CapStar Hotel Company

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CapStar Hotel Company

1010 Wisconsin Avenue N.W., Suite 650
Washington, D.C. 20007
U.S.A.
(202) 965-4455
Fax: (202) 965-0478
Web site: http://www.capstar.com

Public Company
Incorporated: 1992
Employees: 6,200
Sales: $109.79 million (1996)
Stock Exchanges: New York
SICs: 8741 Management Services; 6531 Real Estate Agents and Managers; 6512 Operators of Nonresidential Buildings

CapStar Hotel Company owns and manages hotels in the upscale end of the lodging market, including such familiar names as Hilton, Sheraton, Westin and Marriott. Since going public in 1996, the company has been rapidly acquiring properties in major markets in the United States and Canada. With a successful track record of acquiring, renovating and improving occupancy rates in its hotels, CapStar has become an important player in the North American lodging industry.

Founded in 1987

CapStar’s beginnings date to 1987, when Paul Whetsell, then a vice-president at Lincoln Hotels Co., resigned to start his own hotel management company. He found backing from a New York real estate syndicator, Lepercq Capital Partners, who were promised that the new venture “would be good enough to compete against the big brand names,” according to Whetsell. The first hotel to be managed by the Washington, D.C.-based company, which called itself LCP Hotels, was the Latham in Philadelphia. An established luxury name, the Latham had been losing market share and prestige. Whetsell’s new venture promised to turn the hotel around and return the Latham to a position of strength.

The 1980s had seen a big boom in the building of hotels, but by the end of the decade this surge of construction had undermined the industry. During the Reagan years, the ready availability of money from sources like savings and loans, combined with tax laws which favored real estate investments, created a freespending environment that ultimately left the country studded with new hotels, office buildings and other commercial sites. This plethora of new businesses had difficulty finding enough customers, especially when a recession hit in the late 1980s. As the owners of these new developments began to default on their loans, many such properties were foreclosed on by the lenders. Other established hotels which had lost market share to new competition began to lose their prestige and sense of purpose as money for maintenance and staff wages had to be cut back.

Entrepreneurs like Whetsell stepped in to offer their expertise and money to the beleaguered hotels. Whetsell’s years as an executive in the hotel industry had seasoned him, and sharpened his skills for managing and reviving these “distressed” properties. A typical Whetsell approach was to carefully examine the property and the market it was in, and address the unique needs of the hotel with renovations and upgrades. The target market was business travelers, who could often be counted upon for repeat business, as well as leisure travelers. As part of the strategy, Whetsell generally stayed with established luxury hotel brand names such as Hilton, Westin, and Sheraton, seldom changing the properties’ franchise affiliations. LCP’s revenues were derived from a management fee or a percentage of the hotel’s profits.

Having succeeded with the Latham, the company soon began to use Whetsell’s contacts in the lodging industry to win more business, increasing its management portfolio to 13 properties by 1990. LCP also began to invest in the ownership of hotels, acquiring partial stakes in three properties by 1991. By the end of that year the company had management contracts for 19 establishments.

CapStar is Created in 1992

In 1992 LCP Hotels merged with Pace Management Service Corp., a smaller New York-based rival that managed six properties, to form CapStar Hotel Co. The new company began with contracts to manage a total of 35 hotels, 17 of which it wholly or partially owned. These properties, located in 18 states and the District of Columbia, had a total of more than 5700 rooms. Whetsell, who was made President and CEO of CapStar, predicted that the company would add 50 properties to its portfolio, half of which it would own, within the following year-and-a-half to two years. Though it did not come close to this level of expansion, the company did continue to grow steadily. The company’s annual revenues during this period were in the $3 to $4 million range.

By mid-1994 CapStar had management contracts with 42 hotels, 16 of which it had ownership interest in. The company announced a new venture at this time, the formation of CapStar Inns, which was created to build and operate budget hotels. Plans were laid to build as many as 25 hotels within a five-year span. The hotel industry was on a rebound, with the so-called “limited service” segment of the market leading a move to new construction. According to an analyst for Coopers and Lybrand, this was due to the limited availability of capital, a strong demand for inexpensive lodging, and the better economics of operating a property that avoided frills like restaurants and meeting rooms. The cost of construction was estimated to be $30,000 per room, including land, as opposed to an average of $80,000 for a full-service hotel room. Despite the optimistic projections, however, CapStar Inns soon fell by the wayside, as the company’s focus returned to the upscale segment of the market.

In January of 1995, CapStar joined with Acadia Partners, an investment group headed by Texas financier Robert Bass, to form EquiStar Hotel Investors L.P., to purchase hotel properties. The management of hotels continued under the CapStar Management Co. name. EquiStar sought to buy upscale hotels, and within 18 months owned a total of 11 properties. The state of the market was such that luxury hotels were being sold at a price which, even including the expense of renovations performed after their acquisition, was only 60 to 70 percent of replacement cost. Because the cost of building new full-service hotels was high, there was also a significant barrier in place to competitors entering the market. In 1995, the company’s total revenues skyrocketed to $26.4 million, though there was a net loss of two-thirds of a million dollars.

