Extended Stay - No Value In This Hotel IPO At This Point In The Cycle

| About: Extended Stay (STAY)
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Extended Stay America (NYSE:STAY) made its public debut on Wednesday, Nov. 13. Shares of the owner and operator of company-branded hotels in North America ended their first day with gains of 19.3%. I think shares are already valued fairly high at these levels, given the current earnings multiples and this point in the cycle. I remain on the sidelines.

The Public Offering

Extended Stay owns and operates 682 hotel properties comprising some 75,900 rooms in 44 states across the U.S. and Canada. The company operates 630 of these properties under the Extended Stay America brand, serving the mid-price extended stay segments.

The hotels are designed to provide affordable and attractive alternatives to traditional lodging or apartments, targeting self-sufficient and value-conscious guests. Besides targeting the leisure segment, the company also focuses on business men on long term assignments. The efficiencies of having a longer stay makes the segment attractive according to Extended Stay. The average length of stay was 28 days in 2012, compared to just 2.5 days for traditional hotels. This was combined with higher occupancy rates.

Extended Stay sold 28.25 million shares for $20 apiece, thereby raising $565 million in gross proceeds. All of the shares were being sold by the company, with no shares being offered by selling shareholders. Initially, bankers and the firm set an initial price range of $18-$21 per share. Shares were eventually sold just above the midpoint of the preliminary initial public price range. Some 14% of the total shares were offered in the public offering. At Wednesday's closing price of $23.87 per share, the firm is valued at $4.77 billion.

The major banks that brought the company public were Deutsche Bank, Goldman Sachs (NYSE:GS), JPMorgan (NYSE:JPM), Citigroup (NYSE:C), Bank of America/Merrill Lynch (NYSE:BAC), Barclays, Morgan Stanley (NYSE:MS), and Macquarie, among others.


Extended Stay was founded in 1995, and through a period of consolidating hotel properties now employs 10,400 employees led by an experienced management team. The sponsors, behind the company which bought what is now known as Extended Stay in 2010. Ever since, the company has boosted average daily rental rates by a quarter to little over $52, thereby significantly boosting earnings.

For 2012, Extended Stay generated annual revenues of $984.3 million, up 7.8% on the year before. Net earnings roughly halved, falling from $46.6 million to $22.3 million. Reported revenues for the first nine months of 2013 came in at $864 million, up 14% on the year before. Earnings rose sharply by 77% to $98 million. The company operates with $105 million in cash and equivalents. Total debt stands around $3.11 billion, resulting a net debt position of around $3.0 billion.

Extended Stay stands to receive $565 million in gross proceeds from the offering. The net proceeds of little over $500 million are used to retire expensive debt, yielding around 10%. This will reduce the net debt position towards $2.5 billion, while boosting pre-tax earnings by some $50 million. With the equity in the business being valued around $4.8 billion, Extended Stay's equity is valued around 4.8 times annual revenues and over 200 times GAAP earnings. Note that earnings are expected to improve notably in 2013, so are revenues.

Investment Thesis

As noted above, the offering of Extended Stay has been a success. The company priced the offering at $20 per share, some 2.6% above the midpoint of the preliminary offering range. Ever since, shares have seen a decent first day jump, trading some 22.4% above the midpoint of the preliminary offering range.

The first half of 2013 showed some very encouraging trends. The total number of hotel rooms rose by nearly 2,300 rooms to just under 76,000. At the same time, average daily rates rose by some $5 to little over $53 per night. This was combined with an increase in occupancy numbers, as occupancy rates rose by 150 basis points to 73.8%. At this pace, annual revenues of $1.10-$1.15 billion are attainable, as earnings could come in around $125 million. Add to that a $50 million reduction in interest rates following the deleveraging from the public offering proceeds, and earnings could increase towards $160 million, assuming statutory tax rates. Even then the valuation at 4.2 times annual revenues and 30 times earnings is steep.

Besides the valuation risks, Extended stay is subject to normal risks including competition, a cyclical business, a high debt position and the reliance upon bookings of intermediaries. On the plus side, the company aims to pay dividends being qualified as a REIT which suggests that shareholders stand to receive at least 90% of taxable income. Given the bankruptcy event of its predecessor in 2010, I don't have to tell you about the risks involved with leverage. Buying into this offering at 30 times earnings, although the company can still make a lot of improvements, seems rich, a bit too rich for me. With sophisticated sellers on the other side, I chose to remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.