Strategic's Management Present at Deutsche Bank Hospitality & Gaming Conference (Transcript)

| About: Strategic Hotels (BEE)

Strategic Hotels & Resorts Inc (NYSE:BEE)

Deutsche Bank Hospitality & Gaming Conference Transcript

November 10, 2011 1:05 PM ET

Executives

Diane Morefield – Chief Financial Officer

Analysts

Tim Wengerd – Deutsche Bank

Tim Wengerd – Deutsche Bank

Welcome back from lunch everybody. My name is Tim Wengerd. I cover lodging here at Deutsche Bank with Carlo Santarelli with me right now is Diane Morefield, the CFO of Strategic Hotels. And before we get started just one note, there are cards like this in front of you and on these cards, there's a URL that allows you to post the anonymous questions and they will come up here to this IPAD and I can sift through them.

So about, about 20 minutes in I'll look to this bulletin board and see what your questions are. And with that, why don't we start with the thing that's on everyone's mind right now, this past week Strategic made an offer to for just some preferreds and why don't we just start by asking Diane and what she can tell us about that offer.

Diane Morefield

Okay. Sure. For those of you who have been following Strategic Hotels & Resorts, I'm sure you're well aware that we have been in a major balance sheet restructuring phase pretty much since the beginning of 2010.

We, at the beginning this is year, made a decision to early accelerate all of our debt maturities that actually were back ended maturities in 2011 and throughout 2012. And luckily we decided to go to the market and refinance all of our debt, that debt done literally the last deal closed, the last week of July just as the debt ceiling crisis elevated and the capital market shutdown.

So with all of the debt refinancings behind us and pushed out well into the future, the last stage of our balance sheet restructuring is our preferred stock. As of the end of the year, we will be 12 quarters in arrear on our preferred dividends and we also have looked at the level of preferred stock on her balance sheet and made a determination that we would like to right size it to a lower level than $370 million of par value on the balance sheet today.

So we on Monday went out with a formal tender that is two fold. We are offering to tender between roughly 3.7 million and 4.8 million shares of our preferred stock. It is at a price to the premium toward the stock had been trading and it's roughly between 25% and 33% of outstanding preferred.

If the tender is successful, we will pay -- we've declared that we will pay the catch-up dividend on the shares outstanding effective on June 15th for payment on June 29th of 2012, and that dividend is contingent on the tender being successful at its minimum level.

So that is the last stage in step of our balance sheet restructuring and we have plenty of liquidity to cover this tender with $300 million line of credit that is zero of it is outstanding other than the $2 million letter of credit and we have roughly $80 million of unrestricted cash on our balance sheet effective 9/30.

Tim Wengerd – Deutsche Bank

Thanks, Diane. And with that let's move into the 2012 outlook. Operators have offered a much wider guidance range heading into 2012 while the pace of group booking still looks good. At this point, what big picture trends make you optimistic about lodging in 2012 and what makes you more cautious.

Diane Morefield

Okay. Well, I mean, we are cautiously optimistic actually. We've -- we announced on our third-quarter call our group pace or group pace remains very healthy, year to date in 11 our group room nights are up 6% at rates higher, 5% higher than same time last year, and then for next year already are group pace for 2012 bookings is up 6% room nights and there is anomaly in two hotels that had very high rated group business this year that's bringing down the rate to 1%. However, if you exclude those groups, it's more like 8% in rate, so group pace is still very strong.

What, causes us to be cautious is on any given day, there's -- the stock markets down or there's uncertainty, in August, there was more talk of a risk of a double deep recession that seems to have subsided again, but generally we're seeing in our businesses and our bookings pretty favorable turns.

Tim Wengerd – Deutsche Bank

And then the strength of business transient this year has been particularly good. It's probably a story of 2011. How are changes in the mix of business affecting your portfolio right now and there's a little bit of talk on this on the third quarter of call, but is there any sort of potential that the AIG effect reemerges and that corporates are reluctant to spend at a nice resort.

