PRIVATE EQUITY COMPETITION: HILTON LBO

FINNOVATORS

JIN HO KIMHYUNG YOON KIM(STEVE)NATALIA MURCIAFRANCESCO ROMEO

Afbeelding invoegen SUMMARY

• Hilton’s needed funding to implement its aggressive expansion strategy

• Blackstone was the best partner because of its expertise

• LBO with high debt under favourable condition

• High risk but well structured operation

• IPO best exit strategy because of bullish IPO market

• At IPO the company debt went down by 41%

• Blackstone had a satisfactory return (at IPO valuation) 14.9% or 2.3x

• Not selling the shares at IPO was the right strategy ( +14% after six months)

CASE DEBRIEFAfbeelding invoegen

PRE-BUYOUT POST-BUYOUT POST-IPO

• LBO Boom• Privatization trend in

the U.S• Need funding for the

future projects• Hilton’s assets served

as collateral• Blackstone’s Expertise

• Privatization done before the crisis

• Term re-negotiation after the crisis

• Restructuring and operation efficiency

• IPO was the best option to exit for the profitability

• Good performance in terms of operation

• Good investment return(14.9% annually) in terms of profit

WHAT IS TYPICAL FEATURES OF LBO TARGETS?

Yes No• Mature industry and company• Feasible exit option• Strong competitive advantage and

market position• Low EV /EBITDA multiple• Large amount of tangible • Assets for loan collateral• Potential for expense reduction

• Clean balance sheet with no debt• Strong management team and

potential cost-cutting measures• Low working capital requirement• Low future capital expenditure

requirement• Possibility of selling assets• Steady and predictable cash flows

Even though it didn’t meet all the criteria, the LBO was under a traditional proposal

THE HILTON ACQUISITION WAS AN LBO/MBO/PTPAfbeelding invoegen

• Why debt financing in LBO? Higher debt expect higher return on investment (Leverage effect)

Bank debt is a lower cost-of-capital (lower interest rates) compared to equity

Tax shield effect

• Usually, LBOs are also MBOs. Why? Most of LBOs are MBOs because they have the power to change the

management

Purpose of MBO is to avoid external buyout or to implement growing plans by management team of the target company

WAS THIS A RISKY DEAL?

A broad Risk Assesment of investing in the Hotel Industry• Main risk factor for Hotel industry is market situation because the service

is used when people have extra money

1/2/2003

7/17/2

003

1/29/2

004

8/12/2004

2/24/2

005

9/8/2005

3/23/2006

10/5/2006

4/19/2

007

11/1/2007

5/15/2

008

11/27/2008

6/11/2

009

12/24/2009

7/8/2010

1/20/2

011

8/4/2011

2/16/2

012

8/30/2012

3/14/2

013

9/26/2

0130

200

400

600

800

1000

1200

1400

1600

1800

2000

Booked hotels room S&P 500 index(2003.1~2013.12)

WAS THIS A RISKY DEAL?

• Given the deal structure, was the 2007 transaction a risky one?

Equity: 5.7 bio(21.76%)

Debt: 20.5 bio(78.24%)

Value of transaction:

26.2 bio(100%)

• The deal looks risky because it was with 78.24% of debt

• However, it is not as it looks like

WAS THIS A RISKY DEAL?

• The economic situation and Debt capacity of Hilton group

According to the article:

1. 2006 was a record year for PE sector with 874 bio of invested capital

2. Increase in availability of covenant-lite loans

3. General trend of privatization of America Industry

In 2006, Hilton Group just finished the acquisition of HT

international:

1. Its debt amount increased significantly

2. But leverage ratio didn’t change much because much portion of debt came from non-interest bearing debt

Economic Context Economic Status

WAS THIS A RISKY DEAL?

• The leverage ratio of the Hilton hotel

• Non-interest bearing debt

$Mil 2004 2005 2006Long-term debt 3,633 3,572 6,556

Current maturities 14 47 412

Total Asset 8,242 8,743 16,481TA/LTB 2.26 2.42 2.37

$Mil 2004 2005 2006

Account Payable 611 772 1,901

Deferred taxes 781 678 2,065

Economic situation was favorable, and there was no trouble sign of Debt level in Hilton group

WAS THIS A RISKY DEAL?

