Pebblebrook CFO Raymond Martz Opens Up About The LaSalle Bidding War
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But Pebblebrook's executives, who previously founded and led LaSalle, had once thought it might be the other way around, Pebblebrook Chief Financial Officer Raymond Martz told Bisnow in an interview Wednesday.
The stock market premium that Pebblebrook achieved over LaSalle allowed it to position itself as the buyer and make a bid to acquire the fellow Bethesda-based lodging REIT, but the process did not go smoothly from there.
LaSalle's board rejected Pebblebrook's first offer and called the bid "grossly inadequate." It then rejected multiple additional offers from Pebblebrook before coming to an agreement to be acquired by private equity giant Blackstone.
When Pebblebrook continued to increase its offer following the Blackstone agreement, LaSalle's shareholders ultimately pressured it to back out of the deal with the private equity giant and instead take Pebblebrook's deal.
While more consolidation would likely benefit the hospitality REIT sector, Martz said this lengthy back-and-forth saga with LaSalle's board shows why it might not come as easily as some would hope.
"It would be more efficient from a corporate side to have some consolidation," Martz said. "But in order to have consolidation, you have to have a willing seller. And certainly what we’ve seen from the LaSalle side that would keep some other consolidation from occurring is if a management team and a board doesn’t want to sell, they can make it very difficult for a variety of reasons.
"LaSalle and their board made it very difficult and made it as painful as possible."
Below is Bisnow's interview with Martz, edited for length and clarity.
Bisnow: When did Pebblebrook first decide it wanted to grow by making an acquisition, and why did it make that decision?
Martz: To give you the history, we started the company at the end of 2009 and we had zero hotels. It was known as a blank pool REIT where we raised $400M with an IPO but had no assets and really no prospects or opportunities. We proceeded to start acquiring hotels because at that time with the recession, with Lehman and everything going on there, a lot of the other REITs and even on the private equity side, they had bigger concerns than looking at the acquisition market. So it was a great time for us because in many cases we were the only buyer out there in a lot of these markets.
So we made our first acquisition in mid-2010 and we preceded to grow on a one-off basis acquiring hotels. We grew up to 37 hotels and then we sold a handful in 2016 because there was a big arbitrage opportunity. But we had about 28 hotels as we were finishing up 2016.
And as you probably know, [Pebblebrook CEO] Jon Bortz started LaSalle Hotels. It went public in April 1998. I was from LaSalle, too, as well as some of our other folks here, so we certainly had familiarity with the company.
We thought when we started Pebblebrook that a national takeout partner would be LaSalle because we have very similar investment strategies, very similar portfolios, very similar geography and a similar type of assets, which are a lot of the independent, lifestyle-oriented hotels.
So we thought they would acquire us, but what happened over time is we continued to perform well and as we made our acquisitions, we made the right decisions, we developed properties and executed very well. So when you look over a period of time, from our IPO through early 2018, we generated total return of about 70%. You compare to LaSalle, they were up only 24%. So they clearly underperformed.
You look at the multiples and effectively that's what allows these things to happen on a public-to-public basis. It’s what is your trading multiple versus the company you’re targeting. And we’ve historically traded at a multiple premium since our IPO. Over the last couple years that continued to widen, especially over LaSalle, where LaSalle for a variety of reasons they were underperforming and we were outperforming. So while we thought LaSalle would likely be a takeout buyer for us and we would sell the company and go on and do something else, it actually happened in the reverse where we traded at a multiple premium and the numbers certainly worked for us because of the difference.
That’s something we were thinking in the back of our minds that this may be an opportunity to acquire them. But it was something we were evaluating that wasn’t something that was aggressive or major. But then in February of 2018, LaSalle issued their year-end earnings report, which really surprised the market, actually it probably stunned the market because they missed their numbers, they brought down numbers for 2018 and talked about slashing their dividend by 50%, which was surprising on a number of levels.
Certainly, throughout this period, a lot of LaSalle’s investors, which are also our investors — I think we had a 70% shared investor base between two companies — reached out to us and said they want to see about acquiring or merging with LaSalle. We felt that it was a fiduciary responsibility for us to have that discussion and engage with them, understanding there was an opportunity. That’s what led up to us making the offer because it was the opportunity out there. There were others looking at them, we knew a couple names on the private equity side that were running numbers.
The things were lining up, so one way or another something was going to happen to LaSalle after that February earnings release. So that’s what kind of led up to it. It’s unusual for a smaller company to buy a larger company, but given the significant multiple premium that we had, we could make that offer. And additionally, LaSalle was under-levered, so because of the low leverage that created a capacity for us to ultimately, during the summer, increase our offers and offer a cash component, because essentially we were just using some of LaSalle’s balance sheet to fund the acquisition.