Diane Morefield

Yeah. We are not seeing corporate group business pull back at all in '08, '09 and into the 2010, certainly financial services pulled back and there was an AIG effect. Financial services had always been the second largest category of our group business and our hotels that had dropped to 4 during those years. It's back up to 2. So we think that's behind us with most of the banks obviously paying back their TARP money.

So and then pharmaceuticals is our largest category. But group what we are experienced in our demographic generally whether it's group or transient is very healthy. Corporate America is generally healthy. They have a lot of cash, they're running their businesses and they're having group events.

And the transient business travelers very strong and then our transient leisure traveler we haven't seen any pull back either. So I think it's partly unique to our portfolio being high-end but the demographic of our underlying customer or guest is generally very healthy and so I think that's why our trends are holding up.

Tim Wengerd – Deutsche Bank

Okay. Just a little more on the group business you know one thing that our airlines analysts have been saying is that in the airlines are seeing a massive sort of diversions between bookings from financial services companies and companies that are in business services like consultants and et cetera.

Consultants are booking very strong whereas financials are sort of flat and you mentioned pharma was number one, financial was number two, sort of water that next sort of group categories below after that or what are other major categories?

Diane Morefield

Yeah. What is insurance consulting firms, tech, I think is three actually, particularly in our West Coast portfolio of assets. So it's sort of the usual suspects. I think the chain and all of those types of industries were doing group business even 08/09 is just a financial dropped pretty significantly in the number of groups that they booked.

Tim Wengerd – Deutsche Bank

Okay. And then looking at 2012, where do you see the best EBITDA growth opportunities in your portfolio, which hotels have particularly good upside potential over the next few years?

Diane Morefield

I think, generally, we're seeing the California -- Southern California properties come back stronger this year and into next year partly because they didn't really recover last year as much as East Coast markets and Northern California did.

So probably if you're saying looking out over the next year, they probably have a little more upside because their comp isn't as difficult as some of the other markets.

Tim Wengerd – Deutsche Bank

Yeah.

Diane Morefield

And generally though we're seeing good RevPAR growth, we announced in the third-quarter that five of our hotels had over 15% RevPAR growth and those were actually from variety of markets from Scottsdale, California, DC, Chicago was under 15%, but very strong RevPAR growth this year as well.

Tim Wengerd – Deutsche Bank

Okay. And then moving on from that, what transient you're seeing at your Oceanfront Hotels in Southern California that you touched on a new supply, especially in California is?

Diane Morefield

Yeah. Non-existent.

Tim Wengerd – Deutsche Bank

Yeah. It's just not there. Leisure demand in Southern California seems to be pretty good in 3Q. It wasn't just your portfolio with Sao I think also had a lot of strength in Southern California. How are booking trends for these hotels and Southern California and how much of it is occupancy growth compared to rate growth?

Diane Morefield

Well, the one that really stood out an occupancy growth as Ritz-Carlton Laguna Niguel that's come back very strong. Again it was harder hit in the downturn, so it's really -- it's just regaining I think what was more of a normal stabilized business.

The Dale is doing very well, particularly in transient with and even Northern California both Ritz-Carlton Half Moon Bay and Western San Francis are both really having great years. So we're seeing California again it was lagging but now it's coming back very strong.

Tim Wengerd – Deutsche Bank

Okay. And then some of the other markets, can you talk about Chicago, DC, New York Scottsdale, Punta Mita, London.

Diane Morefield

Yeah. New York, we're not in so.

Tim Wengerd – Deutsche Bank

Right. Not an issue.

Diane Morefield

I hear it's a strong market, but we don't have any hotels there. Chicago has come back, I think that surprised us a little bit on the upside because city wide conventions are still below what they had been in peak years, but Chicago has very strong group business, very strong transient.

I mean it's obviously the financial for the Central America or center of the states, it's a huge financial market, so a lot of transient business travelers with the group on IPL, maybe there is a lot more coming this year to Chicago.

But and DC, our DC asset obviously is an anomaly from what I think a lot of the other companies are saying about DC where there's some softness, we have no sort of government per diem business of the four seasons DC. So it's really more lobbies foreign travelers and again in the third-quarter DC had over 15% RevPAR growth. So that market is very strong for us.

