Complicated road ahead for Ashford-FelCor deal
 
Complicated road ahead for Ashford-FelCor deal
06 MARCH 2017 10:20 AM

Analysts said Ashford Hospitality Trust's proposed acquisition of FelCor Lodging Trust seems to make sense on paper, but there are some significant obstacles remaining before a deal can get done.

REPORT FROM THE U.S.—Hotel industry analysts believe there are reasons to be optimistic about the possible combination of FelCor Lodging Trust and Ashford Hospitality Trust, but there are some significant roadblocks to overcome.

Ryan Meliker, managing director and senior real estate investment trust analyst at Canaccord Genuity, said Ashford Trust officials have shown they have the ability to improve performance of portfolios like the 37 hotels owned by FelCor.

“Ashford has a track record of driving substantial value to shareholders through major (mergers-and-acquisitions) activity,” he said. “We’ve seen so much value creation (for Ashford) from big transactions that they get the benefit of the doubt.”

But the cold reception Ashford Trust’s proposal received from FelCor officials underscores the fact that the two sides are a long way from getting a deal done, said C. Patrick Scholes, managing director and lodging and leisure equity research analyst for SunTrust Robinson Humphrey.

“The offer as (it stands) is definitely not a sure thing,” he said.

The back-and-forth so far
A public back-and-forth about the deal started on 21 February when Ashford Trust officials issued a series of news releases detailing the proposal for FelCor—though negotiations apparently began in October 2016—and announcing a slate of candidates they were nominating to the FelCor Board of Directors that would be more receptive to a sale than current board members.

Ashford Trust’s proposal was an all-stock deal that would give FelCor shareholders a combination of Ashford Trust and Ashford Inc. stocks for a total consideration of $9.27 per share based on closing prices from 17 February.

Soon after, FelCor officials issued a release detailing what they saw as the problems with Ashford Trust’s proposal, including Ashford’s higher leverage and management structure, and qualms about the all-stock structure of the proposal. Ashford Trust officials responded in kind through another news release and in comments during their fourth-quarter earnings call with investors.

The back-and-forth continued in a pair of open letters from the companies’ top executives. FelCor’s incoming CEO Steven Goldman announced his preference for a cash deal, and Ashford Trust CEO Douglas Kessler said his company would be glad to get back to the negotiating table.

Land and Buildings, one of FelCor’s largest shareholders, also publicly weighed in on the deal, calling it “woefully inadequate.”

Obstacles
Ashford Trust currently has two pathways to get a deal done: Find a way to meaningfully re-engage FelCor officials in negotiations or sway investor sentiment enough toward the deal that they vote in the proposed slate of pro-sale directors.

Meliker said FelCor’s decision to extend management deals with Hilton for a set of properties that were set to become unencumbered is telling.

“Whenever you encumber an asset, the value gets reduced,” he said. “And that’s exactly what they did in the middle of negotiations. That tells you a lot upfront about where their appetite was to sell the company at the time.”

Even if Ashford Trust can come up with an appealing deal structure, there could be some incentive for FelCor officials to sit back and wait.

Mike Bellisario, VP and equity research senior analyst at Robert W. Baird & Company, said if he were Goldman, he would want to take his first 30 days as CEO to determine who FelCor spoke with in the last year to see who was a potential buyer and whether any are still potentially interested.

“I would restart a mini process or at least do the due diligence to see what was discussed and see why the deal didn’t happen,” he said.

If Ashford Trust executives are committed to going hostile with the deal, they would have to woo other FelCor investors since they can’t simply come in and buy up a controlling share.

Real estate investment trusts have ownership restrictions, Bellisario said, which prevent any one shareholder from buying too much of the company in open shares on the open market. Ashford Trust could take its 4% up to FelCor’s threshold if executives thought there was value.

Scholes noted that puts Ashford Trust at the whims of proxy advisors who may suggest that investment funds stay away from the deal.

“The challenge is, historically, proxy advisors have not looked favorably at externally advised (companies in) deals,” he said. “That’s a big hurdle that Ashford has to overcome.”

He said those types of investors hold roughly a third of FelCor’s shares, making them a significant voting bloc.

Scholes also noted that various investors might feel inclined to give Goldman a chance at the helm given his strong track record in the industry, even though confidence in FelCor’s track record isn’t so high at the moment.

Ashford Trust is going to hang around the hoop, Bellisario said, and it has to stay active and vocal while engaging with investors. As Ashford Trust executives go back and forth with FelCor’s Goldman and board members, they could amend their proposal to include cash.

