Starwood Hotels & Resorts Worldwide Q2 2010 Earnings Call Transcript

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Starwood Hotels & Resorts Worldwide (HOT) Q2 2010 Earnings Call July 22, 2010 10:30 AM ET

Executives

Frits van Paasschen - Chief Executive Officer, President and Director

Vasant Prabhu - Vice Chairman, Chief Financial Officer, Executive Vice President, Chief Financial Officer of Starwood Hotels & Resorts and Vice President of Starwood Hotels & Resorts

Jason Koval - Vice President of Investor Relation

Analysts

Shaun Kelley - BofA Merrill Lynch

Smedes Rose - Keefe, Bruyette, & Woods, Inc.

Jeffrey Donnelly - Wells Fargo Securities, LLC

Janet Brashear - Bernstein Research

Felicia Hendrix - Barclays Capital

Chris Woronka - Deutsche Bank AG

Joseph Greff - JP Morgan Chase & Co

Ryan Meliker - Morgan Stanley

Joshua Attie - Citigroup Inc

Steven Kent - Goldman Sachs Group Inc.

William Marks - JMP Securities LLC

William Crow - Raymond James & Associates

Operator

Good morning. My name is Jasper, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2010 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Jay Koval. You may begin, sir.

Jason Koval

Thank you, Jasper, and good morning, everyone. Thanks for joining us this morning for Starwood's second quarter 2010 earnings call. Joining me today I have Frits van Paasschen, our CEO; and Vasant Prabhu, our CFO.

We will be making statements on this call related to company plans, prospects and expectations that constitute forward-looking statements under the Safe Harbor provision of the Securities Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as: Starwood or its management believes, expects, anticipates, foresees, forecasts, estimates or other words or phrases of similar import. All such statements are based on our expectations as of today, and should not be relied upon as representing our expectations as of any subsequent date. Actual results might differ from our discussion today. I point you to our 10-K and other SEC filings available from the SEC, or through our offices here and on our website at starwoodhotels.com for some of the factors that could cause results to differ.

With that, I'm pleased to turn the call over to Frits for his comments. Frits?

Frits van Paasschen

Thank you, Jay, and thanks, all, for joining us on our call today. We're happy to report that the economic recovery continued with the global GDP growth rising above 4%. This fueled lodging demand and drove our business in the second quarter. Occupancies continued to climb and rate increased for the first time since Q3 of 2008. At today's occupancy levels, we're confident that rates will sustain their rise through the year. And as each month passes, we're increasingly convinced that the great lodging depression of 2008 and 2009 is behind us.

Nonetheless, we continue our scenario planning in the face of an uncertain economic picture. Our base case remains cautious about the near-term recovery, playing out somewhere between the new normal and the typical past recoveries. Longer-term, we continue to be bullish about getting more than our fair share of the huge secular growth in demand in emerging markets.

So with that as a backdrop, I'd like to cover four topics today. First, a review of our second quarter results; second, an update on why Starwood is well positioned to own the upswing; and third, some background on our owned assets and our strategy for getting the most value as we move toward asset light; and fourth, a look at how we create value for our owner partners.

So let me start with the first topic, some second quarter highlights. We were able to beat EBITDA expectations by $50 million and EPS by $0.10. For some time now, we've been talking about our leading global position, our strong brands and our skew towards luxury. And it was precisely these drivers that accounted for our strong top line results.

Company-operated REVPAR growth was nearly 30% in Asia Pacific and Latin America. North America company-operated REVPAR was up 12%. And Europe, despite its troubling headlines, was up 10% in local currency. Only Africa and the Middle East under-performed, thanks mostly to oversupply in the Emirates. Overall, worldwide-owned REVPAR jumped 16%, and margins expanded by 400 basis points.

The big story behind our REVPAR growth is the rebound in business travel, which is 75% of our business. Revenues from global accounts and midweek occupancy are nearly back to 2008 levels. The sectors that are leading the charge are financials, consulting and tech.

Group business played out well in the second quarter also, with surging booking in the quarter for the quarter. For the first time in two years, total group business on the books is in positive territory. I should also add that booking windows remain quite short, often only four to five months out. So we expect additional pickup for 2011 during this year. Overall, new leads were up 20% and rates for 2010 bookings were up 16%.

The rebound in business travel bodes well for corporate rate negotiations this fall. After two years of declines, industry-wide occupancies have now reached levels where rates tend to rise. North American property saw occupancy above 71% in the quarter, with midweek levels in June for New York, Boston and Chicago over 90%. So it's not a surprise that ADRs are up roughly 5% in North America for June and July. And in London, June midweek occupancies were 98%, with Paris and Rome at 92%.

Throughout 2009, we talked about our commitment to contain costs as we moved into the up-cycle. Our efforts are paying off as margins increased 400 basis points in the quarter. Around the world, our 145,000 associates did a great job of maintaining a lean structure. And at the same time, we were able to deliver record guest satisfaction scores even as hotels continue to fill. This success speaks well to our efforts at communication, branded service culture training and succession planning. We're proud to say that Starwood is a great place to work and build a career.

Our corporate SG&A was up in the quarter, but importantly, net of some lumpiness around incentive compensation, our SG&A spending run rate is actually below last year. Remember last year at this time, we were in declining EBITDA so we lowered accruals. While this year's results have exceeded expectations, those accruals have gone up. Over time, the real driver of cost is headcount, which is flat in the quarter and will remain flat through 2011. Rest assured, we'll keep a tight control on our overhead costs.

