Interstate Hotels rebounding under new ownership

The stars seemed aligned in 2005 for Arlington's Interstate Hotels & Resorts to buy up the kinds of upscale properties it was known for running as one of the nation's largest independent hotel managers.

An abundance of low-cost capital coursed through the industry, ushering in a steady flow of acquisitions. Interstate sought to diversify its revenue stream beyond the few lodgings it already owned by snagging more properties. And boy, did it ever.

In the ensuing four years, the company averaged an annual 15 to 20 joint venture or outright acquisitions, according to its chief investment officer, Leslie Ng.

That frenzied activity, he said, left Interstate open to massive debt exposure once the credit markets froze and hotel property values took a nosedive in late 2008. Things got so bad that at the start of the following year the company had to eliminate 45 corporate positions and reduce pay by up to 10 percent amid one of the worst periods in its 51-year history.

By the close of 2009, it was clear that Interstate, having suffered consecutive quarterly losses, was in need of a lifeline. Enter hospitality veteran Frederic Malek, whose Thayer Lodging Group, in partnership with Shanghai Jin Jiang International Hotels, acquired the company for $307 million.

More than a year later, Interstate says it has regained financial health and is eager to pounce on the acquisition and management opportunities emerging as the hotel sector rebounds.

Interstate has made some significant moves in the past year, though getting a read on its full investments is difficult now that the company is privately held.

Just a few weeks ago, Interstate teamed with Waramaug Hospitality to acquire the Sheraton Denver Tech Center for an undisclosed price. The joint venture partners are embarking on a $5.75 million renovation for the 262-room property.

That deal came on the heels of three management agreements that were announced one week after the other, including one to oversee Summit Hotels Properties' portfolio of 65 select-service hotels, with a total of 6,533 rooms in 19 states across the country.

One of the more publicized recent transactions involved private-equity firm Blackstone Group, which inked an agreement in December to have Interstate manage 13 of its upscale, full-service properties. The portfolio includes Hiltons, Sheratons, Marriotts, Westins and a Wyndham, totaling 5,466 rooms in nine states, the District and Canada.

All told, Interstate's portfolio of managed properties has grown from 232 hotels at the time of the takeover to 311 hotels as of Feb. 24.

Analysts said the company may be better positioned to handle the acquisitions this time around.

“I think the company is in great shape,” said David Loeb, a hotel analyst at Robert W. Baird. While Interstate's finances are no longer transparent, he said, “It has better resources coming from its parents to help with the property debt,” which plagued its balance sheet in the past.

Ng said the company's past problems stemmed from its debt-laden properties, not the lucrative management agreements. Interstate, he noted, simply didn't have the capital structure to allow for much margin of error, making the collapse of the credit markets and hotel values at the same time devastating.

“We felt [the company] was undercapitalized. With a stronger capital structure it would be able to grow faster,” said Malek, who as president of Marriott Hotels & Resorts in the 1990s led the acquisition of the Ritz-Carlton hotels. “We saw value in the company's hotels and joint venture deals. It's progress is way beyond anything that could have been expected.”

To be sure, Interstate is more conservative this time in the way it structures purchases. Ng said the Sheraton deal in Denver was an all-cash buy and did not rely on financing.

“We're buying at significant discount, probably 50 percent of what we could have seen a couple of years ago,” Ng said. “Those of us who have been through previous cycles know that this is the right time to buy.”

Malek projects earnings this year will be roughly 50 percent above the prior year.

Much of that growth will likely derive from Interstate's activities in Asia, a region ripe with management opportunities, according to chief executive Thomas F. Hewitt.

One of the benefits of being partially owned by a major Chinese hotel operator and developer, Jin Jiang, is the access it provides. Interstate and its Asian parent formed a joint venture last April to create a third-party management company in China.

“We will have a very significant pipeline in China very soon,” said Hewitt, noting that Interstate has been active abroad since 2005. “Over the next two years, I would be disappointed if we don't have 40 to 45 good substantial properties in major markets.”

Hewitt is bullish on all of the economically advancing BRIC countries -- Brazil, Russia, India and China -- where the professional hotel management business is only now starting to take off.

Loeb of Robert W. Baird noted that management contracts abroad tend to be very profitable, with low risk and higher returns.