Editor's note: "Bricks and Mortar" is a series of columns written by real estate reporter Nicholas Yulico meant to help TheStreet.com readers generate real estate and gaming-related stock ideas.

With Hilton Hotels ( HLT) being sold at a hefty premium to private-equity buyers, the best bet left in lodging is Starwood Hotels ( HOT).

So today, I'm adding Starwood to the Bricks and Mortar mock portfolio as a company worth buying.

Starwood owns some of the best brands in the hotel industry -- including Sheraton, Westin and W Hotels -- that will provide a strong international growth platform for years to come. Meanwhile, the spinoff of many of its hotel assets last year has left the company with a business model weighted toward a high-margin management and franchise fee business, along with time-share sales.

In addition, Starwood's operations produce a ton of free cash flow, while the balance sheet has low debt levels. That combination makes the hotelier an attractive buyout candidate for private-equity firms, which continues to eye hotel assets because they're cheap relative to other real estate sectors.

My last hotel pick, Hilton, agreed to be acquired by Blackstone Group ( BX) for $47.50 a share, a 37% premium to where the stock was trading when I added it to the Bricks & Mortar portfolio.

Starwood shares have climbed since the Hilton deal, so it doesn't offer as much upside. But I still expect the stock to rise more than 15% from the current $72 level -- and as much as 25% if a buyout company approaches.

Starwood's stock should perform well so long as lodging fundamentals remain strong over the next few years, which admittedly isn't a risk-free proposition. Rival Marriott ( MAR) on Thursday tempered its revenue projections for 2007, signaling that the hot growth for the group may be cooling.

"Growth is slowing (in lodging), but it's still stronger than other sectors," says Dean Frankel, portfolio manager with Urdang Investment, which owns Starwood and other hotel stocks. Frankel says lodging is in a midcycle pause right now, but he expects growth to pick up next year, once the economy improves.

Starwood's management expects revpar, or revenue per available room (a key hotel operating metric), at its worldwide hotels to grow 8% to 10% this year. Last year, the growth was 10%.

Even if growth is decelerating, lodging continues to exhibit strong fundamentals.

"The combination of growing demand levels and low projected supply growth haspositioned the industry for a period of sustained earnings growth," Citigroup analyst Joshua Attie wrote in a recent research report.

"Hotels are currently experiencing very strong pricing power, which should drive solid margin and profit growth over the next several years, due to the significant operating leverage inherent to the lodging business," Attie wrote.

Room-rate increases help boost margins at hotel operators, since they add revenue without requiring more employees. The story on Starwood in coming years is one of impressive margin growth, assuming fixed expenses don't rise too heavily. Starwood's margins are also being helped by a larger piece of the business now coming from management and franchise fees.

Meanwhile, the super-hip W Hotels brand -- attached to just 20 hotels so far -- has significant international expansion opportunities. Some analysts predict that by 2010 Starwood will generate half of its profits outside the U.S. -- which makes the stock a good hedge against the U.S. dollar and domestic property market.

The sale of assets, and the focus on brand expansion, means Starwood has become a less capital-intensive business. That frees up cash for other uses, such as a hefty share buyback, says JMP Securities analyst Will Marks.

Under scenarios where management hits its 13% growth targets for earnings before interest, taxes, depreciation and amortization over the coming years and reduces the diluted share count by 5% or more through buybacks, Starwood stock could move to between $85 and $90 over the next year. Without the buyback, shares could still hit around $80, assuming management doesn't cut guidance.

The Hilton buyout has boosted shares of Starwood and other lodging names. At its current price around $72, Starwood is admittedly not the steal it was in the spring. The stock, with an enterprise value of $18.1 billion, trades at 13.5 times analysts' estimate for this year's EBITDA. That's near its historically high valuation, but the Hilton buyout is coming at more than 15 times this year's EBITDA (Hilton, however, offers some strategic synergies to Blackstone).

Buying Starwood is a bet that the lodging cycle won't fall more steeply than analysts and investors are currently forecasting. But with the company's strong free cash flow, healthy balance sheet and trophy assets providing downside protection, that's a bet worth making.

Bricks and Mortar Portfolio
A Look at How Nicholas Yulico's Picks Have Performed
Rating Date Price at Rating Rating Current Price* Return**
Brookfield Properties (BPO) 1/23/2007 $28.67 Own $23.98 -16.4%
Global Real Estate ETF (RWX) 1/23/2007 $64 Own $65.03 1.6%
Ryland (RYL) 1/23/2007 $56 Flag $36.09 35.6%
Trump (TRMP) 1/23/2007 $17.50 Flag $10.05 42.6%
Penn National (PENN) 2/6/2007 $45.56 Own $60.34 32.4%
Hilton (HLT) 3/2/2007 $34.69 Own $45.40 30.9%
Melco PBL (MPEL) 3/12/2007 $15.46 Own $13.12 -15.1%
Home Solutions of America (HSOA) 4/24/2007 $4.98 Flag 5.34 -7.2%
Starwood Hotels (HOT) 7/12/2007 $72.37 Own 72.37 N/A
Average Total Return, Unweighted 13.0%
Close At Start of Portfolio Current Value
S&P 500 1427.99 1518.76 6.4%
U.S. MSCI REIT Index 1140.36 1006.08 -11.8%
*(7/11/07 closing prices)
**For "flagged" stocks, a drop in price is tracked as a positive for the portfolio, and a rise in price is a negative.

'Bricks and Mortar' is a mock portfolio meant to generate investing ideas. In keeping with TSC's editorial policy, Yulico doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

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