So in many ways, our call today continues the themes from last quarter. Top line growth was stronger than expected, cost controls resulted in higher margins and so far, we aren't seeing any change in our outlook for the back half of the year, emphasis on the so far. The global economy remains volatile and unpredictable. If, for example, the European sovereign debt scare that began in May were to derail the recovery, it would not be until later this fall that it would hit our business. Again, so far, we've not seen anything. So our new outlook does not anticipate a major slowdown and is set at 7% to 9% for worldwide system-wide REVPAR growth in 2010. In a few minutes, Vasant will share greater detail on trends by region and our 2010 baseline scenario.

So with that as a backdrop, let me move to my second topic, why Starwood is well positioned to own the upswing. Specifically, I want to highlight three reasons why we outperformed our competitors and why we believe this will continue.

First of all, having high-end brands and properties means we under-perform during down periods like 2009. Conversely, we also outperform in up-cycles. This is good news, not only now but also over time as there tend to be more up-years than down-years.

Second, our footprint takes us to parts of the world that are likely to grow faster for some time to come. With 52% of our hotels located outside of the U.S., Starwood is not a U.S. company with some assets overseas. Today, we are a global company that happens to be based in New York. Our global presence has fueled a pipeline of 85,000 rooms, representing 28% unit growth, and 80% of our new hotels were opened outside of the U.S., with valuable 20-plus year management incentive based contracts.

Third, our portfolio of hotels is not only the strongest in the company's history, it keeps getting better. From 2007 through the end of this year, we will have added 320 new hotels. In addition, we've also renovated 350 properties with our owners. That means that 2/3 of our hotels are now new or as good as new.

So now I'd like to turn to my third topic; how we'll maximize the value of our own portfolio as we become asset light. Our experience in 2009 proved once again how the fee-based model can reduce volatility. Our own profits were down over 50% while our fee revenues fell only 12%. Now in the near term, that volatility actually has a positive flipside. To quote Vasant in the last quarter's call, "our own earnings are like a coiled spring". You saw some of that earnings growth potential this quarter with owned EBITDA up 40%. So while our goal is to have over 80% of our EBITDA driven by fees, we'll be patient balancing earnings growth, time value of money and the right prices.

To gain insight into our thought process, I thought it might be useful to take a look at what we did during the last cycle. Let's start with the sale to host our largest transaction. It demonstrated how we can structure a win-win deal for both sides. We sold 33 hotels to host in early 2006 including 16 Sheratons and 12 Westins. The multiple was over 15x mid-cycle 2005 EBITDA. With 40-year contracts, we joined hands with a terrific owner whose long-term plans aligned with ours and who's balance sheet is one of the best in the industry. Host invests in our brands, as we could see from last year's $55 million renovation of the Sheraton Boston and the $100 million planned renovation for the Sheraton New York. They also recently announced acquisitions of a Westin and a W.

Investors often ask if we would split out a rate, and the answer is yes, but only under the right circumstances. In 2006, the spin-off would have been an untested entity likely to trade at a discount to host. Also host had the corporate overhead in place to absorb these assets. And finally, the host transaction was extremely tax efficient.

I should also mention that in the prior cycles, Starwood also made some large one-off sales such as the Westin Philadelphia, St. Regis, D.C., Turnberry Resort and Venetian Hotels. These hotels traded at roughly $400,000 a key.

Today, we see a transaction market that's down almost 90% from its peak. But after nearly two years, we're seeing a real uptick in interested parties with access to capital. For example, there are potential buyers from markets outside of the U.S. such as sovereign wealth funds, high net worth individuals and real estate companies. Inside the U.S., REITs, blind pools and new private equity funds are coming to life. This money is on the sidelines and is increase in the year to get work.

As you may know, ground is being broken on few new hotels. Financing is difficult to find and it's cheaper to buy a hotel than to build a new one. This means that room rates and the financial results of existing hotels should rise for some time to come. Accordingly, we value our hotels not based on earnings today but on the present value of their earnings two to three years from now. In other words, we remain committed to the asset light model for us but we have adjusted our expectations on timing and not on pricing. In the meantime, we expect to enjoy strong growth in profits from our owned assets.

In that context, let me share some statistics on our owned portfolio. As of today, we own or lease 62 hotels with over 21,000 rooms. About 90% of those rooms are in urban locations in markets and resort markets where it's difficult to build new hotels. Roughly 55% of our own EBITDA was generated outside of the United States. Of these 21,000 rooms, almost 18,000 are wholly owned. I'll share some more details on these properties in just a moment. Just under 2,500 rooms at leased, including the brand new W Barcelona, W Times Square, Sheraton Park Lane in London and Sheraton Charles de Gaulle in Paris. These remaining leased properties are detailed in our property list. And there's one unbranded hotel in the list where we own a majority stake and that's the 941-room Boston Park Plaza.

So let's take a look at the 18,000 rooms that are 100% owned. The first classification we use internally is what we would describe as high-value hotels that have no major capital needs. We could sell them on short notice or continue to own them and enjoy the rebound in earnings. Examples include the Phoenician, Sheraton on the Park in Sydney and St. Regis, San Francisco. We estimate that 60% of our owned rooms fit in this category.

