Host Marriott Is Overdue for a Renaissance

Can Host Marriott (HMT) , the REIT, stand up and shine? That's the question being bantered about as the company reported fourth-quarter results, its first as a REIT. Before, the company was a C-corporation, required to pay corporate income tax.

Late last spring the company announced intentions to convert to a real estate investment trust, or REIT, to avoid corporate tax. Its timing couldn't have been worse. As one analyst says, "It's eerie. Host's announcement was the exact top of the REIT market." Even in the wake of the plunge in REIT prices, the company stood by its decision.

The transition was not pretty for shareholders. From a high of near $22 before the announcement, the stock steadily declined, recently trading below $11. Now, however, many believe the company represents a real value play for REIT investors.

REIT Idea, Wrong Time

Most agree the move by Host Marriott to become a REIT was prudent. The company emerged from the 1993 breakup of

Marriott Corp.

into two pieces -- Marriott International, which manages hotels, and Host Marriott, which owns the hotel properties of the Marriott organization. The tax advantages of holding real estate in a REIT have been on Host Marriott's mind ever since.

Little did the company know, hotel REITs would be besieged by problems. Concerns of overbuilding, an economic slowdown and reduced demand stifled the once-endless upticks in hotel stocks. Then news of the elimination of the paired-share REIT benefits shook

Starwood Hotels & Resorts

(HOT)

and

Patriot American

(PAH) - Get Report

, both of whom were in the throes of rapid expansion.

The crowning blow came when it became clear Patriot's finances were on the brink of

collapse, thanks to the company's unrelenting borrowing binge. Hotel REITs lost nearly half their value in 1998, and Host Marriott shared in the plunge.

Host Marriott completed its conversion, but a mere two weeks later, announced that the company's fourth-quarter earnings would be lower than expected. "That was a major disappointment," says one buy-side analyst. "It was like a slap in the face to investors. They should have known much earlier."

The stock slipped on the news and has remained depressed. "They pissed a lot of people off," says the analyst. "It will take time for people to get comfortable again." Still, many think the investment story is now compelling. While the fundamentals for the stock look good, the chart isn't quite as compelling. As

TheStreet.com's

resident technician, Gary B. Smith, suggests, the chart argues against any quick advance in the stock.

Diversifying Host Marriot's Portfolio

"Host Marriott has the highest quality hotel portfolio among the public REITs," wrote

Donaldson, Lufkin & Jenrette's

Larry Raiman in a recent report, which reiterated the company's buy rating on the stock. DLJ has provided banking services to Host Marriott in the past three years. Host owns 126 full-service hotels, mostly operating under the Marriott,

Hyatt

,

Ritz-Carlton

,

Four Seasons

and

Swissotel

flags.

The company's recent acquisition of a dozen hotels from

The Blackstone Group

adds to both the portfolio's quality and diversity. The $1.8 billion deal includes Ritz-Carlton and Four Seasons properties in Atlanta, Boston and Philadelphia as well as Hyatt and Swissotel properties in business hubs across the country.

"It's additional diversity, away from the Marriott name," says the buy-side analyst. The company also says the deal is immediately additive to earnings.

The portfolio sets Host Marriott as the new industry leader. "Host Marriott's premier asset base and larger capitalization positions the company well for what we believe will be an upcoming separation process with the REIT industry," said DLJ's Raiman.

Value-Priced Luxury

What's more, "The company is clearly cheap when priced on an asset basis," said the buy-side analyst. "The company has the cleanest balance sheet among hotel REITs."

Thanks to a recent refinancing, the company has $2.5 billion in debt with an average cost of 8% (80% of which is fixed rate), and an average maturity of eight years. The company has a credit line of $900 million available for potential acquisitions.

Raiman estimates the company will earn $1.78 per share in 1999 and $1.92 in 2000. Applying the average hotel multiple of 7.3 times earnings, he has a 12-month price target of $14. However, Raiman makes the case that Host should trade at near the top of REIT valuations.

One reason is Host Marriott's dividend, which, at 84 cents per share, represents a yield of about 7.5% on the stock. And, with estimates of funds available for distribution (a REITs measure of free cash flow) exceeding $1.10, the dividend appears safe.

Host Marriott's biggest risk appears to be the impact of an economic slowdown. Hotel REITs are the most exposed to the economic cycle -- a danger we wrote about last

October -- because their tenants turn over their "leases" nearly every day.

So far, of course, the economy has remained strong, and previous fears of overbuilding by the hotel companies have been overblown.

"We project steady declines in supply growth," said Raiman. "Demand, on the other hand, should remain strong based on current GDP estimates."

The other concern is that Host's conversion to a REIT restricts its ability to make acquisitions, in spite of the company's ample credit lines.

"Stringent REIT requirements limit the company's ability to grow internally," says

Schroders'

John Rohs. "

That will force Host to access its bank line or the debt markets if it is to continue to make acquisitions."

Rohs maintains a neutral rating on the stock with a price target of $13. Schroders has provided banking services for the company in the past three years.

Notwithstanding those concerns, Host Marriott's entry into REIT-land could provide a catalyst to jump-start the sector. At the very least, it appears to be a "value-priced" diamond in an otherwise rough lodging business.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds' firm was long Starwood Hotels & Resorts, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he welcomes your feedback at

invest@cjnetworks.com.