Sunstone Hotel Investors Inc (SHO) 2012 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Sunstone Hotel Investors' first quarter earnings call. (Operator Instructions).

I would like to turn the conference over to Bryan Giglia, Senior Vice President of Corporate Finance of Sunstone Hotel Investors.

Thank you, Patricia. Good morning everyone, and thank you for joining us today. By now you should have all received a copy of our first quarters earnings release and supplemental which were released yesterday after the market close. If you do not yet have a copy, you can access it on our website at www.sunstonehotels.com.

Before we begin this call, I would like to remind everyone that this call contains forward-looking statements that are subject to risks and uncertainties including those described in our prospectuses, 10-Qs, 10-Ks and other filings with the SEC which could cause actual results to differ from those projected. We caution you to consider those factors in evaluating our forward-looking statements.

We also note that this call may contain non-GAAP financial information including EBITDA, adjusted EBITDA, FFO, adjusted FFO and hotel EBITDA margins. We are providing that information as a supplement to information prepared in accordance with generally accepted accounting principles.

With us today are Ken Cruse, President and Chief Executive Officer; Marc Hoffman, Chief Operating Officer; John Arabia, Chief Financial Officer and Robert Springer, Senior Vice President of Acquisitions and Dispositions. After our prepared remarks, the team will be available to answer your questions. I would like to turn the call over to Ken. Ken, please go ahead.

Thanks very much, Brian. Thank you all for joining us today. On today's call, I will start by covering some of the high points from our first quarter and our acquisition of the soon to be named Hyatt Chicago Magnificent Mile. Mark will then cover operations in detail and John will discuss our balance sheet, finance transactions and guidance before I wrap up our prepared remarks and open up the call for questions.

So let's get started. In spite of expected and isolated softness in certain of our hotels, the Renaissance Washington DC in particular, our portfolio performed well in the first quarter. We are seeing continued strength across a broad range of leading indicators including group booking productivity, group pace and business transient demand. In short, the turbulent macroeconomic backdrop is having little to no discernible impact on the lodging business trends. In fact, lodging industry fundamentals are currently as good as we have seen. As a result, we expect to realize continued growth in our operations through the remainder of 2012 and for next several years.

Drilling down on our first quarter, as compared to Q1 2011, our corporate revenues grew by 29% to $205.2 million. Property level revenue growth was driven entirely by occupancy gains as we worked to push our portfolio to peak occupancy levels before aggressively driving rate.

Our adjusted EBITDA grew by 33% to $43.1 million and our adjusted FFO per diluted share grew by 71.4% to $0.12 in the first quarter. In Q1, our hotel EBITDA margins improved by 120 basis points. This is adjusted for credits and assessments to 24.5%.

While this was a nice step in the right direction, especially considering that all of our revenue growth was driven by occupancy, we know our hotels are capable of generating stronger performance. For reference, our Q1 margins in 2007, the prior peak, and this is excluding the Hilton San Diego Bayfront and the JW Marriott New Orleans were 27.4% or 290 basis points higher than our level in Q1 of this year. Mark will discuss various steps we are taking aimed at not only retaining prior peak margins, but exceeding prior peak levels as this recovery continues.

As a result of the strength we saw in Q1 and the positive leading indicators we have increased our 2012 guidance. We are now projecting our full year RevPAR to increase between 5% and 7%,adjusted EBITDA to come in between $229 million and $238 million and adjusted FFO per diluted share to be between $0.96 and $1.04.

In addition to generating decent operating performance in the first quarter of 2012, we are also making solid progress against a number of a 2012 corporate initiatives. As we have stated before, our overall goal is to achieve industry leading stockholder returns by improving our portfolio quality and scale while gradually deleveraging our balance sheet. The transaction we announced yesterday solidly advances each of these objectives.

Our acquisition of the 417 room, Windham, Chicago for a net acquisition price of approximately $212,000 per key represents a value additive real estate deal with clear upside at a very attractive price. Post renovation and repositioning, we expect our all end investment will equate to the approximately $250,000 per key which we estimate will result in a run rate even of multiple inside of 10 times once we complete planned renovations and the hotel stabilizes.

We were able to achieve attractive deal terms in part because the seller, the Blackstone Group, rather than selling the hotel to us outright is taking back the bulk of the purchase price in our stock at a price of $10.71 per share, a 3% premium to yesterday's close. In short, we are acquiring a high quality hotel with significant growth potential at a very attractive price and Blackstone is acquiring a nearly 5% interest in Sunstone at a price we both believe represents a very compelling value given our team, portfolio and strategy and growth prospects.

Typically acquisitions are a $0 sum gain. One side wins and one side loses. In this case, both sides are in a position to win, and we couldn't be more excited about having a Blackstone as a major stockholder and potential strategic partner going forward.

A few more details on the transaction. First, immediately upon acquisition, we will rebrand the hotel to Hyatt Chicago Magnificent Mile. Both we and Hyatt see tremendous upside in this asset, and Hyatt clearly represents the best brand for the hotel given Hyatt's strong demand base and market representation. Hyatt has provided a very attractive package of terms in exchange for the flag, and we are thrilled to expand our relationship with the Hyatt organization.

