September 14, 2009 2:46 pm
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The Blackstone Group is talking to lenders about restructuring USD 20bn of debt that backed its 2007 LBO of Hilton Hotels, a source close to the company, two mezzanine lenders and several market participants told Debtwire.
Much like the burning bed buyout of Ohio Mattress in the 1980s, Hilton earned the dubious distinction of ending the jumbo LBO wave of 2007. And like the underwriter of the burning bed – First Boston – Hilton’s biggest banker, Bear Stearns, ended up in a bailout.
But Blackstone likely intends to write a very different ending to its purchase of the hotel chain by cleaning up Hilton’s balance sheet and salvaging some of its equity investment, speculated the buysider, a sellside head of distressed, and a lawyer not directly involved.
Buoyant capital markets and the transfer of some of Hilton’s mezzanine debt into hedge fund hands should facilitate a debt overhaul, said the first mezzanine lender. The involvement of the US government through Maiden Lane I’s stake in roughly one-quarter of Hilton’s debt throws a wildcard into the mix.
A Blackstone spokesperson declined to comment.
Blackstone is perusing a varied menu of capital structure changes, said the source close to the company. One option would be to reduce debt by swapping mezzanine lenders into a new piece of paper with warrants or a convertible option, said three financial advisors uninvolved in the credit and two mezzanine investors. The sponsor could also issue new long-term bonds to refinance part of Hilton’s senior commercial mortgage-backed debt due in 2013, said the advisors, the mezzanine investors, and the first trading head.
Aside from resuscitating Blackstone’s equity investment, a workout would give the PE firm a “reputation trade,” particularly if it involves new debt issuance, said a real estate asset manager. Such a deal would both prove that Blackstone retains access to capital markets and show its commitment to rightsizing overlevered deals. Hilton’s suite of A-brand properties should facilitate the process, he added.
The company recently held informal calls with senior lenders this summer to discuss the restructuring, said a buysider not directly involved, and two of the advisors. The private equity giant has already written down its investment by more than half, said the buysider and the second distressed trading head.
In October 2007, Bear Stearns, Goldman Sachs, Morgan Stanley and Bank of America were among the banks that underwrote the USD 8.6bn CMBS and USD 12bn of mezzanine notes that paid for Hilton’s acquisition. The banks failed to syndicate the deal at the time but offloaded some of the debt in the ensuing years.
GE Capital was sold a large slice of the senior debt, said two sources involved in the original transaction. In terms of the mezz, Goldman Sachs’ Archon Capital, CW Capital and Capital Trust bought in earlier on, while Farallon Capital, Centerbridge Partners, and Filmore Capital are among funds that took positions more recently, according to multiple market participants. All of these funds and institutional investors did not return requests for comment.
Not all market participants interviewed were convinced that Hilton has to act now. The company is paying a below-market rate of Libor+ 240bps on its first lien paper which does not mature until 2013, said a sellside desk head, the real estate investor, and a buysider.
The day the music died
A small army of Wall Street lawyers and bankers structured Hilton’s buyout, touting it as a shining example of how companies should tap their undervalued real estate with bond hungry CMBS investors waiting in the wings. The underwriters collected awards and plaudits for creating a novel structure that combined cash flows from real estate with a whole business securitization.
About 10 assets accounted for 80% of the value of real estate cash flows, estimated the first mezzanine lender. The Waldorf Astoria, Hilton on 6th Avenue, along with other trophies in London and Hawaii make up the mix, the source said.
Bear Stearns and the other arrangers intended to slice up the senior debt into stand-alone deals backed by the hybrid mortgage/revenue stream. The banks certificated, marketed and obtained ratings for CMBS making up one-third of the debt, but the CMBS market collapsed before they could pull the trigger.
The Federal Reserve and American taxpayers became involved when Bear fell into the arms of JPMorgan. The Fed created the first of the Maiden Lane vehicles – Maiden Lane I – to hold around USD 30bn in Bear real estate assets that JPMorgan refused to acquire. Blackrock, which currently manages the assets, declined to comment.
Maiden Lane I held USD 8.4bn of commercial mortgage loans as of 31 December with a fair value – defined as 65% of principal – of USD 5.5bn, according to SEC filings. The government-owned fund stated that 80% of the mortgage-backed debt it inherited is hospitality related and that 48% of the USD 8.4bn face value originated from one issuer. The disclosure implies that Maiden Lane owns USD 4bn of Hilton debt, or roughly 25% of the total financing package, suggested the second sellside trading head.
Back to the future
Blackstone does not break out figures for Hilton, making it difficult to glean how under water the investment may be. Last fall, published reports pinned interest expense on the LBO at around USD 1.3bn and expected annual cash flow at around USD 2bn.
With USD 1.18bn in net credit default swap contracts outstanding, the CDS market is the best way to track the black box situation, said a second trader. Five-year CDS is quoted at around 18 points upfront, while three-year protection is quoted at 12 points, showing a jump in the cost of protection during the time period the loans come due. CDS spreads dropped around 200bps on decent volume between 4 August and 6 August before drifting wider again, said a trader.
In terms of new debt Hilton might issue, Starwood Hotels is a decent comparable given that, like Hilton, it both owns and franchises properties under its brand. But Starwood, which owns the W Hotels, supports a significantly less levered capital structure, making it a far stronger credit, pointed out a real estate investor and the second trading head.
Though Starwood posted a 22% year-over-year TTM EBITBA decline through 2Q09 and a 35% decrease for the quarter compared to last year, the company has improved liquidity in the past few months.
Starwood amended its credit agreement by loosening its leverage cap by one turn to 5.5x EBITDA, issued USD 500m in new bonds and completed a securitization in 2Q. The USD 500m 7.875% bonds due 2014 were issued with a yield to maturity of 8.75% and have since rallied in secondary markets to 7.63%, according to MarketAxess. Five-year CDS is quoted at 363bps mid, according to Markit.
Recent precedents do exist for taking out LBO debt through the resurgent bond markets. In July, Toys R Us issued a new high yield bond at the property company level and used proceeds to repay a looming unsecured loan due in 2010. The retail chain printed the deal with a rich 10.750% coupon, paying “a premium for certainty”, said a source involved in that transaction.
He noted that although the big opco/propco LBO deals, including Toys and Hilton, are highly structured, Hilton has the benefit of dealing with only a handful of holders who have also taken writedowns. Other hung LBO real estate deals – including Archstone Smith – are also exploring restructurings that could include tapping the public markets, said the first sellside trading head.
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