Starwood, Hilton off to new starts in 1999

What a difference a year makes.

The world's two largest gaming and lodging companies enter the new year with revamped appearances and subdued expectations after the sobering experiences of 1998.

Starwood Hotels & Resorts shareholders will vote Wednesday on a restructuring plan prompted by the lobbying success of its biggest rival, Hilton Hotels Corp., which has undergone its own massive makeover.

It was just a little over a year ago that the victor and vanquished in gaming's biggest battle strolled out of a packed ballroom at New York's ritzy St. Regis hotel to address separate news conferences.

A beaming Barry Sternlicht struggled to contain his excitement over Starwood's just-won victory for control of ITT Corp. and its high-end hotel and gaming properties, including Caesars Palace and The Desert Inn.

The Starwood chairman vowed the real estate investment trust's stock price would hit $75 in 1998, although the actual value "should be around $100 a share" because of the $25.50 in cash it would spend for each ITT share.

Starwood would "change the paradigm in the hotel industry," Sternlicht pledged, using "positively devastating marketing strengths to continue our story of performance. This will be a company that could be potentially lethal."

Meanwhile, Hilton President Steve Bollenbach struggled to find a bright note in his company's stunning loss to Starwood in the hotly contested bidding war for ITT.

"Sometimes," Bollenbach, "the best deals are the ones you don't get."

Judging from the companies' stock performances last year, Bollenbach's comment proved more prophetic.

After opening at $57.875 a share, Starwood stock closed out 1998 at $22.3125. For the year, the company lost $6.24 billion, or 61.4 percent, of its market capitalization. Starwood was lethal, all right, but largely to the portfolios of its owners.

Hilton didn't fare much better, winding up 1998 at $20 after opening at $29.25. Its market cap plunged 31.6 percent, or $2.41 billion, in the past 12 months.

By comparison, the Dow Jones Industrials wound up 16.2 percent higher in 1998. An investor who bought $10,000 of Dow index stocks and spent similar amounts on Starwood and Hilton at the beginning of 1998 saw his or her Dow stake rise to $11,620 by year-end, his Starwood stake drop to $3,860 and his Hilton holdings down to $6,840.

The two gaming and lodging giants were savaged by investor concerns about global economic turmoil, over-capacity in major markets such as Las Vegas and a lack of new growth opportunities.

"Starwood and Hilton were impacted by highly competitive conditions in gaming, but more significantly by the maturation of the lodging cycle, which saw terrific years from 1992 through 1997 but a year of slower revenue growth in 1998," says Jason Ader, a senior managing director of Bear Stearns & Co.

There were other problems, as well.

Hilton stock was battered as investors lumped the values they assigned hotel assets with those of casinos, which were facing especially stiff competition in Las Vegas and Atlantic City. The main growth potential appeared to be acquisitions, and Hilton had stumbled in its attempts to buy ITT and Circus Circus Enterprises Inc.

But Hilton finally cut a deal with Grand Casinos Inc., gaining three successful casinos in gaming's most dynamic growth market -- Mississippi. And the merger allowed Hilton to separate its gaming and lodging businesses into separate companies, letting investors rate the two new entities' performance in relation to their specific industries.

The new gaming company, Park Place Entertainment, is based in Las Vegas.

And today, Hilton Hotels is a pure lodging company that owns, manages or franchises more that 250 hotels worldwide. On a pro forma basis, it generated cash flow of nearly $600 million in 1998, the lion's share of it from its full-service hotels in cities such as New York, Chicago, Washington and Los Angeles.

It will spend about $500 million acquiring hotel assets this year, and is expected to expand its franchising activities, especially in the upper mid-market segment.

"Steve Bollenbach's conservative approach to acquiring companies benefited Hilton greatly because he didn't leverage up the balance sheet," says Andrew Zarnett, a managing director of Ladenburg Thalmann & Co.

"Hilton now has the opportunity to look for good buying opportunities and continue to get incremental increases in average daily room rates and occupancy rates," he says. "I believe lodging will continue to see strong ADRs because the national economy should continue to be strong."

Ader, though, says questions about the future of the economy will present Hilton with challenges in sustaining earnings growth.

Besides looking at mergers, Park Place will have to focus on competing in a much more competitive gaming industry -- particularly in Las Vegas.

"Park Place has an opportunity to take assets that now encompass every significant gaming jurisdiction in the world and bring some efficiencies to them," says Zarnett.

"The questions are how Park Place will fare in what are highly competitive gaming markets and how Arthur Goldberg will exploit any new acquisitions," says Ader.

Meanwhile, Starwood faced different concerns. Its status as a paired-share REIT, which had allowed it to outbid competing corporate entities for assets, came under attack. Hilton and other lobbyists convinced Congress to add a rider to a tax-reform bill last year that eliminated most of the REIT's advantages.

In essence, the new law prevented Starwood from operating hotels acquired after March 1998 unless it changed its structure. That threatened to put the brakes on the buying spree that had given Starwood the Sheraton, Caesars World, Westin, Ciga, Luxury Collection and other brands and made it one of the world's largest REITs in just a few years.

As a result, Starwood executives developed a restructuring plan that would allow it to remain a REIT, but would cut the annual dividend to shareholders to 60 cents from $2.08.

The restructuring won't affect Starwood's ownership, management or franchising arrangements with more than 650 hotels located in most of the major world markets. But it will, the company says, alleviate the consequences of the new tax law and allow Starwood to make selective acquisitions in the future.

Starwood is still struggling to integrate the ITT and Westin acquisitions, trim corporate overhead and sell under-performing and non-synergistic assets such as The Desert Inn and ITT's educational and publishing divisions.

So far, Starwood has been unable to find a buyer for The Desert Inn at the price it wants, although it has met with several "tire kickers," analysts say.

But Sternlicht is apparently growing more comfortable with the performance of Caesars World properties after early concerns over the volatility of their high-end gaming business.

Future growth, the company says, will come from maximizing internal cash flow growth.

"Starwood clearly overpaid for the ITT assets," says Zarnett. "Its challenge on the gaming side is to make sure Caesars maintains market share in the face of increased competition in Las Vegas."

"Starwood's future is much more tied to the lodging industry and how business and leisure travel will be affected in a slowing economy," says Ader.

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