europe and the Middle-East and Africa, as Hilton operates in a highly fragmented market.

For 2012, Hilton generated annual revenues of $9.28 billion, up 5.6% on the year before. Net income attributable to Hilton's shareholders rose by 39.1% to $352 million.

Revenues for the first six months of the year came in at $4.64 billion, up 2.7% on the year before. Net profits rose by 65.8% to $189 million in the meantime.

The company operates with $661 million in cash and equivalents. Total debt stands at around $15.1 billion, resulting in a net debt position of $14.5 billion.

Note that Hilton will use the nearly $1.3 billion in gross proceeds from the offering to reduce leverage. Hilton paid some $274 million in interest expenses in the first half on the year, on its roughly $15 billion debt position, which means the effective interest rate is about 3.5% per annum, which is a very acceptable rate. The leverage reduction following the offering could boost earnings by about $40-$45 million per annum on a pre-tax basis.

With the equity in the business being valued around $21.8 billion, Hilton is valued around 2.3 times annual revenues and 62 times GAAP earnings.

Investment Thesis

As noted above, the offering of Hilton is a modest success. The company priced the offering at $20 per share, some 2.6% above the midpoint of the preliminary offering range. Ever since, shares have seen a decent jump, trading some 13.3% above the midpoint of the preliminary offering range.

Recent revenue and earnings growth was driven by higher rates and improved occupancy rates. Revenues per room inched up by 4% to $136.43 in the first half of this year, while occupancy rates were up by 120 basis points to 72.3%. This resulted in a double whammy to revenues per available room which increased to $98.69.

While Hilton is an established name, there are some risks related to this offering. Besides the general economical risks, Hilton also faces competitive pressure from emerging platforms like Airbnb.com while internet travel intermediaries like Expedia (NASDAQ:EXPE) and Priceline.com (NASDAQ:PCLN) are dominating in directing travel streams as well.

The high debt position is an issue, despite the modest deleveraging following the public offering proceeds. Other large competitors of Hilton with over 600,000 rooms as well include InterContinental (NYSE:IHG), Marriott International (NYSE:MAR) and Wyndham (NYSE:WYN), among others.

Again, this is an offering of a formerly owned private equity firm. While Blackstone has done a great job, boosting the company's operations, the firm has incurred a lot of leverage as well. Not only results this in leverage risks, the valuation of the equity has become steep as well. This is even as the firm could boost annual earnings to about $500 million on an annual basis at the moment.

I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.