Scottsdale is coming back nicely this year. We're doing a major ballroom, additional ballroom there that won't be ready until fall of next year. But already I think our RevPAR growth in double digits. So far this year once the ballroom opens we think Scottsdale has a lot of upside potential.

Tim Wengerd – Deutsche Bank

Okay. And that will be -- is it going to be mostly complete by the end of next year?

Diane Morefield

Yeah. Fall of 2012 opening, so as you go into the high season in Scottsdale for the late 2012 and into the 2013, early 2013 will have two ballrooms and will be able to really increase group business capacity.

Tim Wengerd – Deutsche Bank

And how about London, I know Startwood on their conference call. They said that they starting it around September, they noticed a little bit of weakness and they weren't sure if it was trend yet or if it was just a sort of localized, you're already seeing anything, what are trends like in London?

Diane Morefield

Yeah. London, third quarter our RevPAR growth there was certainly below the rest of our portfolio. Again, whether that was just more of a blip, but generally our London asset is doing very well.

We have over 50% gross operating profit margin in that asset. It's roughly $15 million of EBITDA year. So it's very strong for us, we're not seeing weakness and if it's little bit below some of our other assets, again we don't think that's anything long-term.

Tim Wengerd – Deutsche Bank

Okay. And then, I mean, I guess, since we're talking about London on the asset sales side. I think London is one that you've said that perhaps you would be looking to sell, I guess how are you thinking about that, I don't think you, there's no rush to sell it.

Diane Morefield

Right.

Tim Wengerd – Deutsche Bank

But and especially it seems like right now cap rates are sort of backed up a little bit and the spread between what buyers are willing to pay?

Diane Morefield

Right.

Tim Wengerd – Deutsche Bank

And what sellers are looking for is definitely widened?

Diane Morefield

Yeah. On London, we are not proactively marketing the asset for sale. We've certainly put out there that if we get the right offer on London, we will sell it, in longer term we would probably completely exit Europe, which is what we announced about a year and a half ago. And we pretty much effectively have exited Europe, except London.

But, again, London provides terrific EBITDA and cash flow to the company, great margins. It's actually an easy asset to manage all the CapEx has been spent on it. We upgraded all the rooms. We took the parking garage it was the basement level and turned it into meetings rooms in the Marriott Gold Room. So there's no capital that we spent on it and it's a very profitable asset.

And for us in a lot of ways it's a proxy for not having New York, because London and New York have a lot of the same characteristics. So by owning London, in a sense it's sort of making up for not having an asset in New York.

Tim Wengerd – Deutsche Bank

And then on the capital investment side, can you talk about I think especially in the third quarter call, you talked a little bit about the projects that you have in-house that can add? And that the ROIs are actually pretty good?

Diane Morefield

Right.

Tim Wengerd – Deutsche Bank

Michael Jordan Steakhouse is one, the wine shops, can you talk about just how many of those projects you have, if that's where you'll allocate capital?

Diane Morefield

Right. And we definitely will. This year we've spent about $22 million in owner funded capital. The bulk of it was the room renovations in Miami, which has had a very positive effect. We're really are group pace for next year has up, because we're bringing in meeting planners and they're seeing the new room and the facelift, and it shows very well. And then the Michael Jordan Steakhouse was the other main project this year.

We'll probably spend a similar level sort of that $20 million in owner-funded capital next year. We have at any given time probably 10 to 12 ROI projects on our list that we're always analyzing, so for next year when more finish last third of the rooms in Miami.

And then we're looking at potential additions of these, wine bars which have been very successful in several of our hotels. We're looking at adding one in D.C., one in the Western St. Francis and in San Francisco. We may start a staged room renovation for the intercontinental in Chicago on Michigan avenue we're analyzing that.

But we underwrite those as we would any -- acquisition or capital expenditure and if it doesn't have at least sort of a mid teens ROI cash yield, we're not going to do it. But the nice thing is a lot of what we've spent money on like [INOs] have proven to have that kind of yield, so they're sort of tested concepts that we consider for other hotels.

Tim Wengerd – Deutsche Bank

Okay. And so it would be around $20 million, $21 million.

