Will Choice sweeten its offer to acquire rival Wyndham?

Editor's note: Story updated at 8 a.m. cst on Wednesday to include potential new scenarios to move the deal forward.

What’s the next move after Wyndham Hotels & Resorts on Tuesday rejected Choice Hotels International's announced intention to acquire all the outstanding shares of Wyndham Hotels & Resorts for $90 per share, payable in a mix of cash and stock?

At $49.50 in cash and 0.324 shares of Choice common stock for each Wyndham share, which the would-be seller called “underwhelming,” would a $95/per share bid, a 15x multiple of 2024 estimates, and a larger cash component get the deal across the finish line? Truist Securities analyst C. Patrick Scholes added in his Tuesday evening note that Wyndham shareholders said the deal is not currently even worth $90/share to them with Choice stock falling on Tuesday. It was off 6.83% on Tuesday, closing at $116.37 per share.

Scholes added that Choice shareholders told him they are not very comfortable with the initial nearly 6x net debt/EBITDA leverage. “Besides financial risk, such high leverage will make it challenging for Choice to allocate capital to growth initiatives such as brand development as the company will be delevering for the ~next three years,” he wrote. “Investors also called out that management has a respectable track record of extracting synergies, such as with the Radisson acquisition.”

Besides financial risk, such high leverage will make it challenging for Choice to allocate capital to growth initiatives such as brand development as the company will be delevering for the ~next three years.

C. Patrick Scholes, Truist Securities

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As for a white knight or other suitor, a like-minded player in the franchise space could step forward and Scholes submitted that private equity was raised by some investors as well, "including the possibility of a real estate-heavy large PE entity that has acquired hotel brands for many years."

There is also the question of antitrust challenges given what a combined heavy concentration of Economy and Midscale rooms in the U.S. would mean. Choice is confident it won’t be an issue, whereas Wyndham doesn’t exactly share the same view. That snag could be settled by a breakage fee, Scholes opined, to account for the risk if the deal can’t get past regulators.

That is the latest on this massive deal proposal that would bring together Choice, which operates about 7,500 hotels in 46 countries, with a much larger chain in Wyndham, which operates nearly 9,300 hotels under a host of brands including Days Inn, Howard Johnson, La Quinta, Ramada, Super 8 and Travelodge. Choice noted that they would not have to give up any brands for the merger. The combined company would have more than 1.4 million rooms and rival the size of Marriott International.

Deal details

In what is considered a hostile offer, Choice's proposal represents a 26% premium to Wyndham's 30-day volume-weighted average closing price ending on October 16, an 11% premium to Wyndham’s 52-week high, and a 30% premium to Wyndham's latest closing price. In addition, Choice's proposal includes a cash or stock election mechanism, which would provide Wyndham shareholders with the ability to choose either cash, stock, or a combination of cash and stock consideration, subject to a customary proration mechanism. The proposal implies a total equity value for Wyndham of approximately $7.8 billion on a fully diluted basis. With the assumption of Wyndham's net debt, the proposed transaction is valued at approximately $9.8 billion.

Wyndham responded with a statement around midday on Tuesday, saying it has rejected the bid with its board of directors determining the proposed transaction involves significant business and execution risks, including an extended regulatory timeline and uncertainty of outcome, potential franchisee churn, and excessive leverage levels at the pro forma combined company. It added that the consideration mix includes a significant component of Choice stock, which the board believes is fully valued relative to Choice’s growth prospects, especially when compared to Wyndham. Finally, they said the offer is opportunistic and undervalues Wyndham’s future growth potential.

Choice’s offer is underwhelming, highly conditional, and subject to significant business, regulatory and execution risk. Choice has been unwilling or unable to address our concerns.

Stephen Holmes, Wyndham chairman

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“Choice’s offer is underwhelming, highly conditional, and subject to significant business, regulatory and execution risk. Choice has been unwilling or unable to address our concerns,” said Stephen Holmes, chairman of the Wyndham board of directors. “While our board would support a value-maximizing transaction, given the substantial, unmitigated embedded risks and value destruction potential presented by the proposed transaction, our board determined it is not in the best interests of Wyndham shareholders. We have engaged with Choice and its advisors on multiple occasions to explore these risks. However, it became clear the proposed transaction likely would take more than a year to even determine if, and on what terms, it could clear antitrust review, and Choice was unable to address these long-term risks to Wyndham’s business and shareholders. We are disappointed that Choice’s description of our engagement disingenuously suggests that we were in alignment on core terms and omits to describe the true reasons we have consistently questioned the merits of this combination – Choice’s inability and unwillingness to address our significant concerns about regulatory and execution risk and our deep concerns about the value of their stock.”