Bisnow: It sounds like LaSalle was the primary target for a merger or acquisition given the history you and Jon Bortz and others had there. But had you looked at any other potential companies to acquire or were you always focused on LaSalle and were waiting for the right time for it to happen?
Martz: Certainly the M&A side was something new for us. When I was at Eagle Hospitality Properties, we sold ourselves to Apollo back in 2007. So I’ve been on the sell side, but on the buy side we only grew through individual, one-off property acquisitions. So this was something certainly new for us, buying a company.
And we’ve evaluated other names out there. LaSalle isn’t the only name. We’ve looked at other opportunities and for a variety of reasons maybe where certain things worked in the portfolio, but we would have to sell a lot of hotels or it was maybe a different quality level of the portfolio, so it didn’t really fit. Our goal has never been to be the biggest just for growth's sake. It’s really to be the best.
What was unique with LaSalle was how the two portfolios fit in so naturally together. In many cases we would have similar hotel operators in several markets, which would allow us to effectively merge those operations. That way you could have, as an example, one director of sales overseeing two or three properties. So that allows you to get a higher-quality director of sales because you could pay them more because they have more responsibilities, and you can retain them longer and ultimately it's more efficient on the cost side. That was why there was a uniqueness that LaSalle presented that other portfolios that we evaluate didn’t.
We always evaluate these things. Just because you keep numbers on another company, it doesn’t mean you’re going to do anything, but you always want to be prepared so if an opportunity ever presents itself, you can react quicker.
Bisnow: I want to talk about the bidding process. It was several months long and LaSalle had an agreement reached with Blackstone. And then Pebblebrook was ultimately able to increase your bid and win the deal. Was your ability to do that primarily because of the multiple premium you discussed or were there other factors that played into your ability to win that deal?
Martz: It was a combination of things. First, to be perfectly candid, on LaSalle’s board’s perspective, they did not want to do the deal with us. It was evident actually about a year ago, May 21 of last year, when the board agreed to a merger with Blackstone. Even though Blackstone’s offer at the original time was 7% below our offer, which was a significant difference in amounts, and ultimately at some point in time it was in the 13-14% range below ours. It was evident that they didn’t want to do the deal with us because most responsible boards would not agree to a sale at lower price.
Then what happened was after they announced the deal, LaSalle’s shares traded above the Blackstone offer, which really showed it was clear that LaSalle shareholders thought the company was worth more. It was also clear in retrospect that LaSalle’s shareholders would not have approved the Blackstone deal.
That was the starting point. And an interesting thing was when we made our first offer to LaSalle in late March public, our stock actually traded up as well as LaSalle’s. It’s very unusual for the acquirer to have their stock go up when you make an announcement for a merger, usually it goes down. But it showed what the investment community felt about the merger. They were really excited about it. And the fact that LaSalle never traded a single share below the Blackstone price shows that shareholders did not support that.
What was also happening last year, so our original offer was at an exchange ratio of 0.8655. And our final offer in September was 0.92, so ultimately the exchange ratio didn’t really move that much. When we submitted our original offer, we had a game plan, we knew we wanted to provide some room to increase. Given that we certainly learned early on that LaSalle had no interest to engage with us whatsoever, we knew it would be a little more contested. What happened over the spring and summer of last year is all the lodging REITs were trading up, including us, so our offer was effectively increasing through the summer just from the sheer fact that our share price was going up.
Since our offer was on share price, that’s an advantage we provided to LaSalle’s shareholders. Whereas Blackstone’s offer was just a cash deal with a fixed cash component so they wouldn’t benefit from the growth of the combined company. That was one thing that made the investors of LaSalle support us.
Also along the way, we certainly were open to having a dialogue with LaSalle shareholders who would call us and talk about the deal and we went through the rationale. That certainly helped our side. On the LaSalle side, I think their level of engagement wasn’t as open. Ultimately that affects it, because we led the business rationale for why a combination with us makes sense and that’s ultimately why LaSalle’s shareholders did not support the Blacksone deal, and LaSalle’s board had to come to us because the deal was really dead on arrival by the end of the summer.
Bisnow: Sticking on the topic of share price, I'm curious what your reaction is on the market's response over the last six months since the deal closed. After the closing in the December the stock price went down, but do you think that was the overall stock market fluctuation or more about the merger itself?
Martz: Well, in November and December obviously we had a large market sell-off, not only the broad stock market but also within the hotel REIT sector. With fear of interest rates and all that, everyone sold off. We clearly underperformed. Some of that continues to be there are a lot of moving parts of the portfolio.
