Hilton Worldwide: Stock Spinoffs, Reverse Stock Split

Big news for shareholders and prospective shareholders of Hilton Worldwide (HLT):

First, the Board of Directors at Hilton Hotels is spinning off two businesses to shareholders. It is bundling its timeshare business up into a new business called Hilton Grand Vacations (HGV). And some of the real estate located at hot-spot destinations is going to be packaged into a publicly traded company called Park Hotels & Resorts (PK). This spinoff will occur on January 3rd. On the same day, Hilton will execute a 1-for-3 reverse stock split. This is done because some corporations feel shame about having a $15 stock price, thinking a $45 stock has more credibility. Nearly everyone sees through this maneuver, but the game goes on.

What I see as the risk for shareholders of Hilton, either for the parent entity or its successors, is the distribution of debt that will be accorded to each of these three enterprises.

Like almost every other operator in the hotel industry, Hilton Worldwide is loaded with debt. It has over $10 billion in debt, and the kicker is that almost $9 billion of it is due before 2021. Therefore, it’s fair to classify Hilton’s repayment requirements as medium-term in nature rather than long term.

Given that Hilton’s earnings power is leveraged ten to one, it is going to need to refinance some, if not most, of the principal. My expectation is that the interest rates will be higher.

I want to pay close attention to how this debt burden gets allocated across the three company. I wonder if there is an effort similar to what Peabody Energy and Arch Coal did with Patriot Coal in which they used Patriot Coal as a vehicle to offload their own debt. If I had to guess, I would look to Hilton Grand Vacations (HGV) as the entity that might absorb more debt than you’d expect. And if a recession soon follows, I would think it would face a very significant solvency risk.

When creditors loan to a business, the terms almost always include anti-assignment clauses. This prevents you from unilaterally transferring the debt of your business to an entity with a lower risk profile. This makes sense–the bank didn’t loan money to just your resort business; they loaned it to your resort, timeshare, and plain vanilla hotel-renting operations in full.

But anti-assignment clauses don’t mean that debt fails to get transferred during stock spinoffs. Instead, it means that the management team at Hilton must do something to secure the permission of bank creditors to transfer the debt to the smaller, high-risk entity. Sometimes, this comes in the form of a one-time fee to allow the debt assignment, but usually it means negotiating a higher interest rate for the debt.

I am completely agnostic on whether Hilton Worldwide is a good investment. It is building stable cash streams for itself by franchising some of its operations, particularly through the Marriott International arm. On the other hand, its growth during the prosperous economic condition is never quite as good as you’d expect, and the debt limits its flexibility and may become a bigger part of the story when interest rates increase concurrent with expected refinancing. I see the Hilton breakup as something to watch from afar with academic interest rather than something actually worthy of your hard-earned money.