Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Starwood Hotels & Resorts Worldwide (NYSE:HOT)

Q3 2011 Earnings Call

October 27, 2011 10:30 am ET


Frits van Paasschen - Chief Executive Officer, President and Director

Jason Koval - Vice President of Investor Relation

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


William A. Crow - Raymond James & Associates, Inc., Research Division

Joshua Attie - Citigroup Inc, Research Division

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

Joel H. Simkins - Crédit Suisse AG, Research Division

Steven Kent - Goldman Sachs Group Inc., Research Division

Robin M. Farley - UBS Investment Bank, Research Division

Joseph Greff - JP Morgan Chase & Co, Research Division

William C. Marks - JMP Securities LLC, Research Division

Shaun C. Kelley - BofA Merrill Lynch, Research Division


Good morning, and welcome to Starwood Hotels & Resorts Third Quarter 2011 Earnings Conference Call. [Operator Instructions] Thank you. I will now turn the call over to Mr. Jason Koval, Vice President of Investor Relations. Sir, you may begin.

Jason Koval

Thank you, Sylvia, and thanks to all of you for dialing into today's third quarter 2011 earnings call. Joining me are Frits van Paasschen, our CEO; and Vasant Prabhu, our Vice Chairman and 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 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. As in prior calls, today, I'll start by offering our perspective on global events and how they influence our business. Last time we spoke, the U.S. debt ceiling debate was in the news and today, all eyes are on Europe. And there is persistent talk of a possible hard landing in China. All this uncertainty eroded business confidence and global GDP growth has slid below 4% for the first time in 8 quarters. And while it seems unlikely, we can't rule out the possibility that today's issues are a prelude to a full-on double dip. What we can say is, that so far, this does not feel anything like 2009. And that despite the headlines, the impact on Starwood is far less dramatic than you might think. Even in a lackluster economy, both our corporate and leisure customers are doing pretty well and still traveling.

Right now in Europe, this caused austerity and weak recovery of slow demand growth, but the effect is neither drastic nor uniform across the region, and our business in many emerging markets continues along a strong trajectory. So with that as a back up, I'd like to turn to 3 topics for today's call. First, our recent results and an update on the current state of our business and pipeline. Second, a review of what we've accomplished since 2007 and why we're positioned for 2012 and beyond. And third, our outlook for the rest of 2011 and our preliminary view of 2012.

So let's start with our Q3 results. We beat the high end of our guidance EBITDA by $6 million and EPS by $0.02. Worldwide REVPAR grew by over 7% and tight cost controls helped to drive 140 basis points increase in GOP margins. Our results led the market in the developed world. North American REVPAR increased 8% with growth in Phoenix at 23%; Honolulu, 14%; San Francisco, 14%; and New York, 5%.

Europe's REVPAR grew by 7%, including Paris at 19%, Barcelona at 15% and Florence at 8%. And in Tokyo, occupancies are recovering well from earlier this year, but REVPAR was still down 12% compared to last year pre-disaster.

These results point to the resilience of both our fee businesses and the sustained growth in high-end global travel. We're confident that the trends will continue to work in our favor. And to explain why, let me reconcile the disconnect between dismal economic headlines and our trend lines.

Imagine a scenario, let's call it, Economy A, or the land of the haves. It has full employment, record low interest rates, corporations flush with cash and prospects for global growth. Economy A shows little slack capacity in our industry and no near-term growth. Well, Economy A pretty much sums up the high-end hotel business in the U.S. if not the rest of the developed world. Unemployment among experienced college educated workers in the U.S. for example, is around 4%. Affluent households have low personal debt and our corporate customers are enjoying another year of growth, with expectations for the S&P 500 profits to be up 13%. And travel continues to remain the key to their pursuit of growth around the world. In Economy A, we weren't surprised to see occupancies reach prior peak levels in the quarter and room supply is growing at scant 0.5%, which is a small fraction of its average over the last 4 decades. So the basic law of supply and demand would tell us the rates will continue rising. Eventually, they'll reach a point where they trigger new hotel development, but from where we sit today, supply growth remains years away as few new projects are being financed.

Unfortunately, there is also an Economy B and it's the land of have-nots. Unemployment remains high for those who are less educated or experienced and governments have limited availability to help. We’d love to see the situation change, which is why we've been so critical of U.S. Visa policy. The U.S. is missing a huge, an entirely self-funding opportunity to create jobs.

Here's what I mean. The U.S. lost 1/3 of its share of global travel over the last decade. That represents 1.3 million jobs, equal to about 20% of the 7 million jobs the entire U.S. economy lost during the crisis. This isn't a pipe dream. Here's a case in point. Today, 5x as many Chinese visit the U.S. as Europe -- excuse me, 5x as many Chinese visit Europe as the U.S. because it's far easier to get a Visa to go to EU countries. We, at Starwood, have been vocal with lawmakers in Washington, but it's frustrating for us not to mention the ranks of the unemployed, but this is not getting quickly resolved.

Meanwhile, the rapidly growing regions, those outside the U.S., Japan and Europe, are forging ahead. Rising economies are fueling both REVPAR growth and their pipeline. Major new travel patterns are springing up, spurred by travel and by rising wealth among billions of people. And we stand to benefit as these emerging travelers are loyal to brands they know from home and that speak to their needs.

And these dynamics are reflected in our Q3 results. Asia-Pacific REVPAR was up 16%, excluding Japan and Shanghai. Our Chinese hotels X Shanghai grew over 20%, led by Beijing at 24%.

Bali was up 49%; Jakarta, 14%; and Mumbai, 11%. Latin America is also booming with REVPAR up 19%; including Rio at 38%; Cancún, 29%; Mexico City, 25%; and Buenos Aires, 24%.