CapStar’s strategy of renovation was not just for new acquisitions. In 1995 it completed improvements to its original managed hotel, the Latham in Philadelphia. Dubbing the project “Latham 2000,” CapStar remodeled a floor of rooms to create “a hotel within a hotel” that sported all the latest high-tech business and entertainment gear. Each studio suite was outfitted with computer hookups, a laser printer, modem and fax machine, and a two-line telephone. For entertainment, there were videocassette and compact disc players with a library of tapes and discs to choose from. Rooms also had irons and ironing boards, coffee makers and grinders with fresh beans, and specially designed alarm clocks. The target customer was younger professionals who were gearing up for business presentations, and leisure travelers used to state-of-the-art accommodations like those of top New York or L.A. hotels. The new suites were also intended to give the Latham a higher profile in the competitive Philadelphia luxury hotel market.

Going Public in 1996

Having recently begun a period of rapid growth, CapStar made the decision to go public to acquire funds to pay off debt, as well as to purchase additional properties. In mid-1996 9.25 million shares were offered on the New York Stock Exchange, selling for an initial price of $18 a share. EquiStar Investors and CapStar Management were merged to form a single entity called CapStar Hotel Co. Acadia Partners of Texas sold off much of its stock, retaining only about 11 percent of the company. Citing an increase of 12.5 percent in average revenue per room in the first half of the year, and noting that occupancy rates were climbing while new construction remained depressed, CEO Whetsell stated that the company would vigorously pursue new acquisitions, adding, “There are a significant number of hotels for sale at prices well below replacement cost.”

At the same time as the public offering, which netted $166 million, CapStar also secured a $225 million line of credit for the purpose of acquiring and renovating more hotels. The first hotel to be purchased in this new program of acquisitions was the 293-room Hilton Southwest in Houston, Texas, which was announced in early November of 1996. The hotel, which had recently undergone $3.2 million in renovations, was to be given an additional $1.1 million refurbishment, completing a total make-over of the property, according to Whetsell. As with earlier acquisitions, the total expense to CapStar was estimated at only 65 percent of replacement cost. Whetsell stated at the time, “This hotel … is typical of the properties we seek to acquire—upscale, full-service hotels with excellent upside potential. We have a substantial number of properties in the pipeline both as acquisitions and as management contracts.” According to an industry analyst, the hotel business was entering its third year of recovery from a recession, but prices of existing hotels had not risen since the early 1990s.

Company Perspectives:

Foundations for Growth: A targeted growth strategy to identify, acquire and manage upscale, full-service hotels in strong markets across the United States and Canada; Results-oriented management that creates customized business plans to maximize the growth potential of each hotel; Focused renovations to enhance a hotel’s appeal to business travelers, leisure travelers or other targeted segments; Established brands, including Hilton, Marriott, Westin, Embassy Suites and Sheraton, that are familiar to travelers.

The company continued adding new hotels at a steady pace. A joint venture was announced with Hallmark Investment Corp. in late November 1996 to acquire a long-term lease for the Holiday Inn Riverfront in St. Louis, Missouri. The hotel was to undergo an $8 million renovation, which was to include two new elevators, 6,600 square feet of new meeting space, and refurbishment of all guest rooms and public areas. In December, hotels were purchased in Washington, D.C.; Sacramento, California; Colorado Springs, Colorado; and Santa Barbara, California, with three others added to the list of managed properties. By the end of 1996, less than six months after the initial public offering of its stock, CapStar had spent over $350 million to acquire new properties. The company’s annual revenues for the year were almost $110 million, over four times the previous year’s total, with a reported profit of over $19 million.

The company used a variety of methods to improve revenues and implement its acquisitions strategy. In one instance, the sales managers of CapStar properties met at a seminar designed to give them the latest information on use of direct mail as a marketing tool. While most hotels used direct mail, it was not always effective, and the seminar stressed ways that could significantly increase responses. CapStar also set up an Internet web site which promoted the company’s hotels, gave information to potential investors, and, importantly, offered a contact point for future acquisitions. The company was growing so fast that the number of hotels listed on the site was not always current.

In February of 1997, CapStar announced both the purchase of eight more hotels, bringing the company up to a total of 30 owned properties, and a secondary stock offering of 5 million shares. The new hotels included CapStar’s first three in Canada, two of which were located in Vancouver, British Columbia, with another in Calgary, Alberta. This deal was made with a real estate investment company called Highgate Hotels, Inc., and CapStar announced plans to continue to pursue acquisitions in affiliation with Highgate. Two hotel management contracts were also signed for properties connected with Highgate at this time. It was expected that $4.35 million would be spent in renovations across the whole group of new hotels. The company’s second stock offering, priced at $24.75 a share, was valued at over a third more per share than the initial offering of just six months earlier.

With two more hotels purchased in June, the company’s holdings by mid-1997 consisted of a total of 32 owned hotels, with 8,040 rooms, and 29 others, with 5,154 rooms, under management contracts. There were also a number of deals in the works to add to these holdings. CapStar was the largest owner of franchised Hilton hotels, and a significant force in the hotel industry as a whole. Though other companies were pursuing the same strategy as CapStar of purchasing and renovating upscale hotels in major markets, few had grown as quickly and generated as much interest among investors.

With its strong track record, seasoned senior management, and vigorous financial health, CapStar Hotel Co. had grown to be an important force in the North American hotel industry. The company’s expansion following its initial public stock offering was particularly swift and in the mid-1990s CapStar appeared well positioned for future growth.