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Big question for management.

Following up on our Hilton IPO presentation and call yesterday, we pose another question for management.  How low would you go?

On July 3rd Blackstone announced that it would acquire Hilton Hotels for $26BN, writing an equity check for $6BN to seal the deal.  Despite paying over 14x 2007E EBITDA for Hilton at the top of the market, Blackstone will still make a pretty penny on the IPO which was priced at $20. 

While the IPO will provide Blackstone with a vehicle through which it can slowly sell its stock, BX will still be the majority shareholder of Hilton for several years to come.  Post IPO, Blackstone and other insiders will own close to 80% of the stock.  Blackstone’s lock-up expires in 1/3rd chunks over 6, 12 and 18 months, after which they will be subject to Rule 144A.  While a large insider holder can sometimes be an overhang on the stock, we believe it also has a major benefit.  BX is incentivized to keep something in the kitty to set the stage of several beat and raise quarters and potentially some assets sales.

At some point, Blackstone needs to return the $6BN+ of equity plus a preferred return they used to buy Hilton for their investors.  Only after investors get their preferred return does BX’s promote become in the money.  The questions HLT minority shareholders need to ask is this: If BX needs to return money to investors, at what price would they be willing to dump their shares in Hilton? 

To answer this question we make several assumptions:

  • BX’s total equity investment in HLT
    • $6BN was in the initial investment but during the 2010 restructuring, another ~$900MM was used to retire debt at a deep discount.  We are unsure if that additional cash came from Hilton’s balance sheet or from an additional infusion of equity from the sponsor.
      • Preferred return that BX investors are entitled to - we assume 8-9%

Assuming a $6.9BN of total equity and a 9% threshold, our analysis suggests that once BX’s lock up expires 18 months post IPO, its promote would be in the money as long as HLT’s stock price is above $14.60.  The question is would Blackstone sell their stake above $15 bucks or do they have the ability to hold on to share longer to get a better price. Alternatively, can they spin shares out to their investors as a dividend?  This is a very important question for management.