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July 13, 2010

Blackstone (& Friends) Buy Extended Stay Hotels - This Time at Half Price

Three months before becoming the world's largest hotelier (by rooms) with the 2007 leveraged buyout of Hilton Hotels Corporation, the private equity Blackstone Group unloaded the Extended Stay chain for USD 8 billion. It was a hell of a deal for Blackstone, who picked up the chain in 2004 for just under USD 2 billion.

It was a less than brilliant deal for the buyer, the Lightstone Group, for whom the purchase proved the beginning of an extended stay in bankruptcy and a narrow escape from personal liability for Lightstone's boss.

Blackstone had loaded up Extended Stay with debt: the 8 billion purchase price consisted of a billion in cash and 7 billion in debt. Two years later, in June 2009, Extended Stay filed for bankruptcy after struggling for months on life support, unable to service over 7.6 billion dollars in debt

Fast forward to May 28, 2010 when a consortium of private equity investors assembled by Centerbridge Partners, including Blackstone and Paulson & Co, successfully bid USD 3.92 billion to take Extended Stay out of bankruptcy protection. Centerbridge narrowly beat out a rival investor consortium including TGP and Starwood Capital Group, the financial power behind Starwood hotels. Bankruptcy advisers had previously estimated the value of Extended Stay at somewhere between USD 2.8 and 3.6 billion - a far cry from the 2007 8 billion price tag.

Centerbridge had already been picking up some of the Extended Stay mortgage debt on the cheap, so they could beat out their rival bidders by offering more but putting up less cash. Paulson of course is famous for raking in USD 20 billion by betting against the mortgage bubble prior to the financial meltdown, and has recently come into the news again for allegedly hand-picking the assets in a Goldman Sachs fund and betting on its collapse (though only Goldman has been indicted).

According to the Wall Street Journal, the cash paid to get Extended Stay out of bankruptcy (should the court approve) is nearly enough to retire some 4 billion worth of mortgage debt, but holders of the mezzanine (junior) debt are unlikely to see any money. The largest single loser in all this is the US tax payer.

When the US financial system collapsed along with the mortgage and other debt markets, the US federal reserve was left holding some USD 744 million in Extended Stay mezzanine debt and an additional 153 million in mortgage debt taken on through the Fed's assumption of Maiden Lane, a vehicle set up to shift ostensible 'assets' to the US government to finance JP Morgan's bargain basement acquisition of the collapsed Bear Stearns. The vast bulk of these 'investment grade' assets - CDOs, mortgage debt and related structured products - have since been downgraded to 'junk'. JP Morgan and Deutsche Bank backed the Centerbridge bid.

That leaves the US taxpayer on the short end of the deal, for a second time. The Federal Reserve, according to the WSJ, has already written down the USD 744 million to zero.

Since Extended Stay will eventually most likely be parked in a Real Estate Investment Trust, paying no taxes provided it distributes the vast bulk of the profits to investors as dividends. That will free up cash for lobbying against financial regulation. This is what lobbyists like to refer to as a 'win-win situation'…