And we're happy to see that the long awaited lodging recovery in Mexico is beginning to play out. REVPAR for Africa and the Middle East was down 2%. But in countries not touched by political turmoil, REVPAR increased 6%, both Doha and Addis Ababa were up 30% and Dubai was up 12%.

Growth in Africa continues to reflect global demand for commodities. In North Africa in the Eastern Mediterranean, everything hinges on political stability and in the Gulf states, our footprint is expanding quickly. So sustaining REVPAR will depend on demand rising in tandem or ahead of supply.

Let me turn to our pipeline more broadly. We continue to reap the benefits of our work over the decades in markets all around the world. We stand on the shoulders of strong brand awareness, local smart operating teams and our reputation as a great partner. Now 80% of our pipeline lies outside the developed world, and get this, our emerging market pipeline is equal in size to 70% of our entire existing footprint in those countries.

On past calls, we've talked a lot about India and China, but we've always been quick to add that there are other dynamic countries and a recent visit to Indonesia highlights this point. Le Méridien and Sheraton have been active in these markets since the 1980s and we currently have 12 hotels. Among these are world class resorts in Bali like the St. Regis, the W Retreat, the Laguna Nusa Dua and the Westin.

We also have 7 Sheratons around the country and Le Méridien in Jakarta. Our Indonesian footprint is nearly the same size as Marriott, Hyatt and Hilton combined. We have 4 more hotels under construction and a burgeoning list of others on the way. For example, we just signed the W Jakarta and Le Méridien Bali. My read is that Indonesia is poised for long-term growth with a young and growing population of 240 million, natural resources and major tourist destinations. In 5 years, our hotel count there could easily double.

And these hotels represent high-value management contracts for 5-star hotels with first-dollar incentive fees. In valuing our global pipeline, remember that the average non-U.S. managed luxury contract is about 3x the present value per room of a typical American mid-market franchise. This underscores the value of our pipeline, which is comprised of 80% emerging markets; 84%, managed contracts; and over 75%, upper upscale and luxury hotels.

A couple of additional points regarding our pipeline. First, we have a track record of delivering growth. This year, we'll open about 80 new hotels, making for a total of 320 since 2008. This should give you confidence that the majority of the 350 hotel pipeline will open over the next 4 years.

Our pipeline and momentum also enable us to be very selective about the right partners and the right contracts. Over the long run, we've observed that it's far better for brands and owners to do the right thing than to compromise our standards for short-term gains.

And this longer-term perspective leads me right into my second topic for today, a look back on the progress we've made over the 4 years in transforming the company according to the Starwood journey, as we call our long-term strategy.

When I joined Starwood a little over 4 years ago, I saw 3 key ingredients to creating value for shareholders. First, leveraging innovative brands through a period of unprecedented global growth. Second, bringing discipline to the top line growth and controlling costs. And third, unlocking value while transforming to asset light.

So let me walk through each of these. During our third quarter earnings call in 2007, I mentioned that Starwood's high-end brands should allow the company to outperform over the long run. Major innovations like the Westin Heavenly Bed, W and SPG No Blackouts had set our brands apart. These brands were in a great place to benefit from rising wealth around the world.

Consider our luxury brands. W once known as a New York brand has more than doubled in size since 2007 from 20 hotels to 41, and it's gone global. The non-U.S. hotel count has gone from 3 to 13 hotels and with over 30 more Ws expected to open in the coming years, W is on track to be the first high-end brand created in the last 40 years to reach 100 hotels.

St. Regis has enjoyed a similar trajectory. In 4 years, St. Regis has increased its footprint from 13 to 24 hotels and with 17 expected to open in the next 4 years, the brand will have more than tripled in less than a decade. About 90% of these openings will be outside of the U.S. We also added 5,000 distinctive luxury collection rooms to our portfolio, including Equinox, the Chatwal and the Astor Hotel in Tianjin. So with our 3 luxury brands, we've taken the largest portfolio of luxury hotels and grown the room count by 73% in just 4 years.

Turning to Westin. The brand's positioning around renewal has turned into a global category killer. Since third quarter 2007, we've grown Westin by 35% of markets outside the U.S. This includes 29 hotels in new markets such as India, Dubai, China and South America. Our innovations at Westin and W have also helped us rethink the Sheraton Grande, leading to the Lincoln Sheraton and revamping club force. These concepts were coupled with nearly $10 billion of investment by us and our owners to reshape the hotel portfolio. We took out 60 properties, renovated well over 100 and added 80 new hotels. And the result as we've been reporting for a while is record highs in guest satisfaction, meeting planner satisfaction and likelihood to return.

On a REVPAR index basis, we've gained 300 basis points worldwide since relaunching the brand at the start of 2010.

We've also been hard at work on our next slate of innovations. Aloft just celebrated its third birthday and has already passed the 50-hotel milestone.

With Q4 openings in Colombia and Costa Rica, Aloft has also gone global right out of the gate across North America, and into Europe, the Middle East, Latin America, India, Southeast Asia and China. Aloft has redefined its category and in our view, is at least as disruptive to its concept as the W is to Luxury.

Regarding Element, I can honestly say that this brand is ahead of its time as the first select serve green brand and it's already delivering. In fact, the brand resonates so well that many travelers choose Element over competing full-service hotels at comparable rates.

Innovation is as important to SPG as any of our hotel brands. They pioneered No Blackouts, full access to luxury properties and its unique SPG Moments program. Another point of differentiation is summed up by our more luxury and more locations campaign.

