Strategy 1: "always use other people's money." (Corporate Finance)

Francis P, Bissaillon Senior Vice President-Administration & Treasurer La Quinta Motor Inns Inc.

Business: Motel operator

Total assets: $550 million

Credit rating: B2

The rundown on La Quinta: We own 210 motels, each with about 120 rooms. We operate in 29 states, although about 50 percent of our properties are in Texas. Our concept is limited services. That is, we don't offer conference rooms, restaurants, or bars. We don't franchise. Unlike most of our competitors, we now own most of the real estate on which we're located.

Our revenue stream is a little over $200 million a year, and we generate anywhere from $30 million to $40 million a year in cash flow. From the accounting earnings perspective, we've had a few tough years recently. Most of our earnings have come from disposition of properties and asset sale gains. But if you look at operating earnings relative to the $30 or $40 million in cash flow, we're probably at only $2 or $3 million in worth.

La Quinta built its first motel in 1968 and went public in 1973. Our stock is traded on the New York Stock Exchange, and our headquarters is in San Antonio.

Over the years, our financial strategy has been based upon the overall strategy of the company: first, to grow, and second, to always use other people's money. Our shareholders' equity is about $150 million, but add the equity of our partners plus the total long-term debt, and that number is $508 million. Of course, borrowing sometimes has been extremely difficult. Lenders are very nervous today, especially about lending to any facility that has beds, be it a hotel, motel, nursing home, or hospital.

But we've found ways to make lenders more comfortable with us. First, we don't finance long-term assets with short-term debt. We've used our bank credit lines for construction loans, for instance, but only when we've had a long-term debt commitment waiting.

Second, La Quinta has no compulsion. Our building program at one point was around 20 properties a year. In 1986, when Texas went into its recession, we virtually stopped building. We've always been very cautious, probably because of our highly leveraged position. And I think potential lenders and equity investors recognize that fact.

The type of financing we've used over the years, some asset based and some corporate, has depended on the markets. Some techniques still work and some techniques don't.

The financing path

The first approach La Quinta used to raise equity, from the late 1970s to the early 1980s, was to form partnerships with individuals who owned a parcel of land on which we wanted to build a motel. Typically, these deals gave the landowner a 50-percent equity interest. With the equity in the land, we were able to get an 80- or 85-percent mortgage on the property. Because this was done in an era of relaxed tax laws, we gave the landowner a preferential cash-out in the first couple of years; so he essentially sold the land to us on a tax-free basis, because the cash-out was from operations rather than from selling the land to the venture.

But we found these single deals a very inefficient way of doing business since we were trying to assume a strong growth posture. The offshoot was we began joint venturing with insurance companies, starting with Prudential in 1973. Real estate markets were down. Money wasn't available. Basically, we got the growth money by structuring a transaction in which La Quinta gave away half of the interest in the property for the loan balance.

So Prudential became a 50/50 partner with us. We did get some development fees. And we were charged a couple hundred basis points less on the note than we would have been had we gotten a straight loan. But Prudential participated 50 percent in the properties, on the up side and the down side. At one point, we had 39 motels in the venture, so it's been very successful for both Prudential and La Quinta.

As we started building a larger pool of properties and our reputation spread within the financial community, we used the same venture structure with Metropoutan and New York Life and also with several smaller insurance companies.

In 1987, we set up a joint venture with CIGNA, who also provided all the cash. But instead of taking a 50-percent ownership interest, CIGNA took a 75-percent interest. When we established the venture, we thought we could use it over and over again with other insurance companies. But soon the industry was becoming significantly overbuilt. Insurance companies hesitated to get involved in asset transactions. But we still wanted to grow and were looking for a way to do it.

Last year, La Quinta entered into a series of negotiations with a pension fund manager in Boston to form a venture. The funds were to be used to acquire properties owned by the Resolution Trust Corporation and failing banks. We eventually closed a partnership arrangement with the pension fund manager, and we now have $150 million of capital over the next three years. La Quinta, the general partner, has a 40-percent interest in the limited partnership, and the fund manager and 17 individual pension funds have a 60-percent interest. To give our partners additional liquidity and exit vehicles, $50 million of their investment can be converted into our common stock. When we completed the transaction, our stock was selling at around $17 a share, and we negotiated a conversion price of $20.50. Now, our stock is at around $11, and the conversion price is still $20.50.

We also did about $100 million of industrial revenue bonds when they were popular. That was successful, because interest rates were particularly low. But we encountered an operational problem: we started chasing the financing. We began building properties just because the financing was there. The best example was in Kalamazoo, Michigan, 500 miles from any other property we had. But the financing was there, so we built a motel. Fortunately for us, the industrial revenue bond market dried up. So we began to focus more on the operational side of our growth.

In 1986, we successfully engineered the first master-limited partnership in the lodging industry. We sold 31 motels into this new public company. It gave us a lot of cash and the financial staying power to survive through the Texas recession of 1986 through 1989. But looking at the financing vehicle as a director of the company, representing the unit holders, I'm not enthusiastic about the approach. The units were issued at $20 each in 1986, and they're selling for about $4 today, because of changing capital markets, depressed conditions in the lodging industry, and a defection by the analytical community from limited partnerships.

Today, we're focusing La Quinta's financial efforts on reducing the interest rates on some of our debt, particularly on the industrial revenue bonds.