Hilton's IPO Soars. Should You Buy?

The much-anticipated initial public offering of Hilton Worldwide Holdings went off without a hitch today, with the largest hotel IPO ever pricing last night at $20 per share and the stock quickly posting a 6.5% jump at the open and rising to a 9% rise as of 1:30 p.m. EST. Yet even if Hilton's honeymoon period goes well for investors, the bigger question facing the hotelier is whether it can outpace competition from rivals Hyatt Hotels , Marriott , and Starwood Hotels & Resorts and justify what some see as a fairly lofty valuation.

Hilton Hotel, Bangkok. Source: Wikimedia Commons.

Cashing in on hotels
When private-equity firm Blackstone Group took Hilton private back in 2007, it paid about $26 billion in stock and debt assumption for the hotelier. At first glance, the $2.35 billion take from Hilton's IPO today might seem like a huge loss for Blackstone. But the IPO only included 117.6 million shares in its offering, representing less than 12% of the 985 million shares that Hilton said in its registration would be outstanding after the offering. At the current trading price, that puts a more than $21 billion valuation on the hotel operator. When you add in the fact that Hilton still has about $15 billion in outstanding debt from Blackstone's buyout, Blackstone has made an almost-unprecedented paper profit on the IPO, with Bloomberg estimating the private-equity firm's take at $8.5 billion.

The gains are just the latest in a series of profitable hotel transactions for Blackstone. Two of them involve Extended Stay America, which Blackstone bought in 2004 and sold at the top of the market in 2007 before joining a group of other funds to take the hotel chain private again in 2010. The most recent Extended Stay IPO just last month raised $565 million, valuing the company at about $4 billion and helping Blackstone and its partners roughly triple their investment.

Moreover, Blackstone intends to tap the equity markets again with its ownership of La Quinta. Reports last month said that the private-equity company would likely seek an IPO rather than trying to sell La Quinta outright. Given its success in moving hotel-company shares, Blackstone's attempt to repeat that success with La Quinta makes plenty of sense.

Paying up for quality?
But even if Blackstone made money on Hilton, will shareholders buying the stock in the IPO share the same results? According to Hilton's registration statement, the hotelier made $462 million over the past 12 months, or about $0.47 per share. That equates to an earnings multiple of about 46. Because of the nature of the hotel business, that actually isn't as excessive as it looks. But it's still well above Hyatt's earnings multiple of 40, let alone Marriott and Starwood at a more reasonable 22. Paying roughly double the earnings multiple for Hilton for those two equally impressive hotel chains definitely requires giving it premium status over its rivals.

Moreover, even when you consider Hilton's leveraged balance sheet and look at earnings before interest, taxes, depreciation, and amortization, you still get a fairly lofty enterprise-value multiple of 13.7 times future projections for EBITDA. That's higher than Starwood's projected EV/EBITDA ratio of just over 12, as well as Hyatt's 10.7 and Marriott's 13.2, according to S&P Capital IQ. Again, the metric suggests that investors are willing to put a premium on Hilton because of its status in the industry.

Obviously, Hilton would argue that it deserves that premium pricing. The hotelier has posted revenue per available room figures that are above the industry average, taking full advantage of greater demand for hotel rooms throughout the industry. Moreover, given the performance of Extended Stay America -- whose shares has added another 3% on top of its first-day gains of almost 20% -- investors clearly have an appetite for hotel stocks.

Is Hilton worth buying?
For long-term investors, it's worth noting that Blackstone itself didn't offer any of its Hilton shares in the IPO, choosing to hold onto them. That suggests at least a short-term vote of confidence for the stock, as the private-equity firm apparently believes Hilton shares will be worth more in the future. In the long run, though, Hilton will have to demonstrate its competitive advantage over other premium hotel chains in taking advantage of favorable economic conditions. Otherwise, Hilton will have a hard time justifying an above-average valuation for its stock.

Make smart buys
Companies like Hilton are attractive in part because your best investment strategy is to buy shares in solid businesses and keep them for the long term. In the special free report "3 Stocks That Will Help You Retire Rich," The Motley Fool shares investment ideas and strategies that could help you build wealth for years to come. Click here to grab your free copy today.

The article Hilton's IPO Soars. Should You Buy? originally appeared on Fool.com.

Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Hyatt Hotels. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story