Hilton Hotels stock has been soaring since February, but old Conrad Hilton must be turning in his grave. Hilton started his career when he began renting out rooms in his family’s New Mexico home in 1919. From that meagre beginning, he successfully built his enviable franchise. When the Great Depression hit in the early 1930s, Conrad was hurt, but unlike many other hoteliers, he survived. The reason? He leased the land for his hotels; he hadn’t borrowed to buy it.
That lesson had a big impact on Conrad, and his antipathy toward leverage was passed on to his son, Barron. Now 68, Barron became president of the chain in 1966; he still owns 25 per cent of Hilton’s stock and controls a further 8 per cent held by the Conrad Hilton Fund, a charitable trust.
Even after his father died in 1979, Barron remained conservative and reluctant to leverage the company. Twice he put it on the block, before having second thoughts about selling the family business. And last year he toyed with the idea of spinning off its gaming operations. ‘Hilton Hotels is a chronic underperformer, plagued by the indecision of its chairman,’ Business Week wrote in early February this year. At the time, the stock was selling at eleven times earnings, about half the rate of its competitors.
But a dramatic change took place in February when Barron stepped back and named as CEO a 53-year-old financial hotshot, Stephen F Bollenbach. Bollenbach became the first non-member of the Hilton clan to run the chain. And unlike the Hiltons, Bollenbach was not bogged down by an overly cautious Depression-bred mentality. A financial wizard and lover of fast cars, Bollenbach has a history of taking bold moves to reshape troubled companies.
He is probably just what Hilton needs. He’s not afraid of leverage but he does know what harm it can do. He directed a $2.6 bn recapitalisation of Holiday Corp in 1986, helped the over-leveraged Donald Trump keep his Atlantic City casinos in 1990; and in 1992 was hired by Marriott International to help it reduce its high level of debt.
With Hilton, Bollenbach appears to be going in the opposite direction, upping the company’s leverage. No-one doubted that he would take daring steps. Immediately after the February 5 announcement of his appointment, Hilton’s stock soared. On February 2 it closed at $737/8; by February 9 it was at $903/8, up 22 per cent.
Bollenbach’s first major move came on June 6, when Hilton announced that it would acquire Bally Entertainment in a stock-for-stock deal. The value of the stock transaction was $2 bn. Investors cheered. By mid-June, Hilton shares were at a high of $122, up more than 65 per cent from the pre-Bollenbach days. The excitement was palpable. Hilton’s p/e ratio rose above 30.
Morgan Stanley analyst Neil Barsky raised his price target to $138, and forecast that Hilton’s earnings would rise to $5.15 a share in 1997, from $3.56 a share in 1995. Oppenheimer & Co analyst David Wolfe predicted Hilton shares would rise to $150 within a year. Actually, for the very short term, at least, the analysts’ optimism was overdone. After reaching the high of $122 on June 18, the share price came back more than 9 per cent, to $110.75, by June 26. Analysts attributed the decline to the market’s view of the gaming industry. But even at the lower price, Hilton’s p/e ratio stood at a dizzying 30.3.
No-one questioned the wisdom of the deal. It catapulted Hilton into the world’s biggest casino operator by far, 25 per cent larger than its closest rival. It also gave Hilton great strength in Atlantic City, where it had been casino-less. Atlantic City has become increasingly important as a result of growing anti-gaming sentiment in the US.
Two years ago, it was expected that many states would allow the opening of casinos, but political opposition has doomed that prospect – at least for the time being. This makes the traditional gambling centres, Nevada and Atlantic City, more important than ever. ‘We gain an important, immediate leadership position in Atlantic City through Bally’s two existing properties, Bally’s Park Place and the Grand,’ Bollenbach says in a press release.
But the deal was a bit more complex and much more costly than a simple stock-for-stock transaction: Hilton also agreed to assume $1 bn of Bally debt so the actual cost was $3 bn, not $2 bn. It provided clear evidence of Bollenbach’s willingness to increase Hilton’s leverage substantially.
If the deal were effected immediately – it still needs shareholder and regulatory approvals – Hilton’s debt would have suddenly doubled. Its debt-equity ratio had been about 46 per cent before the proposed acquisition, according to Marc A Grossman, who heads corporate communications and investor relations at Hilton. The deal, plus a 10-year, $575 mn convertible bond issue sold in April, would bring that ratio to more than 100 per cent.
