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There's More to Hilton's Turnaround than Blackstone's Leverage

NEW YORK (TheStreet) -- A lot has been made of Blackstone's (BX - Get Report) $10 billion paper profit on its Hilton Worldwide (HLT - Get Report) leveraged buyout, in the wake of the hotelier's first day of trading on Thursday.

Those billions stand out as among the biggest PE-industry profits, and Blackstone's internal rate of return on the deal is even more impressive when you consider the timing of Hilton's $26 billion leveraged buyout. When you run the numbers, Blackstone's Hilton investment also further underscores the importance of leverage for PE-industry returns.

But in Hilton's case, there is far more to the story than Blackstone's financial engineering and, in particular, a 2010 debt restructuring that gave Singaporean sovereign wealth fund GIC Private Ltd. a 5% stake in the company.

Blackstone may have had a no-lose plan when making its Hilton buyout bid.

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Whatever Blackstone's profit winds up being when the firm cashes out of its Hilton shares, much of it will also be attributable to the firm's reliance on franchised hotels as a source of growth.

Since taking Hilton private, Blackstone has focused on achieving growth at the hotel chain without putting up much of its own cash to buy and develop real estate in the U.S. and internationally. As a result, 99% of new rooms opened or in construction since 2007 have come from franchisees, allowing Hilton to realize industry-leading growth at little cost to the debt-laden company.

According to Hilton's S-1 documents, the company has grown its total rooms by 36% since June 30, 2007 -- the fastest growth rate of any major lodging company. Rooms in the company's development pipeline have grown 60% and rooms under construction have grown 133%, virtually all of which has come from franchiseess.

Hilton's reliance on franchisees has also allowed the company to expand into fast-growing emerging markets without taking on the type of credit and real estate price exposure that would come from developing wholly owned hotels.

In China, Hilton has increased its total hotels from just six as of 2007 to 171 hotels currently open or in development. China, as it turns out, has led the world in revenue per available room (RevPAR), a key metric in the hotel industry.

"In the Americas, RevPAR has increased at a CAGR of 6.9% over the past three years and demand has returned to pre-economic crisis levels. The Asia Pacific region also has experienced high RevPAR growth during the last three years, primarily fueled by China and to a lesser degree Southeast Asia. Weaker economic conditions in Europe dampened RevPAR growth, but recent trends show improvement," Hilton stated in its S-1.

Still, Hilton's growth push through franchise businesses doesn't come completely without risk. Were franchisees to dilute Hilton's brand, it could undermine the company's ability to maintain existing relationships and grow new ones. Such a scenario would impact Hilton's franchise earnings, now the lion's share of the company's overall EBITDA.

In that sense, Blackstone's operational improvement of Hilton and its reliance on brand equity is a bit of financial engineering after all.

Hilton offered its shares to public investors at $20 apiece. Shares in the McLean, Va.-based company were up over 10% from that offering price to $22.21, as of Friday afternoon.

HLT Chart HLT data by YCharts

-- Written by Antoine Gara in New York.

Follow @antoinegara

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