Case Analysis

The case is selected from the case packet: Astor Park Hotel by William Poorvu & Arthur Segel, 2001, HBS Case_9-800-194 (the access link to HBP coursepack is provided under Required Readings in the syllabus on Bb). This case study discusses the interest of Starwood Hotels in acquiring an underperforming hotel in the Pacific Northwest. Steve Goldman, Starwood Vice President for acquisitions and development, is wondering how much to pay for the property and how to reposition it. This study also provides a good overview of the earlier development strategies that made this company one of the global leading hotel organizations today. Apply the knowledge and methods studied in this course to analyzing this case. The following is the guideline for this case study: Your written analysis of a case should generally contain five sections 1. Executive Summary 2. Brief overview of key case facts 3. Identification of the case problem or central issue 4. Discussion of 2-3 alternative solutions to resolve the problem 5. Selection of the preferred solution and explanation of how it solves the problem The body of your case analysis should be no longer than 4.5 pages, double-spaced. Allow yourself an average of one page per section (2-5 above) and a half-page for the executive summary. Part of the learning experience is the distillation of notes, ideas and opinions into succinct presentations of your thinking on a particular case. Articulately state your points. You are encouraged to use other resources.
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For the exclusive use of J. Dennany, 2018.
9-800-194
REV: AUGUST 2, 2001
WILLIAM POORVU
ARTHUR SEGEL
Astor Park Hotel
Steve Goldman sat at the desk in his room at the Astor Park Hotel in the Astor section of Pacifico,
a large Pacific Northwest city, thinking about his upcoming presentation to Barry Sternlicht,
Starwood Hotels and Resorts’ (Starwood) Chairman and CEO. Goldman was the Executive Vice
President of Acquisitions and Development at Starwood and responsible for growing Starwood’s
worldwide portfolio of hotels. His job entailed originating, structuring, and negotiating development
related investments for the nation’s largest Real Estate Investment Trust (REIT). It was March 9, 1999
and Goldman’s due diligence work on the Astor Park was about to come to a close after weeks of
investigating everything from the fire preparedness to the quality of the kitchen floor at the 257-room
all-suite hotel. His exhaustive efforts over the past month had convinced him that the bankrupt Astor
Park was undervalued and had not maximized management efficiencies because it was an
independently managed property. His analysis led him to believe that Starwood would do well with
its investment if he could propose a sound strategy for purchasing and repositioning the property
from its current position at the low end of the luxury hotel segment. Contemplating the numerous
issues that he faced in preparing his investment recommendation, Goldman began to put pen to
paper developing a list of outstanding issues regarding financing, deal structure and repositioning
that he needed to address before his meeting with Sternlicht which was less than a week away:
“Given the market, how should the hotel be repositioned? Is the deal structure I have proposed
really attractive to both Starwood and our equity partner? Can we pull this property out of
bankruptcy at a reasonable price and generate an attractive return for our shareholders?”
Background
The Astor Park Hotel was originally constructed as a dormitory for the University of the
Northwest (UNW) in 1969. By the mid 1970’s, the property had changed hands and was converted
into a retirement home. The conversion was financed by Wells Fargo, a large California based bank.
The property’s stint as a retirement home lasted only a year as the property quickly fell into default.
Wells Fargo took over the asset and brought in Hyatt to remodel and operate the property as a hotel.
In 1979, Andrew Pimentel, a Pacifico based real estate developer purchased the hotel from Wells
Fargo for $9 million (financed with $6 million of 10% interest only debt for 10 years) and changed the
name of the property to the Astor Park Hotel.
________________________________________________________________________________________________________________
Entrepreneurial Studies Fellow Matthew C. Lieb prepared this case under the supervision of Professor William Poorvu and Senior Lecturer
Arthur Segel. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of
primary data, or illustrations of effective or ineffective management.
Copyright © 2000 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording, or otherwise—without the permission of Harvard Business School.
This document is authorized for use only by James Dennany in Hotel and Resort Market Analysis-1 taught by Larry Yu, HE OTHER from January 2018 to May 2018.
For the exclusive use of J. Dennany, 2018.
800-194
Astor Park Hotel
Pimentel successfully positioned the Astor Park as one of the exclusive hotels in the Pacific
Northwest. The success of the Astor Park in the early 1980’s prompted Pimentel to take a 25-year,
$40 million non-recourse loan with interest accruing at 10.69% from Equitable in 1987. $6 million
from the loan was used to payoff Pimentel’s original acquisition financing and consolidate other
loans on the property. $10 million of the Equitable debt was used for improvements to the property.