The second category, about 25,000 owned rooms, includes high value hotels also in great hard-to-replicate markets but that need renovation. These are assets that we'd either sell with a committed property improvement plan or that we would hold and renovate ourselves. Examples would include the St. Regis, Aspen and the Grand in Florence.

The third classification of our owned hotels is what we call the transaction with partner bucket. This includes a few large box hotels with upside potential, but that need strategic repositioning or a large-scale renovation. We'd like to work with a partner to manage the complexity and capital needs of these projects. About 15% of our rooms are in this category, including the recently [ph] defied (21:34) Sheraton Manhattan and the Westin Peachtree.

In addition to the wholly-owned hotels, we also have 28 unconsolidated joint ventures that represent 3,000 additional rooms with an average share of 33%. These JV hotels are located in gateway cities including Hong Kong, Tokyo, Bangkok, Kuala Lumpur, San Diego, Montréal, Seattle and New Orleans. With our minority positions, the timing and sale of these assets is a little trickier for us to control.

So before I move to my fourth topic, and while I'm talking about their balance sheet value, I wanted to touch on two more potential sources of cash: Starwood vacation ownership and Bal Harbour. As you may recall, our SVO team took early action to generate cash from timeshare by working through the existing inventory on our balance sheet. Between 2009 and 2010, we generated $525 million in cash from the business and we expect an even greater amount over the next three to four years. And Bal Harbour is on track to open by 2012, providing another inflow of cash as we close on the residential sales.

As we move towards a largely fee-driven business, it's important for us to reflect on how we create value for our owners. This is my fourth topic for today and I'll touch on a few ways we do this in the context of the five essentials of the journey, our strategic touchstone. Under our first essential, win with talent, we created an aligned corporate team over the last three years. This team supports our regional divisions as they recruit, retain, develop and challenge local smart teams. Their job is to deliver culturally relevant on-brand experiences for our guests around the world. Together, we've been able to increase associate engagement and effectiveness despite tough times.

Under our second essential, execute brilliantly, we achieved some dramatic cost-savings over the past 18 months. But our work is not finished as we continue to find ways to improve efficiency at our hotels. Through our lean hotel operations and procurement efforts, we intend to offset 1/2 of the inflationary growth. This includes maintaining flat headcount into the cycle. Thus far, we've sustained our guest satisfaction scores despite a 10 percentage point increase in occupancies. We've also expanded the coverage and sophistication of our revenue management systems, realizing [ph] lists (23:53) of 2% or more were implemented. Our sales reorganization is now complete in four markets, and we'll be rolling out six more by the end of the year. At the same time, we're strengthening our IT capabilities to better serve our customers. With our worldwide market share up over about 100 basis points this year, we couldn't be more pleased with how our team continues to execute on behalf of our owners.

Under our third essential, build great brands, we've kept the hammer down on innovation. Whether it's the Link@Sheraton, the launch of a loft or the worldwide rollout of W. Our brand teams are also working with our properties to reduce costs by simplifying brand standards. And SPG'S latest Free Weekends promotion is on track to exceed last year's record. Today, SPG members account for 44% of our room nights, the highest in our history, providing a loyal occupancy base for owners. We also generate the majority of online bookings through our branded websites.

And as I look at our brands, I'm delighted to share progress on the success thus far with the Sheraton re-launch. On top of the $6 billion already invested in the brand, we're looking forward to another $5 billion to be spent opening 60 new Sheratons. Worldwide, we're seeing Sheraton grow 150 basis points faster in top line than its competitive set, and even faster than that in North America. We continue to reach new highs in overall guest satisfaction, likelihood to return and likelihood to recommend.

Turning to Le Méridien, we've added some terrific hotels in North America, including Philadelphia, Minneapolis and Cambridge. And as we introduce Le Méridien to North America, we're bringing Westin to points around the world. As mentioned on the last call, Westin is entering India with four openings and expanding in China with properties in Shenzhen, Tiangjin and Huangzhou. Even in ramp-up mode, many new Westins are already outperforming their concept.

Before I move onto the next essential, let me add that our luxury brands are enjoying a great rebound with the REVPAR gains over 15% for the year. We have the largest base of luxury hotels in the world, with 120 properties and almost 27,000 rooms. The fact that this footprint continues to grow shows that developers see the value of these brands, which gets me to our fourth essential, deliver global growth.

Our development teams are focused on the right partners, the right properties and right places. We're not afraid of walking away from a deal that's not with the right partner, if it's not for right our brands or if the contract terms aren't right. We'll soon have opened 320 hotels in just over four years and have a pipeline of 350 more. And don't forget, each new hotel creates more demand for our brands.

Take our backyard, for example. New York City is one of the world's great urban hotel markets and a stronghold for Starwood. In the next year or so, roughly one in four new hotel rooms will carry the Starwood flag as our footprint grows by roughly 50%. This includes two new Sheratons in Brooklyn and Tribeca, the W Downtown, to more lofts in Brooklyn and Harlem, an Element in Times Square and the Four Points on Long Island.

And now for our fifth and final essential, drive outstanding results. Starwood has executed well over the past decade. Looking ahead, we have an organization focused on a multi-year plan. This includes a relentless focus on driving industry-leading top line growth, margin expansion as well as net unit additions. This is geared towards creating great returns for our hotel owners and growing our fee business. Meanwhile, we can generate cash as we transition to an asset-light model.

