We re-established a new substantially larger investment in Hilton (HLT, Financial) during the recent market selloff as a significant decline in the company’s share price provided us with an opportunity to once again own Hilton at an attractive price. Hilton is a high-quality, asset-light, high-margin business with significant growth potential led by a superb management team. The company primarily franchises and manages hotel properties under more than a dozen hotel brands, including Hilton, Hampton, DoubleTree, and Hilton Garden Inn.
Hilton’s extensive and growing network of brands and properties offers a significant and self-reinforcing value proposition to both guests and hotel owners, which creates a strong competitive moat around the business. For guests, Hilton provides a consistent and reliable experience in a large variety of destinations at divergent price points, as well as an attractive loyalty program with enhanced customer service, amenities, and awards. For hotel owners, Hilton provides access to its more than 80 million loyalty program members, large-scale marketing programs, reservation and IT systems, as well as supply chain purchasing power.
We previously exited our position during the summer of 2017 to allocate capital to other investment opportunities after the shares’ substantial appreciation. Since then, Hilton has grown its free cash flow per share by more than 30% due to a combination of strong RevPAR growth (a measure of same -store sales for the lodging industry) and net unit growth, margin expansion, a lower tax rate due to U.S. tax reform, and significant share repurchases. Despite its meaningfully positive business progress and earnings growth, Hilton’s share price is only modestly above the price at which we sold it nearly a year and a half ago – while its valuation, due to increased free cash flow and reduced shares outstanding – is now 25% lower than before. We attribute the recent decline in Hilton’s share price to investor concerns regarding a potential downturn in the lodging cycle and broader worries about the impact of a potential economic slowdown on Hilton’s business.
While future RevPAR growth may decelerate from the 3% average achieved over the last couple of years, we believe RevPAR growth will remain positive. Moreover, our study of prior lodging cycles suggests that even if RevPAR declines in a recession, it is likely to recover quickly as the economy turns. Unlike a typical hotel owner, Hilton’s high-margin, fee-based business model insulates the company from an outsized negative impact on profitability due to a slowdown or decline in RevPAR. In addition, the embedded growth in Hilton’s industry-leading pipeline of hotel rooms should allow the company to maintain its current 6% to 7% annual growth in room count and drive earnings growth even if RevPAR slows or declines. Hilton’s pipeline, more than half of which is under construction, currently amounts to more than 40% of Hilton’s existing hotel rooms. We believe that Hilton can maintain its current pace of unit growth over the longer term as the company expands its international footprint with its existing brands, continues to create new brands, and converts unbranded hotels to Hilton’s network of brands.
At the current share price, Hilton is trading at only 20 times our estimate of next year’s free cash flow. This is one of the lowest valuations at which Hilton has traded since the spinoff of its owned hotels and timeshare business at the beginning of 2017, significantly below our estimate of the company’s intrinsic value based upon its high-quality, fee-based business model and strong future growth potential.
From Bill Ackman (Trades, Portfolio)'s third-quarter 2018 Pershing Square shareholder letter.
