HOT: FALLING EBITDA PULLS COVENANT INTO QUESTION

Starwood’s Maximum Consolidated Leverage Ratio calculation simply divides gross debt at the end of the period by Adjusted EBITDA (Reported Adjusted EBITDA less JV interest expense add-back plus adjustments for asset dispositions).  We estimate that HOT’s leverage ratio at the end 4Q08 was 3.6x, giving the company a 21% cushion on its EBITDA at its current debt balance of $4BN. 

Given Starwood’s reduction in capital expenditures and IRS refund, and a likely timeshare note securitization, we believe that the company will be able to reduce gross debt by $400MM by 4Q 2009. However, the debt reduction alone will not be enough to offset our projected 35% decrease in Adjusted EBITDA.  At 4.9x Leverage, HOT will violate the leverage covenant by $70MM or $320MM of debt capacity.  In other words, in order to make the 4.5x covenant, Starwood must generate reported Adjusted EBITDA of $820MM or reduce gross debt to $3.3BN on our EBITDA number.

HOT: FALLING EBITDA PULLS COVENANT INTO QUESTION - HOT LEVERAGE COVENANT

We believe, barring an asset sale, that Starwood will seek a credit amendment to increase leverage to 5.5x or (more likely) completely re-do its credit facility.  Since September 2008, there have been three relevant credit facilities amendments in the lodging space:  Ashford 12/24/2008, Strategic 2/25/2009, and Interstate Hotels: 3/30/2009.  Based on the comps, we believe that such an amendment would increase Starwood’s cost of borrow by approximately 150 bps. We also believe that the banks will ask HOT to discontinue its dividend in 2010 and seek to reduce the facility size by a $200-$500MM. 

However, given that the revolver matures April 2010 (including an extension option to Feb 2011), with a $500MM term loan maturing this June and another $500MM term loan maturing in June 2010, HOT will probably seek a complete refinancing of its bank facility.  A new credit facility is likely to be smaller in size ($1.25BN), and is likely to cost closer to 7% all-in (LIBOR Floors), which would represent $40MM in incremental annual interest expense or $0.15 in EPS.   

As we wrote about in past notes (“HOT: THE CREDIT IMPLICATIONS OF OUR FORECAST”, 01/28/09), we don’t see this as a big concern for the credit – but equity holders tend to get skittish on bad credit news.