Boring Portfolio

Boring Buying FCH, Part 2
November 05, 1997

Operating Results

1996 Operations

Revenues from percentage leases for the year ended Dec. 31, 1996 was $97.95 million, an increase of $74.16 million or 312% over 1995. Other revenues included $2.01 million from unconsolidated partnerships and $984,000 in interest income. Total expenses increased from $13.8 million in 1995 to $57.7 million in 1996, due primarily to the additional hotels acquired in 1996 and 1995.

Funds from operations (FFO) was $77.1 million versus $20.7 million in 1995. FFO per share (fully diluted) was $2.65 in 1996, a 14.5% increase over 1995's $2.31.

1997 Results to Date

Third quarter 1997 revenues increased to $51.1 million as compared with $26.4 million in the third quarter of 1996. Fully diluted FFO totaled a record $39.2 million or $0.89 per fully diluted share and unit as compared to the $21.5 million and $0.70 achieved during the third quarter of 1996. This represents an increase in FFO of 83% and an increase in FFO per share of 27%.

For the nine months ending Sept. 30, 1997, percentage lease revenue totaled $122.7 million, a 69% increase over the comparable period in 1996. Total revenue of $128.7 million represented a 72% increase over the first nine months of 1996. Net income increased 37% to $48.1 million. Fully diluted FFO per share increased 25.4% to $2.57 versus $2.05 for the first three quarters of 1996.

The average daily rate (ADR) across all 71 hotels during the third quarter was $111.61 as compared with $105.04 in the year ago quarter. ADR in the 18 converted CSS hotels increased 11.9% to $113.40.

On Sept. 30, 1997 FelCor announced an increase its common stock dividend to an annual rate of $2.20 per share, beginning with a third quarter 1997 dividend of $0.55 per share. That represented a 10% increase over the dividend paid in the previous quarter. That works out to about a 6.0% annual yield.

Balance Sheet

FelCor's charter limits consolidated indebtedness to 40% of its investment in hotel properties, at cost. The company possesses one of the strongest balance sheets in the REIT universe, with total assets on Sept. 30, 1997 of $1.62 billion, debt and capital lease obligations of $418.2 million, and a 22% debt to market capitalization.

On Oct. 1, 1997, FelCor announced the completion of a private placement of $300 million of long term senior unsecured notes. The notes were issued in two maturities, consisting of $175 million of 7-3/8% seven-year notes and $125 million of 7-5/8% ten-year notes.

Also in October, shareholders approved an increase in authorized stock from 50 million to 100 million shares. There were less than 4 million shares left, which would not permit any transactions that would require new shares. With only about $12 million in secured debt outstanding, more than $1.6 billion of free and clear assets, and about $450 million available in its line of credit, management says they currently have no intention of going to the equity market to raise capital for making additional acquisitions.

The Stock

On May 6, 1996, FelCor completed an offering of 6.05 million shares of Series A Convertible Preferred Stock at $25 per share. Each share of the Series A Preferred Stock is convertible at the shareholder's option to 0.7752 shares of common stock, subject to certain adjustments, and may not be redeemed by the Company before April 30, 2001.

On Sept. 30, 1997 weighted average shares and units outstanding totaled 39.3 million. Including the preferred shares at their conversion value results in a fully-diluted share count of 44.0 million. Average daily volume over the past 30 days is around 150,000 shares (source: Marketguide). At a recent share price of $36 5/8, FelCor's market capitalization is approximately 1.61 billion, and its total capitalization (including debt) is about $2 billion.

At March 18, 1997, the company estimated that there were approximately 12,000 beneficial owners of the common and preferred stock. At that date, owners of 5% or more of the stock were: Capital Growth Management (2.19 million shares), Franklin Resources (3.29 million), FMR Corp. (2.33 million), LaSalle Advisors (1.64 million), and Promus Hotels (2.89 million). The Sept. 16, 1997 proxy indicated that FMR had increased its stake to 3.82 million shares, or 10.4%. Altogether, approximately 74% of FelCor stock is held by institutions.

In order to qualify as a REIT, no individual or affiliated group may own more than 9.9% of the outstanding common stock. As of Sept. 7, 1997, company insiders collectively owned 3.8% of the common stock and 1.6% of the preferred stock.

Feldman and Corcoran entered into an agreement with FelCor Inc. under which, for a period of ten years, any after-tax distributions they received from DJONT will be used to purchase FelCor stock at current market prices. Feldman and Corcoran are restricted from selling that stock for a period of two years from the date of purchase. From Jan. 1 to June 30, 1997, insiders purchased a total of 65,000 shares of FCH, according to Vickers. No sales were recorded.

The stock's 52-week range is $32 1/8 to $42 7/8. FCH's Beta is a relatively placid 0.80.

Projected Performance

FelCor's management recently said they expect to use approximately $250 million in 1998 to acquire additional properties. The company hasn't fully assessed yet the opportunities to acquire Doubletree Suites to convert into Embassy Suites or the opportunities to acquire full-service Doubletree hotels, so those possibilities are not included in this estimate, and the final number could be appreciably higher than $250 million.

FelCor previously announced a letter of intent to partner with Promus in opening five new Embassy Suites, with Promus as the contractor. FelCor would be a 90% partner in the deal, with Promus putting up the other 10%. These properties probably won't open until late 1999 or 2000. Beyond that, FelCor is looking for opportunities in major cities and suburbs of major cities in which the Embassy brand currently does not have representation, because the Embassy brand is expected to get even stronger.

