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After winning LaSalle Hotel deal, Pebblebrook eyes a path forward

Pebblebrook Hotel Trust's ability to reap rewards from its cash-and-stock acquisition of LaSalle Hotel Properties hinges in part on planned asset sales and the combined company's ability to wring increased returns from the former LaSalle portfolio, observers say.

Pebblebrook, whose chairman, president and CEO, Jon Bortz, is a former CEO of LaSalle, waged a monthslong fight to acquire LaSalle, persisting even after LaSalle agreed in May to be bought out by Blackstone Group LP.

The real estate investment trust's efforts paid off when, on the eve of a scheduled LaSalle shareholder vote on the Blackstone transaction, LaSalle's board decided to accept Pebblebrook's latest offer instead. The move came after prominent shareholders, and two proxy advisory firms, criticized the Blackstone deal.

Blackstone had an option after LaSalle's reversal to revise its own offer, but declined. Now, the Pebblebrook team's task is to integrate the company's portfolio with LaSalle's in a way that justifies the M&A campaign.

The company has already said it has agreements to sell three LaSalle properties to help fund the cash component of its payment to LaSalle shareholders. In an interview, Robert W. Baird analyst Michael Bellisario said he expects further sales, totaling about $1 billion in the first 18 months after the deal closes.

In particular, Pebblebrook does not own any hotels in New York or Chicago, and could seek to sell LaSalle properties in those markets, along with some in Washington, D.C., where the combined company would have 10 properties, Bellisario said. Besides honing the portfolio, the asset sales would help reduce the combined company's leverage, which at the close of the transaction would stand at a 5.4x debt-to-EBITDA ratio, relatively high among hotel REITs, he added.

Pebblebrook also has argued that it will generate higher returns from LaSalle's properties, in part through capital improvements. Bellisario said greater scale within markets, such as San Francisco, San Diego and Los Angeles, could enable the company to save on some costs.

Meanwhile, Jeung Hyun, a portfolio manager at REIT-dedicated investment firm Adelante Capital Management, said the unbranded hotels in which both Pebblebrook and LaSalle invest could respond especially well to the change in ownership. In contrast with hotels tied to major brands, which operate relatively predictably because of their association with wider booking networks, unbranded properties require more individual attention but may benefit more from especially strong owners and operators, he argued.

Hyun called the transaction, in which Pebblebrook topped Blackstone's offer price by about $300 million based on Sept. 5 closing share prices, "obviously a win for LaSalle shareholders and a neutral for Pebblebrook shareholders," but said Pebblebrook could derive difficult-to-forecast benefits.

"I really do believe that in these unflagged hotels, whoever owns and manages these hotels can have a bigger influence on the overall economic outcome," he said. "I think people have a lot of confidence in Jon Bortz and the Pebblebrook team, so maybe there's a little bit more upside in the next three-year period."

The combined company's heavy presence in San Francisco, where the Moscone Convention Center is reopening after being partly closed for a renovation and expansion, could also contribute to strong year-over-year returns in 2019, while overall strength in the U.S. economy should buoy the broader hotel industry, Hyun said.

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Hyun and Bellisario — along with Stifel's Simon Yarmak, in a note — said the transaction was likely to close without contention from another bidder, and had been widely vetted in the hotel REIT space in the months since Pebblebrok made its first offer.

Bellisario estimated that Pebblebrook is acquiring LaSalle at a 5.2% capitalization rate, based on projected net operating income for the third quarter of 2018 through the second quarter of 2019, and excluding any planned asset sales and the $112 million termination fee payable to Blackstone.

The deal appears to leave both LaSalle's board and its top executives without a role at the combined company, in contrast with Pebblebrook's initial acquisition proposal, which called for a combined board comprising members from both companies.

Bellisario said the absence of a significant LaSalle presence after the transaction was somewhat surprising, but added, "Pebblebrook was in a position of negotiating power, given where the likely Blackstone-LaSalle vote was going to shake out, and I think the shareholders kind of voted with their feet in terms of who they wanted to manage the properties and allocate the capital."

Hyun, whose firm owns shares in Pebblebrook and has invested in LaSalle in the past, said the LaSalle leaders' decision to accept a deal that was best for shareholders but meant the end of their roles was a sign of good corporate governance — though he noted that it came after months of rebuffing Pebblebrook offers that many investors supported.

LaSalle executives had consistently said they preferred the certainty of Blackstone's all-cash bid and feared the downside risk of receiving Pebblebrook stock. They agreed to sell to Pebblebrook after Pebblebrook increased the amount of cash it was offering.

In the end, Pebblebrook was able to exploit a strong share price relative to other lodging REITs, likely grounded in investors' confidence in its management team, to pay a premium that other parties interested in LaSalle would not match.

"You like to see real estate get into the strongest hands," Hyun said, noting what he described as the two companies' strategic fit. "Some combination of mild shareholder activism and the prospect of the Blackstone deal being voted down led to, in the long run, the right outcome for the shareholders."

Representatives of LaSalle, Pebblebrook and Blackstone declined to comment.