Second, later this year, we will commence a comprehensive renovation and repositioning program aimed at making the Hyatt Chicago Magnificent Mile one of Chicago's top business destinations. Sunstone has an outstanding in-house design and construction team and we have a high degree of comfort with our ability to execute on a full repositioning of this hotel that will fundamentally change its character and materially improve its attractiveness as a business hotel.

Finally, there will be no debt on the hotel. And so coupled with the repayment of the mortgage on the Renaissance Long Beach which we completed last week, we will have 13 unencumbered hotels with an estimated value approximating $700 million to $800 million, and we maintain full access on our undrawn $150 million credit facility.

As John noted our release, at this point, we are comfortable with our low rated, well staggered leverage. In our opinion, while we remain committed to gradually deleveraging over the next several years, we firmly belief our capital structure is an asset at this phase in the cycle. We own an outstanding portfolio of institutional grade upper upscale hotels, one of the best portfolios in our space and we are appropriately leveraged for the recovery.

Subsequent to our acquisition of the Windham, Chicago, our average hotel size will be 413 keys, the majority of our hotels are recently renovated and in very good condition and our primary exposures are to the top urban growth centers in the US. While we continue to trade at a discount EBITDA multiple to most of our peers, we couldn't be more confident in Sunstone's upside opportunity in terms of earnings growth from this point forward.

Looking ahead, we are highly committed to unlocking our portfolio's full potential and as you saw this quarter, we are confidently executing on a strategic plan oriented around proactive portfolio management, intensive asset management, disciplined external growth and measured balance sheet improvement. With that, I will turn the call over to Marc Hoffman to discuss our portfolio operations in greater detail.

Thank you, Ken, and good morning, everyone. Thank you for joining us today. I will review our portfolio's first quarter operating performance in greater detail.

We have used some of our asset management initiatives aimed at recapturing peak profitability and provide an update on our major 2012 CapEx projects. All hotel information discussed today, unless otherwise noted, is for our 32 hotel portfolio which includes on a pro forma basis, all 2011 acquisitions, including the Doubletree guest suites, Times Square, JW Marriott New Orleans and the Hilton San Diego Bayfront. The Chicago, the Hyatt Chicago Magnificent Mile is not included in the statistics I am providing today.

For the first quarter, our portfolio RevPAR was up 5.5% to $117.45 driven by a 6% increase in occupancy which grew to 73.8%. Seventeen of our hotels generated double digit RevPAR growth, including our hotels Marriott Houston, Doubletree Guest Suites Minneapolis, Marriott Quincy, Courtyard LAX, Marriott Long Wharf and Sheraton Cerritos just to name a few. From a total room segmentation standpoint in Q1, group revenues were up 0.8% with a 5.9% growth in rooms and a 4.9% decrease in group ADR. Q1 transient room revenue increased 9.2% to last year with a 6.4% increase in room nights and a 2.6% increase in ADR.

In Q1, our hotels had 431 sell outs compared to 278 sell out nights in the first quarter of 2011. Based upon a 98% occupancy standard which shows the continued signs of strengthening demand in our portfolio similar to the trend we saw in Q4, the highest number of sell outs in five years for Q1; indicating our portfolio is operating at occupancy levels that will enable our operators to compress rates and capture a higher percentage of premium rated business going forward. The Hilton Times Square, Marriott Houston, Courtyard LAX and Sheraton Cerritos all saw significant increases in sell out room nights.

As we have previously, discussed Q1 RevPAR was negatively impacted by soft group calendar in Washington DC. Our 807 room Renaissance, which like other convention group houses in Washington DC, depends upon city wide conventions to fill their rooms was meaningfully impacted by a weak convention year causing Q1 RevPAR to decrease 17.4%. This one asset brought the portfolio RevPAR down 230 basis points.

Said another way, excluding the worth of the Renaissance Washington DC, our portfolio RevPAR would have been up 7.8% in Q1. We expect this weakness to continue through 2012 especially as we commence on our complete bathroom, guest room, suites and corridor renovation in Q3.

The good news is that in stark contrast to 2012, the mid term outlook for DC is outstanding. 2013 in particular, is shaping up to be a banner year in DC. We will have a completely new product and our group pace is up a strong 66% to 2011. And we are active in more mini city wide conventions in the market. We expect 2013 to be a fantastic year for the market and our hotel and our outlook for 2014 and beyond is also very positive.

The 13 hotels we renovated in 2011 continue to ramp up very nicely with Q1 RevPAR up 14%. As many of these hotels completed their renovations in Q2 through Q4 of last year, we expect to see continue quarter-over-quarter growth as we realize return on the invested capital and these hotels continue to improve their performance.

As noted, our 2012 group pace is up 8.2% over 2011 levelswith all growth coming from additional group room nights. You may recall that last quarter, we noted the [2000 and group pace] was up 4.5%.