These features have helped drive enrollment, promotion and global relevance. The result, SPG’s share of occupancy is up 34% to 50% in just the past 5 years. Today, we have 35% more active members than in 2007, a non-U.S. membership is up 67%. Soon our non-U.S. membership base will be larger than our U.S. base.

So why does this matter? Simply put, SPG members spend more money and stay more. They're also the best insurance against hard times. In 2009, non-SPG room nights were up 9%, but SPG nights were actually up 2%.

So I hope this gives you the sense that the innovative spirit is not only alive and well at Starwood, but driving results. It's our nature to see what's happening in the wider world and to take action. This spirit is behind our going to the White House to shut down the rhetoric against travel, speaking out on national television in favor of tourist Visa reform, bringing our top 100 leaders to China, temporarily moving our headquarters to Shanghai and shifting almost 90% of our marketing spend to digital platforms and social media. Incidentally, we now have 1.5 million fans through our social media outlets.

The second big opportunity I saw in 2007 was great potential to bring more discipline and alignment to our innovative spirit. Through our rigorous AVA process, for example, we were able to reduce our SG&A by $100 million. And those savings have held even while the hotel count has grown by 20%.

As another example, our lean operations efforts have realized $100 million in savings across 90 hotels in North America alone. But discipline and alignment aren't just about efficiency. We've also successfully rolled out our up-to-date revenue management systems to our hotels. We more than doubled the reach of these systems over the last 4 years to 530 hotels today. We've invested about $100 million to support our proprietary websites as well. To borrow a phrase, where you book matters, which is why savvy travelers book where they can get the best rates, SPG points and access to more properties. And that's why our own websites bring in about 3/4 of our total online revenue.

We've also taken the same discipline to building alignment and a culture that lets our associates be their best. We measure this through our annual Star Voice Survey. This year, 96% of our 145,000 associates weighed in and for the fourth year in a row, we saw a significant increase in engagement. For the second year in a row, we reached record-high results. So why does this matter? It's a simple premise. Happy associates mean happy guests, stronger brands and better returns. And note that guest satisfaction at our hotels, and that's including 880 same-store hotels, has risen in each over the last 4 years and is now at record levels.

The third opportunity I saw in 2007 was unlocking value by selling owned hotels and moving towards our goal of being 80% fee-driven. In 2007, fees drove 45% of EBITDA before overhead. In 2011, we're on track to be over 60%. Despite the most difficult period for lodging in our lifetimes, our fees have increased by 13% since 2007. And we've reduced our fixed asset base during this tumultuous period. Our asset sales have averaged a multiple of 19x EBITDA and that doesn't count the value of renovation commitments or the value of management contracts. Our vacation ownership team has returned $700 million in cash to the company net of capital over the past 3 years.

These efforts leave us with a strong balance sheet, net debt under $1.7 billion. We've also invested significantly in our own hotels, IT infrastructure and the build-out of Bal Harbour. In an uncertain world, our approach continues to be plan for the worst, but be on offense.

So we'll continue transforming to asset light, using our best judgment to balance timing, proceeds, partners and management contracts.

Right now, we're seeing weaker demand for hotel sales. The strongest buyers over the last couple of years has been the public lodging REITs, and they’ve pulled back. But we can afford to be patient. Our business model is resilient, thanks to a fee-based that's 75% top line driven. Even our incentive fees are less volatile as they are almost entirely based on first-dollar fees and are geographically dispersed.

In my remaining comments, I'll turn to my final topic of today, our outlook for the rest of 2011 and for 2012.

We see the balance of this year in line with what we've said in our Q2 call. In fact, it's essentially in line with what we expect for 2011 at this time last year. Full year EBITDA of $980 million to $990 million, and that's up 12% over last year before adjusting for asset sales, not to mention North Africa and Japan, which would have added, by the way, about another 500 basis points to EBITDA had those not occurred.

EPS will come in at around $1.75 to $1.79 for growth of over 40% and fully REVPAR remains at 7% to 9%.

Overall, for 2012, group pace is up mid-single digits, corporate rate negotiations are only just beginning but unlike last year, our customers expect higher rates as they see occupancy and virtually no new supply in key cities. As you may have seen in our earnings release, occupancy is at levels now where historically rates have always risen. And that's why we are targeting negotiated rate increases close to double digits. Bear in mind, we're still recouping rate loss during the downturn. Our worldwide REVPAR range of 4% to 8% reflects a sustained recovery at the high end and a more anemic one at the low end. It does not, however, contemplate Iraqi Lehman style resolution in Europe. We're not anticipating one either, but our balance sheet is set to manage through such a scenario.

REVPAR at 48% would be consistent with EBITDA of $1.03 billion to $1.12 billion and EPS of $1.96 to $2.25 per share. These numbers include an estimated impact of about $20 million from completed asset sales this year, planned renovations and foreign exchange.

REVPAR growth implies a continued growth in market share of at least 100 basis points, and it implies rigorous cost control. You'll note that between 2010 and 2012, we expect SG&A to be up only about 2% to 3% per year. We plan to reinvest significantly in our own hotels as Vasant will detail in just a few minutes. This will detract from EBITDA in 2012, but importantly, will position us well when the time comes to sell assets.

Also, we're going to continue to step up investments in technology and systems as they form a critical part of how we plan to gain more share.

We expect to have ample cash from these investments, generated by operations, Bal Harbour and time share and as a reminder, we don't budget for asset sales. So if the transaction market improves, any sales will be an additional source of cash.

So let me close my remarks by simply saying that we find ourselves entering 2012 in great shape. Our revenues are increasingly fee driven, our team has never been better aligned, and our properties are creating brand loyalty like never before. And at the same time, our balance sheet and strong cost discipline had prepared us for whatever may come.