So to summarize my comments very briefly, we've had another great quarter, and we're well positioned to continue on that success even if the recovery moderates. Before I turn the call over to Vasant, I wanted also to let you know that we'll be holding an investor day at the St. Regis New York on December 8. So please mark your calendars and stay tuned for details. Vasant?

Vasant Prabhu

Thank you, Frits, and good morning, everyone. As Frits indicated, we had a strong quarter that exceeded expectations on multiple fronts. REVPAR growth and market share gains, cost control and margin improvement, hotel signings and openings and of course earnings. Over the next few minutes, I'll provide some color on the drivers of these results, current business trends and our outlook for the balance of the year.

Asia continued its sharp recovery track. Local currency REVPAR was up 28%. China once again led the charge with growth of 46%. Rate was up 7% and occupancy was up 10 points. REVPAR growth was around 14% in India, Australia and the rest of Asia, more than offsetting weakness in Thailand, which was down 6% due to the political crisis. Even Japan, which has been sluggish to date, was up in the double digits driven by occupancy gains. This recovery trend continues into July but comparisons get a lot tougher. Between Q2 and Q3 2009, REVPAR at company-operated hotels in Asia improved by 800 basis points and by another 1,200 basis points between Q3 and Q4. So despite the strong demand trends on the year-over-year basis, the rate of growth will slow down.

We continue to see a healthy level of new development activity. Out of the 39 new deals we have signed in 2010, 18 were in Asia. And Asia continues to account for 60% of our 85,000-room pipeline. Of the 32 hotels we have opened worldwide this year, 10 were in Asia where we expect to open at least another 20 before year-end. As we have seen in Beijing post-Olympics and elsewhere in Asia, it does not take long for demand growth to absorb new supply. With well-established brands, the largest footprint and a strong local smart team, we remain very well positioned to capitalize on the huge opportunity in Asia.

Our largest region, North America, was up a solid 13% at company-operated hotels, reminiscent of pre-crisis days. REVPAR growth accelerated during the quarter from 12.6% in April to 14.6% in June as rate turned positive in May and was up 5% in June. The shape of the recovery is similar to what we saw post 9/11. This time, the dip was deeper and the bounce back is stronger. Growth was especially strong in New York, Boston, Chicago and Toronto. Western cities, Seattle, San Diego and Phoenix did not recover as fast. Corporate travel is a primary driver of demand. As midweek occupancies rose into the high 70s, we were able to manage a mix of business to drive rate. For the quarter, occupancy at company-operated hotels was 74% with rate up 2%. Group room nights were up 16% with rate down 1.3%. Transient room nights were up 9% with rate up 5%.

Another American-owned hotel portfolio with its major metro concentration and Ws, St. Regis, Westins and Sheratons was even stronger, up 21% in Q2. In June, our owned hotel REVPAR grew 27% with rate up 9.5%. The tone of business remains strong in North America as we enter Q3. Short-term booking trends, as well as conversations with customers about future plans, remained positive. In the year, net group production is running at 3x last year's depressed levels and leads continue to increase. Last year, we filled our hotels in July and August as best we could with lower-rated leisure business. This year, corporate transient demand is robust, and we will be reducing our least attractive leisure channels to manage average daily rate up.

While Q3 business demand is strong, it is important to point out again that comparisons get a lot tougher. In 2009, REVPAR at company-operated hotels improved 700 basis points between Q2 and Q3, and by over 1,000 basis points between Q3 and Q4. As such, the year-over-year REVPAR growth will be lower in Q3 and Q4 than it was in Q2, even ph] if a huge (32:07) levels of REVPAR continue to rise. While occupancies approach peak levels, margins remain well below peak levels as do rates. With limited supply in the pipeline, the demand supply equation has tightened faster than we have seen in prior recoveries, and supply is likely to remain muted as long as rates and margins are at these levels. While raising rates is not something that delights customers, this is a business where rates are determined by the demand-supply balance in each market every night. We price our inventory using increasingly sophisticated revenue management systems to deliver a good return to our owners. As retail rates rise, corporate-negotiated rates, which have declined almost 20% since 2008, will need to rise too.

In Europe, local currency REVPAR at company-operated hotels rose 10% with strong occupancies in London, Paris, Frankfurt and Vienna. ADR was flat. Our owned hotels were up 6.5%. Occupancies rose but rates were down. As in the U.S., major gateway cities expertise had mid-week occupancies in the 90s in June. Despite the problems in Spain, our new [ph] LEEDS (33:22) hotel, the W Barcelona is off to a great start. The trajectory of recovery is slower in Europe than in the U.S., and the weaker euro adds an additional headwind to reported numbers.

As we enter Q3, we expect some benefit from the weaker euro at our owned hotels in Italy. However, the timing of Ramadan will hurt business originating from the Middle East. The euro was at 142 in Q3 last year versus 125 to 130 today, further impacting numbers as reported in dollars.

While group business is solid in the back half, the primary driver of demand remains late-breaking transient business. Primarily due to excess supply in the Gulf, our business in Africa and the Middle East was flat in Q2, our weakest region. As we enter Q3, conditions will remain challenged in the Gulf, stronger in Egypt and the rest of Africa, but Ramadan will affect August.

