Hilton Hotels

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Diwaker

Andrew Lewis

Hilton Hotels Corporation (NYSE:HLT) is one of the leading hotel and leisure companies in the world. It is primarily involved in the management and development of hotels across the globe. Earlier, Hilton focused on acquiring and owning more real estate. However, it has recently changed its growth strategy, and it now focuses on spreading its operations through franchisees. This enables the company to earn revenues in the form of franchisee fee without incurring any additional costs to purchase real estate and construct hotels. Increasing the number of franchisees also provides the company with a stable and predictable stream of revenue, and shields it from any temporary downturn in the industry. The revenue of a hotel company tends to fluctuate due to several reasons. One of the primary factors is the number of customers a hotel attracts. Thus, in case the number of travelers coming to a particular region declines, the revenues from the hotel in that region will also decline. However, if the company owns the brand (and the hotel is run by a third-party), the company is ensured a fixed amount (in terms of management and franchisee fee), the number of customers coming to that hotel notwithstanding. Increase in airfares can reduce a customer’s ability to spend on a hotel room, resort or other services, which has a negative impact on the hotel industry. However, as Hilton targets upscale business travelers, the impact of increasing airfares will not be too significant for Hilton. On the other hand, an economic slowdown will reduce the number of business travelers, and create a significant impact on Hilton’s revenues. Besides these business concerns, there is a looming threat of terrorism, wars and outbreak of contagious diseases. Owing to these problems, people either stop traveling to those areas or choose alternative destinations for travel, which has a negative impact on the hotel and tourism industry in the affected area.

Company Description

Hilton primarily operates in the U.S and is also present in major cities, such as London, Paris, Rome, Sydney, Tokyo, Beijing, Shanghai, Toronto, Stockholm, and Sao Paulo. Hilton has been involved in purchasing small and medium-sized hotels since 1970, primarily for the purpose of expanding operations in the U.S. The company acquired Hilton International, the lodging assets of Hilton Group Plc, for GBP 3.3 billion in 2006. This made Hilton the biggest lodging company in the world. The revenues for the company increased from USD 3.8 billion in 2002 to USD 4.4 billion in 2006 at a compounded annual growth rate of (CAGR) of 3.7 percent, which is considerably lower than the 7 percent growth achieved by its competitors such as Marriott and Starwood.

Business Drivers

The number of hotels and rooms, geographical presence, occupancy rates and revenue per available room (revenue divided by average number of rooms occupied in a year – RevPAR) are the main drivers of revenue in the hotel industry. Increase in the number of hotels owned or franchised by a company as well as the number of rooms available for rent provides an indication of how the company is expanding its capacity to cater to the growing number of travelers. Occupancy rates and revenues per available room on the other hand indicate how efficiently a company is using its available resources (i.e. hotels and rooms).

The following table depicts Hilton’s past performance relative to the above-mentioned industry drivers.

Source: Company Data

Hilton has been continuously increasing the number of hotels it owns (including owned as well as franchised hotels). The company owned 2,800 hotels across the globe at the end of 2005 and became the world’s largest lodging company with the successful acquisition of U.K-based ‘Hilton International’. Hilton’s occupancy rates and revenues per available room have also increased continuously over the last few years, indicating that the company has been able to sell its hotels/rooms well. Hilton has hotels spread across various geographies, including major commercial markets in Europe, Asia, the Middle East, South America, and the Nordic countries. These markets have a high demand for hotels and related services throughout the year. Owing to its presence in these geographies, the company does not face the risk of falling demand in a particular city or country.

