Time to Check-In to Hyatt?

In one of the more anticipated IPOs of the year, Hyatt Hotels will come to market Friday in an offering that could approach $1 billion. Morningstar equity analyst Michelle Chang values the shares at $25, within the firm's stated offer range, and worries about the lingering effects of economic weakness as well as the number of competing brands in the hotel sector. While a billion-dollar offering demands attention, the capital raised won't benefit the company, as Pritzker family business interests are the sole selling shareholder. However, Hyatt will receive proceeds from a 5.7 million overallotment of shares, which would raise around $142 million at our fair value estimate. Here is Michelle's full investment thesis on Hyatt:

"Hyatt Hotels has experienced significant weakness in recent quarters as both business and leisure travel have taken a nosedive. We believe Hyatt has strong brand recognition among consumers, which we think will help it maintain a solid portfolio of properties and grow its network of managed and franchised hotels. However, the near-term should be challenging given its heavier dependence on owned and leased properties, leading us to a high uncertainty rating.

"Hyatt's brands are on the higher end of the price spectrum, and they have been hit hard in the economic downturn. Systemwide revenue per available room is down between 18% and 30% for the first three quarters of 2009, depending on the concept, about on par with its competitors. There has been heavy pressure on room rates as operators have cut rates to maintain occupancy. We expect that rates should remain depressed in the near term, as business and leisure travel still appear to be weak.

"The contracting revenue base has hurt profitability particularly for Hyatt since its portfolio is more skewed toward owned and leased properties compared to its competitors. Owned/leased hotels accounted for 85% of total revenue in 2008, compared to 30% for  Marriott (MAR). We believe this has negatively impacted Hyatt in the downturn because owning properties is more capital intensive and has a larger fixed cost base. We prefer to see more managed or franchised hotel deals, which generally consist of just a base fee, or a base fee plus an incentive fee based on the profitability of a property, because they create a steadier stream of earnings and have lower overhead costs.

"Although Hyatt intends to keep a decent portfolio of owned/leased properties, we expect the majority of Hyatt's expansion to be in management and franchise contracts, particularly as it grows overseas. We believe the firm's select service brands, Hyatt Place and Summerfield Suites, are relatively underpenetrated. Hyatt has also recently introduced Andaz, an upper upscale concept that we believe may gain traction in certain contemporary urban markets.

"However, there are a plethora of brands in the industry, which could mute the success of the younger concepts. Additionally, booking windows continue to be short for both business and leisure travel, making for an extremely cloudy outlook. Growth may be stagnant in the short run given that financing for new properties has slowed to a near halt. Although we believe Hyatt can manage through the downturn, the near term should remain rocky."

Michelle's fair value estimate assumes a long-term growth rate of roughly 6%, with margins approaching double-digits given a shift in property mix, as she describes below:

"Our fair value estimate is $25 per share, which implies forward price/cash flow and enterprise value/earnings before interest, taxes, depreciation and amortization multiples of 16 and 11, respectively. We expect a 17.5% decline in revenue this year, driven by weakness in all regions and categories. Longer term, we expect Hyatt can generate annual revenue growth around 6%, driven by new management and franchise contracts and growth in its younger brands. Profitability has been hit hard this year, as cost cuts have not been sufficient to offset the effects of deleveraged fixed expenses associated with a lower revenue base. We expect an operating margin of around 3% this year as a result, down from 7.2% in the prior year. Longer term, as economic conditions recover, we believe Hyatt can generate an operating margin of approximately 12% as the property mix shifts towards more managed and franchised rooms. We value separately the income the company receives from investments in unconsolidated business ventures, which we place at $1 per share."