In Latin America, strong growth in the South and Mexican H1N1 impact last year resulted in REVPAR up 30%. Argentina grew 44% and Brazil 32%. In Mexico, business travel is recovering but results have been hit by drug-related crime concerns. These trends remain intact as we enter Q3. This quarter, we will lap the significant impact from H1N1 we saw in South America last year.

On the hotel cost front, our multiple initiatives continue to pay off. At owned hotels worldwide, EBITDA margins were up 400 basis points, a healthy flow-through rate of around 50% despite deriving most of our REVPAR increases from occupancy gains. In North America, productivity was up 7%. At all company-operated hotels, worldwide operating profit margins were up 150 basis points. We remain focused on driving productivity and on our ongoing lean hotel operations and procurement initiatives. While it's tempting to add cost as revenues increase, our hotel GMs understand that margins are well below peak levels and a return to peak margins as fast as we can is job number one. This will, of course, require not just good cost control but also further recovery in REVPAR, especially rates. We expect the margin improvement trend to continue into the back half with operating margins increasing 100 to 150 basis points worldwide.

On the SG&A front, we're holding the line on headcount additions. The only adds will be in areas like Asia, Africa and Brazil where we see significant growth opportunities. Versus Q2 of last year, our SG&A headcount is down 6% and is flat versus the last quarter. Our reported SG&A was up in Q2 due to year-over-year changes in incentive compensation accruals as Frits described. Last year, at this time, business trends were far worse than we expected, and we were reducing incentive compensation accruals. This year, trends are better than we expected, and we are adding to incentive compensation accruals. Adjusted for this, SG&A is flat year-over-year. This issue will persist into Q3. SG&A will be up again in the 10% to 12% range. We made deep and what we believe are sustainable cuts in SG&A last year and we remain determined to maintain them.

In our Vacation Ownership business, which is our most consumer-dependent enterprise, the tone of business is best described as sluggish. Customer propensity to tour is lower, close rates are stable and pricing is lower due to our reductions as well as mix. In a tough environment, we did well to hold intervals sold roughly flat. With consumer confidence declining, we do not expect these trends to improve in the second half.

At Starwood, we remain very optimistic about the long-term for all the reasons that Frits described. Our best-in-class brands and global footprint, a great pipeline, sharp recovery in owned hotel profits and significant cash generation from operations, asset sales, SVO and Bal Harbor. Over the next six to nine months, however, we think some caution is called for. A variety of leading indicators about the macro-economy have turned negative. Confidence is eroding, markets are volatile. We are, as you know, sensitive to corporate profit expectations and business confidence. If these trends persist, it is possible we will see some impact later this year. Booking windows are short and visibility is limited. That said, it is important to reiterate that there is no evidence of any slowdown at this point.

Our outlook reflects the current trend and the fact that we lapped much tougher comparisons in the second half as described earlier. As such, we expect 8% to 10% local currency REVPAR growth in Q3 at company-operated hotels. Exchange rates will be a significant headwind reducing dollar reported REVPAR growth to 5% to 7%. The forex impact will remain a headwind in Q4 too.

For the full year, we are raising constant dollar REVPAR growth to 7% to 9%, 200 basis points above our prior expectations, and 6% to 8% as reported in dollars. Our full year EBITDA expectations have also increased to a range of $815 million dollars to $845 million.

Finally, a quick word on our balance sheet. We finished Q2 with net debt under $3 billion. Our net debt to EBITDA ratio is now below 4x. We're working on the securitization of Vacation Ownership receivables. Market conditions are favorable and assuming they stay that way, we should get a deal done in Q3. We continue to expect our $200 million-plus tax refund this year. It is making good progress at this point through the internal processes of the IRS. As such, we expect to end the year with net debt of around $2.5 billion. We will have reduced debt by $1.5 billion over 18 months excluding FAS changes. With that, I'll turn this back to Jay.

Jason Koval

Thanks, Vasant. We'd now like to open up the call to your questions. So in the interest of time and fairness, please limited yourselves to one question at a time and then we'll take any follow up questions you might have as time permits. Jasper, we're ready for the first question, please.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Shaun Kelley [BofA Merrill Lynch].

Shaun Kelley - BofA Merrill Lynch

Guys, I was just wondering, I wanted to talk about Asia Pacific a little bit more since it's just a big component of your business and obviously the future. Maybe right now Asia Pacific makes up 18% or so of your fee base. But we obviously know it makes up a lot more of your pipeline. Could you guys maybe give us a roadmap of how you think that, that percentage, that 18% increases over the next three to five years in terms of what your target looks like?

Frits van Paasschen

Yes, I'm not sure we could give you a specific number but let me share with you some of the factors that would drive that growth in the fee base. You mentioned the pipeline and I think that's important. So a very high percentage of the 300 rooms in our pipeline come from Asia Pacific. I believe it's over half now, it's about 60%. The second thing you have to be able to have insight into was what the growth will be in REVPAR. And what we're seeing now is a bounce back in REVPAR to levels that are getting close to pre-crisis. So looking farther ahead, it's unclear exactly what that pace will be but that certainly would be another piece. In either case, we also have growing incentive fees as we continue to build the profitability of those hotels and as that REVPAR rebounds. And then finally, there's the currency effect, and greater minds and powers than ours are talking about China and what will happen with renminbi over time, but given the size of Fee business and the number of hotels we're adding, were there to be appreciation in the yuan, that would add to it as well. So those are the things that I would be putting in if I wasn't model out what that percentage is over time.

