Hilton Insider Trading Leads to Merger Buzz.

Could yet another major corporation be about to disappear from the local scene? Investment circles were buzzing last week about Beverly Hills-based Hilton Hotels Corp. possibly being in negotiations to be acquired by real estate investment firm Colony Capital Inc., which has significant hotel holdings in the United States and overseas.

Neither Hilton nor Colony Capital officials would comment on the buzz coming from well-connected sources in the finance industry. Adding fuel to the speculation was the recent large purchase of Hilton shares by company Chairman Barron Hilton, who seldom engages in trades of his company's stock.

Industry insiders said such a deal, if it were to happen, would make a lot of sense for both parties.

"A deal between Colony Capital and Hilton wouldn't completely surprise me," said Mike Happel, an analyst with Morgan Stanley Dean Witter. "Colony Capital has made a number of major investments in hotel properties in the past, and it would seem that Hilton's low valuation would make it an ideal takeover target for them."

Colony Capital, also based in Beverly Hills, is a private equity fund with more than $6 billion in assets. Headed by Chairman and Chief Executive Thomas Barrack, it has a strong track record as an opportunity fund that specializes in finding and buying undervalued assets at bargain prices and waiting for the market to turn around.

Right now, Hilton has all the markings of an undervalued company, with a price/earnings ratio of 14.3, even though its stock price has been showing some signs of a turnaround in recent months.

For almost two years, Hilton's market value had been in a state of steady decline, as expensive acquisitions ate away at its earnings growth. Hilton's shares, which traded hands for more than $20 in June 1998, had fallen as low as $6.38 by early March.

But since then, on the strength of better-than-expected earnings, the share price has rebounded, and Hilton stock was trading at around $9.50 a share as of late last week.

A takeover bid from Colony Capital, or any other suitor, might be the best news for Hilton shareholders in quite some time, because any buyer would likely pay a steep premium over the company's current share price.

"Whoever wants to buy Hilton will have to pay for the name," said Kevin Calabrese, an analyst with Argus Research Corp. "And the price they'll have to pay will be significantly higher than the current market value."

Calabrese believes that the premium Hilton could command might be as high as $18 a share -- or about $6.6 billion.

Colony Capital is hardly the only company that has been mentioned as a possible buyer of Hilton. Hilton Group plc, until recently operating under the name Ladbroke Group plc, has been repeatedly named as a possible acquirer. Hilton Group is the U.K.-based parent company of Hilton International, which owns and operates Hilton hotels outside the United States.

More recently, another British company, Bass plc, was reported to be shopping around for an upper-tier U.S. hotel chain. Bass sold its interest in beer brewing for $3.5 billion and is looking to reposition itself as a main player in the international hotel industry.

Further fueling the takeover buzz is the recent flurry of insider buying at Hilton, led by Barron Hilton, who purchased $2.4 million worth of shares last month. Although it is quite possible that Hilton and other executives are merely showing their faith in the financial future of the company, it could also be an indication that something more is afoot.

"When Barron Hilton buys, people pay attention," said Harry Curtis, an analyst with Robertson Stephens. "He has proven in the past that he knows what he's doing, and that he knows when to buy and when to sell."

In fact, the recent purchase was Barron Hilton's first major transaction involving his company's stock since May 1998, when he sold 24 million shares. That was when Hilton's stock was trading for more than $20 a share and shortly before it began its decline.

If Hilton Hotels were indeed sold, it would be a dramatic development for a company that over the last few years has been noted for its aggressive acquisitions, cumulating in the $3 billion purchase last November of Promus Hotel Corp., which owns the Doubletree and Embassy Suites chains.

The acquisition of Promus was a play to expand Hilton's presence in the franchised hotel segment and diversify the company's revenue stream. However, some industry analysts at the time of the deal said that Hilton had paid too much for Promus, and Hilton's shares took another dive.

"Many people believed that they overpaid for promus," said Curtis. "It came on the heels of earlier expensive acquisitions during the past two years, and as a result, their share price got discounted."

Wrong timing?

Hilton's aggressive and expensive expansion in the lodging industry (it now manages or franchises more than 1,800 hotels worldwide) also has raised eyebrows because it comes at a time when the Federal Reserve is busy trying to slow down the U.S. economy. That doesn't bode well for the hospitality industry, because it would likely result in less business and leisure travel.

"We are concerned about overbuilding in the hotel industry," said Bryan Maher, an analyst with Credit Lyonnais Securities. "Room demand correlates strongly with gross domestic product growth, and we expect that GDP growth is going to slow down this year."

However, Hilton's senior vice president for corporate affairs, Marc Grossman, last week downplayed such concerns, arguing that in the markets where Hilton has the strongest presence with its owned-and-operated hotels -- central business districts in major cities -- the risk of overbuilding is minimal.

"There is no new supply being built in city centers in New York, San Francisco or Washington, and demand is very strong in these markets," Grossman said. "In our other market segment -- middle-range hotels outside city centers -- there is new supply being built. But in those markets we are franchisers and are less exposed to risks. Those hotels are built by owners who believe there is still money to be made, otherwise they would not build them. The only question is, what name will be on top of the hotel and who is going to market it?"

Meanwhile, after a number of disappointing quarters in which the company reported lower earnings than Wall Street's estimates, Hilton surprised analysts with a better-than-expected first quarter.

For the quarter ended March 31, Hilton posted net income of $58 million (12 cents per share), compared with $42 million (16 cents) for the like quarter a year ago. (Earning per share were down because more Hilton shares were issued following the Promus acquisition.) The earnings performance beat analysts' consensus estimate by 20 percent.