Blackstone's Acquisition of Hilton Hotel: What Can We Learn From It?

In 2007, Blackstone, a private equity group, shockingly announced its acquisition of the Hilton Hotels for US$26 billion through leveraged buyouts. Why was this such a significant event? What can we get out of this? 

Context

In the early to mid-2000s, the global financial markets found themselves in lots of cheap debt due to a low interest rate and aggressive lending (especially building up to the 2008 financial crisis). This environment became the optimal environment for large private equity (PE) firms to raise a large amount of money through leveraged buyouts (where a company loan, often 60-90%, is used to acquire the target company; the collateral here is the target company's future cash flow and assets).

This allows the PE firm to put in less of its own equity while still controlling its business. If the business improves and the debt is paid down, the returns will be much higher. Despite that, it still holds lots of risk if the target business underperforms. 

The Target: Hilton Hotels

Founded in 1919, the Hilton Hotels corporation has achieved numerous successes. By 2007, they had more than 2,800 hotels in 76 different countries. However, despite having a great global presence, it was seen as undervalued and is underperforming mainly because of three reasons: asset-heavy model, low profitability metrics, and lack of innovation. Hilton owns a large portion of its hotels in properties unlike its competitor (which owns through franchise or management models), making a large amount of its capital tied to real estate, making it inflexible. Moreover, the EBITDA margin was very low, especially in comparison to their competitors such as Marriott or Starwood.  Hilton's portfolio was less diversified in comparison to those of their competitors; they lacked presence in the luxury, boutique, or extended stay segments. 

All in all, it is what private equity looks for: a strong brand with a weak execution. Blackstone, one of the largest private equity firms, saw huge potential to monetize real estate assets, modernize operations, improve margins, reposition Hilton as a global brand, and change it into an asset-light operator.

The Acquisition

In July 2007, the world was shocked after the announcement that Blackstone offered to buy 100% of Hilton Hotels Corporation at US$26 million. The purchase price was $47.50 per share, which is a 40% premium over Hilton's stock price at the time. The acquisition was a friendly one; with the Hilton's board and shareholder approval, the deal was then closed very quickly, within just a few months after the offer.

The deal was financed through a leveraged buyout (as explained above). Blackstone used mostly debt to fund the acquisition, with only around one-fourth of the equity coming from Blackstone's private equity fund, and the remaining came from debt. As it is an LBO, it was put on Hilton's balance sheet.

The capital stack came from a few investment banks, with the lead arranger being Deutsche Bank, alongside Brea Stearns, Bank of America, Morgan Stanley, and Lehman Brothers (some of these banks do not exist anymore). Their source of finance came from senior secured loans (loans that are first-in-line to be repaid), mezzanine debt (debt that is second-in-line to be repaid after senior secured loans), and high-yield bonds. All this debt was meant to be paid down through Hilton's future EBITDA.

Blackstone then set up a Special Purpose Vehicle (SPV) (basically, Blackstone set up another company, and they use that company to acquire Hilton; Blackstone operates that SPV, but it remains a separate legal identity from Blackstone) to mitigate the financial and legal risk. Hilton board approves of the offer, the deal was finalized in October 2007, and after that, Hilton was taken private (hence private equity).

The acquisition is complete, marking the second-largest hotel deal and one of the largest LBO deals in history. The acquisition, however, was not receiving good feedback at the time due to the poor timing, right before the 2008 financial crisis, and its extreme use of leverage (4x debt-to-equity ratio).

Success

The acquisition was a complete success, Blackstone completely repositioned Hilton Hotels. Under Blackstone management, Hilton turned from an asset-heavy company to an asset-light one, similar to their competitors. Moreover, they launched and scaled brands like Hampton, Curio, and Home2Suites, allowing them to reach different market segments as well as helping them with global expansion. 

Hilton's EDITBA more than tripled within 7 years, from US$1.2 billion to over US$3.5 billion. Blackstone then IPO'd Hilton in 2013. After that, they gradually pulled away in 2018, achieving a 30% IRR and securing US$14 billion in profit.

The Importance

This deal is significant, in private equity as a whole, but especially in real estate private equity (REPE). The deal validates that with strong operational improvements and patience for strategic turnaround planning, companies can survive a crisis, especially as in the 2008 financial crisis (where lots of private equity deals failed). 

Hilton's success showed that hotels are not simply just cash-flow real estate assets, but they could rather brand platforms with great global scalability. Furthermore, this deal opens doors for private equity-backed hotel platforms such as KKR, Starwood Capital, and more. 

Its success encouraged more institutional capital to invest in hospitality through REIT structure, private real estate funds, and strategic partnership with PE firms, making hospitality a more respected, financialized asset class. 

Lastly, for Blackstone itself, this deal solidified its dominance over both PE and REPE, allowing them to become the largest hotel owner at one point and gave them confidence and template to acquire or build other branded real estate platforms.