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The Price Is Right - Or Is It?
June 22, 2007

The chattering cognoscenti of our industry have been busy again with their “oohs” and “ahs” about the US$23 per share price for Equity Inns. I don’t intend to give you an investment banker’s analysis of the deal, but I want to make a point or two to put the matter in a rational perspective.

Let me start with a statement and a premise – Equity Inns is a well run company with a good business model. Their modus operandi works as well in the good times as it does in the bad.

Providing they wouldn’t overstretch their balance sheet as the cycle rolls on (and based on history there is little evidence they would), they will have capacity to have a growth spurt when the cycle changes and the deals come up looking increasingly attractive.

Thus coming out of the next slow down, they would be stronger than before and poised to become even more dominant in their public sector with the inevitable multiple expansion for the benefit of their shareholders.

So why are they selling? Is their business model broken? The answer, I believe, is - NO.
Is the price they are getting so outrageous that it would take many years for management to grow to that price? The answer, I believe, is – NO. Is the price per room for this large portfolio so high that a devoted management team could simply rebuild a similar portfolio with the money and have buckets of dough left over? The answer, I believe, is – NO. Is Whitehall (part of Goldman Sachs) a dumb buyer and unable to recognize value and paying a price so far above market that the deal will never yield them their required private equity IRR’s? The answer, I know, is – NO.

So what does the sale signal? Not being in the board room and listening to the wise prognostications of the board, I don’t know and wouldn’t dare hazard a guess. However, were I a cynical person (and any of you that know me will realize that I am far from that!) I might say that (despite the no doubt brilliant charts of the investment bankers hired as the company’s advisors showing supply growing in the sector, lack of product to buy, GDP growth rate extrapolations, the timing of a cyclical slowdown, valuations above short term replacement value and so on) the management decided this is a good time for them to cash in at today’s peak, take the dough they are owed from their latest contracts and look like heroes.

So what is the point of this note? Simple. There are two types of REITs in the lodging market: Those that are just an accumulation of miscellaneous assets and have no fundamental value adding story or unique reason for being in business; and then there are those that clearly do. Equity Inns is one.

While the willing seller might argue that they are getting a full price (retail) in today’s market for their portfolio of properties, our cynic might rightly ask “That may be so, but then what price are you getting for the business itself – the team, the reputation, the experience, the quality of the board, the systems, the intellectual property, the relationships, the goodwill? If the seller will not pay for all of that which years of overhead and work have created, then should the board sell, or rather should the company simply continue its tried and tested strategies and make increasing amounts for the shareholders?

Management of any public lodging REIT is daily pressured from managers of private equity needing to put money out for their own placement fees, asset management fees and promotes; from investment bankers needing increasingly high fees to drive their own bonuses; peer pressure from those already wealthy; and from other corners that lurk at every turn in the twisting road of daily business.

The question therefore that this hypothetical cynic might pose is “Should management force a sale of a thriving business for the purpose of cashing out for themselves?

“Ah ha!” you might respond “If management wants to pack it in, then what else could the board do?”

Perhaps the answer is simple – get another management team!

Posted by Laurence Geller on June 22, 2007 | Comments (0)