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I work for a small long/short, value-oriented investment partnership. On the long side, we prefer to invest in high quality businesses that possess discernible competitive moats, which operate in industries with reliable, growing end markets. For short positions, we generally look for companies... More
  • Why Eagle Preferred Shares Could Triple 9 comments
    Sep 26, 2012 7:20 PM

    Disclaimer: The investment fund I work for is long shares of EHPTP. This report is not a recommendation to buy or sell any securities. The author and/or employer may buy or sell shares in any company mentioned, at any time, without notice. The information contained herein is believed to be accurate as of the posting date. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information.

    On September 10th Eagle Hospitality announced that it had reached an agreement with its lenders permitting the company to sell its portfolio of premium hotel properties and repay debt owed to Blackstone at a discount. Commenting on the agreement, Marc Beilinson, Eagle's chief restructuring officer stated, "It's a great outcome that is beneficial and allows Eagle to enter a robust, wide-ranging marketing program with the opportunity of paying off Blackstone at a meaningful discount to the debt's face value." In response to this news, Eagle's preferred shares (EHPTP) proceeded to jump 75% over the next week to $5.50/share. Considering the strong characteristics of the portfolio and robust market hotel market, we believe that considerable upside remains. Though not without risk, total recovery for EHPTP shareholders could exceed $18/share. Recovery at $25 par is not out of the question.

    The Portfolio
    Eagle Hospitality owns 13 premier branded hotels with a total of 3,538 rooms. The properties are diversified amongst large MSAs (Boston, Denver and Phoenix), second tier and suburban locations (suburban Chicago, Cincinnati, Tampa and Cleveland) and a destination hotel and casino in San Juan, Puerto Rico. With $77MM spent over the past four years on capital expenditures(+$20k/key), the hotels are in very good condition and each carry strong brand-name flags, with eight branded as Embassy Suites, two Marriott, two Hilton and one Hyatt. As evidenced by their 75.4% occupancy levels (690 bps higher than the average full service hotel), $129 average daily rate (ADR) and 15.9% EBITDA growth in 2012, the hotels are well positioned in their respective markets. In 2012 the portfolio is expected to generate over $45MM in NOI.

    The Hotel Market and Implied Value
    Real estate investors use a number of metrics when valuing hotel properties. The three most common approaches include using a multiple of total room revenue, cap rate of NOI and price per key. While no single metric is sufficient to determine the value of a portfolio, using all three can help triangulate a reasonable estimate of value.

    According to Smith Travel Research, in 2011 the average upscale hotel transaction was completed at a multiple of 4.86x annual room revenue. Considering that Eagle's portfolio averages $50k/key in annual food and beverage revenue (3.5x a typical full service hotel), a multiple above this average would likely be warranted. At 4.86x and a $97 RevPAR the portfolio would be valued at $172k/key, or $608MM.

    Through the first half of 2012 the average cap rate for full service hotel transactions was 6.9% (based on data compiled by RealCapital Analytics). Looking at the twenty or so transactions I have been able to identify with confirmed cap rates, over the past year and a half cap rates on Embassy Suites transactions have average 7.5%, Marriott's have averaged 6.8% and Hiltons have averaged 8.3%. Based on my conversations with market participants, cap rates for most properties in the portfolio would likely come in near 7%, while others would be closer to 8%. Using a 7.25% cap rate on 2012 NOI of $45MM would value the portfolio at $620MM.

    Lastly, it is worth looking at valuation in the context of per key prices. In 2011 the average upscale hotel sold for $217/key (Smith Travel Research US Hotel Operating Statistics Study). In 2012 there have been a number of portfolio transactions involving similar assets with values anywhere from $150k/key to +$330k/key (DiamondRock, Apollo and Inland Real Estate Group have all been active buyers). Based on a review of announced portfolio acquisitions and individual transactions, a per key valuation of $170k to $190k seems like a good range (San Juan and primary market locations would likely fetch +$300k/room, while the Midwestern properties would likely come in at the low to mid $100k range). This would value the portfolio between $600MM and $670MM.

    When taking into account market transactions, portfolio fundamentals and current financing environment (real estate financing is cheap and REIT equity values are strong), a valuation of $615MM to $630MM seems quite attainable.

