It's Time to Buy Choice Hotels

Hotel franchisor Choice Hotels (NYSE: CHH  ) announced earlier this week that it will pay a special dividend of $10.41 per share. The market gave a solid Bronx cheer to the announcement, sending shares up only $2 since the move was first hinted at in mid-June. But my Special Situations portfolio will be acquiring shares.

That special dividend will be paid out on Aug. 23 to shareholders of record on Aug. 20. That's about 25% of Choice's market cap that the company is returning to shareholders. The payout will cost the company $600 million, which it is funding through new senior debt of $400 million, cash on hand, and a new revolving credit facility.

The senior debt will accrue interest at 5.75%, or about $23 million per year. That's easily covered by trailing operating earnings of $190 million. In addition, the company pays already about $13 million in interest, so total interest expense should come to a little over $36 million -- so the company with its cash-gushing business should be able to manage the extra burden handily. And it pays another $43 million annually for its 2% dividend yield.

The company highlighted the reasons for its decision in the recent conference call. Management noted the record low interest-rate environment (5.75% for a company with very limited hard assets), a favorable environment for dividends (which could end at the start of 2013), and the desire to create value for shareholders. The company expects that "substantially all of the dividend will not be deemed a return on capital, but rather would be ordinary dividend income," meaning that it would pay tax at the ordinary dividend rate.

Choice Hotels is a cash machine, gushing $140.6 million over the last four quarters on capital expenditures of $12 million. That low level of capex is fairly consistent for the company. In its most recent quarter, the company increased revenue 5% and grew net income by nearly 16%.

So tomorrow I will buy $2,000 of Choice Hotels for my Special Situations portfolio. Interested in Choice Hotels or think I'm nuts to buy it? Let me know (or let me have it) on my discussion board and follow me on Twitter (@TMFRoyal).

Jim Royal, Ph.D., owns no shares of any company mentioned here. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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