Our sales teams have been booking significant business resulting in a 3.6% increasein pace. Looking farther out, our booking pace for our four convention group hotels is up an outstanding 22% for 2013. In Q1, our group booking production for all current and future years was up significantly 52.4% compared to Q1 of last year. This was our highest first quarter group booking production in the last five years for these 32 hotels.

For the first quarter, group production for these 32 hotels was 231,105 group rooms. In addition to the positive pace trends in our group hotels, a number of our transient hotels, especially our hotels in New York, Chicago and Boston will benefit from strong convention calendars in those cities as those cities experience considerable compression.

As an indication of both our operator's ability to shift business into higher rated segments and the continued recovery in the business demand in the first quarter, our revenues from premium demand sources were strong with premium revenues increasing 10%, with premium ADR increasing 5.7% and premium room nights increasing 4%. As hotels continue to mix shift their business into higher rated segments, our corporate negotiated business increased slightly at 2.1% in Q1as we were able to close out our lower rated corporate negotiated channels, and in some of our higher occupancy hotels pushed those customers into premium rated segments.

Our asset managers continued to work closely with our managers on a weekly basis to maximize hotel room strategies and profits through nimble rate and occupancy shiftsdepending upon the changing market conditions, street corner by street corner. In addition, we continue to work with all of our operators to ensure that as RevPAR increases, operating expenses do not creep back in unless significant occupancy increases justify higher costs and we as an asset management team agree to those increases.

As Ken noted, our focus is not only reattaining prior peak margins, but exceeding them. To this end, specific profit initiatives include our continued execution of a portfolio wide retro commissioning energy improvement program as well as our ongoing gastro-bar F&B refinements.

Moving to CapEx. During the first quarter we invested $21.8 million in our portfolio. For the full year 2012, we expect to invest between $85 million and $100 million into the portfolio including major renovation of our Renaissance Westchester and our Hyatt Newport Beach.

Additionally, two of our most significant projects will be the complete room, bathroom and corridor renovation of the 807 room Renaissance Washington DC which we are budgeting at $25 million, and ordering and the initial phase of the conversion and reinvention of the Hyatt Chicago Magnificent Mile. The majority ofwork done in Chicago will be in 2013, but we will begin to place deposits and immediately work towards the end of 2012. Overall, we expect to incur approximately $3 million to $5 million in renovation related revenue displacement for the entire portfolio during 2012, which is roughly $1 million to $3 million higher than the displacement we incurred in 2012.

In 2012, our asset management team will continue to roll out our successful gastro-bar concepts at the Renaissance Westchester which will result in the addition of 5,000 square feet of function space as well as the Marriott Tysons Corner. Both of these will occur in Q4 of 2012.

Throughout 2012, we expect to complete total energy audits at 50% of our portfolio, which we expect to result in between $5 million to $7 million of energy related ROI investments. With that, I will turn the call over to John. John, please go ahead.

Thank you, Mark. Good morning,everyone. Today, I will give you an overview of several topics, including first, our liquidity and access to capital. Second, recently completed and anticipated finance transactions. And, third, details regarding our earnings guidance.

With respect to liquidity, Sunstone ended the first quarter with $198 million of cash including $126 million of unrestricted cash. Subsequent to the end of the quarter, we used $32 million to repay maturing mortgage secured by the Renaissance Long Beach. We expect to utilize the bulk of our significant cash position during the remainder of 2012 to fund the cash portion of the Hyatt Chicago Magnificent Mile acquisition, for CapEx and for debt reduction according to our stated plan to methodically delever our balance sheet.

In addition to our strong cash position, we have an undrawn $150 million line of credit and will have 13 unencumbered hotels once we close the Hyatt Chicago that collectively generated roughly $250 million of EBITDA in 2011. Our pro forma unrestricted cash balance exceeds the $58 million of our all of our debt maturities through early 2015. As detailed on page 20 of our investor supplemental, our own near-term debt maturity is the remaining $58 million of exchangeable senior notes which are likely to be put to us next January.

At the end of the quarter, Sunstone had $1.56 billion of consolidated debt which includes 100% of the $237 million mortgage secured by the Hilton San Diego Bayfront. Adjusting for the debt attributed to our minority partner in this asset and the transactions completed subsequent to the end of the first quarter, our pro rata debt balance is currently $1.47 billion. Our debt has an average term to maturity of nearly five years and an average interest rate of approximately 5% including the effect of our interest rate derivative agreements.

Our variable rate debt as a percentage of total debt stands at approximately 27%. The $58 million of debt maturing through early 2015 represents less than 2% of our current enterprise value, and again, we hold more unrestricted cash than the sum of our near term debt maturities.

Our liquidity is strong. Our near term debt maturities are few and we have access to several sources of attractively priced capital. We will continue to enhance our already strong financial flexibility over time as is evidenced by the highly equitized Hyatt Chicago Magnificent Mile acquisition and the repayment of the mortgage on the Renaissance Long Beach.