FelCor is projecting RevPAR growth to be in the high single-digits for the entire portfolio in 1998, although the 1998 budgets have not been finalized yet. General and administrative costs as a percent of revenues are expected to remain basically where they were in the third quarter of 1997.

According to First Call, the consensus estimate of 12 analysts is that FelCor will achieve FFO of $3.32 in 1997, or a 25% gain over 1996's $2.65. The consensus estimate for 1998 is $3.80, which would constitute a 14.5% increase over the 1997 estimate. Long-term FFO growth is projected at around 12% (range: 10-18%), or three percentage points above the REIT industry average. The consensus recommendation of 10 analysts is 1.2 ("strong buy" to "buy").

At a current price of around $36 5/8, FCH trades at 11.1x estimated 1997 FFO. Even without any expansion of the multiple, the current 1998 consensus estimate suggests a target price of $42 and change, or a 15% gain. Add the 6.0% yield and you're at a 21% annual return. Not bad.

If FelCor were to expand beyond DJONT into a multi-lessee structure, there's a possibility that the stock's multiple would increase modestly, adding perhaps another buck to the target price. In a recent conference call, FelCor management said they would consider such a move.


As does any equities investment, FelCor presents certain risks, some of which reflect risks associated with its industry and some of which are company-specific.

Interest Rates

Significant increases in interest rates increase the cost of debt required to make new acquisitions, and they also increase the interest costs on existing variable-rate loans, which FelCor has. FelCor has certain interest rate "swaps" in place to mitigate the impact of such fluctuations upon its variable-rate loans.


On October 20, 1997, Starwood and ITT (NYSE: ITT) signed a definitive merger agreement under which Starwood would add ITT's Sheraton hotels to its portfolio at a cost approaching $10 billion. FCH dropped following the news, on the presumption that the merger would severely limit FelCor's ability to acquire additional Sheratons. FelCor's management asserts, first, that they aren't all that interested in buying more Sheratons and, second, if and when they did decide to buy a Sheraton, they have very good relationships with Starwood and can make mutually acceptable deals with them.

As this report is being prepared, HILTON HOTELS (NYSE: HLT) is challenging the proposed Starwood-ITT merger. The outcome of all this is unknowable, as is its ultimate impact on FelCor, positive or negative. It is our belief that dynamic situations often provide opportunities for smart, nimble entrepreneurs and that the FelCor team is both smart and nimble.

Recent news that Promus would acquire Doubletree also raised in some investors' minds the possibility that FelCor would find fewer Doubletree Suites available for acquisition in the future. When Promus completes the merger, it will own approximately 70% of the all-suite market, between its Embassy Suites and Doubletree Guest Suites.

To that, FelCor replies that they have worked very closely with Promus in the past -- including a number of 50/50 joint ventures -- and they see no reason why that will change. Also, FelCor's management believes that Promus will take some of the Doubletree Guest Suites they will acquire in the merger and convert them to Embassy Suites, which is a better-known brand. That in turn should benefit FelCor by further enhancing the Embassy Suites label. There may also be some current owners of Doubletree Suites who will decide to sell their properties, and FelCor will look to acquire at least several and convert them to Embassy Suites. FelCor may also pursue acquiring several of the traditional Doubletree Hotels, as part of their long-standing and excellent relationships with the Promus and Doubletree management.

FelCor's future profit growth could also be limited by competition from recent entrants into the all-suite segment, such as Amerisuites (owned by PRIME HOSPITALITY (NYSE: PDQ)), Woodfield Suites (owned by MARCUS CORP. (NYSE: MCS)), and privately-held Summerfield Suites -- as well as by tough competition from upscale non-suite hotels such as MARRIOTT (NYSE: MAR). The other all-suite brands are lower rated than Embassy Suites, however.

Capitalization Rates

The flurry of acquisition activity appears to be raising the prices of existing properties. Obviously, the more that FelCor has to pay up front, the less room there is for capital appreciation. Also, although FCH stock is currently valued at a multiple to FFO that is reasonably attractive compared with those of some competitors, there's not a lot of wiggle-room left between FelCor's stock multiple (or those of its competitors, for that matter) and the current cost of capital. This makes non-dilutive acquisitions all the more difficult to pull off. The possible risks in this regard are mitigated by the fact that, at the end of the day, FelCor still owns a portfolio of properties that could be very attractive as acquisitions by a Starwood, Patriot American, or Promus.

Lack of Diversification

By placing its bets heavily on the all-suites concept, FelCor has benefited from the strong growth of that segment in the 1990s. Should that segment see a downturn in the future, however, FelCor's high concentration in all-suites hotels could come back to haunt it, and its investors. On the other hand, FelCor has recently added some non-suite upscale hotels to its mix, and management has indicated that they are open to continuing along those lines.

Possible Conflicts of Interests

FelCor currently uses DJONT, which is half-owned by Feldman and Corcoran, as its sole Lessee. Since those individuals are on both sides of the transactions between FelCor and DJONT, conflicts of interest may exist. In FelCor's case, potential conflicts are mitigated because insiders are required for a period of ten years to use any after-tax distributions they receive from DJONT to purchase FelCor stock at current market prices and are restricted from selling that stock for a period of two years from the date of purchase. Also, DJONT's financial statements are included in FelCor's SEC filings, and there's no indication that DJONT is ripping off FelCor. DJONT's earned profits have not exceeded the 3-5% average earned by typical third-party lessees.

Next: Buy Appendices

**This trade is being made under the regular portfolio policy, namely, once The Boring Portfolio announces an intention to trade, that trade will be made within the next WEEK, as opposed to the next day. For more detail, please read the "New Trades" section in the hall of portfolios.**