In Part 5 of his series, Lawrence Meyers and Monty Bennett discuss Ashford’s deployment of its corporate strategy

By: Lawrence Meyers

L:  Right now, how is Ashford Hospitality Trust  (NYSE: AHT) deploying its four-pronged capital strategy?

M:  We target hotel first mortgages, mezzanine loans, sale-leasebacks and direct ownership in different proportions depending upon the current state of the hotel lodging cycle.  At any given point in a cycle we are typically engaged in at least two investment strategies – a dominant strategy and a secondary strategy.

L:  But you are the one-stop shop.

M:  Indeed.  And when we pursue an opportunity, we’ll bid several ways. Many times we’ll go to a hotel borrower and say, “Hey, if you don’t get the loan terms you want, here’s what we’ll offer you.” And we’ll give them several options under our strategy such as a different kind of loan or a sale-leaseback. When they don’t get what they want from a lender, we are already in the door ahead of our competitors, we’ve already done the underwriting, we know the property, and they’ll hopefully choose us. 

This strategy works well from both ends.  Meaning, from the investment’s community standpoint, they put their capital with us to deploy to the best risk/reward ratio at the time. Imagine the individual investor trying to figure out where they are in the hotel cycle, and having to move their money around to the different companies that take advantage of each point in the cycle.  An individual investor doesn’t have time to do that, and they may also misjudge the cycle.  We have the expertise, and hopefully therefore a more stable platform.

L:  And because there are still hotels coming on-line during the down cycle, will there be a greater need for mezzanine loans during that time period?

M:  Likely to be.  Let’s use our Mr. Larry – Dr. Ben partnership example again, with our $10 million hotel. You were loaned $6 million by your first mortgage lender, $2 million by your mezz lender, and you and Dr. Ben each put in $1 million. When times go bad, and the hotel’s value drops — if your loan is due, you’re potentially in trouble —  100% of the hotel’s value may then only be $8 million.  A new first mortgage lender will only give 60% of the value.  That’s only $4.8 million.  Now you have to come up with cash out of pocket ($1.2 million) to pay off that original first mortgage, and another $2 million to pay off the mezz loan.  But a mezzanine lender can refinance that entire balance.  The price the mezz lender charges will be higher, but at least you and Ddr. Ben don’t have to come cash out of pocket to do so.  Because if this is a recession we’re in, your other investments may also be in trouble.  That’s a great time to make mezz loans..

L:  Ashford’s business plan, I must say, looks pretty darn strong.  I’m having a hard time finding a downside.  So where is the downside?

M:  There will always be volatility in the hospitality industry that cannot be avoided, even through diversification.  Also, you could always have a catastrophic event.  Say you get a series of terrorist attacks that severely damages travel in the USA.  Still, what we’ve seen in other economies is a shock to the economy at first, but then they come back.  9/11 is a perfect example.  The travel industry was very depressed then, especially because we were already in a recession. But business did pick back up.  For us, the impact would have to be both significant and for a long period of time. But that threat will always exist and there’s nothing we can do about it.

L:  And every other business has that same exposure.  Now, could you miss the cycle?

M:  We could.  It’s not likely, but it’s a possibility. We believe the cycles are relatively easy to identify.

L:  Let’s talk about diversification of your hotel portfolio.

M:  We purposely diversify by geography, brand, price segment, and capital structure. Some institutional investors don’t like that.  For example, they want you to be in certain areas only.  That strategy works until that specific market suffers from a regionalized recession or from a catastrophe such as New Orleans. Many iInstitutional investors want to play within very specific sectors.  While that may work for an institutional investor’s hold and trade strategy, we believe that model to be sub-optimal from the standpoint of running a business and maximizing shareholder returns for the long-term.

L:  By my estimation, the market isn’t rewarding Ashford stock right now.  Based on what you’re saying, my take is that the institutions have a bias towards certain types of assets at certain times.

M:  And in the end I believe we’ll be rewarded for our discipline.  Our deals are outstanding. The market just hasn’t seen it yet.  It’s a diversified platform vs. a pure play. 

Stay tuned for Part 6, where Lawrence Meyers and Monty Bennett discuss Ashford’s REIT structure and how to read their balance sheet.

Lawrence Meyers is a former writer for the Motley Fool, and is President of PDLCapital, a private equity firm (www.pdlcapital.com). He currently owns shares of Ashford Hospitality Trust. This article is only an expression of the author’s opinion, may contain inaccuracies, and is not a solicitation to buy or sell any security. All readers are advised to consult with a financial advisor prior to making any investment. The author may be contacted at pdlcapital@earthlink.net

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