Fitch: Leverage Up-Tick Dilutes Benefits From Starwood's Timeshare Spin-Off

CHICAGO--()--Starwood Hotels & Resorts' (Starwood) planned spin-off of its more volatile and capital intensive timeshare business to shareholders is a positive strategy shift that will improve the company's credit profile over the cycle, according to Fitch Ratings. However, the company's leverage will likely increase to the upper bound of Fitch's target at the 'BBB' rating, in the near term, making the tactical execution less bondholder friendly. Separately, Fitch views Starwood's plan to more aggressively use its balance sheet to bolster its rooms system growth as a modest incremental negative, albeit within the scope of its rating.

Exiting the timeshare business should moderately reduce the volatility of Starwood's through the cycle earnings profile. Timeshares are a riskier business than hotel franchise and management; the cash flows are more volatile and the capital requirements are higher. However, Starwood has indicated that its leverage will increase in the near term as a result, which balances the credit benefits from lower earnings volatility, in Fitch's view.

Other aspects discussed on its earnings call suggest Starwood plans to incrementally use its balance sheet more aggressively to support rooms system growth. This could include the tactical purchase of hotels to foster brand growth, perhaps similar to what Marriott has done successfully with its EDITION brand. Starwood also indicated it will broaden the scope of its management and franchise investments towards more franchisee debt and operating profit guarantees and less 'key money.'

Off balance sheet guarantees are generally more challenging to analyze than key money, which flows through the cash flow statement. Guarantee disclosure can be limited and the need to satisfy these obligations often increases during periods of economic and capital markets stress. Importantly, the changes management outlined essentially aligns Starwood more closely with its peers, rather than distinguishing it.

Fitch is more comfortable with Starwood operating towards the upper end of our 2.75x-3.0x leverage target at the 'BBB' rating, under the assumption of less earnings volatility without timeshare. Notably, Fitch did not adjust its 3.0x-3.25x leverage target for Marriott at the 'BBB' rating following its timeshare spin-off in 2011. Fitch's lower leverage target for Starwood at the 'BBB' rating reflects the company's smaller size and less diversified brand portfolio, as well as its outsized exposure to more volatile international markets.

Positively, Starwood has indicated that 75% of its EBITDA will be comprised of recurring fees post the timeshare spin-off, leaving it well positioned to meet or exceed its 80% target by 2016. Moreover, management expects 2015 owned hotel sales to pace the roughly $800 million of gross proceeds from 2014 sales, notwithstanding its proximity towards its asset light business mix target. To date, the company has achieved 40% of its previously established $3 billion asset sales goal, after adjusting for the five hotels it will contribute to the timeshare spin-off.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Fitch Ratings, Inc.
33 Whitehall St.
New York, NY, 10004
or
Michael Paladino
Senior Director
+1 212-908-9113
or
Timothy Lee
Associate Director
+1 512-215-3741
or
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elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Stephen Boyd, CFA
Director
+1 212-908-9153
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY, 10004
or
Michael Paladino
Senior Director
+1 212-908-9113
or
Timothy Lee
Associate Director
+1 512-215-3741
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com