So with that, let me hand it over to Vasant.

Vasant M. Prabhu

Thank you, Frits, and good morning, everyone. The high anxiety about the global economy in newspapers and TV news channels is not evident in the actions of global corporations and the global business traveler at this point.

Q3 REVPAR globally was up 7.4% in local currencies and 11.6% in dollars. Our EBITDA and EPS once again exceeded the high end of our outlook range. Global owner REVPAR at Starwood branded hotels was up 9.2% in local currencies, 16.2% in dollars.

Good cost control pushed owned margins up 265 basis points. Owned EBITDA was modestly below our expectations due to some soft spots in London and Rome, as well as the stronger dollar. We had healthy fee growth of 16.8% despite the drag from North Africa and Japan. X North Africa and Japan, fee growth would have been 250 basis points higher. The Vacation Ownership business remains stable, with good door flow and close rates. SG&A benefited from lower incentive compensation accruals relative to last year, as well as the translation benefits of a stronger dollar. We gain market share globally, once again, all in all, it was a good solid quarter from our standpoint.

So what is the state of our businesses as we enter the last leg of 2011? In North America, our company operated REVPAR was up 8.5% with rates up 5.1% and occupancy at 76%. Transient REVPAR grew 9% with group REVPAR up 7%. Company-operated GOP margins were higher by 200 basis points. Group base heading into Q4 is good with more than 90% of group business already on the books.

Secondary indicators like leaves and cancellations also remained positive. Transient booking momentum remains strong and at this point, we are not seeing any changes in trend.

As such, we are projecting that Q4 REVPAR growth in North America will remain generally in line with what we saw in Q3. We are closely watching Canada, which is showing some signs of softness partially due to the strong Canadian dollar.

While Europe has been the epicenter of the current crisis, we did not see it in our business in Q3. Q3 REVPAR was up 7.7% in local currencies, modestly below Q2 levels. The rate was up 5.2% with 1.8 points of occupancy growth. However, we have seen some softening in booking trends as we entered September. As such, we are projecting that Q4 REVPAR growth in Europe will be in the 3% to 4% range.

At this point, it is too early to tell if this is a generalized trend or some local soft spots. Hopefully the announcement last night on the euro rescue plan will improve business sentiment in Europe.

REVPAR in Africa and the Middle East declined once again in Q3, but the rate of decline moderated meaningfully from Q2 levels. As you all know, the situation in North Africa remains unstable and we do not expect to return to normalcy anytime soon.

Year-over-year fee growth comparisons will suffer in Q4 since we do not expect to earn any incentive fees in North Africa, which are generally recorded in the fourth quarter.

In total, our 2011 fees in North Africa will be down $10 million, which is in line with what we had estimated early this year.

Asia continued to power along in Q3 with local currency REVPAR at company-operated hotels up over 9%. X Shanghai, which had the World Expo last year, REVPAR across Asia was up 15.4%.

China related economies was strong, while India was soft. Japan is slowly recovering with domestic travel coming back, but international travel remains subdued. The full year profit impact of Japan remains at around $20 million as estimated earlier this year.

As we enter Q4, booking pace remains on trend, leads are up and cancellations are down. India is weak and Thailand is severely disrupted by the floods. As such, we expect a small sequential slowdown in Asia REVPAR growth in Q4.

Latin America had a very good quarter with 24% REVPAR growth and good margin gains. We do not expect this level of growth to continue into Q4 based on current booking trends. Nevertheless, Latin America will grow in the double digits.

Finally, [indiscernible] tours are up as of close rates versus last year. The business remains stable and predictable. We hope to complete the securitization in the fourth quarter if turns are attractive. Default trends continue to improve and are now at 2006 levels.

Assuming we complete the securitization, SVO will generate over $200 million in cash in 2011. Our 2011 EBITDA is expected to come in at $980 million to $990 million in the middle of our original outlook range we provided you at the start of the year. Our REVPAR growth is as projected in the 7% to 9% range in local currencies. Volume in our margins will be up by 150 to 250 basis points, again as expected. SG&A will increase 3% to 4% for the year. SVO will be at the high end of expectations.

Year-to-date, we have opened 53 hotels and remain on track to open approximately 80 hotels in 2011. Our Q4 EBITDA range of $270 million to $280 million was negatively impacted by $4 million to $5 million since we last spoke due to the strengthening of the dollar. Owned EBITDA in Q4 will be negatively impacted by approximately $8 million versus last year due to renovations and preopening costs at our new St. Regis Bal Harbour.

In the fourth quarter, we will recognize income from Bal Harbour residential unit closings in addition to our core EBITDA. I will discuss this in more detail later.

Moving on to our outlook for 2012. It goes without saying that there are risks and uncertainties aplenty as we try to look ahead 4 quarters. First, I'll outline the reasons for optimism. Our focus on global corporation and high-end traveler, our Best-in-class brands and global footprint, especially in emerging markets, the unprecedented lack of new supply in developed markets, the inexorable rise of middle classes in emerging markets. The big unknown is the global economic outlook, it's impact on corporate profits and as a result, on demand for travel.

As such, we are providing a broad range for 2012 at this point. The upper half of our 2012 range corresponds to the continuation of a normal cyclical recovery in lodging. Since early 2010, we've had a textbook lodging recovery very much in line with past recoveries despite subpar GDP growth in developed markets.

At this point, as evidenced by our Q4 outlook, that trend remains intact. 6% to 8% REVPAR growth and the upper half of our EBITDA range would be in line with this Q4 momentum being sustained through 2012.