Now, let's turn to our updated earnings guidance. A full reconciliation of our current guidance can be found on pages 16 and 17 of our supplemental as well as in our earnings release. We expect second quarter 2012 RevPAR growth of 5.5% to 7.5% with adjusted EBITDA of between $65 million and $68 million and adjusted FFO per diluted share between $0.30 and $0.33. I should note that the quarter to date through April 30, our portfolio RevPAR is up approximately 8%.

As Ken noted, our first quarter performance has led us to increase our full year 2012 RevPAR growth by 100 basis points to 5% to 7%. Accordingly we have increased the mid point of our adjusted EBITDA guidance by $4.5 million to a range of between $229 million and $238 million. We have increased the midpoint of our guidance for adjusted FFO per diluted share by $0.05 to a range of $0.96 to $1.04.

We expect full year RevPAR to be negatively impacted by isolated factors including soft group business in Washington DC and Baltimore, as well as approximately $3 million to $5 million of hotel revenue displacement from our 2012 renovations, specifically at the Renaissance DC and the Renaissance Westchester. This compares to revenue renovation disruption of approximately $2 million in 2011.

That said, we remain optimistic regarding the outlook for revenue and profit growth in 2012 as a result of positive group booking pace, strong group booking production and healthy pricing pressure in many cities stemming from increased occupancy and a high number of sold out room nights. Moreover, as occupancy strengthens into 2012 in the backdrop of an anemic supply growth, pricing pressure is likely to intensify which is likely to result into a re acceleration of RevPAR growth into the future. With that, I will turn the call back over to Ken to wrap up our prepared remarks.

Great, thank you, very much, John. Some final comments.

As you have heard us say before, our goal is to achieve industry leading stockholder returns by improving our portfolio's profitability, quality and scale while gradually deleveraging our balance sheet. We hit on all of those objectives this quarter. Operations continue to improve and the Chicago acquisition will enhance the portfolio quality while deleveraging our capital structure in a way that's clearly additive to our stockholders.

Looking ahead, lodging industry fundamentals have materially strengthened over the past year, and are now highly constructive. Supply trends and capital costs are at historic lows while lodging demand continues to build with groups booking and business travelers hitting the road in record numbers. The lodging industry's leading indicators unquestionably point toward prolonged growth over the years ahead.

Our Company is well positioned to capitalize on strong industry fundamentals, and we as a team, are confidently and enthusiastically executing on our plan. We sincerely thank you for your interest in Sunstone. And with that, we would like to open up the call to questions. Patricia, please go ahead.

Absolutely. (Operator Instructions). Our first question comes from the line of Ian Weissman with ISI Group. Please go ahead.

Good morning, and congratulations on a good quarter. Just quickly with respect to the Blackstone deal, maybe you can give us a little bit of background color on how that deal came to your table. Blackstone has a lot of real estate they would like to sell. And then they committed to doing more deals with you in the future?

Thanks, Ian. Good morning. Good question.

The deal with the Blackstone Group is typical of the deals that we have done over the last year. Last year we acquired $900 million worth of hotels, all through privately negotiated relationship based transactions.

We have had a fairly strong relationship with the Blackstone Group although we haven't done any significant transactions with them over the last few years, but we know the guys well. We have a mutual respect between our two firms.

And so, when this opportunity came up, it was clear to both sides that this fit squarely within our strategy and our objectives. It certainly made sense for both sides as was evidenced with the way we structured the deal.

As far as commitments to sourcing arrangements or other transactions going forward, there is nothing formal here. I would tell you that both sides obviously would love to do more together, but there is no formal commitment there.

Okay. And finally, just the last question If you look at the pipeline of deals so far this year, there has maybe been $2 billion or $3 billion worth of transactions. 80% of them have been concentrated in gateway cities and that's clearly the markets in which you are targeting. But you also have four or five assets on the market for sale. Can you may be talk about what the investor bid is for assets outside of gateway cities and what interest you have seen so far, or at least give us a status update on those asset sales?

Sure. And what I would like to say first and foremost is that our policy is to not comment on any pending transactions before there is a formal go hard. So at this point we have no specific details to provide on any potential asset sales.

What I will tell you is based on our observations. Historically, obviously secondary and tertiary markets do command higher cap rates and correspondingly lower values.

That said, you need to look at all the facts in any given transaction. What is the growth potential and the upside potential of a specific asset?What is the capital structure that may be stapled to the deal?

For example, if hotels are being sold with legacy indebtedness at a very low rate and a high LTV, that can be attractive to certain buyers and that can certainly add to valuation. So at this point, I would say I think that any seller would realize on a secondary or tertiary market asset in today's environment is going to be a product not just o the market, but the assets upside potential and the capital structure, itself.

Okay. Great. Thanks so much.

You are welcome

Thank you. Our next question comes from the line of Eli Hackel with Goldman Sachs. Please go ahead.

Thank you. Good morning. Two buckets of questions. One related to the deal and one related to group pace.