    The Debt
    Eagle's debt consists of senior mortgages and mezzanine financing. The total par value is $609MM. The loans were acquired by Blackstone earlier this summer from the Federal Reserve Bank of New York in the wind-down of the Maiden Lane fund. Blackstone paid $468MM to acquire the obligations, obtaining a $350MM loan from JP Morgan and contributing equity for the remaining $138MM. The note matured on September 9th, at which time Blackstone had the option to either pursue foreclosure or negotiate a workout; obviously the second option was selected.

    At first one might ask: why would Blackstone willingly take a discount to par? We think the nature of the investment vehicle - an IRR-driven private equity fund - is a big part of their rationale. If Blackstone were to have pursued foreclosure the process would likely have taken over a year. While full recovery would be very likely, the process would not only have required significant time and resources, it also would have had an adverse affect on the investment IRR (which determines the GP promote). As an example, if Blackstone accepts a 10% discount to par and the sales process is completed by the end of 2012 they will book nearly a 70% IRR on the investment. Alternatively, if they pursued foreclosure and the process drug out until the end of 2013, assuming another $17.5MM in interest expense and $10MM in legal fees, their IRR would be cut to just over 35%. For a manager incentivized to get through a return waterfall as quickly as possible, we think accepting a discount to par makes a lot of sense.

    As for determining the size of the discount Blackstone agreed to - your guess is as good as ours. Our view is that the discount is likely around 10%. At that point Eagle is sufficiently incentivized to maximize recovery and Blackstone can still post a very nice return. Anecdotally, Beilinson's comment above was that the discount is "meaningful". Arbitrarily, a discount of less than 10% doesn't seem very meaningful.

    Available Cash
    You might have noticed that financials are not publicly available for EHPTP. In order to obtain financials you have to send a request to the company, along with proof that you are a shareholder. As background, in 2007 Eagle Hospitality's equity was acquired by a joint venture between Apollo, Aimbridge Hospitality and JF Capital Advisors. The preferred shares, however, were not redeemed and continued to trade. Following the acquisition the company "went dark", meaning that Eagle was no longer subject to SEC filing requirements (for those who like me are not familiar with this process here is a pretty good presentation:

    As a result, the company no longer files current reports with the SEC and restricts dissemination of information to existing shareholders. Furthermore, when financials are delivered they are accompanied by a confidentiality agreement prohibiting the recipient from disclosing the company's financial information. While I cannot discuss the details of the company's financial status, I think a reasonable person would deduce that there is a good chance there will be significant cash available for distribution once the debt is paid off (and likely cash available even if Blackstone were to take back the keys). If you add in cash generation from the first nine months of 2012 then you get even more cash available for the preferred shareholders.


    With 4MM preferred shares outstanding, this is the valuation walk I get:

    Hotel Sale Proceeds$625,000,000
    Transaction Expenses (3% of Proceeds)-$18,750,000
    Net Proceeds$606,250,000

    Par Value of Debt$608,000,000
    Debt Repayment$547,200,000

    Net Proceeds$59,050,000

    2012 NOI YTD$33,750,000
    Less: Interest Expense-$15,000,000
    Less: Cap Ex-$5,000,000
    Available Cash from 2012 Operations$13,750,000
    Total Available for Preferred$72,800,000
    Units Outstanding4,000,000
    Recovery per Unit$18.20

    This does not include available cash beyond what has been generated year to date. Additional cash available could be quite significant.

    Clearly the biggest risk is that the sales process is unsuccessful and Blackstone ends up taking back the properties. In this outcome there likely would be some cash available for distribution to preferred shareholders. It is possible that available cash exceeds the current share price, but it could also be less.

    This is not the most straightforward process. There could be unforeseen risks related to the wind-down that I have not considered.

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Comments (9)
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  • pone
    , contributor
    Comments (707) | Send Message
    Assume the preferred must be paid in full before equity gets any return. In your envisioned scenario the preferred get a partial recovery of par and no accrued dividend. Apollo must therefore take away nothing as the equity owner?