It goes against FelCor’s strategy of maintaining a large cash balance, he said, but Ashford Trust could bring the balance below the minimum threshold.

“The way we read all this back-and-forth is cash is an option, but the board wanted stock, so that’s what (Ashford Trust) gave them,” Bellisario said.

The inclusion of cash in the deal brings an added level of complexity to things because Ashford Trust is restricted on how much cash it could use in the deal due to the covenants of some of FelCor’s recourse bonds that effectively cap the amount of debt the company can carry.

“It’s unlikely the FelCor board will accept an offer that doesn’t involve a substantial cash component, and that was probably always the case, but the question is how much Ashford can offer without triggering (the bonds’) make-whole payment,” Meliker said. “It’s not about Ashford’s access to cash. It’s about whether (they are) sure they can pay enough for that payment to not materialize and also give enough for the board to be excited.”

A public negotiation
Bellisario compared Ashford’s and FelCor’s public negotiations to a soap opera. He said the two companies are doing a bit of negotiating with each other in public, he said, which is an unusual move in the business world.

He also said there are obvious downsides to this move.

“You don’t want the market to know you’re even thinking of selling (properties),” he said. “People will ask questions if you don’t sell them. (If kept a secret) you never have to answer the question why you didn’t sell them.”

Because of the public announcements and disclosures, everyone knows about the proposal, Bellisario said. If the deal doesn’t go through, it will be the topic of discussion for the next year or two.

But analysts agreed that Ashford Trust officials felt they were put in a corner, where going public with their proposal in order to win over investors and put pressure on FelCor was their best option to get a deal done.

“Basically Ashford has become an activist here, and that came out of frustration from working to get a deal done with FelCor,” Scholes said. “They felt they had no choice.”

Analysts said this sort of public back-and-forth and hostile takeover attempt has been relatively rare in the hotel REIT space, but it’s not unheard of for REITs overall. Both Scholes and Meliker compared it to Simon Property Group’s pursuit of Macerich Company in 2015.

In that situation, those companies—both REITs that focus on retail real estate, particularly shopping malls—were unable to come to a deal.

“We’ve seen it, but not in hotels so much,” Meliker said.

For the time being, the back-and-forth seems to have at least slowed down if not stopped. Neither company offered comment for this story.

Are there alternatives?
One of the things that might have spurred Ashford Trust executives to take their proposal public is the fact that there seems to be no other obvious buyer for FelCor, sources said.

Throughout the negotiations, Kessler has pointed to various reasons why a combination of the companies makes the most sense, including the fact they are both based in the Dallas area.

Ashford officials have praised the potential of FelCor’s portfolio while pointing to a history of mismanagement and poor decision-making that have limited the company’s growth prospects. Kessler has been particularly critical of FelCor’s decision to purchase three New York City hotels, including The Knickerbocker, which are now being actively marketed for sale.

The sales of FelCor’s three New York City hotels holds a lot of value for both companies, Bellisario said. The three assets represent a big percentage of both companies’ equity cap, he said. If Ashford Trust is successful in its bid before FelCor sells off those three hotels, the two companies would need to work out a structure to determine how to split the proceeds.

Meliker said it’s unlikely another buyer could crop up who would have the same combination of interest in FelCor’s existing portfolio and the ability to realistically pursue a deal.

He said private equity buyers would be turned off by FelCor’s bond covenants and most hotel REITs would be interested in only bits and pieces of FelCor’s portfolio.

“There are abundant challenges across this portfolio that I think set Ashford up as the most willing buyer and the buyer that has the best structure to capitalize,” Meliker said. “There aren’t really other REITs looking to buy suburban and secondary market hotels.”

Both Meliker and Scholes noted there are a number of high-quality assets in FelCor’s portfolio that most REITs would want to own, but the combination of those with less typically appealing assets will discourage most REIT buyers because of how they come off as unappealing to investors.

“FelCor owns a lot of suburban Embassy Suites,” Scholes said. “That’s fine for what it is, but the typical hedge fund manager wants to stay at the properties he’s owning. He’s not going to a suburban Embassy Suites. It doesn’t have that cachet. That might not be deserved, but it is what it is.”

FelCor has a number of higher-value properties, Bellisario said, but they don’t fit together as collection to sell off at one time.

“There’s not one buyer who can come in and buy all 37 assets,” he said, noting there might be buyers for individual assets.

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