Just on the deal, it seems like just a little bit of a different franchise deal given it's an upper upscale brand in a major city. Just curious how much of the reason to go with Hyatt was the brand itself, and how much was related to the money that Hyatt was willing to put in towards the renovation?

And then also just on the hotel's location. I think it's maybe a block or so off of Michigan Avenue. Does that matter at all?I am not sure it does.

Second on the group pace, you noted a very big pickup in bookings in the quarter. Just some color on that. Is that corporations, associations, any industry call outs?Any help there would be great as well.

Sure, Eli. First on your question about the brand. If you look at the Chicago market, Hyatt obviously is based in Chicago. Hyatt also happens to be somewhat under represented in Chicago relative to the other major brands, and yet if you look at the demographics of travelers to Chicago, there is a great depth of Hyatt loyalists who travel to that market.

So from our perspective, the Hyatt brand was a no brainer in terms of what brand to put on this particular asset in this particular location with all of the business transient qualities that we expect to capitalize on once we are finished with our repositioning program. We can't comment on specifics in terms of the economic enhancements that Hyatt provided.

In any case, when we are changing the flag on a hotel certainly that brand enhancements will be considered. But that was not the deciding factor in terms of going with Hyatt. We couldn't be more pleased about growing our relationship with the Hyatt brand.

As far as the location, you are exactly right. This is about a block off of Michigan Avenue, very what we would consider to be an A minus, B plus location within the Chicago market. And the hotels orientation around a growing and vibrant medical complex within the city is one of the unique qualities that attracted us to the asset.

It's interesting how that particular high rated business is not currently being penetrated to the level we believe our hotel is capable. And so part of our business plan is to reposition this asset to firmly and squarely capitalize on that business.

And then with respect to your group pace question, let me turn it over to Marc Hoffman for that one.

Good morning. Thanks. Group pace, the pickup in the year so far for the year really has been short-term corporate around the country, and additional pick up at a large convention hotels with the blocks coming in larger. In our current pace for 2012 breaks down, we were up 0.5% in Q1. We are up a strong 12.5% in Q2 plus 7.3% in Q3 and up 2.3% in Q4.

As a separate note, our Q1 sales production was strong for the quarter. Just for current and futures over last year 39%-plus, almost 40%. And as we said in the original remarks, the bookings were strongest in our portfolio for five years.

On that, are you getting any concerns for corporations?It seems like maybe they are still able to book short-term and no one is really being priced out. Is there starting to build any concern within corporations that maybe if they don't start booking further out there won't be space for them?

I think that's a good comment. Look, we are starting to see very strong occupancies. We had very good occupancies in Q1 and we do have some hotels that don't have much space left in places. So that would be naturally the next curve in the growth of being able to grow ADR future out, would be that there will be less and less space available and then people will have to book further out.

That's great.

Thank you, Eli.

Our next question comes from the line of Smedes Rose with KBW. Please go ahead.

Hi. I wanted today ask you in your deal with Blackstone, is there any thought that they would take a seat on your Board?And, also, what do you think their end game is here?I mean is have they committed to being a long term holder of your stock?Is there any holding agreement, I guess?I am just interested a little more in your relationship with that company going forward.

Good morning, Smedes. First of all, no. There is no board seat contemplated at this point and Blackstone will be a regular shareholder. There is no lock up. No piggy back right. There is really no special bells and whistle on this investment.

Our view from management's perspective is that Blackstone is taking an investment based upon what they perceive as an attractive value. And from our perspective, it's our job to continue to unlock that value. So as long as we continue to do our jobs, I would expect Blackstone will remain a stockholder.

If their investment philosophy or desires change, they will probably move out of the shares. But there is no artificial lock up. We prefer to have a free market system here, and [muster] on our own merits, if you will.

But I mean you could potentially do a similar deal with them again, I guess, in the future?I mean, they obviously hold a lot of hotels.

Absolutely. We could do a deal with Blackstone or any number of other institutional holders of assets. We think that our currency, if employed in an acquisition that's attractively and appropriately priced is probably the best way to capitalize a deal.

All right. Thank you. That's helpful. Thanks.

Thanks, Smede.

Thank you. Our next question comes from the line of Enrique Torres with Green Street Advisors. Please go ahead.

Good morning, guys.

Good morning, Enrique.

Ken, your comments on the Company being appropriately leveraged for the recovery and the capital structure being a strength right now. It seems to have a little bit different tone than the deleveraging emphasis you guys have placed in the past. Does that imply you are going to be looking to strengthen the balance sheet or delever later in the cycle?

So Enrique, good morning. Look our comments, my comments, today, I think, are highly consistent with what we have been saying all along. And that is if you look at our capital structure which is single asset secured financing, very well staggered, very low rated with a great deal of coverage. As I mentioned on the call, we have $700 million to $800 million of unencumbered assets, an undrawn credit facility, great access to capital and and we believe we are at the front end of a cyclical recovery.