The remaining $24 million from Equitable was distributed to Pimentel and his partners. In 1990,
Pimentel added more debt in the form of a $5 million, 20-year second trust deed with a constant of
11.75% provided by Equitable. The proceeds from the new Equitable loan were used for hotel
improvements. At the time of this loan, the Astor Park Hotel was valued at $75 million.
In the early 1990’s the hotel market in the Pacific Northwest began to change dramatically for two
reasons: increased competition and a precipitous decline in the health of the Pacifico economic
environment. By 1992, a new Four Seasons and The Inlet, a luxury boutique hotel, had come on line.
As a result of the altered competitive and economic landscape, the performance of the Astor Park
began to erode dramatically (see Exhibit 1 for historical financial performance of the Astor Park). As
a response to this decline, Pimentel and his lenders restructured the property’s loans allowing for a
future debt service deferral of $6 million, which was to be used for renovation. Additionally,
Pimentel and his partners committed an additional $6 million in equity in an effort to bring the hotel
to a quality level commensurate with that of the new local competitors. From 1993 to 1996, the Astor
Park underwent significant renovations at a cost of $12 million, bringing the total cost of renovations
since Pimentel’s acquisition to $27 million.
Pimentel had conducted detailed analysis on the market and the property and believed that a
significant facelift would drastically improve the performance of the Astor Park (see Exhibit 2 for
Pimentel’s forecast of the property’s performance following the scheduled $12 million renovations).
Suites on floors 10 through 16 received new carpeting, wallpaper, lighting, fixtures and entire
bathrooms. Additionally, the lobby received new wallpaper, marble floors and furniture. Despite an
excellent location, recent renovations and first-class amenities, the Astor Park continued to perform
poorly. By 1998, the hotel’s poor performance caused deferred interest to grow from $6 million in
1993 to over $18 million leaving the property encumbered with a total of $63 million in debt. The
debt burden proved to be too much for the property and Pimentel was forced to file for Chapter 11
bankruptcy proceedings for the Astor Park (see Exhibit 3 for a description of Chapter 11 as it relates
to real estate).
Astor Park Hotel
The Location
The Astor Park was situated in a central location bordered by three of Pacifico’s most exclusive
neighborhoods: Emeraldville, De Pere and Bayview Hills. The hotel was within walking distance of
Astor Village’s numerous shops, restaurants and theaters as well as the UNW campus. In addition,
the Astor location afforded hotel guests convenient access to the large supply of well-occupied class
“A” office space situated along the West Water Corridor of Pacifico. While the Astor locale had many
advantages, it was considered a very good, but not premier location relative to the hotels in the
trendy section of Bayview Hills or the scenic beachfront of Inlet Sound.
2
This document is authorized for use only by James Dennany in Hotel and Resort Market Analysis-1 taught by Larry Yu, HE OTHER from January 2018 to May 2018.
For the exclusive use of J. Dennany, 2018.
Astor Park Hotel
800-194
The Property
The mix of rooms at the 257 all-suite Astor Park included 177 one-bedroom suites, 39 twobedroom suites, 2 three-bedroom suites and 39 penthouse suites. Standard amenities included multiline speaker phones, voice mail systems, fax and modem lines, 27-inch remote controlled televisions
and deluxe bathroom accessories. The Astor Park offered a variety of food and beverage options
consisting of the fine-dining Denmark Room, the three-meal Bayview Terrace, the poolside dining
Café Solaris and the Astor Lounge. The hotel currently maintained minimal meeting space consisting
of five separate rooms totaling nearly 4,000 square feet. The Astor Park Room, the largest of the
meeting rooms, was capable of accommodating 150 guests. In addition to the suites, restaurants and
meeting spaces, the Astor Park maintained a 170-space underground parking facility, a wellequipped exercise room and two outdoor swimming pools situated within an attractively landscaped
garden area. Consistent with its location and amenities, the Astor Park offered premium services
such as valet parking, 24-hour room service, a concierge, same day laundry and complementary
chauffeured transportation to area shopping destinations.
The Competition
The Astor Park Hotel faced competition on two fronts. The primary competitive set was
comprised of the lower end of Pacifico’s luxury market. The Northwest Hyatt, Pacific Inn, Nakota,
Emerald Hilton, Sheraton Mirvue, Matilda and Porcouver Bismarck all competed with the Astor Park
for business and leisure guests. These seven hotels plus the Astor Park represented a total of 2,594
rooms. The Astor Park also competed against Pacifico’s premier luxury hotels. This secondary
competitive set consisted of the Inlet, Four Seasons, Regent Emeraldville, Lane Forest Hotel and
Windows on the Sound. Along with the Astor Park, this secondary competitive set operated a total
of 1,672 rooms (see Exhibit 4 for description of competition).