    How can we count on Apollo to act against their own interests in protecting recovery for preferred?
    27 Oct 2012, 05:11 AM Reply Like
  • bgoud007
    , contributor
    Comments (80) | Send Message
    What's Apollo going to do? If there's no equity, there's no equity, They could take the cash and try to grow it and eventually create some equity, but that's an uphill battle as preferred dividends will continue to accrue.
    6 Nov 2012, 02:44 PM Reply Like
  • pone
    , contributor
    Comments (707) | Send Message
    I worry about the first five words of your third sentence: "They could take the cash...."


    Preferreds need to have substantial representation from someone who would litigate if they tried any tricks.
    7 Nov 2012, 02:05 AM Reply Like
  • bgoud007
    , contributor
    Comments (80) | Send Message
    I was not implying that they could steal the cash from preferred holders. Esopus Creek Capital is a major holder of the preferred and elected 2 directors to the board, so there is already representation on the inside.
    7 Nov 2012, 01:03 PM Reply Like
  • mandjb
    , contributor
    Comment (1) | Send Message
    Wrong on all counts. Wipeout.
    11 Dec 2012, 01:45 PM Reply Like
  • pone
    , contributor
    Comments (707) | Send Message
    I interpret this result to mean that the equity holders just didn't try very hard to sell the assets. They didn't have any economic incentive to do so since they were working for preferreds. Maybe this is their way of flipping the bird at the preferreds. Committed suicide?
    11 Dec 2012, 09:15 PM Reply Like
    , contributor
    Comments (7) | Send Message
    I’m speculating on what happened here.


    Apollo and Blackstone made a deal. Apollo knew there was no possibility of getting any payment on their equity and they didn’t want any risk that their “bad boy” clause might trigger. Blackstone wanted to own these hotels on the cheap, at say, $132,000 per room (price of note purchase from FRBNY).


    To give Blackstone what it wanted, Apollo gave a sweetheart forbearance agreement in September that made it impossible to maximize value within a short period, plus allowed Blackstone to take all the cash with the keys, and never need to go to court to perfect the foreclosure or legitimately auction the properties. As part of the deal, of course, Apollo eliminates the bad -boy risk.


    So, despite all the analysis here on cap rates, room values, cash build, this was all a setup from the start with a fictitious attempt to sell the hotels to maximize value.


    Am I warm or cold?
    18 Dec 2012, 01:54 AM Reply Like
  • pone
    , contributor
    Comments (707) | Send Message
    Hank, I think you can be correct in the theme without our ever knowing the details. My concern was also that Apollo had the wrong incentives here for them to work a deal on behalf of preferred shares. I expected a different kind of trick and was surprised to see no offer for the assets.


    Did Apollo receive indirect compensation for giving away those assets? If yes, did they fail in a fiduciary obligation by doing so? Someone with a good lawyer would need to go after them on behalf of the preferred's estate. It's a tough case to make but I don't know the specifics.


    Another approach here might be to put together the investor group that buys the hotels and try to put that in front of the judge prior to a foreclosure, or try to get any agreement to give up the properties reversed. Not sure if that is possible at this point.


    While I liked this story, I'm big on understanding incentives. When a story relies on a big powerful entity to act in your interests instead of their own, I know where that usually ends.
    18 Dec 2012, 03:15 AM Reply Like
  • laterre
    , contributor
    Comments (650) | Send Message
    A fascinating case, and I've also been scratching my head at how this all played itself out: the trifling 3 month "extension," the non-existent cash, the bankruptcy bluff that folded with the keys just being handed over. Who were the big losers, the secret winners? Ah, to be a fly on the wall...or a lawyer with discovery motions.


    And speaking of incentives, something about this never smelled quite right, beginning with all the conspicuous chatter about these preferreds.


    Imagine the following purely hypothetical game theory proposition. For an average cost of $1, I can buy a security with a highly asymmetric risk-reward set of 0 or $15. It's not a continuous distribution, but binary: I'll either get the $15 or I'll get diddly squat. Provided there's a modestly plausible scenario for the $15, I take that bet all week long and Sundays.


    Suddenly, though, voila and something changes. Now I have the option to take $5 (for a guaranteed 400% profit!) or wait around to find out what's behind Door #2. Selling off even 30% of my holdings takes me out of that original binary scenario and into a new opportunity set whereby with heads I win a little, tails I still win an awful lot. Who wouldn't rationally migrate from scenario A to B?
    23 Dec 2012, 02:55 PM Reply Like
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