Operator

[Operator Instructions] Your next question comes from the line of Joe Greff with JPMorgan.

Joseph Greff - JP Morgan Chase & Co

The line on non-incentive compensation costs and headcount, I think that comment was in regard to the corporate initiative. Can you talk about what's going on at the property level in terms of headcount? Are you anticipating increasing that in the second half? And if you can just share with us what's embedded in your second half guidance in terms of same-store owned hotel expenses, that would be helpful. Thank you.

Frits van Paasschen

Yes, so I'll touch on it and then hand off to Vasant. And the beginning of your question was slightly cut off. So let me try to fill in the blank a little bit. The first part of your question was around flat headcount, and that does refer to what's happening at the corporate level and offices. And we do believe that first of all, as we said in the script just a moment ago, that spending rate overall is flat-to-down, that the change you're seeing is largely due to we're moving the incentive comp accrual in the opposite direction from a year ago for all the reasons you can appreciate. But then we do intend to keep headcount flat-to-down for our corporate and SG&A functions. At the property level, as we've described now for a while, we continue to work to roll out a lean hotel operations model. And we continue to look at ways to simplify the execution of our brand standards, focusing really on those things that make a difference and differentiate our brands. And we believe that in doing that, overall, we can hold our expenses to about half the inflation rate. We expect that if occupancy gets a lot higher, we clearly will have to add some variable headcount. But at this point, we're very much focused, at least at the management level of the property, to hold that flat. Vasant, perhaps you want to add something?

Vasant Prabhu

Yes, nothing much more, Jeff, than to point out that the sort of rallying cry we have internally is how to get back to peak margins fast. So we keep pointing people to -- sorry, I said Jeff, I meant Joe. We keep pointing people to the fact that our margins are well below peak. So we're keeping the discipline, the pressure on cost. I did mention that our productivity, for example, in North America was up 7%. So we're very focused on holding the line of headcount even at the hotel level.

Operator

And your next question comes from the line of Felicia Hendrix from Barclays Capital.

Felicia Hendrix - Barclays Capital

Frits, I was a little surprised you didn't brag, I'll use that word if I may, a little bit in your prepared remarks on the improvement in Sheraton. So I'll take the opportunity to ask. Clearly, some impressive results there. I was just wondering, how much of the REVPAR that you posted in the quarter has come from some Sheraton revitalization? And then also, clearly you had some market share gains in the brand. I was wondering competitively, who do think you're taking share from. Thank you.

Frits van Paasschen

It's I think in some respects hard to disaggregate exactly how much of the out-performance of Sheraton to attribute to which, but a few things to think about. Clearly, the revitalization program is paying off. And the way we can see that is looking at the performance of individual hotels before and after, and also the fact that the guest satisfaction scores and some of the subcomponents of those scores, as in people's appreciation for the physical aspect of the property and people's willingness to recommend and return, are all moving up in tandem with REVPAR. So there's clearly both correlation and causation going on there. We continue to see a build in our SPG occupancies around the promotions there, but we believe also because of our work to continue enrollment and retention of SPG members. The sales reorganization in those markets where that's been unfolded have also yielded considerable benefits, some of which went to Sheraton. And then finally, as we look at revenue management, and Vasant talked about the more sophisticated programs, and I mentioned an average 2% or better lift in properties there. It really was boils down to three things. Not just having the sophisticated systems, but also getting the hotels to use those systems more consistently. And in some cases, to use them as their primary way of doing business, which hasn't always been the case in the past. And the third piece is to train our associates to be able to do that. If you add up all those four things along with a number of other efforts, we're looking at a growth rate in REVPAR for Sheraton that's about 300 basis points faster than some competitive brands at a comparable place. And I think it's the confluence of all of those things. But primarily, the first one, the revitalization program because we're seeing that so much in tandem with that being rolled out right now. So thank you.

Operator

And your next question comes from the line of Steven Kent with Goldman Sachs.

Steven Kent - Goldman Sachs Group Inc.

Could you just talk a little bit about selling hotels essentially this year? It seems like we have seen some transactions pick up. Could you talk a little bit about the opportunities there? Maybe even talk about, which was mentioned a while ago, spinning off REIT. And if any of this occurs, what would you do with the cash, what would your focus be?

Frits van Paasschen

Yes. So the first part of your question related to selling hotels this year and what we're seeing. And as I mentioned in the script, a year or year and a half ago, there really wasn't much interest from very many people. We did have a good transaction setting the W San Francisco. But we were lucky, I think, to find an owner that recognized the value and had the liquidity and confidence at a much darker time. Today, a lot of capital is starting to look at buying hotels. A lot of it's still on sideline as I mentioned. And yet, we think that in the next six to nine months that we'll continue to build and probably get a little bit more impatient. If we find the right transaction, the rest of this year, early next year, it's more likely to be a rightful shot deal where we find an owner in a situation that works out well for us. And as we were talking about in the script earlier as well, really balancing what we think that hotel will do over time. What an owner might be willing to put in, in terms of their own capital to renovate the property, and what the value of that money today is versus two or three years from now. In terms of the REIT question, remind me again what you were asking there exactly, Steven.

Steven Kent - Goldman Sachs Group Inc.

Plans on a spin off of the REIT.

