Fitch Ratings Affirms La Quinta at 'BB-'; Outlook Stable.

NEW YORK -- Fitch Ratings has affirmed the senior unsecured ratings of La Quinta (LQI) at 'BB-' following LQI's recent announcement that it will acquire the limited service lodging business of Marcus Corporation for $395 million in cash. Structured as an asset sale, the acquisition entails 178 properties or roughly 16,837 rooms, which include 84 owned Baymont hotels, seven owned Woodfield hotels, one owned Budgetel hotel, seven joint venture interests and management contracts; and 84 existing Baymont franchises. Baymont branded hotels account for 85% of acquired EBITDA. The proposed transaction represents a 12 times (x) multiple of LTM pro forma EBITDA of approximately $33 million, or approximately $38,000 per room. In the event that certain liabilities are assumed, the purchase price would be reduced accordingly. The purchase price appears to be in line with recent limited service hotel transactions, and well below estimated replacement cost. The Rating Outlook is Stable.

The acquisition will initially be financed with cash-on-hand of $291 million (primarily reflecting proceeds from a November 2003 equity offering) and committed debt financing of $150 million. Committed debt financing will take the form of either a term bank loan or senior notes, and may be upsized to $200 million to meet additional financing requirements (including $56 million for retirement of the 7.114% notes and the associated premium, and roughly $45 million in renovation capital and conversion expenditures for the new properties). The acquisition can be accommodated within existing financial covenants, but required a waiver under the current credit agreement which limited acquisition spending to $300 million. The acquisition is expected to close sometime in late-summer or early-autumn 2004. In the event that the deal is not completed, Fitch would continue to regard LQI's acquisition appetite as overhang to the rating despite credit metrics that are relatively strong for the rating.

From a credit perspective, the acquisition increases fee income (which has very little operating leverage) and keeps credit measures within an acceptable range for the existing category. Pro forma for the acquisition, fiscal year-end (FYE) 2004 total leverage and net leverage is projected to be 4.4x and 4.3x respectively versus 5.8x and 2.9x, respectively at FYE 2003. This is the same level of leverage that existed prior to the equity offering in November 2003. Coverage ratios are actually projected to improve slightly post-acquisition. Notably, Fitch's December 2003 rating affirmation incorporated the assumption that LQI's acquisition ambitions would ultimately reverse improvement in net leverage achieved in 2003 by the equity offering. Management has stated that it is targeting net leverage range of 3.5x - 4.5x. At these levels, upward revision of the rating may be considered. Fitch's conservative case projections suggest that leverage will decline at an acceptable pace over the next several years.

From a strategic perspective, the acquisition is in line with LQI's stated priority of growing the company through acquisition through both complementary brand purchase and/or real estate expansion. The well-regarded regional Baymont brand provides a strong new presence in Illinois, Wisconsin, Michigan and other parts of the Midwest, and reduces relatively high geographic concentration in certain markets (Texas exposure is reduced from 30% to 24%). This should drive increased brand awareness through conversions, and improving delineation of existing product through re-branding. Revenue synergies are expected to be achieved by combining loyalty programs, improving Baymont's electronic distribution activity and utilizing LQI's yield management skills. In calendar 2003, LQI outperformed the Baymont branded properties on all these fronts. The acquisition also provides new growth opportunities through the franchising of additional brands, and accelerates franchising of the La Quinta brand. On the cost side, LQI management believes there is an opportunity to improve Marcus' lodging margins, which have been on the decline since 1995, even prior to the lodging downturn when revenues were increasing. The combined entity will leverage LQI's existing overhead and Baymont's operating costs will be rationalized through the implementation of LQI's training programs, utilization of a single technological platform and consolidation of purchasing and sales.

Fitch acknowledges the progress management has made since assuming control in April 2000. This team has performed well in a challenging environment, executing on stated goals to divest the healthcare assets, improve the capital structure, launch a franchise program, and upgrade assets. The challenging demand environment over the last several years has made it difficult for management to improve operating results over their tenure. However, LQI is starting to benefit from both a general improvement in lodging industry fundamentals, as well as revenue enhancement strategies implemented in recent years ($90 million renovation program, an enhanced loyalty program, improved electronic distribution and an expanded sales force). Over the last several quarters LQI has posted strong RevPAR gains of 7%, 10% and 11%, outperforming industry RevPAR growth of 2%, 4% and 6%, respectively. Importantly, positive RevPAR comparisons and outperformance extended to LQI's top-ten markets, which had been hardest hit by the downturn. Looking forward, Fitch believes LQI will be able to positively leverage this RevPAR growth to EBITDA increases in 2004 and beyond. As such, management is now calling for standalone La Quinta RevPAR growth of approximately 6% (versus industry estimates of 3%), and a concomitant rise in EBITDA of 8% in 2004. Based on year to date performance, this appears to be achievable.