• For the debt financing, Syndication debt financing was used from reputable financial institutions: In an financial event, Syndication loan brings diversification effect

• Also the loans were accompanied with low cost due to the Real Asset collateral

Debt: 20.5 bio(78.24%)

WAS THIS A RISKY DEAL?

• Overall, the deal was risky because of the huge amount of debt, but the deal was under well structured plan with favorable condition– The company utilized many instruments to hedge the risks

Good financial status

Sydication loan from reputable financial institutions

Low interest rate thanks to Real Asset collateral

Conditions

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BLACKSTONE OFFERED A HEFTY 40% ACQUISITION PREMIUM

• General Key sources of value creation in LBO

• In case of Public-To-Private(PTP), we can expect

Leverage brings substantial tax-shield

The level of regulatory requirements and investor communications are reduced

More discretion on the management by replacing passive shareholders

Existing clients and monopoly business

Stable cash flow from natures of services

Afbeelding invoegen BLACKSTONE OFFERED A HEFTY 40% ACQUISITION PREMIUM

• Private Equity Sponsor VS Strategic Buyers

• Private equity sponsors also know as Financial buyers have purposes to identify private companies with attractive future growth opportunities, giving them desired return

• Strategic buyers have purposes to identify companies whose products or services can synergistically integrate with their existing P/L to create incremental long-term share holder value

Private Equity Sponsor Strategic Buyers

BLACKSTONE OFFERED A HEFTY 40% ACQUISITION PREMIUM

• How did Blackstone justify?– Blackstone was a leading real estate private equity company, owing

more than 100,000 hotels rooms in the U.S and Europe– At the moment, it had the successful track record of reinvesting in its

hotel properties, La Quinta Inns and Suites, and LXR Luxury Resorts and hotels, leading them to grow approximately 45%

– Hilton hotel was the one fitting well to Blackstone’s business strategy and expertise

Jonathan Gray, Senior Managing Director, Blackstone, commented, "It is hard to imagine a better strategic fit for us than Hilton with its world-class people, brands and network of hotels. This transaction is about building the premier global hospitality business.” 07/03/2007

40% PREMIUM, OVER PRICED?

Acquisition price $47.5Original Price $33.93

Multiple method: P/E

Peer group EPS Share price P/E ratioMarriott 1.50 38.31 25.54Accor 2.33 19.41 8.33Starwood 4.91 51.64 10.52Average 2.91 36.45 14.80

EPS Current price Share valueHilton 1.49 33.93 $22.04

Afbeelding invoegen 40% PREMIUM, OVER PRICED?

Multiple method: Market cap/EBITDA

Peer group EBITDA Market CAP ratioMarriott 1,199 11,500 9.59Accor 1,248 12,500 10.01Starwood 1,145 13,170 11.50Average 1,197 12,390 10.37

EBITDA Market CAP Share priceHilton 1,274 17,784 $46.33

Afbeelding invoegen 40% PREMIUM, OVER PRICED?

EV(DCF) method

Debt: 6,556

Equity: 1,023

86.5%

13.5%

Long-term debt

Common equity

Risk free: 4.61%Market return: 10.53%

Market Beta: 1.18Tax rate: 30%

Cost of Debt: 5.60%After tax

Cost of Equity: 17.03%CAPM model

WACC:7.14%

Afbeelding invoegen 40% PREMIUM, OVER PRICED?

• Method to calculate the value – Perpetuity method (Discount cash flow)– Predict the Free cash flow in 2007, and discounts it with required rate of

return minus growth rate

2007 (prediction)2006

FCF1 FCF2g

present

ValueDiscounted @ r

40% PREMIUM, OVER PRICED?