So the comment that we are comfortable with our capital structure at this point is absolutely accurate. And the fact that we believe it is a strength and a competitive advantage currently is also an accurate comment. That does not mean that our plan has changed to gradually and methodically deleverage our balance sheet. So that as the cyclical peak approaches, we are at a very low leverage level with high liquidity, so that we can capitalize on opportunities as the next cyclical trough ensues.

As you know, in our business value is created at the inflection points in the cycles. If you hit the peak of the cycle with very low leverage and very strong liquidity, massive opportunities tend to present themselves during the trough for those companies who are appropriately capitalized.

So for where we are in the cycle right now, we are very comfortable. But that does not mean that we are going to stop deleveraging from this point forward. We will gradually continue to execute on deleveraging initiatives like the one we announced today, that are additive to our stockholders.

Enrique, it's John. Let me add emphasis to that.

I agree, absolutely agree with Ken. There is no change in tone or direction for our balance sheet management. Over time, we will continue to gradually delever the balance sheet and add in incremental flexibility. I think the two transactions you have seen out of us in this recent announcement solidify the types of things that we will continue to do forward so that we can gradually reduce leverage while being incredibly mindful of maintaining shareholder value.

Ken's comments regarding being comfortable where we are is we have built in significant amount of liquidity and also made sure that our near-term debt maturities are very few. So while our leverage is a little bit higher than some of our peers or where we want it to be eventually, we are comfortable with our capital stock. We don't believe that there are really any potential defensive costs that we could incur as a result.

Okay. It looks like the market is pretty hungry for equity. Hersha's deal this morning just got upsized. Another company deals where they've issued equity to pay down their [profit], have been pretty well received. Is that something that you guys would consider?

Hey, Enrique. This is Ken. As you saw today, we announced a transaction that was funded with attractively priced equity in order to acquire an attractively priced hotel. I guess we answered that question with the deal we announced today. We are going to do it in a smart way.

But certainly as we mentioned in the past, we think the most elegant way to achieve our leverage objectives is by improving the quality and scale of our portfolio by carefully acquiring hotels using equity in a way that's additive to our stockholders. So long winded answer, but for the right deals at the right price in a way that's additive to our stockholders, we would certainly consider deploying equity.

Comment also was targeted at the profit. If you think that is at the appropriate level in terms of the percentage of the capital structure?

In terms of preferred equity?

Yes.

We consider preferred equity to be more debt like than equity like. So our view is that we have certainly got a sufficient amount of preferred, would not be looking to tap market as a first choice currently. My guess is over time you will see us whittle down the preferred.

Great. I appreciate the color, guys.

Thanks, Enrique

Thank you.

Our next question comes from the line of Jeffrey Donnelly. Please go ahead.

Jeffrey, are you on mute?

Good morning, Jeff. You there?Tricia, why don't we circle back?

No problem.

Hello.

Hi, Jeff.

That was strange. I don't have a mute button. So actually, yes, I apologize then for the delay. But maybe you gave this in your remarks and I just missed us, but can you share with us what the STR index was for the Windham, I guess soon to be Hyatt that you acquired for 2010 or 2011 and maybe talk about where you think that could get to down the road post renovation?

Sure. We will give you a little bit of color on that one. First of all it's important to note that the hotel that we acquired today is clearly not representative of the asset that we are underwriting. There is a big change in that hotel going forward. So historical RevPAR penetration for the hotel is somewhat disconnected with our long term aspirations.

And so first of all, we are looking to change the competitive set for the hotel. It's historically run an index for its current set, but -- right around 100%. But its current set includes some hotels that include the Double Tree Chicago, the Crowne Plaza, the Millennium Knickerbocker, the Allerton, and the Embassy Waterfront.

We have a new competitive set that we think is much more representative to what the aspirational quality and characteristics of the hotels will be going forward. Our model shows our hotels being well below 100% on that competitive set, which includes the W Chicago Lakeshore, the [Sofitel], the Omni, the Intercontinental, Magnificent Mile and the Conrad. Those are much more representative of the quality of the hotel that we will ultimately execute on. For that com set, we see the hotel approaching 100% after renovation. Our model shows it gradually gravitating toward that level, certainly not hitting 100% on day one.

When you say well below, do you mean 90%, or do you mean 60%?

To the current com set?

No, toyour new com set. Like how it might have done in the past versus that new com set?

Where we are currently versus our new com set, we are at about -- call it between 75% and 80% in [penetration].

You talked on this earlier, about marketing to the medical community. There are lessons you can take from the [Kahler] portfolio and apply them here. I'm just -- I'm curious of what maybe some of those examples are, if it's something about the room product itself, or is it just really more on the marketing side?

Hey, Jeff. It's Marc Hoffman. Yes,absolutely. Look, we have learned a lot from our relationships up at Mayo. First and foremost, the -- there are some clients in the building that have been very clear with us, that have several thousands of rooms related in the medical business, that they stopped use that hotel because of its current condition. Those clients are very high rated, and we see as good impact.

