Back in July 2007, Blackstone Group (BX) agreed to pay $26 billion for Hilton, the second-largest hotel operator in the U.S. The deal was the largest in the industry's history. It was also the largest equity investment Blackstone CEO Stephen Schwarzman (pictured) had made, coming to $5.6 billion.Unfortunately, the deal was struck at the worst possible moment -- right before the credit crunch hit and the world plunged into one of the worst recessions in decades. As a result, the hotel industry fell into a slump as vacancy rates spiked.

Of course, the equity values of other major hotel operators such as Marriot (MAR) and Starwood (HOT) have dropped significantly. Over the past three years, their stock prices are down 46% and 47%, respectively.

However, these companies do not have to deal with a huge debt load. Keep in mind that Blackstone loaded Hilton's balance sheet with $20 billion in obligations and has had little choice but to find ways to restructure things.

But there is some good news. According to the The Wall Street Journal, Blackstone was able to get lenders to reduce the debt by $4 billion, including extensions on maturities of different debt issues. Blackstone had to pony up another $800 million to get the concessions, but it was worth doing. Although it's likely to mean reduced returns for its investors, that's better than losing the whole equity investment or being forced to divest assets.

A Look Back at the Hilton Deal


It was back in 1919 that Conrad Hilton launched his company, with the purchase of a flophouse for $40,000. He then went on to build his empire with many other acquisitions and equity financing deals.

By the mid 1990s, Hilton hired Stephen Bollenbach, who came from Disney (DIS) and understood the art of dealmaking. Under his tenure, Bollenbach transformed Hilton into a megahotel operation, with acquisitions of brands like Doubletree, Hampton Inn, Homewood Suites and Embassy Suites.

Even with the acquisitions, it became tougher to keep ascending the growth curve, and Hilton's stock started to underperform its peers. Moreover, because of the real estate boom, hotel capacity soared, putting pressure on room rates. In other words, it looked like a good time to sell.

While private equity firms do not necessarily pay the highest prices, the environment was much different in 2007. The cost of debt was nearly zero, and there was no shortage of buyers for asset sales.

And in the case of Blackstone, the firm was really a strategic buyer. Since the early 1990s, Blackstone has built an extensive portfolio of hotel properties, accounting for more than 100,000 rooms in the U.S. and Europe (with brands like La Quinta and LXR Luxury Resorts). In fact, the firm also had a big footprint in the e-comerce travel market (with a business now called Travelport, which recently had trouble with its proposed IPO).

So by combining Blackstone and Hilton, the result would be a global hotel empire. However, the price tag was at nose-bleed levels, coming to roughly 28 times earnings.

Looking at the Future


As the economy has rebounded, the hotel industry has shown signs of life. Profits are starting to increase as companies realize gains from cost-cutting. Occupancy rates have also begun to creep higher.

But a full comeback will probably take a few years. This means the Hilton deal is likely to take some time to get traction. Even with the recent debt restructuring, the company is still highly leveraged.

Despite all this, Blackstone isn't gun-shy about real estate deals. For example, the firm recently purchased a 50% interest in Broadgate, which is the largest office complex in London's financial district (the deal was struck at $3.4 billion). And now there's talk that Blackstone is going to join Simon Property's (SPG) $10 billion bid for General Growth to create an empire in the U.S. mall market.

Tom Taulli advises on
business tax preparation and is also the author of a variety of books, including the including The Complete M&A Handbook. His website is at Taulli.com.

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