Diane Morefield

Yeah. It probably still…

Tim Wengerd – Deutsche Bank

Okay.

Diane Morefield

Not huge dollars and curbed projects barely minimal, some of these only $2 million or $3 million projects.

Tim Wengerd – Deutsche Bank

Okay. See -- where are we?

Diane Morefield

I can't see.

Tim Wengerd – Deutsche Bank

Checking to see if we have any questions.

Diane Morefield

Okay.

Tim Wengerd – Deutsche Bank

All right. We don't have any on the wall yet. We can take a few live if that's any one has questions. I think there's a mic around. All right. We'll keep moving along.

The near-term debt maturities were handled quite nicely, you guys did a really good job with that.

Diane Morefield

Thank you. I didn't pay him to say this.

Tim Wengerd – Deutsche Bank

That appears to be up lodging cycle to sort of gradually lower leverage at this point, will Strategic begin to look more closely at acquisitions. Are there any particular markets that you'd like to enter like New York?

Diane Morefield

Yeah. Again, I mean, our near term priority is to handle the preferred stock the tender and what not. But looking out into next year for acquisitions, we're always going to look at opportunistic acquisitions, Laurence Geller, our CEO is really also effectively our Chief Investment Officer, very well connected throughout the industry.

And we're always talking and we're always keeping a pulse on what's being marketed or you just for obviously market intelligence. I think for us we have 17 hotels. So overtime even if we add two, three, four hotels it's meaningful to our growth and to our size.

When you're looking acquisitions the first thing is going to be the qualitative serve, it's going to have to be upper scale or high-end. We have that highest end portfolio in the public markets and we're not going to do with the quality of the portfolio.

The second criteria is really going to be location. We're going to be in great geographies, Gateways cities, high barriers to entry. So in the markets we're already in, where we could add additional assets like Washington, DC or Miami, or even the Chicago, or entering new markets like we're not in Boston, we're in New York. So those are the sort of targeted geographies that anything were to present itself those would be attractive markets and again we're still look in California.

And then, finally, of course, it's ultimately though, if it makes those criteria, which is the sort of the first thresholds then it's going to be the, what are the economics of the deal. What's the unlevered IRR, what's the cap rate, what's the going in accretion and yield? So, it's, I think we feel like over time there will be opportunities, but we are currently not in a sort of proactive acquisition mode.

Tim Wengerd – Deutsche Bank

Okay. And then I'll just check again for questions, do we have any more questions. All right. I think on the acquisition front, the ones that you did early this year with the Four Seasons and Silicon Valley, and also on Jackson Hole. Do you see, foresee doing more acquisitions like that where you used equity to sort of -- to basically buy a hotel which -- you give the owner equity as part of the purchase?

Diane Morefield

Yeah. Again, each deal is going to be unique and it's going to depend on who the seller is and it certainly would greatly depend on where stock price was. So, we could use stock as currency but that's only going to be if the stock is at a price that makes sense to do it. And again it's going to depend on the seller and do they want to take a position in Strategic. So it's just going to case specific.

Tim Wengerd – Deutsche Bank

Okay. All right. Well, we'll check again for questions and if not I'll…

Diane Morefield

Somebody – somebody have a question.

Tim Wengerd – Deutsche Bank

Give you the opportunity to sort of if you have anything that you think investors are really missing about your story. What do you think is the biggest thing you think people are missing?

Diane Morefield

Well, I mean, one of the things we point out, there's a couple things. First, I guess also to close the loop-on growth and acquisitions. I mean we have dealt in growth. We have a lot of embedded growth and lot of runway in this recovery without the need to actually buy growth.

So that's certainly and that couple with ROI projects are going to make a big difference in our EBITDA growth. The other things we talk about are supply. There's absolutely zero supply. And given that the capital markets have really tightened again. We just don't see any new supply coming on the market in our geographic markets or again in our abrupt scale, luxury type hotels, any time soon, likely for years.

And that is really an unusual -- unusual to this cycle versus any past cycles. So, we think you know we're going to be able to push rate luxury demands are already beyond what it -- peak to know seven. So demand is back, there's no new supply and that's going to really help us to continue to push rate.