Frits van Paasschen

Right, so as we get to the point where we're looking at a bigger transaction, that would be when we would be considering, among other options, spinning out of REIT. Now as we described in the script, the host transaction was terrific for us in so many respects and we would look at another transaction like that with a select number of owners who have the wherewithal and the capability and the mindset that we would think would work for that. And we'll balance that against what the public markets are saying about a REIT and what that might look like. So we'll make that evaluation when and if the time comes. Vasant, perhaps you want to add something to that, I don't know.

Vasant Prabhu

No, I think Frits referred to quite a bit of this in the script. There's a variety of factors that go into that. How public REITs are trading. What the G&A leakage would be. How a new REIT would trade relative to existing REITs. And those are some of the considerations we went through last time and we would do the same again.

Operator

And your next question comes from Josh Attie with Citigroup.

Joshua Attie - Citigroup Inc

How do we think about pricing as you talk to your biggest corporate customers? Is it only versus 2009 levels? Or is there some thought to how far you've fallen over the last couple of years? And if so, could pricing be an offset to more difficult occupancy comparisons in the fourth quarter and even in 2011?

Vasant Prabhu

Josh, I mean clearly, it is something we have to deal with, both us and the industry as a whole. In our case, corporate-negotiated rates are clearly one of the factors that are holding back ADR growth this year. And we are down on average about 20% from 2008 levels. With occupancies in the 90s, and retail rates climbing like they are, it is hard to justify holding corporate rates where they are. So we certainly would look to get back to where we were over a two- to three-year period, and therefore would look for high-single-digit increases in our negotiations later this year. Of course, it is a case-by-case negotiation. It also depends on what the rest of the industry is doing. But that would be our intent.

Operator

And your next question comes from the line of Bill Crow with Raymond James.

William Crow - Raymond James & Associates

If I look at your guidance for the second half of the year, it seems to imply REVPAR growth up in the 7% range for the fourth quarter, but EBITDA growth of kind of up 1% to 3% or 4%. Am I missing something on that? I think we've worked in some asset sales into that growth rate. If you could just kind of give us some color on the fourth quarter guidance.

Vasant Prabhu

Sure. There's two or three things to consider. There's some comparison issues relative to last year, as you said, asset sale differences. Second, forex. Don't underestimate the impact of a significant move in forex year-over-year compared to last year. We also have the SG&A incentive comp deltas from last year that we've talked to you about. So you put those together and it does explain a big chunk of that. If there are any other specific sort of questions around that, I'm sure we can -- Jay can help you with that. But those would be the big items. The bulk of the upside we're seeing is driven in our owned hotels. The Fee business is improving but also has the forex headwind outside the U.S.

Operator

And your next question comes from the line of Ryan Meliker with Morgan Stanley.

Ryan Meliker - Morgan Stanley

Just a question on booking window. Frits, I know that in your script you talked a little about your group booking windows still being pretty short, close to five months. Can you just give us some color on both the group and corporate transient booking windows? A, where they stand today, and b, how they have changed throughout the course of this year? Thanks.

Frits van Paasschen

Yes. So in terms of corporate transient, the booking window is always short, and that's the nature of business travel. And that I wouldn't say has changed as much as it has on the group side. Our sense is that we're still, in some mode, catch-up wise in terms of pent-up demand up for the group business. And so the short window reflects meetings that have been tentatively planned and that are now becoming real, or a realization that there are group activities that need to take place. And as the world continues to improve, the funds and the confidence is available to do that. My own sense is that as we get to the back half of 2010 and into 2011, we'll be out of the catch-up part of this and things will return to something more like a normal tempo. But that obviously depends a little bit on trajectory of the overall recovery. But I think that it's fair to say that the catch-up and pent-up demand piece and the building of confidence is something I suspect will happen through the rest of this year, and at least into early 2011.

Operator

Your next question comes from the line of Smedes Rose with KBW.

Smedes Rose - Keefe, Bruyette, & Woods, Inc.

I was just wondering on your worldwide REVPAR outlook, could you break out what you think for North America versus international?

Vasant Prabhu

Break out North America versus international, let me just see if we can do that quickly here. North America and international actually are becoming relatively similar because Europe does pull down the international number. So I think you could assume that they are not that different. Yes, in fact, I think that is in fact -- yes, that is the case. In the second half, we had sharper recoveries outside the U.S. than we saw in the U.S. like in Asia. And then we also have Europe recovering a little slower when you put those two together. And, of course, we talked about Africa and the Middle East also being somewhat sluggish. So it's about the same at this point.

Operator

And your next question comes from the line of Will Marks with JMP Securities.

William Marks - JMP Securities LLC

You've talked about sources of cash selling assets and obviously free cash flow. What about uses? Can you talk about share repurchase and any plans for that? And your balance sheet's in good shape, so what do you plan to do with cash?

Frits van Paasschen

Yes, so I think it's hard to speculate because it will depend on how we view the situation at the time. And I think actually that's the back half of Steven Kent's question that we didn't get to in its entirety. It's just useful I think, therefore, to look back on what we've done before as a model for how we think about it a little bit along the lines of how we talked about selling assets in the past and what that says about our thought process looking forward. So we've issued special dividends. We've raised our dividend. We've repurchased stock. In some cases, we've put some of that capital back into our owned assets. And so those would be some of the ways we do that. But we recognize that as we make a transformation from -- and I should add one more, we made an acquisition of Le Méridien. So there's a variety of things that we could do and what we do will depend on when cash comes in and which of those alternatives makes the most sense for our shareholders based on our view of the world at that time. But what is absolutely clear is that between the monetization of a large part of our Vacation Ownership business, between the closure and sale of the residences at the St. Regis Bal Harbour, as well as obviously asset sales over time, we'll come into a lot of cash at the same time that we transform ourselves to a business model, that doesn't require a lot. So we will definitely have that problem. It's not just a conceptual one or I should say probably that's a luxury problem to have. We'll have that opportunity. And when the time comes, as I say, we'll look at makes the most sense for our shareholders.

