As expected, Pebblebrook and LaSalle will be combining. The lessons from this saga are likely to resonate in the years ahead.
The takeover battle for LaSalle Hotel Properties is over, with Pebblebrook Hotel Trust expected to close on its acquisition in about three months, following shareholder votes from both companies’ investors.
Blackstone has been paid $112 million, providing its fund investors a nice payday while no capital was put at risk. LaSalle’s management team is set to receive its change-of-control payouts upon closing. What can we learn from this process? How will this impact the hotel ownership landscape?
With the LaSalle shareholder vote on the Blackstone deal approaching, Pebblebrook shrewdly offered a fig leaf to LaSalle’s board, a sweetener. Increasing the cash portion of its offer, partially funded by the sale of three hotels upon the transaction’s closing, gave LaSalle’s board cover to approve Pebblebrook’s offer. The alternative was a shareholder vote LaSalle would almost certainly lose, as two large shareholders, Pebblebrook and HG Vora, publicly stated their intention to vote against the Blackstone deal, and as the two largest proxy advisors recommended voting against the Blackstone transaction. The two-thirds favorable vote requirement would have proved too high a bar to clear.
This long and elaborate dance, as painstakingly documented in LaSalle and Pebblebrook’s joint proxy statement, should teach a generation of companies and investors valuable lessons. Here are a few of the key takeaways:
Two issues appeared to be barriers to this deal that should not have been in my view: whether LaSalle’s officers’ and directors’ shares, received as part of change of control payouts, would be exchanged for cash or a mix of cash and PEB stock, and whether any LaSalle directors would join PEB’s board. Clearly all shareholders, including insiders, should be treated equally. Investors would not tolerate any differential treatment of performance shares. Similarly, while LaSalle’s board has a legitimate interest in the makeup of Pebblebrook’s board post deal, it is odd to think that this was a sticking point at the end of the process.
It may seem axiomatic that boards and management teams are solely focused on acting in the best interests of all shareholders, but too often biases can creep in. During this process, shareholders were, apparently, quite open with management about what they thought was in their best interest. However, it appears that it was not until the board was facing the likely failure of the shareholder vote that the board chose to endorse Pebblebrook’s bid. The stock market isn’t always right, but stock prices can give important insights into investor sentiment. With LaSalle trading regularly and consistently above the Blackstone deal price, investors were unmistakably clear in their desire to pursue the Pebblebrook transaction.
Cash is king, except when shareholders say otherwise
Investors almost always prefer cash when companies are sold. Cash is easy to value and has no future price or execution risk. In this case, investors believed Pebblebrook’s offer was unequivocally more valuable and appeared unworried about future fluctuations in Pebblebrook’s stock price. Those who had those worries had ample opportunities to sell their LaSalle stock at prices above Blackstone’s offer price for LaSalle. Again, LaSalle’s stock price spoke volumes about how investors perceived the value of Pebblebrook’s offer.
In my view, the biggest factor favoring the Pebblebrook offer was investors’ confidence that Pebblebrook’s management could create more value with LaSalle’s assets than LaSalle’s team. This isn’t just about average EBITDA (earnings before interest, taxes, depreciation and amortization) per key or routine asset management. Pebblebrook’s team has spent years cultivating its credibility and demonstrating its ability to maximize value at its hotels. This appeared to give investors confidence that the execution risk of a stock deal was more than offset by the value premium implied in Pebblebrook’s offer.
Investors are increasingly concentrating their investments in larger market-cap stocks. As funds grow, portfolio managers value liquidity, the ability to establish positions and sell positions without moving the market for a company’s stock. In addition, investors see value from scale, as companies find economic benefits from concentrated positions in markets and from sharing asset management best practices, among other things. Overhead and public company costs can be spread over a larger pool of assets. The most significant aspect of investor preference for larger companies is that it gives those with scale cheaper and more regular access to capital, a major advantage over their smaller peers.
Mergers-and-acquisitions transactions from one real estate investment trust to another are difficult for a variety of reasons, but I expect this trend is here to stay. The cost- and access-to-capital advantages of scale are significant as investors continue to migrate toward larger capitalization stocks and the costs of running a public company are high. Over time, I expect public lodging REITs to grow larger, concentrating groups of assets in similar chain scales into the hands of fewer larger owners. This may lead to more hotel ownership inside public companies where return requirements are generally lower than for private, more entrepreneurial owners.
The next time a public hotel company comes knocking on the door of a public peer, don’t be surprised if the target’s board invites them in for a friendly chat.
After a 30-year career as a stock research analyst, David Loeb created Dirigo Consulting LLC, which advises on capital markets, strategy and communications issues. Clients have included REITs, brands, and private equity investors. He a member of the board of directors of CorePoint Lodging Inc., a publicly traded hotel REIT. He can be reached at firstname.lastname@example.org.
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