And it seems there’s more to come. On June 24, Hilton said it planned to spend more than $1 bn on hotel acquisitions over the next 12-18 months, many of which would probably be financed with more debt. It seems that in terms of leverage, Bollenbach is willing to go to the limit.
‘We understand from our financial advisors and our rating agencies that we probably have the capacity to borrow another $2 bn without jeopardising our investment grade status,’ said Grossman.
The dangers of leverage are very apparent on the Bally side of the deal as well. Bally was rescued from bankruptcy by its present CEO, Arthur M Goldberg, when he took over in 1990. At that time, Bally – which in 1938 produced the first pinball machine, the Ballyhoo – couldn’t meet its debt payments. It had leveraged dramatically as a result of a string of acquisitions in the 1970s.
It went on another buying spree in the 1980s. It acquired theme parks – Six Flags and Great America; the Health & Tennis Corporation of America; and Lifecycle, an exercise equipment manufacturer. It also bought MGM Grand Hotels in Nevada and the Golden Nugget in Atlantic City. In 1987, it came under a takeover attack by Donald Trump, but survived thanks in part to raising money by selling its theme parks.
Ultimately, that wasn’t enough. In 1990, Bally’s Nevada casinos, operated through a subsidiary, missed an $18.4 mn interest payment. The unit went into bankruptcy.
Bally was near bankruptcy itself. It stopped paying dividends on both its common and preferred stock and suspended payment on its debts. Goldberg convinced Bally’s banks that his plan to revitalise the company was feasible, and thus the parent company avoided bankruptcy.
But he allowed Bally Grand, the subsidiary that held the Nevada casinos, to go bankrupt; and he then spun the company off to its shareholders and bondholders. After coming out of bankruptcy, Bally Grand went public in 1993 and listed on Nasdaq. Quietly, Bally Entertainment bought up Bally Grand shares on the open market and regained control. Today, it owns 85 per cent of the stock in Bally Grand, and operates the Nevada casinos for a fee.
Goldberg quickly rationalised other parts of Bally’s business as well, spinning off the manufacturing end and renaming it Bally Entertainment. Kent McMillen, a paralegal who works with the CFO on investor relations issues, said Goldberg found that Bally’s businesses conflicted with each other. ‘We made exercising equipment and owned a company that ran health clubs. We found that our competitors in the fitness operating business were reluctant to buy our machines,’ McMillen points out. ‘If somebody bought the machine and used it at home, they wouldn’t come to our health clubs. Similarly, casinos were reluctant to buy our machines because they saw us as competition.’
Bally’s pre-1990 investors were badly diluted and received no dividends. At end-March 1991 there were 31 mn shares outstanding; today there are 50 mn. At the end of 1994, the stock was selling at $7 a share; today, after the Hilton offer, they’re trading at $28. It doesn’t take much to convince shareholders to go along with the deal.
‘We’re not doing an active campaign to ask them to vote favourably,’ says McMillen. ‘Obviously, the board of directors have approved the merger, they think it’s a good idea. We think that once the merger’s completed, the combined company will be the major force in gaming today, with 15 casinos as well as the other operations. I don’t expect to have any problems. I suspect a lot of folks will sell their stock to reap the benefit of the stock price.’
Goldberg must be among the happiest. He owns 4.9 per cent of Bally stock, worth about $95 mn in today’s market, and he enjoys a salary of $2.2 mn. Bollenbach must be feeling pretty good, too. In addition to his $500,000-a-year salary (along with a potential bonus equal to 100 per cent of that), before joining Hilton he was given the option to buy 1.5 mn shares at $74.68 a share. That would be a $53 mn gain if he were to sell the stock at $110 a share, a $68 mn gain at $120 a share.
Barron Hilton shouldn’t be feeling too bad either. Owning about 25 per cent of Hilton’s outstanding stock, his net worth has risen by about $500 mn since February.
No-one knows how Conrad would feel as his bones creak in his coffin. He must be happy that his descendants are doing so well financially, but he also must be hoping that Bollenbach and company will know when to stop.
