Extended Stay America Might Spin Off Its Real Estate Unit

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At a time when the majority of major hospitality brands pursue being completely “asset-light” companies that own little to no real estate of their own, one holdout is considering joining the rest of the pack.

Charlotte, North Carolina-based Extended Stay America is that company, following the lead of such companies as Hilton and, most recently, Wyndham.

During a conference call with investors to discuss second quarter earnings Thursday, Extended Stay America CEO Jonathan Halyard said, “I want our shareholders to know that we continue to evaluate the merits of alternatives to our current corporate structure.”

Those alternatives include possible merger and acquisition activity and, more likely, the spinoff of Extended Stay America’s real estate investment trust, ESH Hospitality, which owns 599 of Extended Stay America’s 626 economy extended stay properties in the U.S.

Halkyard said the Extended Stay America board was considering the possibility of a spinoff, primarily because of interest both from shareholders and the analyst community.

No definitive timeline was given for if or when a spinoff might be announced. Halkyard said, “I am reluctant to put any kind of timeline on this. I only want to assure our shareholders that it is a topic that we pay close attention to and is one that we and our board continue to evaluate not only in the context of evaluation but also in terms of performance to the portfolio.”

Extended Stay America’s Evolution to an Asset-Light Company

Chatter about a potential spinoff for Extended Stay America’s REIT is nothing new, but Halkyard’s remarks do signal that the company is taking the feedback and interest much more seriously than it has in year’s past.

And the company’s continued evolution — including the introduction of the ESA 2.0 strategy and the opening up of its brand to franchise and management contracts — all point toward the increased possibility of this spinoff becoming a reality.

With the introduction of ESA 2.0 in 2016, the company introduced the ability to franchise the brand for the first time in its history. Historically, shareholders love asset-light hotel companies because of the value they can extract, and the fact that asset-light businesses tend to be more stable and generate higher profit margins.

Halkyard said the company is already well on its way to fulfilling its ESA 2.0 strategy, and that its pursuit of being more asset-light and reinvesting in its existing properties through asset recycling — selling properties to reinvest in others — will continue, whether or not the company pursues a spinoff.

“In the last few months, we grew our total pipeline to 34 hotels, including 19 franchise hotels, we purchased a hotel for conversion, purchased an additional site for a new hotel and we expect to purchase several more sites in the second half of 2018,” Halkyard noted in a statement.

In a note to investors, Baird senior equity analyst Michael Bellisario wrote that the investment community is too upbeat about the value creation in a spinoff, “which we believe increases the downside risk for shares.”

A Soft Second Quarter

There’s been plenty of buzz surrounding the popularity of the extended stay hotel market for at least the past year, but Extended Stay America’s second quarter earnings demonstrated some potential softness in the market, at least it relates to the economy portion of the sector.

In the second quarter, Extended Stay America’s system-wide revenue per available room (RevPAR) slowed from the first quarter of the year, and was up only 1.6 percent compared to the same period in 2017.

“The slowdown in RevPAR growth as compared to the first quarter was unanticipated, and was primarily, due to the reduction in business related to the hurricanes in Florida and Houston last fall,” Halkyard noted. “Our internal research shows that our competitive set underperformed the industry and economy chain scale during the second quarter, as our specific sub markets underperformed relative to the national average.”

Halkyard did, however, note that RevPAR growth the chain’s owned hotels grew 2.4 percent in the second quarter.

Halkyard also noted he didn’t have any particular reason for any softness in the economy segment of the extended stay market, saying, “”There’s no perfect analog for our business in the segment … We do feel like the economy segment is a little closer to us than any other others and — while we are a little better than a little worse, we feel better, especially, recently about how we’ve done relative to the economy segment and the economy segment is picking up in the segment relative to others.”

The extended stay portion of the lodging market has been of particular interest to investors and other brands in the past year. In February, Choice Hotels closed on its acquisition of economy extended stay brand WoodSpring Suites. Choice reported a strong first quarter, boosted by its acquisition of WoodSpring and strength in the extended stay market.

Additionally, the company’s outlook for the rest of the year includes a warning about potential disruption in the fourth quarter as the company focuses on improving the overall quality of its portfolio via renovations as part of the ESA 2.0 strategy.

Previously, the chain anticipated annual RevPAR for 2018 ranging from 1 to 3 percent for the year, but it has reduced that outlook range to be 1 to 2.75 percent.

Total revenues for second quarter of 2018 were $336.5 million, a drop of 0.6 percent over the same period in 2017. That decrease, the company noted, was driven by the sale of hotel properties in 2017 and 2018, and was partially offset by increases in RevPAR and revenue that came from Extended Stay America’s franchise and management fees.

Net income in the second quarter was $65.6 million, up 31.9 percent from $49.7 million in the same period last year and impacted by the decrease in corporate tax rate, as well as lower hotel operating costs.

Shares of Extended Stay America were trading very slightly down at $21.57 from the previous day’s close of $21.79 per share.

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