Does Hilton Think It Happens at Promus? (Fool Plate Special) September 1, 1999

An Investment Opinion

Does Hilton Think It Happens at Promus?

By Warren Gump (TMF Gump)

Promus Hotel Corp. (NYSE: PRH), the operator of Embassy Suites, Hampton Inn, Doubletree, and others, soared for a second day in a row after The Wall Street Journal reported that Hilton Hotels Corp. (NYSE: HLT) is trying to acquire the company. Details on the potential transaction are scarce. The Wall Street Journal article stated that the transaction was for "significantly more" than Promus' closing price yesterday, but didn't specify whether it was a cash or stock deal. Although the newspaper's sources say that the companies want to settle on a transaction shortly, the deal is not imminent and could fall through.

From a business perspective, combining Promus and Hilton makes a lot of sense. At the end of last year, Hilton spun off its gaming operations into Park Place Entertainment (NYSE: PPE) making it a pure lodging company. A majority of its profits come from owned hotels, the most important of which are its 10 largest convention properties in major markets such as New York, Chicago, and Honolulu. While these are wonderful flagship properties, earnings for such properties tend to be quite cyclical. To reduce the impact of this cyclicality on the overall company, Hilton has been trying to increase recurring fee income streams by expanding its franchising operations.

On the other hand, most of the properties in the Promus system are owned by franchisees. Instead of being subject to property-level profitability, Promus takes a chunk of each property's gross revenues for letting owners use its brand names and operating systems. These income streams can fluctuate, but they are much less volatile than earnings at the underlying properties. While Promus has leading brands in several of the categories in which it competes, the company has struggled to conquer the upper-tier full-service market where Hilton shines. Merging these two companies would result in a hotel powerhouse that should be able to effectively compete against strong multi-brand companies like Marriott International (NYSE: MAR) and Starwood Hotels & Resorts Worldwide (NYSE: HOT).

Making the timing of this potential merger appealing, Promus has been suffering from management upheaval following its late-1997 "merger of equals" with Doubletree. Several months after that deal was consummated, key leaders and board members from both companies resigned because they couldn't agree on how to run the company. Promus brought in an outsider, Norm Blake, to take control of the company, but it has not yet regained its prior momentum. Hilton CEO Steve Bollenbach, a renowned dealmaker, has been trying to complete a major transaction for quite some time, having lost out to other bidders in attempts to acquire ITT and parts of Wyndham International (NYSE: WYN).

A big question that will need to be answered is how Hilton plans to finance the potential purchase of Promus. Today's article didn't state whether Hilton is trying to negotiate a cash, cash and stock, or all stock deal. Given the low price of Hilton stock, it's hard to imagine that its management team would want to issue many shares (or that Promus shareholders would want to own Hilton stock). At the same time, Hilton already has a hefty $3.4 billion debt load (compared to book equity of $213 million and a market capitalization of less than $3 billion). While the company could borrow lots of money against Promus' relatively stable and substantial cash flow, equity investors generally shy away from debt-laden hotel franchising companies.

While it looks like Hilton is facing a financing dilemma, one should never underestimate the ability of Bollenbach to structure an innovative deal. In prior jobs, he was the mastermind behind the split-up of Marriott and Host Marriott (NYSE: HMT), as well as Disney's (NYSE: DIS) purchase of Capital Cities/ABC. We'll have to wait and see if he can come up with an attractive structure for a Hilton/Promus combination.