However, the events of the past few months have highlighted the risks of this scenario. Declining trust in governments, the impact of de-leveraging by consumers and the general uncertainty this has resulted in could cause businesses to pull in their homes as we enter 2012. This could lead to the much talked about new normal scenario of low global growth. This outcome would correspond to the lower half of our REVPAR and EBITDA ranges.

If we actually have 4% REVPAR growth, the bottom of our range, owned EBITDA growth becomes hard to realize despite our cost containment initiatives. SVO was relatively flat in all scenarios, in synch with our strategy for this business. So whatever we grow -- whatever growth we get at a 4% REVPAR scenario will have to come from our fee business.

These 2 scenarios are captured in the outlook range we provided. If the crisis in Europe moves to an acute stage causing another global recession or another global financial crisis, then the 2012 REVPAR and EBITDA will be below our ranges.

At this point, and especially after the actions announced last night, these outcomes appear very unlikely. We have made sure that we're well-prepared from a liquidity and leverage standpoint should a worst case scenario play out. By the time we talk to you again in early February, we will have another 3 months to track the recovery trend, more clarity on the results of corporate negotiations, more group business on the books for 2012 and hopefully, a satisfactory resolution of the issues in Europe.

This year, we started out the year by giving you a REVPAR range of 7% to 9% and an EBITDA range of $975 million to $1 billion and we will finish right in the middle of that range while absorbing the impact of Japan, North Africa in asset sales. We would be delighted if 2012 proves to be as predictable as 2011 was.

One point to note is that on a year-to-year comparison basis, our EBITDA outlook range for 2012 is negatively impacted by approximately $20 million due to asset sales, renovations and exchange rate shifts.

We will have some significant capital projects underway next year, including the shutdown of the Gritti Palace in Venice and the Maria Christina in Spain. Major renovations will also be on at The Westin Maui, The Westin Peachtree and the Sheraton Rio. We are also shutting down 2 other hotels in the U.S. to convert them to Alofts.

In terms of exchange rate impacts, as we have done for the past several years, we'll hedge about half our euro profit exposure in 2012 at 1.44 to mitigate the euro risk as best we can.

Not included in our 2012 outlook range is income from residential unit closings at Bal Harbour. TCOs are coming in as planned and we anticipate starting closings in mid-November. We have been in contact with buyers and expect that we will have several closings before the end of the year. The bulk of the closings with contracts previously signed will be in 2011. There will be significant revenue income and cash from Bal Harbour in 2012. We will provide more details on all this in February. We will separately identify Bal Harbour numbers, so you can clearly track performance of our core hotel business.

As Bal Harbour flows through our income statement, it will affect our reported tax rate and our interest expense as capitalized interest is expensed. We will walk you through all this on our next call.

In the final analysis, it is all positive. Bal Harbour will add to our revenue, earnings and cash in 2012. For 2011, we're estimating approximately $10 million in earnings, $0.03 in EPS and $30 million in cash. The numbers of 2012 will be substantially higher.

We continue to expect that we will generate almost $1 billion in revenue from selling all 307 condos at the St. Regis Bal Harbour. By the end of this year, we expect that 70% of this value will be under contract. Average price per square foot on units under contract exceeds $1,300. Sales have been robust year-to-date in 2011, well above our initial expectations. And since we are close to completion, we've asked for and received almost 50% in cash deposits on 2011 contracts. The spectacular 210 room St. Regis Bal Harbour Hotel, which we will own opens early next year adding to the many iconic St. Regis hotels we opened worldwide over the past 3 years.

All in all, we feel very good about this project, but would like to wait until February to provide more specific numbers on revenues, earnings and cash flow in 2012. The expectations with total cash proceeds from sellout of Bal Harbour as provided at our Investor Day last year remain unchanged.

Finally, we finish Q3 with cash in excess of working capital needs of almost $1 billion, and net debt noninclusive of vacation ownership receivables of under $1.7 billion.

Our net debt-to-EBITDA ratio stands at 1.7. Our priorities for cash used remain reinvesting in our business to drive growth in our pipeline and our owned hotels, paying down maturing debt and returning cash to shareholders. We will shortly announce our 2011 dividend and we'll execute start buybacks as we have in the past if our criteria are met.

With that, I will pass this back to Jay.

Jason Koval

Thank you, Vasant. We now like to open up the call to your questions. So in interest of time and fairness, please limit yourselves to one question at a time and then we'll take any follow-up questions you might have as time permits. Sylvia, could we have the first question please?

Question-and-Answer Session


Your first question comes from Joe Greff from JP Morgan.

Joseph Greff - JP Morgan Chase & Co, Research Division

Vasant, with respect to your 2012 outlook I know you touched on it a little bit but can you help us understand what kind of foreign currency assumptions you're making there and then with respect to 2012, you touched on capital investments going up and being fairly meaningful. Can you help us understand that even if it's more directional with what you've spent in 2011 or plan to spend in 2011?

Vasant M. Prabhu

Yes. The first one on foreign exchange, Joe, we don't view ourselves as being forecast as a ForEx. So typically when we talk at this time of the year, we assume current rates continuing. Current maybe a little lower in the euro than it is exactly today. So assume it is high 130 on the euro and roughly where the rates were, let's say, 1 week or 2 ago. In terms of capital, yes, we will have some significant projects underway. We, as you know, we have some capital needs in these hotels. We will sell hotels as we have in the past if a new owner is willing to put the capital in. In total, between ForEx and capital impact and asset sales, we estimate it at approximately EUR 20 million a year impact. I then throw the fact that we will have several hotels shut for renovation. A couple in Europe, a couple in the U.S. And then we have some major renovations in other hotels. So you should expect that our capital spend year-over-year will remain high. The Bal Harbour spend will come down, but some of the capital on owned hotels spend will go up.