Wyndham’s statement also said its board believes that during the long period between announcement and closing or termination of the transaction, Wyndham shareholders would be exposed to the threat of significant long-term deterioration of Wyndham’s brand equity, franchisee churn, and impaired integration execution at the combined company in which Wyndham shareholders would have significant interest.

In addition, Wyndham said the significant amount of debt required to fund the cash portion of the deal would result in the combined company’s net leverage being over 6x adjusted EBITDA. This above-market leverage would increase execution risk and restrict the balance sheet flexibility of the combined company, putting downward pressure on future growth potential, share price and valuation multiples. As a result, it said the value creation from cost synergies may not be fully realized.

Wyndham, based in Parsippany, New Jersey, posted a profit of $355 million last year with revenue of $1.5 billion. Its shares are up more than 170% since it stock price tumbled close to $25 each at the start of the pandemic. Wyndham jumped almost 9% on Tuesday, closing at $75.29.

Choice’s perspective

Choice Hotels President and CEO Patrick Pacious spoke to CNBC after the deal offer was announced and said, “We engaged back in April and had a good sort of five, six months’ worth of dialogue. And then in early September, we thought we were really close agreement on the terms, the consideration and the price. So, for about a three-week period, we thought we were going to engage in a little bit of one way NDA, allowing them to diligence our company. And then at the end of September, about three weeks ago, they elected to disengage. So, what we really wanted to do was to have their shareholders take a look at the offer, and we’re asking the Wyndham board and management team to reengage with us because we feel like this is a really compelling offer for their shareholders. We think it creates a leading hotel platform that really brings a lot of value to our franchisees and to our guests. And we think it’s a real opportunity for both sets of shareholders.”

The sentiment was echoed by R.W. Baird Analyst Michael Bellisario, who added, “Strategically, we continue to believe a merger makes long-term sense; financially, the pro forma leverage profile is quite high. How many Wyndham shareholders want Choice shares? Is now the right time to be adding $4.5 billion of debt? Can Choice raise its offer?”

Truist Securities’ Scholes added, "In our opinion, this is an attractive offer for Wyndham shareholders, though we note Wyndham’s chairman (and former long-time CEO) is very well-versed in M&A and may be strategically holding out for a somewhat better offer from Choice or from someone else."

It’s important to realize these are two really high free cash flow businesses with a really high margin, which gives us the opportunity to de-lever pretty quickly. We’ve demonstrated that in the past as our balance sheet today is only at a 2.6 times net leverage ratio… We believe that putting these two companies together will allow us to realize these synergies on a very quick path and deliver the company back to our normal target range.

Patrick Pacious, president and CEO, Choice Hotels

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Bellisario further wrote that Choice said it has received indications (not a firm commitment yet) for the fully financed cash consideration from two banks. “We calculate approximately $4.5 billion of incremental debt issuance would be needed (including estimated transaction costs),” he said.

The cash portion of the purchase price is expected to be funded with a combination of cash on hand, as well as proceeds from the issuance of debt securities. Choice said it is highly confident in its ability to obtain fully committed financing based on indications from two separate bulge bracket global banks for the entire cash portion of our proposal. Strong free cash flows will allow for continued investments in the proforma business and rapid deleveraging of the balance sheet.

“We feel really confident in our ability to finance the deal at a 55% cash offer," Pacious told CNBC. "We also wanted to provide the Wyndham shareholders with an opportunity to participate in the combined company on a go-forward basis. It’s important to realize these are two really high free cash flow businesses with a really high margin, which gives us the opportunity to de-lever pretty quickly. We’ve demonstrated that in the past as our balance sheet today is only at a 2.6 times net leverage ratio… We believe that putting these two companies together will allow us to realize these synergies on a very quick path and deliver the company back to our normal target range."

In response to a question about the strength of the $90 per share offer, Pacious said, "It’s important to note that there was a leak in the Wall Street Journal back around May 22, which really impacted the price of both company shares. But if you look back in the long term, over the past five years, since they’ve been a separate standalone company, we’ve had effectively a two times multiple advantage over their business… So, what we’re offering is actually to pay them something very close to our historic multiple, not theirs. So, we feel like it’s a very compelling offer for their shareholders. And we’d like them to reengage in a conversation with us to really open up the books a little bit, allow us to diligence each other and see if we can get to a common understanding on price.”

Choice believes it can achieve $150 million of combined synergies, which includes cost savings and “top-line growth potential.” In the August 21 letter, Choice outlined >$100 million of cost synergies, according to Bellisario.

“We really feel like it’s a really compelling time to do it," Pacious added. "There’s a lot of things that are happening in the hotel space. Right now, costs for our franchisees are rising. So, by bringing the two companies together, we believe that through direct bookings, lower operating costs and a much more robust rewards program, we have an opportunity to help our owners of our franchises really improve their value of their assets and their return on investment.”