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Why It Makes Sense For A Hyatt-Starwood Merger?

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Hyatt Hotels is considering acquiring Starwood Hotels in a cash and stock deal, according to a media report. Earlier there were rumors about a merger between Intercontinental Hotels and Starwood, but that was later quashed by Intercontinental. Hyatt could emerge as a serious bidder for Starwood and up its ante against larger players, such as Marriott and Hilton. However, Starwood's market capitalization is close to double of Hyatt's, thereby limiting Hyatt’s options for deal structuring. Starwood anyways is looking to sell its assets and in its latest earnings conference call it stated that the Interval Leisure Group had agreed to buy its $1.5 billion time-share subsidiary – Vistana Signature Experiences. On that note, we discuss below how Starwood fits in Hyatt's global lodging ambitions.

See our complete analysis for Hyatt Hotels

Starwood Would Significantly Enhance Hyatt's Portfolio

Hyatt's worldwide portfolio consists of 587 properties (around 155,000 rooms) while Starwood has 1,222 properties (around 354,000 rooms) as of December 31, 2014. The combined company will have close to 500,000 rooms, which is still less than Marriott's and Hilton's portfolio of 700,000 plus rooms each. Still, if the merger goes through, Hyatt will be able to up its ante against these two big players in the lodging industry.

Looking at the business model, Hyatt derives a sizable portion of its value from owned hotels, unlike Starwood and Marriott, which have very low reliance on owned properties. In fact, despite Starwood’s much bigger overall portfolio, Hyatt has almost double the number of properties in the owned and leased segment. The overall trend in the hospitality industry is to manage the properties owned by a third-party and management fees forms the core revenues with EBITDA margins as high as 90% for almost all the hotel chains. This can be attributed to high capital expenditure that the hotel operator would otherwise have to bear for development and maintenance of a hotel property. However, even owned hotels can be of significant value if their profits exceed revenues the property would have otherwise generated in the form of management fees.

Now if Hyatt succeeds in acquiring Starwood, it will significantly enhance its offerings in both owned hotels, as well as the managed hotels segment. Another advantage to Hyatt will be its massive footprint across the globe. Around 70% of Hyatt's properties are in the America region (North and South America) while 45% of Starwood's are in geographies other than the America region.

Now the question arises, how will Hyatt fund this acquisition? The company's cash balance by end of Q2 was less than $1 billion (including restricted cash) while its debt was around $1.4 billion. While Starwood had similar cash in hand, its debt stood around $2 billion. Hyatt's overall market capitalization is around $7 billion compared to $13 billion for Starwood. It is clear that Hyatt will have to take more debt to fund this acquisition even if it is a cash and stock deal. We’ll be closely watching for any update on this deal.

Trends In Lodging Industry Point Towards Consolidation

It is a tough environment for the lodging industry, especially in the recent past, as the strengthening U.S. Dollar is weighing heavy on the hotel business across the globe. Most of the big hotel chains, except Intercontinental, are based out of the U.S. and report their sales and profits in USD. Both Hyatt and Starwood have faced declining sales amid economic uncertainties, which have weighed on global business travel spending. Furthermore, growth of alternative lodging options such as Airbnb is further adding to the woes of hotel operators. These trends do point toward a consolidation in the lodging industry in the foreseeable future.

The hotel industry as such is closely linked with the macroeconomic environment and continued growth, especially in the U.S. economy, will be of great advantage for hotel operators such as Hyatt and Starwood. Given the challenging environment, it becomes difficult for a small player to compete with the Hiltons and the Marriotts. And Starwood could be the right partner for Hyatt to up its ante in such market. Also, it makes sense for Starwood as Hyatt can help it transform its struggling brands, including Sheraton.

Hyatt-Starwood Merger Would Create A Massive Loyalty Program For Customers

The merger will also offer a solid loyalty program for customers. Hyatt's loyalty program - Hyatt Gold Passport - has expanded its membership base from 9 million in 2009 to 18 million in 2014. Loyalty members earn certain points on each Dollar spent depending on their membership tier. Members can exchange the accumulated points for a reward night. Usually, a hotel loyalty program offers various benefits such as early check-in, late check-out and room upgrades, again depending on the program tier.

Looking at Starwood’s loyalty program, Starwood Preferred Guest, it does not report its actual membership base but could be anywhere around 30 million, in our view. So the joint program will have approximately 50 million members, making it a very large program in size, which in turn, will be good for customers as Hyatt's members would have access to Starwood properties and vice versa. It must be noted that loyalty programs are a big deal in the hotel industry. In fact, 35% of Hyatt's room nights and around 50% of Starwood's annual room nights are booked by their loyalty members. Usually, if a customer likes one hotel operator, he or she tends to stick with it, especially in case of corporate travel as it provides an opportunity to earn more reward nights faster. Also, corporates usually ink yearly contracts with the hotels and in turn are offered lower rates depending on the number of room nights blocked. In such cases, it makes sense for frequent travelers to enroll into the loyalty program with the hotel operator. If the Starwood-Hyatt merger goes through, customers will have access to a wide portfolio of properties. This will boost demand for their properties, which should give more competition to Hilton and Marriott.

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