Frits van Paasschen

Yes, I might just add to that to too the philosophy behind that. As I mentioned in my remarks as is I'm sure many of you are watching, the transaction market for hotels today is very slow and certainly well below its peak from 3 or 4 years ago and since we have the cash and we know that there's a broader set of potential buyers when you have a hotel that's already been renovated because one of the things you do is you take whatever renovation risk out of the picture, you also take whatever approval or any other uncertainties out and not only do you have a broader baseline of buyers but also the potential for a higher rise. So our point of view at this point is we have the balance sheet flexibility to invest in creating a slate of hotels that are in great shape with a proven track record and as Vasant mentioned, if the transaction market picks up more quickly in 2012, we may turn some of these projects over to a potential owner in the same way we did with St. Regis Aspen just a little while ago.


The next question comes from Bill Crow from Raymond James.

William A. Crow - Raymond James & Associates, Inc., Research Division

Two questions. Vasant, first, if you could give us some idea of cash flow -- free cash flow next year after CapEx? And inclusive of Bal Harbour that would be terrific. And then second, China and other fast-growing markets, the REVPAR growth has been terrific. Has the dramatic inflation in expenses especially labor in some of those markets caused would-be developers to pull back at all?

Vasant M. Prabhu

On free cash flow for next year, I'll give you some rough estimates right now, we'll certainly give you more as we get to next year. Despite the increased CapEx that we talked about, there will be of course a reduction in Bal Harbour in terms of capital needs and there will be cash from Bal Harbour. We would estimate free cash flow at least in the $250 million to $350 million range after payment of dividends. So maybe a little higher than that once you consider dividends. So let's say $350 million to $400 million free cash flow. As far as China goes and Frits I'm sure will add to this, our wage rates at our hotels, we're not minimum wage. Our people need a certain level of education, need some proficiency with English. We've always been above the minimum wage. Yes, there's the inflation, but the wage rate, I mean, the labor costs as a percentage of total revenue remains quite low in China. And so far, it has not had meaningful impacts on hotel performance, nor have we seen that as a reason for why people would pull back from hotel construction.

Frits van Paasschen

Yes, and, Vasant, as predicted, I'll add a little bit to the China story as we spent a considerable amount of time there over the past few year. The inflation in the development side has still not compromised the economics of building hotels in China and that's true for a few reasons. First of all, historically, the cost to build a hotel in a per room basis compared to the U.S. is half or less. And so it's still relatively inexpensive to build. The second is generally now, we're seeing development in the second and third tier cities and often times what we're seeing are land that's otherwise undeveloped being put to use with a mixed-use development. And the consequence of that is as developers speak with the government, who typically would be owning the land, they're able to get a very favorable land price. And so because they will be creating value through the overall development that they're doing. So on a development basis, the economics are still quite favorable. On an operating basis, we're seeing GOPs on average in excess of 40%. And so the return side still looks very good.


Your next question comes from Robin Farley from UBS.

Robin M. Farley - UBS Investment Bank, Research Division

Two things I wanted to ask. One is can you give us a sense of how group bookings came in during the quarter versus the same time last year? And then also your SG&A guidance for the full year being up at 3% to 4% is flattish year-to-date. And so that seems to imply like maybe a 15% increase in Q4? I wonder if you could give some color around that.

Frits van Paasschen

Robin, I'll take the first one on group bookings. Our pace going into the fourth quarter is up roughly 6% with the majority of that being rate driven. We continue to look for higher rate of business. So we're pushing for rate and occupancies and year-over-year gain in room nights is roughly flat. Vasant?

On SG&A, there's always a little bit of movement quarter-to-quarter of some expenses. And so I wouldn't make too much of that. What we look at is our corporate headcount and our overall trend line SG&A spend. And I think the important take away is from -- in 2009, we made a significant reduction in costs with the new run rate that you saw starting in 2010. And essentially, we haven't grown, at inflation since then and would anticipate that also for 2012 as well. So Q3 to Q4 is of anything, a timing issue and the important take away here is overall what the trend line is.


Your next question comes from Shaun Kelley from BofA Merrill Lynch.

Shaun C. Kelley - BofA Merrill Lynch, Research Division

I just wanted to touch on Europe a little bit more. You mentioned in the prepared remarks that you had seen some demand slowdown there. Could you talk a little bit more about specifically where you're seeing some of those issues? And then what is contemplated in your 2012 guidance? You said 3 to 4 for the fourth quarter. Is that similar to what your expectation is in 2012 for Europe?

Vasant M. Prabhu

Yes, the soft spots as you may have noted in some of the comments we made at this point in places like Rome and London, what we don't know is if this is just a few scattered soft spots. We don't know if this is a sustainable trend. I think it's too early to -- I'll give you a fairly broad range for 2012. You should assume that in the broad range, we would expect some of our emerging markets to be at the upper end of those ranges. We would expect the U.S. to be somewhere in the middle of those ranges and clearly Europe, to be in the lower end of those ranges including the Middle East. I mean, in North Africa, we're not expecting any fast recoveries. So something along those lines, but we'd prefer to talk more about all of this if we can be more specific in early next year.

Frits van Paasschen

Yes, I think the other take away on that is as you look at next year, there isn't a lot of downside if REVPAR is flat line in Continental Europe because that would be factored into the ranges that we've given. The other thing to remember is that a big part of what drives our European business are the leisure segment, particularly in the locations in Spain, Italy and Greece. And so while those countries overall certainly have had their share of sovereign fiscal challenges, the demand for hotels in some of those markets has held up reasonably well. And I think one example of that clearly would that be the St. Regis in Florence, which has opened very well or the W in Barcelona, likewise.


