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DiamondRock optimistic about Blackstone deal
July 26 2012

Executives from DiamondRock Hospitality Company during a Q2 earnings call discussed their performance expectations from a four-hotel portfolio they acquired for $495 million from affiliates of Blackstone.

Highlights
  • Executives at DiamondRock expect their recent acquisitions from Blackstone to outperform the general market by 2% in compound annual growth rate during the next five years.
  • The REIT expects to eventually exit ownership of the portfolio with a value 100 basis points more than the acquisition price.
  • “Group pace for the balance of the year remains robust,” DiamondRock’s John L. Williams said.

BETHESDA, Maryland—Executives at DiamondRock Hospitality Company expect their recently acquired portfolio of four hotels from affiliates of Blackstone Group LP to outperform the general market and its own 23-hotel portfolio.

The properties should outperform the market by 2% in compound annual growth rate during the next five years, executives of the real-estate investment trust said.

“We see outsized (revenue-per-available-room) growth potential, food-and-beverage margin potential. We see a lot of potential both in revenue and profit growth outsized to our portfolio,” said John L. Williams, DiamondRock’s president and CEO, during a Wednesday conference call to discuss second-quarter earnings.

The call afforded Williams and DiamondRock CEO Mark W. Brugger one of the first public forums to expound on the 10 July acquisition, in which the REIT reached a deal with affiliates of Blackstone Real Estate Partners VI to acquire four hotels for $495 million: the 362-room Hilton Boston; the 406-room Westin Washington, D.C.; the 436-room Westin San Diego; and the 258-room Hilton Burlington in Vermont.

Blackstone also purchased approximately 7.2 million shares of DiamondRock common stock for a cash infusion of $75 million.

The performance assumptions shared during the call were underwritten assuming a five-year hold with a double-digit, unlevered internal rate of return.

As is, the acquired hotels will boost DiamondRock’s total portfolio RevPAR by $2 and margins by 140 basis points.

“We see margin improvement opportunities at the hotels because revenue potential at these hotels comes from rate gains as we enhance revenue strategies and put capital into the hotels to capture higher-rated business,” Williams said.

Areas of opportunity in the four hotels include product repositioning, revenue management, F&B profit maximization, marketing and labor forecasting, he said.

Blackstone had already put the wheels in motion when it bolstered marketing and upped staffing after taking ownership of the properties from Columbia Sussex Corporation in 2010. The company’s efforts “had just started to bear fruit,” Williams said. And with DiamondRock’s use of best practices and willingness to invest capital, they will continue to do so going forward, he said.

“We think we’ll have a lot more market penetration based on that strategy,” Brugger said.

Shifting strategies
DiamondRock’s acquisition from Blackstone represents a strategic shift for the REIT. Whereas much of its portfolio comprised assets in secondary markets, the focus now is on key urban gateways, company executives said.

“We consider this portfolio of acquisitions central to our strategy of using smart capital recycling to enhance DiamondRock’s portfolio through the disposition of lower-quality, slower-growth assets and redeploying the capital into assets such as these, concentrating on high-growth, gateway, urban markets with numerous upside opportunities,” Williams said.

The deal was funded, in part, with proceeds generated from the sale of three non-core assets to Inland American. DiamondRock required only 25% of debt financing, which is consistent with the REIT’s strategy to maintain a low leverage balance sheet, Brugger said.

Of the company’s 27 hotels, 16 are unencumbered by debt.

Q2 performance and outlook
For the second quarter, the REIT’s RevPAR increased to $139.98, representing a 6.5% growth from the same period a year ago. Its hotel-adjusted earnings-before-interest-taxes-depreciation-and-amortization margin improved to 28.2%, an increase of 90 basis points over 2011.

“Lodging fundamentals continue to show strength and are generally meeting our high expectations,” Brugger said.

Company executives expect more moderate growth in the third quarter followed by strong growth during the fourth quarter.

RevPAR is projected to increase between 3% and 4% during the third quarter, and group pace is up 7.8%.

“Group pace for the balance of the year remains robust,” Williams said.

In a research note, Janney Capital Markets analysts Daniel P. Donlan and Elizabeth Bland said the REIT should be able to hit its third-quarter numbers, but the fourth quarter could present more of a challenge for DiamondRock.

“Our negative 4Q ’12 outlook is mostly being driven by our projection for the REIT’s Manhattan hotels to handily disappoint management’s bullish forecast,” the analysts wrote.

One reason for the dour outlook, the analysts said, is that the New York market in general is likely to be “weak” as European leisure travel wanes. The analysts estimate that approximately 20% of fourth quarter EBITDA comes from the company’s New York properties. 

When asked about New York performance by an analyst during the question-and-answer portion of the earnings call, Williams said the market dropped off slightly during the second quarter, to the tune of 90 basis points in margin. RevPAR, however, was up 3.6%.

Williams attributed part of the decline to a drop off in travel from Europe, although the impact was “not so measurable that it’s been highlighted,” he said.

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