And then the other thing we talk about is if someone were to build a new hotel, the cost is probably about $750,000 a key without land and we trade around $400,000 a key. So we're still well below certainly what the replacement cost of our portfolio is and overtime, if you do see development that's sort of an indicator that the economics makes sense to build the hotel at 750,000 a key, which would indicate that our, we should be closer to that as well.

Tim Wengerd – Deutsche Bank

All right. Well.

Diane Morefield

Okay.

Tim Wengerd – Deutsche Bank

Yeah. We have nothing. Well, yeah, I do have a question here, the post of the downturn and now with improved margins, what specific areas are there where Strategic can cut cost and improve margins?

Diane Morefield

Okay. We already, we cut a lot of the fixed costs or a layer of the fixed overhead of all the hotels in the downturn and that's going to stay out of this system. Clearly marginal costs go up as occupancy goes up.

But again, we're going to, I think our margins going to improve just because generally and what we're seeing and what we'll continue to see is that our EBITDA growth is running at about 2 times our RevPAR growth.

Our margins this year were up over 200 basis points and right now our margins -- our EBITDA margins for this year, we gave guidance it's going to be around the 21% to 22% range. Peak EBITDA margins were 28%.

So again just with the way we manage cost, the way we asset manage and push rate even more than occupancy that's going to drop to the bottom line and improve our margins more quickly.

So we feel very confident we'll go back to sort of that peak EBITDA margin and likely exceed it particular with supply staying out of the equation. So we could even see EBITDA margins a couple of hundred basis points above that at some point.

Tim Wengerd – Deutsche Bank

Okay. And then like you mentioned earlier group rates are trending up around 8% if you back out some of the business that you got at the Four Seasons in DC, at an 8% rate growth even if occupancy is flat, what sort of flow through do you think you could get?

Diane Morefield

Well, when, it's more weighted towards a rate growth, the flow through is more like sort of 70% to 80%. Whereas we tend to when we give guidance use assumptions of about 50% flow through. So you'll get in enhanced margin expansion when you have a higher one more that's been rate.

Tim Wengerd – Deutsche Bank

Yeah. That I mean that makes sense. I mean I think that's what we've heard from a lot of people on the third quarter conference calls is that, even if occupancy is flat you get such good flow through on rate that it should be…

Diane Morefield

Right.

Tim Wengerd – Deutsche Bank

I mean that's really the story for 2012.

Diane Morefield

Right.

Tim Wengerd – Deutsche Bank

And then, how is the recent Jackson Hole acquisition and any -- are there any expectations for the asset given the upcoming ski season?

Diane Morefield

I think we're anticipating it would be strong. I know both Silicon Valley and Jackson Hole have performed better than our original underwriting. I would say Silicon Valley at this point is even performed -- outperformed pretty significantly and a lot of that was on pushing rate, and of course the tech industry is very strong and that's a lot of who the customer base is in that asset, Jackson Hole, everything I've heard is it's on track to have a great bookings during ski season.

But I don't know anybody know what the snow is going to be I think that -- partly drives it but I think there's a, yeah, both of those assets are performing ahead of our expectations, and as you know we bought those assets at about 15% of cost so they were tremendous buy.

Tim Wengerd – Deutsche Bank

At what percent of cost, sorry?

Diane Morefield

About 50% of cost.

Tim Wengerd – Deutsche Bank

About 50% of cost. Yeah. I know, so I saw a weather forecast and it's supposed to be a week only in a year which is usually good for snow.

Diane Morefield

What we've heard we're going to be clobbered in Chicago which isn't really good, because we don't really ski there. We just have to try and get to work.

Tim Wengerd – Deutsche Bank

And then, what's the seasonality like if that asset, is that, I mean, mostly sort of fourth quarter and first quarter, and then much business in the summer.

Diane Morefield

Yeah. And, no, great summer.

Tim Wengerd – Deutsche Bank

Yeah.

Diane Morefield

Actually it's sold out in the summer because it's near national parks and there's always outdoor activities. So we actually closed the hotel two months of the year that they're called mud season. So in the spring for month and I guess in the fall, but summer is actually almost as strong as ski season maybe not as higher rates, but I know occupancy is pretty well sold out in the summer.