Business Segments and Products

Hilton’s primary business segments include hotels (ownership and managing & franchising) and timeshare operations (an arrangement under which a purchaser receives the right to use an accommodation or amenities or both for a specified period). Hilton develops and operates timeshare resorts through Hilton Grand Vacations Company, which provides on-site management services to Hilton Grand Vacations Club resorts. The hotel segment contributes the maximum share of revenues (approximately 87 percent in 2005) for the company. Revenue from the hotel segment includes income from owned hotels, management contracted hotels and franchises, and other fees. The company operates under the brand names, Hilton, Hilton Garden Inn, Doubletree, Embassy Suites, Homewood Suites by Hilton, Hampton, Waldorf Astoria, and Conrad.

Consumer Demand

Customers for the hotel industry include tourists as well as business travelers. Tourists may be further categorized into low-medium income groups and high-income groups as the income of a person will determine the kind of hotel he/she chooses. For example, people with high income are more likely to stay in an upscale luxury hotel, which a person with a low-medium income may not be able to afford. Hilton primarily focuses on high-income/upscale group and business travelers. The demand from low-medium income customers is primarily affected by an increase in airfares. These customers generally have a fixed budget for their vacations. Thus, if they are forced to spend more on airfare, their ability to spend on a hotel room, resort or other services declines. On the other hand, business travelers will be affected by an economic slowdown as that would have a direct impact on the volume of business. As Hilton’s customers belong to the high-income group or are business travelers, the impact of an economic slowdown will be more significant for the company. In addition to these factors, certain events, such as acts of terrorism, wars, and outbreak of contagious diseases have a severe impact on the demand from all customer segments. With events such as 9/11, the invasion of Afghanistan, the outbreak of Severe Acute Respiratory Syndrome (SARS), and Tsunami, people either stop traveling to those respective countries or choose alternative destinations for travel, which has a negative impact on the hotel and tourism industry in the affected area.

Competitive Landscape

Hilton competes with global players, such as Starwood Hotels & Resorts Worldwide, Marriott International, Global Hyatt Corporation, the ACCOR Group, and Intercontinental Hotels. Attractiveness of locations, quality of rooms & services, and company’s global operations are some of the key criteria for hotels. Hilton already has a strong presence in the U.S and is expanding its global operations through acquisitions. For example, Hilton acquired the U.K-based Hilton International in February 2006 to establish a footprint in the U.K. It also signed a multi-year agreement with a leading resort real estate developer in Thailand, Destination Properties, to manage a newly built, 358-room golf resort and spa in Thailand. Hilton is also increasingly relying on the franchisee-based model for growth. This enables the company to earn revenues without incurring any additional costs to purchase real estate and construct hotels. This strategy further enables the company to concentrate its efforts towards building a strong brand instead of buying real estate.

The following table compares Hilton’s performance to its competitors in 2006.

Source: Company Data

Although Hilton has 2,935 hotels, its occupancy rates and average daily rates are lower as compared to its competitors. Further, companies such as Starwood and Marriott have grown at a CAGR of approximately 7 percent during the period 2002-06, whereas Hilton has grown at a CAGR of 3.7 percent only.

Bulls/Investment Positives

• Since Hilton targets business travelers, increase in airfares has a minimal effect on its global occupancy rates.
• The company has been expanding its operations in international markets such as Thailand as the industry in these countries is growing at a rapid pace.
• Hilton is increasingly relying on the franchisee-based model; this provides the company with a stable source of revenue in the form of franchisee fee and also allows it to focus on developing its brand.

Bears/Investment Risks

• The company is affected by an economic slowdown as it reduces the number of business travelers.
• Events, such as acts of terrorism, wars, and outbreak of contagious diseases, have a severe impact on the demand for hotels and related services.

Annotations

11/28 – 12/14: Hilton’s share price increased from USD 32.18 on November 28, 2006 to USD 35.61 on December 14, 2006, due to the tie-up between Hilton and a real estate developer in India (DLF); the two will develop 35 hotels in the next five years.

01/30 – 01/31: Hilton’s share price increased from USD 34.40 on January 30, 2007 to USD 35.39 on January 31, 2007, when the company posted a significant growth in profits and also announced the acquisition of the U.K.- based Hilton International.