• Considering the hotel business, which is unpredictable, we may need to add 1~3% of risk premiums to WACC

DR/GR 3.00% 4.00% 5.00% 6.00%7.00% 8.00%

7.14% 59.60 84.98 134.04

268.95

2290.69

-405.75

8.14% 44.69 60.34 85.96

135.48 271.64 2312.2

6

9.14% 34.64 45.29 61.09 86.94 136.92 274.34

10.14% 27.40 35.14 45.89 61.83 87.92 138.36

11.14% 21.93 27.83 35.64 46.49 62.58 88.90

12.14% 17.67 22.31 28.26 36.14 47.09 63.32

13.14% 14.24 18.00 22.69 28.69 36.64 47.69

14.14% 11.43 14.55 18.34 23.07 29.12 37.15

15.14% 9.08 11.71 14.85 18.68 23.45 29.55

Share price range Share price profile

Share was over-priced for normal situation but growth rate can justify the price of $47.5

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7.14%8.14%

9.14%

10.14%

11.14%

12.14%

13.14%

14.14%

15.14%0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

3.00%4.00%5.00%

ALTERNATIVE SOLUTIONS TO FINANCE HILTON’S GROWTHAfbeelding invoegen

• Issue Equity

Expensive because of legal, accounting and investment banking fees and cost of capital

Lose control of a company

Dilution of Equity

• Ask for more debt

More risky of insufficient cash flows to pay more interests

SATISFACTORY RETURN

• Good deal compared to the historic average return of Buyouts• Not great considering the average return of venture capital (16.6%)

8.5 BIOs

BlackstoneNet Gain

(or a multiple of

2.3)

14.9%

Blackstone return on

investment

12.2%U.S.

Buyouts Return(1987-2006)

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EXIT STRATEGY

Raise capital to pay back more than 20 bio debt. After the IPO the debt went down by 41%. The terms for the agreement were favourable .

Growing stock market. Blackstone had a firm belief in a bullish IPO market. In November 2014 the stock price was 25 (+20% compared to initial share price of 20).

IPO

If the company valuation was the same (19.7 bio) probably yes, because the lock-up agreement prevented the Blackstone from selling its shares for the next six months, and even though the stock market was recovering, it was still a risk...

- In theory yes if valuation of the company > 20;- Not attractive for a potential investor because debt > 20 BIO;- Blackstone was very confident about a bullish IPO market.

SECONDARY BUYOUT

TRADE SALE

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LBO IS GOOD OR BAD?

- Can save the company from failure, creating value for both the original shareholders, the employees and the Private equity. - Overall the LBO can increase the long-term value of the company.- Innovation is created.

- If LBO result in dismantling the acquired company (cut and run), no value is created for the company and the only beneficiary is the PE. - Risk of massive layoff as part of the restructuring process. Managers can lose their job.

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SYNDICATION – BENEFITS & DRAWBACKSAfbeelding invoegen

• Benefits Possible to secure a massive capital efficiently in same condition

Possible to use negotiating power and credit of lead manager (Bookrunner)

Possible to spread credit risk of target company

• Drawbacks Complicated interest for collateral among concerned banks

Variable interest rate can be loss in the future

Afbeelding invoegen BLACKSTONE DID NOT REALIZE THE GAIN, WHY?

There are 2 reasons that Blackstone did not realize the gain– Lock-up period which prohibited Blackstone to sell its shares for certain

period– Expectation and Confidence in price increase

NO DIVIDEND POLICY, GOOD OR BAD?

• Hilton has been focused on reducing its high debt levels with an aim to become an investment-grade company– Current Hilton’s ratings from S&P is BB, which is still speculative grade

(Above BBB is considered as Investment grade)– The zero-dividend is compensated with less risky security as the debt

level decreases

Considering its goal, we believe that zero-dividend policy is appropriate not only for Hilton but also shareholder

HILTON’S SHARE RISE BEFORE LBO ANNOUNCEMENT

Share price was expected to rise after LBO announcement, because the buyer usually pays a premium price.

There were rumors of possible bids starting to impact on market prices in the weeks before the first publicly available information.

The company needed cash to implement its expansion plan, and Blackstone not only had the cash but also the expertise.

+6,4%

FINNOVATOR

Thank you!