Tim Wengerd – Deutsche Bank

And Punta Mita's had some issues I guess because, well, it's in Mexico and Mexico has a reputation right now, it's really hard to get over the security concerns.

Diane Morefield

Right.

Tim Wengerd – Deutsche Bank

I mean, I guess, how do you look at that asset going forward, is that something that, if it doesn't improve would you consider selling it or sort of at the point now where, that where you have to sell it for, it's just not even worth trying to sell it?

Diane Morefield

Well, I mean, we think Mexico is going to come back eventually. We've been very disappointed this year it's the only hotel in our portfolio that's really underperformed, whereas most of the others have actually outperformed our early expectations.

So we when enter the year just to give you a prima reference Four Seasons Punta Mita which have -- you've never seen that asset, it's amazing, it's paradise. And it had peaked -- in peak years it was doing about $23 million, $24 million of EBITDA. Last year 2010 it did about $12 million.

So we really thought being 50% off of its high that had bottomed and we went into this year forecasting it would do about $13.5 million, so start to improve on the margin and we just saw this was announced on the third quarter call, are forecast now for the full year this year for Punta Mita is about $7 million. So it's been disappointing. It's really out of our control. It is the continued headlines on violence in Mexico, which is affecting all Mexican resorts. It's not unique to our asset.

And I just think, certainly corporations and group business there's none, because there's no upside for a company to send a group to Mexico. And the transient traveler, we still sell out at Christmas and over thanksgiving and I think the more sophisticated transient traveler are ones that go to Mexico all the time, now it's not unsafe, when you're in those resorts. But you're not getting any marginal travelers, which is really hurting and you're not getting group business.

Having said that we don't, next year it'll be another (inaudible) year until there's the election mid-year. Longer term, it's a terrific asset and again even with these much lower EBITDA levels it's still very profitable. It's probably 45% to 50% gross operating profit margin.

And our basis in the asset is in the low $70 million range. So even at $7 million you're getting about a 10% cash yield. So we don't where -- we're happy but we think it will recover and we think long-term it's a very valuable asset.

Tim Wengerd – Deutsche Bank

And how are trends recently, have you seen are they starting to pick up, I mean, if it's to the point where it's kind of hard for it to get worse, it could actually, it could be upside, there could be upside next year if things just.

Diane Morefield

Yeah. It's hard to predict next year. The holiday season again is sold out and it's fine, it's more it's what's it going to do in 2012 and I think it's just too early to tell. But what we are doing proactively is trying to sell the resort more to a Mexican National because there was always almost a wholly U.S. traveler, who was the guest there.

So we're trying to really sell it to Mexican travelers, as well as South American. So we're trying to at least do what we can, but we're going to really need the U.S. traveler to come back for that to pick up.

Tim Wengerd – Deutsche Bank

Okay. And then moving on to dividends, switching topics a little bit, but on dividends assuming you bring the preferreds, declare the preferred dividends for next June. After that how do you think about the dividend policy for the common equity?

Diane Morefield

Well, obviously our goal is to get back to paying the common dividend. We have a covenant restriction in the line of credit. We have to hit a certain fixed charge coverage hurdle to be able to pay a common dividend. So we would have to get back to that.

And as you say the preferred dividend would have to be caught up. So I can't predict a time but I can tell you it's a priority to ultimately get back to paying a common dividend.

Tim Wengerd – Deutsche Bank

Okay. And I'd just on the dividend policy, like in the past have you set dividends just looking at FFO, as a percent of FFO or as a percent of cash available for distribution.

Diane Morefield

Yeah. It would really be based on the cash available for distribution.

Tim Wengerd – Deutsche Bank

All right.

Diane Morefield

After the preferred dividend which again with the tender if it's successful we'll have right-size the level of preferred and we'll decrease the preferred dividend which again frees up cash for a common dividend at some point.

Tim Wengerd – Deutsche Bank

All right. Well, thank you, Diane.

Diane Morefield

Thank you.

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