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Lodging hasn’t been the sweet spot that it should have been for the last few years. We’ve seen rising employment, lower gas prices and more people traveling, but some of the biggest hoteliers have seen their sales lag.
The answer? Consolidation. By banning together they can keep hotel prices high and help diversify geographically and across the disparate business models of owning or managing hotels.
The big news recently is that Hyatt Hotels (NYSE: H) is looking to buy rival hotel operator Starwood Hotels & Resorts (NYSE: HOT). Granted, Hyatt is half the size (in terms of market cap) of Starwood, but the latter has been exploring strategic alternatives for several months.
A number of hotels have reportedly been interested in buying Starwood, but Hyatt is the first to step up and announce that it’s formally working on a cash-and-stock offer. If successful, this will create one of the largest hotel chains in the world.
Now, Starwood is a name I’ve talked about a lot. It goes back over a year ago, when I called Starwood a must-own hotel dividend stock. It’s currently offering a 1.9% dividend yield.
The name even showed up in my “best way to play the travel boom” piece earlier this year. However, as a global operator Starwood has been hurt by a slowdown in business travel abroad and the ever-strengthening dollar.
Nonetheless, Starwood shares have rallied almost 15% over the last month on the Hyatt news.
Big Positives
The move will give Hyatt and Starwood the reach and resources to better compete with the big boys of the industry, including Marriott International (NASDAQ: MAR) and Hilton Worldwide Holdings (NYSE: HLT).
Starwood is already selling off its vacation and timeshare property business, which gives it an opportunity to gain a larger presence in North America. The majority of Starboard’s properties are located outside of North America.
Meanwhile, the hotel buyout move gives Hyatt a greater international presence; nearly three-quarters of its properties are in the Americas.
But it goes beyond just geographies.
The combined companies would comprise a hybrid hotel manager (Starwood) and a hotel owner/operator (Hyatt). Much of Hyatt’s value is in its owned hotels, whereas Starwood owns fewer hotels and makes money from managing hotels. Hyatt has close to double the properties that Starwood owns.
Thanks to this asset-lite business model, Starwood enjoys the highest operating margins and returns on invested capital among its peers. There’s an opportunity to turn Hyatt into more of a hotel manager and focus on the more cash-generative model.
The Impact on Warren Buffett
Warren Buffett’s Berkshire Hathaway (NYSE: BRK-B) isn’t involved with hotels, but its portfolio could still be impacted by this large hotel merger. One of Buffett’s top five holdings is American Express (NYSE: AXP) – a name that attracted major activist investor ValueAct Capital in the second quarter. The fund took a 1% stake, but has yet to make any recommendations or demands.
American Express stock is still down 20% year-to-date, but depending on how this Hyatt-Starwood merger works out, things could get worse (or better) for AmEx. It’s already set to lose its co-branded partnership with Costco (NASDAQ: COST) in early 2016. Behind Delta Air Lines (NYSE: DAL), Costco was its second largest co-branded card; third is the Starwood co-branded card.
The question is which card will a Hyatt-Starwood combined company go with? (Note that the Hyatt co-branded card is with Chase.)
There are a few bright spots that could put American Express in the clear. First, Starwood likely has over 50% more members in its loyalty program than Hyatt. Then there’s the fact that the Starwood loyalty program means more to its overall brand. About half of its bookings are via loyalty members, compared to 30%-35% for Hyatt.
Hotel consolidation is coming and coming quickly. How it impacts the credit card industry is less certain, but it will be a key catalyst for struggling hotels. Starwood has been exploring strategic alternatives for several months and has said it has attracted the interest of Chinese buyers as well. And with the rise of Airbnb – and with Expedia (NASDAQ: EXPE) buying HomeAway (NASDAQ: AWAY) – look for consolidation to happen sooner rather than later.
For further reading about the global M&A boom, check out Tony Daltorio’s take on the pending Walgreens-Rite Aid merger. And to learn more about several investments that have the Buffett seal of approval, click here.