One of the things we laid out was when we provided our last offer that included a cash bid of one-third of the deal — so it was two-thirds stock, one-third cash — we said if we were going to do the cash deal, we would have to sell a number of assets because it would bring our leverage to a level higher than we were comfortable with. That created a lot of moving parts with the sale of the properties.
So far we’ve sold nine properties comprising $1.2B. Our chief investment officer has done a great job executing these sales and has gotten great pricing. As an example: We acquired LaSalle's portfolio, when you include costs and fees and all that stuff, at a 5.9% cap rate and we’ve been selling the LaSalle assets at a 5% cap rate. So it’s clear the execution has gone well.
And in addition, there are a number of properties that we have announced manager changes. We think there’s a better fit with a different manager for a variety of factors. As well as we have several repositioning programs that will be undergoing with a lot of these legacy LaSalle hotels. This is what the world is now, especially Wall Street. There is a fair amount of the investment community that is more short-term focused, so the quarter-to-quarter numbers matter a lot and some of them believe that if we have moving parts, maybe they’ll go to a simpler story or something that’s not going to be as disruptive. There are a fair number of our shareholders that are long-term investors like we are and are willing to see through this noise.
Bisnow: On the topic of the asset sales, how did you determine which properties you were going to sell? And do you still have other properties on the market that you're looking to sell?
Martz: As part of when we won the deal for LaSalle, there were a couple of folks that actually reached out to us during the process and said we would be interested in buying the properties. That allowed us to sell a number of properties at the merger closing. Those were some of the larger properties — certainly the New York hotels, we don’t have a favorable view of New York — as well as some lower-quality hotels in the portfolio and ones that required a lot of capital reinvesting and probably wouldn’t have much return on that capital.
So that would be easy for some of those assets with the merger closing to execute on. Part of that was when we were awarded the deal in September, our executive team, which is Jon, myself and Tom Fisher, our chief investment officer, we toured each of the assets to understand the opportunities, meet with the teams, evaluate capital investing, evaluate the property or the market we wanted to stay in or not. We had a plan for each of those assets and that led to several that we put on the market.
Since the merger closing, we sold the Liaison Capitol Hill and the Palomar Washington D.C. in the first quarter, that was about $250M of proceeds. That allowed us to reduce our exposure in D.C. That was something where LaSalle had a high concentration of D.C. assets. We think D.C. is a fine market, but we wanted to reduce our concentration in the market and reinvest in other areas.
Part of the sales was also improving the quality, so improving the geographic diversification and also the quality of the assets. We have another asset under contract to sell, which is the Onyx Hotel in Boston. We expect to close that sale in the second quarter. That's one where it’s a fine property, but it would require some capital and we think we could get better returns investing in other areas.
Bisnow: Can you expand on your view of the New York City and Washington, D.C., hotel markets and your outlook for them going forward?
Martz: They’re certainly different markets. For Manhattan, we’re negative on it because of the continued supply increases as well as the continued cost increases. On the supply side, that market has averaged 3-5% supply growth since 2012. Even in 2019, we’re expecting supply growth in low-4s of about 4.4%, and in 2020 it’s also low 4s. So supply is continuing in that market. That hurts you because the rate growth in Manhattan has been nonexistent this cycle.
Supply is hurting that market from a top-line standpoint, and on the bottom line in many cases, cost increases are going up 4% a year even though your top line’s not growing. You look at things like property taxes, they’re going up 10-15% a year.
So you have a case where it’s very bad for property fundamentals, and these are the good years. These are years now where the economy’s humming along, but your bottom line is deteriorating. So when there is a downturn in the economy, a recession, and business travel gets pulled back, New York is going to be a bloodbath. That’s why we're negative on New York and have been negative for several years now. We just have one remaining hotel in New York, The Roger, but we’ve sold the other hotels.
In Washington, D.C., it’s different. D.C. has had some supply growth, but not too significant. For 2019, we’re estimating it to be in the high 3% range, but we estimate it will be in the mid-2s in 2020 and then under 2% in 2021. So it’s not bad, but it just doesn’t have the strength in demand generators.
D.C. is more like, the market has more bond-like characteristics, where it’s a slow grower, a decent performer to have in your portfolio, but not something we want to be outsized in. So that was the idea about selling some of that to reduce our concentration in D.C. versus where it was before.
Bisnow: You mentioned earlier about how you're constantly evaluating other companies in case an acquisition opportunity arises. Do you expect to acquire any other companies in the coming years?
Martz: I don’t want to misrepresent that we’re constantly looking at deals to buy companies. [In] the history of the hotel REIT sector, I think this is the first of what was deemed as a "hostile takeover." It was only hostile to the management and board of LaSalle, not the shareholders.
