Choice Hotels International (NYSE:CHH) recently announced that it will be taking on a $400 million loan at an interest rate of 5.75%. Normally, when I see a company taking on a loan of this size, it's because the company plans on expanding. However, that is not the case with Choice Hotels. The company plans on using the proceeds to pay for a $600 million special dividend to shareholders.
The dividend would be about $10 per share, and that's a significant amount considering the stock is around $40 per share. This is a terrible move by management, not because it is paying a special dividend, but the fact that it is taking on debt to do so. At a 5.75% interest rate, this is a very costly dividend the company is planning.
Management is not seeing the big picture here. At a 5.75% interest rate, the interest expense alone will be $23 million a year. The notes that are issued will not be due until June 2022. That is 10 years from now. So the interest expense for the 10 years will be around $230 million. Considering the loan is valued at $400 million, this transaction does not make any sense.
Management will reap no added benefit to the bottom line by paying out $600 million. It may make shareholders happy short term, but long term they will be disappointed. The balance sheet of Choice will deteriorate on this loan because the proceeds from the loan are not being used to purchase profitable assets. Once the news was announced, Standard & Poor's cut the bond ratings of Choice. Moody's followed soon after with a downgrade as well.
For those who want stronger exposure to the hotel industry, there are better companies out there. Two of the companies I would recommend are Intercontinental Hotel Group (NYSE:IHG) and Marriott (NASDAQ:MAR). Intercontinental pays a solid yield of 3.1%. Intercontinental has also been making a strong move into China, which has proved to be fruitful for the company. IHG nearly doubled its revenue from China since 2009.
While Marriott may not pay a dividend as high as Choice, Marriott is still run by a better management team. Management at Marriott plans to grow its dividend over time. The company recently just increased its dividend by 30%. This could be a great dividend growth stock for the future. Also, just like IHG, Marriott has been making a heavy push in China. The company plans to hire 30,000 workers there. This could be a great emerging market play as well.
Both Marriott and IHG are better investments than Choice. Choice's recent decision to increase leverage in order to pay a dividend means that management has no clear direction for the company. A $400 million loan could have many better uses than a one-time dividend. Investors will be better off by staying away from Choice Hotels. The company is intentionally weakening its balance sheet for the long term just to keep investors satisfied for the short term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.