Difficult debt markets means Blackstone is set for a tortuous ride prior to the end of year closing of the $26bn acquisition of Hilton.
The deal has been struck at $47.50 per share but Hilton’s share price is sticking around 7% below this, reflecting concerns in some quarters that it is no certainty that the deal will complete.
Growing nervousness about debt default in some private equity deals has made it all but impossible to farm out the lending in recent deals across all industry sectors and it has caused some high profile transactions to be pulled.
Given that Blackstone has undertakings from a consortium of investment banks to stump up 80% of the deal value or $21bn, whichever is smaller, it seems highly unlikely that Blackstone will not consummate.
The debt commitment letter has been signed by Bank of America, Bear Stearns, Deutsche Bank, Goldman Sachs and Morgan Stanley. Normally, these lenders would in turn syndicate out the loan but if current market conditions continue, then they will be left playing banker for real.
The current market reality is not one where debt providers have simply shut-up shop. Rather borrowers are being asked sterner questions and usually charged a little more than they would have been just a few months ago.
In some cases, this has been enough for the borrowing private equity fund to walk away. A few basis points increase on debt cost can easily make a deal unprofitable. This does not, at the moment, look to be the case with Hilton and Blackstone. In any case, the deal agreement has no financing condition to allow Blackstone to walk away, it is not impossible, albeit unlikely, that that is exactly what does happen.
The SEC filing about the deal made on July 27th outlined the terms of the financing arrangement. It reiterated that Blackstone would receive a $560m break fee if the deal folds with Hilton entitled to $660m if Blackstone walks away in certain circumstances.
Also noteworthy was the $137m pay day that Hilton CEO Steve Bollenbach will receive when the deal completes.
This sum comprises $74.5m for options, $13.3m for his performance shares, $2.2m for restricted stock, $2m bonus, $34.7m for vested awards and $10.5m for severance pay.
Bollenbach is severing his relationship with Hilton at the year-end but the company has agreed to supply him with an office, an assistant and access to the corporate jet.
The payment to Bollenbach dwarfs the fees being paid to Hilton’s financial adviser, UBS. Provided the deal completes, UBS are set to receive $33.6m with just $2m being paid out otherwise.
The filing also detailed the chronology of the Blackstone bid. The first approach was made by an unnamed rival to Blackstone, believed to be Starwood Capital, in June last year, offering a deal in the low $30s per share.
A formal meeting with Blackstone’s Jonathan Gray took place in August and an offer in the high $30s was suggested but Hilton wanted something in the $40s.
Due diligence was undertaken in September but Blackstone decided not to proceed by early October. Communication continued intermittently until in May, Gray said that a deal in the $40s might be possible and talks began again in earnest.
Blackstone said it would offer $47.50 per share on June 24, with an extra 50 cents being offered (worth $200m) if the debt markets improved. Draft documentation was distributed to Blackstone on June 27. Hilton’s board approved the deal on July 3.
The appeal of Hilton was made clear by EBITDA projections prepared by UBS. These show that the company profits will be $1.6bn in 2007 and $1.8bn in 2008. But by 2012 this will have leapt to $2.9bn. This level of cash flow is clearly capable of supporting substantial debt, assuming trading pans out as expected.
During the second quarter, Hilton’s net profit was up 15% to $165m. Fees were up 16% to $201m and comparable system-wide revpar was up 8.9%. Owned hotels in North America showed a 9.8% increase in revpar.