Operator

[Operator Instructions] Your next question comes from the line of Janet Brashear with would Stanford Bernstein.

Janet Brashear - Bernstein Research

If you look at your vacation ownership sales pace, can you comment on how long it can be sustained with no inventory spending other than what you're doing on Bal Harbour?

Frits van Paasschen

Yes, it depends on the location and a variety of other factors that go into it. But we have a few years of inventory left on average across the system. So we talked about getting the amount of cash we saw over the next three to four years, that would be monetizing a big part of the available inventory that we have today. But again, it varies a lot by location and it's really unclear exactly what the sales pace will be since it's bounced around so much over the last year and a half or so.

Operator

And your next question comes from the line of Chris Woronka with Deutsche Bank.

Chris Woronka - Deutsche Bank AG

Can you share with us maybe what percentage of your hotel portfolio has changed ownership in the last couple of years, or maybe what your expectation is, just kind of directionally? And maybe if there was any brands that stand out in that analysis?

Vasant Prabhu

I think it'll be hard to give you a precise number, but it's not a large percentage. It's probably in the single digits, but we don't have a precise number here to give you.

Frits van Paasschen

Yes, but as we said, hotels obviously aren't trading and haven't for the last couple of years. So it would be a low percentage. Some changed hands through the distress process. And if that's your concern, what we've found is one of the last things new owners want to do or people that have gotten a hotel is debt holders, is to change the operator. So if anything, that's worked out well for us. And in fact, I think the two recent examples of a W Hotel and a Westin Hotel that went into host's hands recently is a great example of how, in fact, in some respects, these properties go to owners that we're very comfortable to work with. So no, we do expect that transaction volume will pick up. But that shouldn't have a dramatic impact on the underlying fundamentals of our Fee business.

Operator

And your final question comes from the line of Jeff Donnelly with Wells Fargo.

Jeffrey Donnelly - Wells Fargo Securities, LLC

Frits, I know the outlook for the global and domestic economy is arguably anybody's guess, but if you could look beyond what may or may not then prove to be I guess I'd call it a bubble in transient demand growth. Can you help us understand the longer-term commitment companies are making to travel right now? Is there data that you can quantify for us on the volume of your room nights on the books for periods, say out more than one year or longer compared to where that measure was back in say 2007? Like are we back to what it was before the downturn?

Frits van Paasschen

Yes, Jeff, I don't think I can give you a systematic answer to that. But what we continue to see -- first of all I think one of the things that's encouraging is the sectors that are growing, whether it's tech or banking or consulting, financials are the kinds of businesses that are more leading indicators than lagging was. What we also find in talking to our key accounts is one of the things that they're stressing is the continued globalization of their businesses. And one of the things that we're able to do with them is talk to them about the fact that our brands are so well distributed around the world. And so if anything, what we're seeing is a change in travel patterns, meaning more global travel around the world. We're also seeing more travel across markets. One of the things that's been very interesting for us to watch is the incredible amount of investment from China into Africa. And undoubtedly, what happens when you put a few hundred billion dollars into a market buying companies, you start to look at what you bought and how you can manage it, which means more travel. And so travel between emerging markets, which is something that hadn't been a major factor a few years ago. And then finally, you alluded to a bubble in occupancy. I actually think it's just a question of remembering how apoplectic and flat on its back the global economy was a year and a year and half ago. And a lot of what we're seeing now I think is just a restart of business activity. And inevitably, that business activity means more travel. As people start to focus, as many of you are on companies that are generating top line and not just continuing to develop earnings by reducing costs. And generating the top line, almost by definition means going out, making the sale, building relationships, holding meetings and having incentive trips. So we again feel that, that bodes well. So that even if we have a moderate recovery, I think business travel is on a trajectory that will continue to go up. And given the occupancy levels we've been talking about, it's a great story for rate. The other thing just to emphasize is because so few new hotels are being built at least in the U.S., we think it says a lot about what will happen to rate in the next two or three years. And then maybe just one final remark. The other thing that we see, and again I couldn't put a number on this for you, is the increasing outsourcing and relocating of workers both inside the United States and elsewhere. So as communication costs that have effectively gone to zero, people are working out of different places. And you might argue that means people would travel less but in fact, what we're seeing and we're hearing about from our customers is since someone who's a senior executive or a rising star is now based somewhere other than where they might logically be closer to their office, they're having to travel to visit that office in a way that they wouldn't have had before. So travel is definitely changing. I think travel intensity is staying at least as high as it was as a proportion to GDP. And I don't think this is a bubble. I think this is just a resurgence or a return to some level of normalcy.

Jason Koval

Thanks, Frits, and thanks to all of you for joining us today for our second quarter earnings call. Please feel free to contact us if you have any additional questions, and we hope you enjoy the rest of your day.

Operator

And this does conclude today's conference call. You may now disconnect.

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