There haven’t been many transactions completed. My comment about the numbers is more that it’s our fiduciary responsibility to our shareholders to not only look at individual acquisitions, but other opportunities like portfolios, and to always be aware of that. So even though we may look at that, it’s not as though we have three books on our desk and are ready to send an offer to someone because they don’t happen that often. You saw the Park and Chesapeake deal announced, and RLJ and Felcor was the only other one. I’ve been in the industry, the public REIT sector, since 1998 and there’s really only been three of these, so it’s pretty limited. I don’t want investors to think we’re like these deal junkies now and we did one thing and are trying to do more.
But we’re open to evaluating opportunities. Right now, we’re really consumed with the LaSalle integration and we’ve done a great job integrating the teams. It was something where when we closed [the] deal at the end of November, and that Friday night and over the weekend we moved all employees around to the new office, with a new desk, new locations, we got their computers all set up so Monday morning when people came in at 8, everything was all set up and it was pretty smooth there.
So on the integration side, for the people that’s going very well. And on [the] property side, as I mentioned we have our property plan for each asset. We’re doing well there, but do have a lot of work ahead of us with a number of property redevelopment projects that will be completing over the next three years, and a number of management changes, some of which we initiated earlier this year. We’ve had six changed and there will probably be a couple of additional changes planned. That’s been a lot of our focus.
Bisnow: You mentioned the Park-Chesapeake deal, and Park CEO Tom Baltimore has been a vocal proponent for more consolidation in the hospitality REIT sector saying it would be more efficient for the management of the assets. Do you agree with that and think this industry is ripe for future consolidation among lodging REITs?
Martz: Yes. Well, it’s like a lot of things where what should happen and what does happen are two different things. If you look at the hotel REITs out there, you look when I started my career in the public space in 1998 there were four other hotel REITs at the time, maybe five. I remember meeting with Morgan Stanley when we were looking to take LaSalle public, and Morgan Stanley said, "Why do we need another hotel REIT? We have enough." And that was when we had five. We have 18 or 19 now. Clearly, the numbers have grown.
When you look at the individual strategies, there’s not a huge difference in strategies. You have a handful of folks focused on the limited service side, that’s somewhat of a different asset class. But you have a bunch that are focused on full-service urban markets. So there’s not a lot of differentiation among them. Then further, when you look at the multiple difference, there’s not a lot of multiple difference with a lot of these similar companies. So from that standpoint, it would be more efficient from a corporate side to have some consolidation.
But in order to have consolidation, you have to have a willing seller. And certainly what we’ve seen from the LaSalle side that would keep some other consolidation from occurring is if a management team and a board doesn’t want to sell, they can make it very difficult for a variety of reasons. LaSalle and their board made it very difficult and made it as painful as possible. They made it hard. So if you don’t have a wiling seller it’s hard to force one through. As evidenced by this was the only hostile takeover, or takeover of this manner, in the hotel sector in 25-plus years.
So that makes it a little harder, but I think ultimately it’ll be determined by the shareholders. Because the shareholders will ultimately be the ones if they want to see consolidation, they will go to the board and be more active. What you are seeing more in the sector now than what we saw five years ago is they’re more active in this space. You have some of those players which weren’t in this space before, which may be a catalyst for some changes. That’s one part of the recipe.
The other side is you need is a multiple difference — if your trading multiple is pretty narrow to your peer, when you factor in all the transaction costs associated with acquiring companies. Take LaSalle as an example, we had almost $300M in transfer fees and costs and investment banking costs and severance we had to pay as part of transactions. That’s $3 to $4/share. If the multiple difference isn’t large enough when you add in all these different transaction costs to complete a merger, it’ll dilute them. In the case where we had LaSalle, our multiple was large enough compared to LaSalle’s that even with all these costs we could still make the deal accretive.
The final point is that you have a lot of boards that they like their prestige of being on the board of a public company. That may not be the right reason for not selling, but it’s certainly a reason and it’s a reality for a lot of these boards. I wouldn’t say all boards, but there are some out there that may not be as focused on their shareholders as they should.
Bisnow: Do you have any other thoughts on the LaSalle acquisition or REIT consolidation in general that you would like to add?
Martz: We are incredibly excited with the LaSalle acquisition. Now we’re the largest lifestyle owner in the country, maybe in the world. So we’re seeing a lot of opportunities that we didn’t underwrite at the time. That wasn’t what was driving it, but we’re seeing a lot of these benefits by having a larger scale. We just have to execute on it, but we feel really good about it.
Even though 2018 was a very active and at many times a very painful process, when we’re going through back and forth with LaSalle and the board on this, ultimately we would do it again. It makes a lot of sense. We have no regrets. We feel good about it and we’re excited about what we can achieve going forward.