The next question comes from Steven Kent from Goldman Sachs.

Steven Kent - Goldman Sachs Group Inc., Research Division

Since you're already back at 2007 occupancy levels, or pretty close to it, what are you telling your hotel managers about pricing for ADR into 2012? And I seem to remember at one point, that the both of you or the 3 of you have all said that you tell your managers that the peak of '07 is not really the peak, that the margins and pricing can go much higher. So I just wanted to understand sort of what you're telling the people on the line, at the property level versus your own views here. And then just separately, what are you seeing outside the room spend from groups? Are people starting to spend more money on food and beverage, other things as you see activity on the group level?

Frits van Paasschen

Yes. So, Steven, this is Frits, and I think there was a wise analyst who put out a report that said that management has little to gain by offering precise predictions. So -- just kidding but -- hey, look, here's what we're doing philosophically. We do believe that with occupancies where they are, particularly in North America, and for that matter, even in Europe, that it's all about rate now and that obviously the profitability of higher rates in terms of flow-through is that much better than occupancy. And given the strength and momentum in our brands, and the build in SPG, we have an opportunity to be pretty bold on the rate side. Now we don't have that kind of influence over the franchise properties but what we are doing increasingly is using our revenue management system, which is a way of forecasting load and elasticity and giving our leadership at the property level more confidence in setting rates that might be above where their gut feel might put them at. And then finally, what's almost most important right now is not what we're telling our GMs or our sales teams on property but what we're doing in terms of corporate rate negotiations and group sales. And making sure that we're leveraging the fact that we do have high occupancies today. To your point, the 2007, while the most recent peak, was not a true peak because it was not a full completion of a business cycle. And so we have a great opportunity there and that's philosophically the way we're taking things. In terms of extra F&B spend, we're seeing some strength there. We've also worked, by the way, on continuously improving our margins from our Food & Beverage in our catering operations. And so even if we weren't to see a complete recovery on the spend there, we're absolutely seeing better flow-through from what we have. I think Jay wants to add something the top line part on F&B. So I'll give it to you, Jay.

Jason Koval

Sure, Steve. Just one quick follow-up. One way that you can look at how the other spend is doing is look at the delta between our owned REVPAR growth and what the owned revenue growth was. And in the first quarter of the year, that delta was about 350 basis points and it was closer to 200 basis points in most recent quarter. It's a slow steady improvement in other spend. We're certainly looking to charge our groups for meeting space and AV equipment and keep more of that F&B in-house when they book events and not just look for rate. But there is steady progress there.


Your next question comes from Bill Marks from JMP Securities.

William C. Marks - JMP Securities LLC, Research Division

You made some comment on dispositions, long term goals, selling assets. I am wondering how you think about that in the near-term with a stock valuation where it is and potentially using proceeds in the near term to buy back stocks?

Frits van Paasschen

Yes. Look, I think those are related, but separate questions. From the asset disposition side, you're absolutely right. There's arbitrage we think between today's stock price and the inherent value of our assets. But there is, I guess, what you might describe as a theoretical valuation for hotels and an actual one should you go to market. And we're in close touch with asset buyers around the world. I mentioned publicly-traded U.S. REITs, but for that matter sovereign well funds, high net worth individuals around the world, private equity firms, other institutions and so forth. And the demand and the confidence right now still isn't there. If for no other reason because of the financing market today, and I think from a U.S. REIT market perspective, since equity is an important part of how they finance their deals and their stocks have taken a hit along with the broader sector, the opportunity to sell right now, candidly, isn't one that we think is very strong and that we've rather hold -- invest in our assets and find a time where we can get a strong price. And the reason, I mentioned the average multiple, the EBITDA in my comments for what we sold over the last 4 years is to give you confidence that the reason we're not selling faster isn't any fundamental reluctance to sell, but a belief that there is a time, a place, a buyer, a contract that makes optimal sense. And from what we're seeing right now, the current market isn't really there. As far as stock buy backs, I think Vasant has put it well in the past and it's something we said very consistently that once we've gotten to investment grade, once we feel like our balance sheet is where we want to be, should we come into considerable cash throughout the dispositions, which is an eventuality, then we would certainly look at ways to return cash to shareholders and we've talked about dividends, special dividends, buybacks, looking at investing in our business, of course, as being the top priority. And we'll continue to have the same philosophical approach.


Your next question is coming Joel Simkins from Credit Suisse.

Joel H. Simkins - Crédit Suisse AG, Research Division

You already addressed London to some degree in your earlier comments. I was hoping you could give us some more color on New York particularly given that in the market lead the recovery on the demand side. Obviously, Wall Street looks like it's going through a soft patch right now, there was a lot of supply absorbed this year. What would your expectations be for this market into 2012?

Vasant M. Prabhu

The occupancies in New York are very high. As you saw in Q3, New York was among the stronger growth markets. Having said that, I mean, the trends are fairly good in New York. We're not concerned about it. It has absorbed most of the supply that it had. It is a global city, definitely depends on Wall Street. So there will be impact if there is a significant shrinkage on Wall Street. There will be impact if financial market activity whether it's roadshows, IPOs, debt deals, et cetera are not significant. But it is much more than the financial services industry in New York. We are not expecting New York to be the leader in terms of REVPAR growth as it was in the start of the recovery. It tends not to be when you are at that stage of the recovery.