In addition to that, there is a new Children's Hospital opening up very, very close, literally across the street from the building. And we know from our learnings at Mayo, particularly around incoming doctors, incoming association business, incoming corporate pharmaceutical business that will be being involved in the rollout of the new hospital. And on the transient side, absolutely, knowing what to do with patients and how to handle patients, and we will be looking at doing a couple of family suites in the room based upon the Children's Hospital as well.

That's great. If I could ask a question also about that transaction, Ken. How did the concept of taking stock come about?Was it something that was pursued by Blackstone, or is it something that you guys offered?And I guess, also, how was the $10.71 determined?

Sure. The concept of using our stock to acquire assets is something that we advance in all of our conversations, or we try to in all of our conversations around acquiring hotels. And in part that's probably why we are more inclined, as is shown by the deal -- the last four deals we have done, to do privately negotiated transactions. So we look for deals where we can use our equity as currency, and obviously we look for counter parties who share our view in terms of the relative upside in our Company. And that was clearly the case here with the Blackstone deal.

As far as the structure of the deal and how we came up with the $10.71 price, it was pretty straightforward. When we negotiated the deal terms, we had a typical due diligence period, which expired yesterday. At the end of the due diligence period we had a decision. We could either go hard or walk from the transaction. And upon going hard, the pricing of the consideration would be determined. And that was set at a 3% premium on our close on the day we went hard. So it just happened to be we closed at $10.40, 3% up was $10.71.

Okay. Great. Thanks, guys.

You are welcome

Thanks, Jeff.

Thank you. Our next question comes from the line of Wes Golladay with RBC Capital Markets. Please go ahead.

Good morning, guys. You mentioned margin expansion opportunities driven partly by expense controls. Outside of energy, where are you seeing cost savings or more moderating expenses?

Particularly, we are seeing a good improvements with what we have done in food and beverage. We now have seven of these gastro-bars where we are consolidating restaurants and bars together and really creating social bar living spaces that happen to serve breakfast, lunch and dinner. And that's where we have seen significant improvement.

We continue to work through our housekeeping area in reinventing housekeeping with a third party company, where it redoes how house keeping is done in the guest room between -- difference between extended stay customer or a single night customer. Those type of things. And even based upon profiling of customers with larger families or individuals.

So those are the base areas, and then the in connection program really is -- we see as a significant process. We have been working for this a few years. We have a couple of test cases that have been huge wins. And wewill be creating relationships -- formal relationships with two energy engineering audit companies that will perform audits on all 32 of our hotels over the next six months. And then we will roll out this retro commissioning throughout all of our portfolio in 2013 and expect to see very measurable results.

Okay, and now going back to the acquisitions. What do you guys see in terms of pipeline at the moment? I guess with the nice move in the stock today, it's the like -- what do you guys see from there as far as -- will you guys be more active youthink in the second half of the year?

Wes, I would say we are going to be -- we're going maintain the same level of discipline and take a very measured approach on acquisitions going forward. Frankly, we didn't see a real fall off on the types of dealsthat we were inclined to pursue over the last few months.

Again, we tend to pursue relationship based negotiated transactions more so than the marketed deals. I think to your question, you probably will see more assets being marketed through the typical channels, the typical broker channels as REITs in general start to get back to more appropriate valuations, as we would say. You will see the REITs in general being more inclined to buy, and therefore sellers more inclined to bring assets to the market. So I think from that side of the picture you will probably see more marketed deals.

But from us, our pipeline remains relatively full with attractive opportunities that we continue to the vet out, and getting deals done that are priced appropriately and structured appropriately is something that we view as being very, very important to pursuing any transactions. So you could see us do one or more deals this year, or you could potentially see us doing no more deals this year. It's going to come down to getting the right deals at the right time.

Okay. Thank you, guys.

You're welcome.

Thank you. Our next question comes from the line of Bill Crow with Raymond James. Please go ahead.

Good morning, guys. John, I am going to direct one to you here. You guys had a great first quarter. You beat your midpoint by $4 million-plus. You raised guidance for the balance of the year by $4.5 million at the midpoint, and in mean time picked up a $90 million that's clearly going to throw off some EBITDA. So when where is the offset? Given your bullish comments on group business, et cetera, itseems like the balance of the year should be, theoretically, coming up more.

Yes, thanks, Bill. Keep in mind that the guidance does not include the impact of the Hyatt Chicago Magnificent Mile yet. So that has been excluded from that guidance. Once we close that transaction, we will be able to layer in new guidance to include that acquisition.

Okay. But even without that, the balance of the year is relatively unchanged. Is that fair?Am I missing something?

No. We took it up a little bit, Bill. We took it up.

$0.5 million?Okay.

Yes. I think that there is still some pockets of identified weakness out there, particularly again in DC, maybe in the third quarter when we started renovation. And so we are still in the mindset of being somewhat conservative when we set our guidance. I think it's a realistic guidance range. But given a couple of the items still out there, it's a little bit on the conservative side.

No. That's fair. Understandable. There is no divestiture built into that though? If you were sell assets, that's incremental --

No. If we were to sell assets, we would update the guidance as well.

Perfect. Good. Good quarter, guys. Thanks.

Thanks, Bill.