Current Operations
In Goldman’s opinion, the Astor Park was suffering as a result of its market positioning and
management inefficiencies. In evaluating hotel properties, Goldman and his Starwood peers
considered average daily rates (ADR) and occupancy levels to be the key measures of the hotel’s
general strength. While occupancy levels often reflected industry wide patterns, they were also a
significant measure of a hotel’s position within its local competitive market. As of September 1998,
the Astor Park was garnering an ADR of only $175 (not including “ownership related” rooms).
Worse yet was the property’s low occupancy rate. The Astor Park was running at only 65% of
capacity in relation to competing hotels that achieved occupancy levels of over 70% on average.
Goldman speculated that the poor performance of the Astor Park in recent years was due to the
fact that undisciplined management had allowed the property to slip from the top tier of the Pacific
Northwest luxury market. He cited an inconsistent and deteriorating guestroom mix on the lower
floors, management turnover, and overstaffing with poorly trained employees as significant
contributors to the poor performance of the Astor Park. As a result of slipping from the top of the
luxury segment, the Astor Park management team had been forced to rely heavily on discounted
government and corporate business which brought down the property’s ADR (see Table A for the
Astor Park’ current market position).
3
This document is authorized for use only by James Dennany in Hotel and Resort Market Analysis-1 taught by Larry Yu, HE OTHER from January 2018 to May 2018.
For the exclusive use of J. Dennany, 2018.
800-194
Table A
Astor Park Hotel
Astor Park Competitive Position
Astor Park ADR vs. Two Competitive Sets
Trailing 12-Month ADR
as of 7/96
$245
$225
$205
$185
$165
$145
$125
Lower Tier*
Astor Park Hotel
Upper Tier**
Goldman believed there were a number of areas where Starwood management could generate
dramatic improvements in the performance of the Astor Park. Obvious cost overruns included food
and beverage operations which lost over $320,000 in 1998 due to generous staffing and an
extravagant, money-losing weekend brunch. Goldman also sited the excessive use of complimentary
or discounted rooms in his analysis. According to his calculations, 6% of total room nights in 1998
were devoted to “ownership related” guests at a $65 ADR (“ownership related” guests are not
included in the $175 ADR from September 1998).
While Goldman believed that Starwood’s management practices could result in significant
improvements at the hotel, he also knew that the turnaround would not be easy. After all, hotels, as
compared to residential, retail and office projects, were perhaps the riskiest and most complex form
of real estate management, development and ownership. Hotels were generally characterized by
large capital building costs, complicated design and construction, high fixed costs of operation,
management intensity, and high levels of uncertainty relating to occupancy levels. Hotels, in effect,
had to ”rent” their entire facilities every night, a constraint which significantly increased operating
risks, and which imposed a need for specialized management expertise and an ongoing refinement of
market positioning. Occupancy was heavily affected by changes in the economy.
Room rates were often used as a benchmark to determine the feasibility of new hotel construction
or acquisition. One industry rule of thumb for full service hotels was that for every $1,000 of project
costs on a per room basis, a hotel must achieve $1 of average daily room rate. If, for example, total
development costs of the hotel amounted to $250,000 per room, an average daily rate of
approximately $250 per room must be achieved. Goldman wondered if this rule of thumb was
applicable to the Astor Park in this case.
Starwood
Starwood Hotels and Resorts was the world’s largest hotel operator generating over $4 billion of
revenue in 1998. The company had grown from relative obscurity in the early 1990’s to international
4
This document is authorized for use only by James Dennany in Hotel and Resort Market Analysis-1 taught by Larry Yu, HE OTHER from January 2018 to May 2018.
For the exclusive use of J. Dennany, 2018.
Astor Park Hotel
800-194
prominence through a series of bold acquisitions led by Chairman and CEO Barry Sternlicht
(Harvard Business School class of 1986). In 1995, Sternlicht purchased Hotel Investors Trust (a hotel
REIT) and Hotel Investors Corporation (a hotel management company). Hotel Investors Trust and
Hotel Investors Corporation allowed Starwood to benefit from a rare paired-share REIT structure.