Frits van Paasschen

Yes, just to amplify that, Joel, New York blazed the way for the recovery early on. It was very strong. And the dynamic of the financial service industry is obviously a challenge for the lodging market overall. But I would also point to the fact that not only is New York resilient, but it's economic base is increasingly diverse. And by that I mean also across different parts of the city. And I would point you to the opening of the Aloft in Brooklyn, the opening of the W in Hoboken, which, I guess, technically isn't New York City, but you know what I mean. And for that matter, also the opening of the Sheraton and Aloft in Brooklyn. So all of those submarkets are fairly distinct and not necessarily as directly driven by what's happening in the financial community. And in fact the performance of New York because of the inbound tourist flow, if we can get Visa reform, which would allow more people to come in, New York would be literally one of the first ports of call. And I think if you look at the overall number of visits into New York, which is getting close to 50 million and essentially already where it was in '07, New York is strong, will continue to be that way but probably off of a higher base, not the same kind of percentage growth that we saw earlier in the recovery.


Your next question comes from Jeffrey Donnelly from Wells Fargo.

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

Two-part question. I know you're not in the market, but how wide do you think the price per key [ph] gap is between your expectations for your owned hotels versus what you think a buyer would pay you today. And then looking to longer term, you have significant recurring cash flow proceeds in Bal Harbour and obviously the possibility of continued asset sales. You've got the potential to generate significant cash over the next several years more than you can probably invest back into the business. Is your philosophy to reduce leverage as the cycle matures, shrink the company to repurchases, if the price is right. Or maybe growth through RAND acquisition. I'm just curious what your preferences are longer term beyond the next few months.

Frits van Paasschen

Yes, first on the bid/ask spread. This isn't a liquid market where we see trades day to day. We have a good sense from each of our properties for having studied them what the capital needs are, what the likely REVPAR numbers and cash flows would be depending on which scenario you pick overall. And therefore, a pretty good sense of what we would want to sell each of our hotels for, recognizing the time value money impact and therefore that a lower price today in some respects may be more attractive than a higher price tomorrow. But I'm going to back to it again. If you look at what has happened to transaction volumes for hotels between 2007 at the peak and the trough at the crisis, the market was off by more than 90%. And while the market is considerably higher than it was on the base, it's still not even half the transaction volume from where it was before. And it's generally true in real estate that transaction volume is a good leading indicator for price which would tell you that there's still a long way to go for transaction volume to recover and therefore also to see prices increase. And with hotels today still trading generally at a pretty decent discount to replacement costs, our point of view isn't so much what's the bid/ask spread today as the expectation for what we could get for these hotels tomorrow net of the time value of money. In terms of the long-term view to cash and the fact that we're coming into a lot of it, Vasant talked a bit about that and I'm going to hand it back to you if you want to more or less restate some of our thoughts about that and maybe going back even to the host transaction where we had exactly this scenario.

Vasant M. Prabhu

Yes. I mean just walking through sort of the way we think about use of cash in a little more detail. Obviously, we said job one is reinvest in our business for growth. We don't have as many owned hotels as we had before. Therefore there isn't going to be a large quantity of the capital required in owned hotels, plus we will be selling them down. We've already stepped up our investment in renovating owned hotels. So there's a certain amount of capital needed there, which might be lower if we sell these hotels sooner. The fee business as you know for growth doesn't need a lot of capital. A couple of hundred million dollars a year is probably as high as it gets. The Vacation Ownership business we are not in a mode where growth is sort of job one, it's more about a stable business that generates cash. So I think from the standpoint of our business, we always said that we wanted a business as we transitioned it that was a good cash generator while delivering growth. So we remain interested in acquisitions that complement what we have. You saw this in Le Méridien the last time around, we will look at those if the price is right and its complementary. Certainly more brand, not interested as much or is not a priority for us to be buying real estate. So that's -- so you can see sort of where the priorities would be in terms of reinvesting in our business. In terms of the leverage, we've stated that our goal is to be a solid BBB. So it's not like we intend to de-leverage significantly beyond that on any kind of permanent basis and we will be solid BBB we think hopefully in the next 12 months or so, which then leads you to returning cash to shareholders which we did in substantial quantities coincident with the asset sales in the last 5 years. We did that in many different ways, and we will do that again. We are definitely a dividend payer and we'll be looking at increases in dividends. We'll shortly announce our 2011 dividend, and we will be looking at other ways to return cash to shareholders once we tick through the other priorities which can be buybacks or other means and we always focus on looking at intrinsic value as we look at buybacks. So hopefully that helps frame how we approach it.


Your next question comes from Josh Attie from Citi.

Joshua Attie - Citigroup Inc, Research Division

I have 2 questions. First, how much of your billion dollars of cash, if any, is located in international regions and would be taxed if you repatriated it to the U.S.? And second, where are your credit metrics today versus where you think they need to be to get a BBB rating?

Vasant M. Prabhu

Yes. On the cash outside the U.S., it's minimal. And we can find ways to repatriate it. Right now as we speak, it's about $100 million in cash out of the $1 billion that sits outside the U.S. specifically in Australia, a little bit in Europe, a little bit in Canada. We can repatriate it through intercompany loans if we choose to. So there really is no trapped cash outside the U.S. And on the second question?

Joshua Attie - Citigroup Inc, Research Division

Credit metrics.

Vasant M. Prabhu

Credit metrics, yes, solid BBB the way the rating agencies calculate it which is very different than a simple net debt-to-EBITDA calculation would be somewhere in the 2.5x to 3x debt-to-EBITDA range. And we should be in those ranges based on current trends by the latter part of next year.

Frits van Paasschen

I want to thank all of you for joining us today for our third quarter earnings call. I know you have a busy earnings calendar today, and we appreciate your interest in Starwood Hotels & Resorts. If you have any other questions, feel free to reach out to us. Take care.


Ladies and gentlemen, this does conclude today's Starwood Hotels & Resorts Third Quarter 2011 Earnings Conference Call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!

This Transcript
All Transcripts