Business Context and Reporting Period
Company: Sunstone Hotel Investors, Inc. (Sunstone)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2009
Business Overview: Sunstone operates as a self-managed Real Estate Investment Trust (REIT) owning, acquiring, and managing hotel properties. As of June 30, 2009, the company owned 41 hotels, primarily upper upscale and upscale brands (Marriott, Hyatt, Fairmont, Hilton, Starwood). The company leases its properties to a taxable REIT subsidiary (TRS) which engages third-party managers.
Key Financial Metrics
| Metric (in thousands) | Six Months Ended June 30, 2009 | Six Months Ended June 30, 2008 |
|---|---|---|
| Total Revenues | $368,419 | $455,077 |
| Net Income (Loss) | $(123,695) | $68,548 |
| Loss Attributable to Common Stockholders | $(134,517) | $56,348 |
| Net Cash Provided by Operating Activities | $34,660 | $87,258 |
| Cash and Cash Equivalents (End of Period) | $195,073 | $36,255 |
| Total Debt (Notes Payable) | $1,453,484 | $1,647,765 |
| Weighted Average Interest Rate | 5.6% | 5.5% |
Operating Performance (Six Months Ended June 30, 2009):
- RevPAR: $99.60 (Decrease of 20.0% vs. prior year)
- Occupancy: 68.3% (Decrease of 750 basis points vs. prior year)
- Average Daily Rate (ADR): $145.82 (Decrease of 11.2% vs. prior year)
Material Changes vs. Prior Period
Revenue Decline: Total revenues decreased by $86.7 million (19.0%) year-over-year, driven by significant declines in room revenue ($58.4 million decrease) and food and beverage revenue ($21.8 million decrease) due to lower occupancy and ADR resulting from the economic recession.
Significant Impairment Charges: The company recorded substantial non-cash impairment losses totaling approximately $130.5 million for the six months ended June 30, 2009. This includes:
- Goodwill and Other Impairment: $70.7 million, primarily related to the Renaissance Westchester ($30.2 million), Marriott Del Mar ($25.4 million), and Marriott Ontario ($8.9 million).
- Impairment of Operations Held for Non-Sale Disposition: $60.0 million related to the W San Diego Hotel following an elective default on its mortgage.
- Discontinued Operations Impairment: $4.9 million related to the Hyatt Suites Atlanta Northwest.
Debt Reduction and Gains: The company repurchased $187.5 million in aggregate principal amount of its Senior Notes, recognizing a net gain on extinguishment of debt of $54.6 million. Total debt decreased by approximately $194 million compared to the prior year-end.
Discontinued Operations: The company sold two hotels (Marriott Napa Valley and Marriott Riverside) in the second quarter of 2009, resulting in a net loss of $10.8 million on the sales. Results for these properties and the Hyatt Suites Atlanta Northwest (held for sale) are classified as discontinued operations.
Guidance, Outlook, and Risks
Management Outlook: Management anticipates lodging demand will remain weak throughout the remainder of 2009 due to the ongoing U.S. recession and credit market conditions. They expect demand to potentially show year-over-year increases beginning in 2010 and 2011. The company intends to maintain higher-than-historical cash balances to preserve capital during this cyclical decline.
Strategic Actions:
- W San Diego Hotel: The company elected to cease subsidizing debt service on the W San Diego Hotel mortgage, resulting in a default. The company is prepared to convey the hotel to the lender in lieu of repayment.
- Renaissance Westchester: In August 2009 (subsequent event), the company ceased subsidizing debt service on this property as well, though negotiations for loan modifications were ongoing.
- Capital Strategy: The company is a net seller of hotels during this cycle and expects few acquisitions until the early growth phase of the lodging cycle.
Risks and Contingencies:
- Financial Covenants: While currently in compliance, management believes a financial ratio violation regarding Series C preferred stock may occur in the second half of 2010 if operations do not improve, which could restrict common stock dividends.
- Litigation: The company is negotiating a settlement for a lawsuit regarding hotels sold in 2006, with an estimated liability of $2.0 million to $2.5 million.
- Tax Audits: Five hotels in Minnesota are under audit for 2006-2008 tax years, with an estimated liability of $0.5 million to $1.0 million.
Investor Verification Checklist
- Impairment Valuations: Verify the assumptions used in the discounted cash flow analyses for the $130.5 million in impairment charges, specifically regarding terminal capitalization rates and projected cash flows for the Renaissance Westchester, Marriott Del Mar, and Marriott Ontario.
- W San Diego Default: Confirm the status of negotiations with the special servicer and the timeline for the potential conveyance of the W San Diego Hotel to the lender.
- Series C Preferred Stock Covenants: Monitor the company's financial ratios closely to assess the risk of a financial ratio violation in late 2010, which could impact dividend policy and board composition.
- Liquidity Position: Review the $81.5 million availability under the amended credit facility and the company's ability to meet debt maturities, particularly the $81.0 million maturing in December 2010.
- Discontinued Operations: Track the final sale price and closing of the Hyatt Suites Atlanta Northwest, which was classified as held for sale.