This structure permitted income from the management company as well as income from real estate
gains to be exempt from corporate income tax, as long as the company paid out 95% of its earnings as
dividends. Any tax due was paid by the individual investors in the Trust. Although the pairedshared status was outlawed in the early 1980’s, Hotel Investors Trust and Hotel Investors
Corporation were “grandfathered” under the 1984 law. As a result of its paired share structure and
unique ability to avoid “leakage” between the management company and ownership entity, Starwood
was able to raise large amounts of equity and debt. At the end of 1997, Starwood further increased its
market presence through the acquisition of Westin Hotels.
By the end of 1997, acquisitions had given Starwood an ownership stake in over 110 hotels.
Despite rapid growth from 1995 through 1997, 1998 proved to be the breakout year for Starwood.
Early in the year, Sternlicht approached ITT’s Chairman, Rand Araskog, as a “White Knight,” and
subsequently beat out Hilton for the acquisition of ITT in a well-publicized battle for control.
Starwood paid $14.6 billion for ITT which was comprised of Sheraton Hotels, Ciga Hotels, Caesars
Casinos, World Directories, and a 50% interest in Madison Square Garden. The acquisition of ITT
propelled Starwood to the top of the hotel industry and made Sternlicht, at age 38, a household name
in the hotel industry.
Later the same year, Congress eliminated the paired-share status of Starwood causing Sternlicht to
combine Starwood’s operations into a single C-corporation, but not before the company had amassed
a portfolio of over 700 hotels in 75 countries including such marquis properties as the St. Regis in
New York City, the Phoenician in Scottsdale, the Gritti Palace in Venice, and the Princeville Resort in
Kauai. The repeal of Starwood’s paired-share status eliminated Starwood’s advantageous tax
position versus other hotel companies, but it also gave the company access to internally generated
cash flow that could be used for further expansion.
Acquiring the Astor Park Hotel
Acquiring the Astor Park would require Starwood to work closely with Andrew Pimentel, the
property’s owner since 1979. Goldman had been introduced to Pimentel by Michael Schedler, a
prominent real estate attorney who was advising Pimentel on the bankruptcy issues the Astor Park
was facing. Seeking a mutually beneficial partnership, Pimentel and Goldman entered negotiations
in an effort to buy the Astor Park out of bankruptcy. Goldman had only recently received word that
Equitable, the largest current creditor of the Astor Park, would be willing to sell its interest in the
property for $33 million. Goldman viewed this as a positive sign as Equitable had over $63 million in
debt against the property. Whether $33 million was the bottom line, he did not know.
After weeks of negotiations, Goldman and Pimentel had come to an agreement on structuring a
partnership deal that broke out cash disbursements according to both ownership interests and
management responsibilities. Under the agreement, Starwood would commit the equity capital and
manage the property. Starwood would receive an 11% preferred return and a management fee equal
to 3% of gross revenue. Following Starwood’s preferred return, distributions would be split 90% to
Starwood and 10% to Pimentel in the form of his carried interest in the property. In addition to his
carried interest, Pimentel also had the option to commit up to 20% of the equity capital.
5
This document is authorized for use only by James Dennany in Hotel and Resort Market Analysis-1 taught by Larry Yu, HE OTHER from January 2018 to May 2018.
For the exclusive use of J. Dennany, 2018.
800-194
Astor Park Hotel
On the surface, the deal appeared to be equally attractive to both parties. Starwood would gain an
underperforming hotel at a potentially attractive price and Pimentel would preserve a carried interest
in the property (which allowed him to avoid the $4.65 million tax liability he would be burdened
with if he sold the property outright).1 However, Pimentel would still have to pay the taxes on the
debt forgiveness of $2.4 million in the event of a continuing interest in the partnership. Pimentel’s
role was critical to Goldman in that Starwood could not bypass the bankruptcy process without
Pimentel’s consent and involvement.
Repositioning
As Goldman began to craft his proposal for Sternlicht, it became obvious that he could not
separate the acquisition decision from the repositioning strategy for the Astor Park. After all, the
success or failure of the investment would be a function of the capital committed and the returns
generated from the investment. The positioning of the hotel would be a critical driver in both the
capital requirements for the hotel as well as the average daily rate, occupancy levels and overall
returns.
To position the hotel effectively, Goldman carefully considered the type of customer that would
be most desirable and profitable, given the Astor’s favorable location and size. Typically, hotel guests
are divided into four discreet categories (see Exhibit 5 for customer profiles). By segmenting the
market by customer type, Goldman could more effectively position the hotel by catering to specific
customers in the Pacifico area.
In positioning the hotel, Goldman would be relying on one of Starwood’s most powerful assets:
the company’s portfolio of well-recognized brands. Starw …
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