Thank you. Our next question comes from the line of Nikhil Bhalla from FBR Capital Markets. Please go ahead.

Good morning. I would just like to get your sense on the outlook for the Chicago market in 2013 and 2014? And also, if you could, maybe give some color on how in the last couple of years -- I believe there has been some management changes at the McCormick Center, and how that may change the dynamics for the Chicago market?Thank you.

Good morning, Nikhil. As far as the Chicago market, the 2012 and 2013 and 2014 performance is in part going to be a product of some fairly weak performance that the market has seen over the last two or three years. Chicago has certainly had some softness that exceeded the softness we saw in other major markets. At this point going forward, the trends for the Chicago market that we are seeing look pretty positive. I think you can look at some PKF data for example that would imply Chicago over the next five years is likely to have stronger growth trends than the average US market.

And then from us, our acquisition decisions are certainly -- we start with market, but we also -- we end with street corner by street corner decisions. And in this case, the location of the asset and the brand upside potential and certainly the repositioning potential for the hotel, all in our opinion point to significant upside relative to the current run rate. So part of it's positive market dynamics. A lot of it, though, is asset specific opportunities.

So no real positive benefit from McCormick so to speak?

I wouldn't say it that way. I think that the McCormick -- there have been some changes to the McCormick Center. I think their approach to conventions in that market is likely to ultimately help broader market trends. Remember, this hotel is a business transient property. But when the market compresses through [city-wides], webenefit. Our view is that certainly the McCormick Center stood to improve in the way it was booking city-wides into the market over the last few years. We think they are making steps in the right direction, and that's helped our conviction that this market is likely to be a strong one going forward.

That's what I thought. Thank you. And one last follow-up question on any accretion from this asset in the 2012. I apologize if you have talked about this already and I missed it. You are not assuming anything to come in from this asset for this year,correct?

We have not -- as John just mentioned, wehave not incorporated the impact of this hotel in our full year guidance. I would tell you just based upon the timing of deal and seasonality there will probably be a push on FFO. Basically flat. And it will benefit us, of course, on the leverage and the coverage ratios.

Yes. Thank you. Appreciate it.

Thank you.

Thank you. Our next question comes from the line of Tim Wengerd with Deutsche Bank. Please go ahead.

Good morning. Quick question on 1Q. I am looking at F&B expense -- or F&B revenues. They were up a little over 4% in the quarter, expenses hardly increased at all. I am wondering, is that -- it really good flow drive through on F&B,and I am wondering if that's because of the gastro-bars, or is that something we should expect to continue?

Yes. I mean, look, as you said, comparable to F&B revenues were up 4.2% in Q1. We had strong lounge revenue, up 5%. We also had a good mix of higher quality catering. So, what I would tell you is I think we had strong flow in Q1. We will continue to have flow in the outer months.

But you have to take into the fact that we are continuing to benefit from these conversions, taking restaurant and lounges out and adding meeting space. Particularly at Long Wharf, we have added this 5,000 square foot ocean-front space and have been doing very well with that incrementally.

Okay. Thanks for that color. And then moving on to just development costs and what you guys think, where do you think development costs are for, say, a 300 to 500 room upper upscale type product in markets like San Diego or New York or DC?

Sure. Obviously having just -- or being in the process of acquiring a hotel in Chicago, we spent a fair amount of time looking at development costs in that market. And it's ultimately going to come down to a lot of the characteristics of the property. But a typical hotel like the hotel we just acquire -- are in the process of acquiring, the starting point is recent data points. So you look at the GW Marriott in Chicago, for example, which was just built at a price that we believe was somewhere in the $600,000 to $700,000 per key. There was a Renaissance conversion in the market also that was somewhere in the $450,000 per key. So for an upper upscale hotel in a major market, you are anywhere from $400,000 to, let's call it $800,000, depending upon land costs and specific features of the hotel.

Okay. Perfect. Thanks.

You are welcome.

Thank you. Our next question comes from the line of Jonathan Pong. Please go ahead.

(Inaudible) -- from the GSA scandal, if you guys are seeing any kind of cancellations or even inquiries on cancellation. And then finally, how much of your business is from government group bookings?

So we missed the first part of your question. I think it was related to the GSA scandal and any impact on bookings?And the answer there we've [had] none.

And then as far as government business, that's also an interesting market by market dynamic, where you see in the DC market, for example, government is available at basically as needed. So hotels when they need to fill up, they can access the government trends pretty well atTyson's and DC Renaissance. And then other markets, government is the less impactful. But if you look at our full portfolio, government comprises 3.8% of the total demand base in terms of our segmentation.

Okay, that's helpful. Thanks.

Thank you. There are no further questions in the queue at this time. I will now turn the call back over to Ken Cruse for any closing remarks.

Great. Thank you very much, Patricia,and thank you all for joining us on our call today. We look forward to meeting with you in the weeks and months to come. Thank you.

Thank you. Ladies and gentlemen, this does conclude our conference for today. Thank you again for your participation, and you may now disconnect.