Blackstone's Inauspicious Timing: Hilton Buyout

One year ago, just as the credit doors were swinging closed, Blackstone Group LP succeeded in pulling off one last deal and it was a beaut: The $26 billion leveraged buyout of Hilton Hotels Corp., with its 2,900 hotels and 490,000 rooms throughout the world.

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The sharp downturn in the hotel market -- with more hotel owners and operators posting dismal results and giving dour forecasts -- is making that deal look like a burden for Blackstone, which sank $6 billion of equity into the acquisition. That was the biggest equity investment ever made by the 23-year-old firm founded by Stephen A. Schwarzman and Peter G. Peterson, and some analysts believe much, if not all, of that equity has been wiped out, at least on paper.

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Hotels are typically the first sector in the commercial real-estate market to feel the economic pinch, and next year will be a gantlet for hotel owners and operators. The foundering economy likely will limit both business and leisure travel. And a glut of new hotels that started development and construction during better economic times will hit the market, sapping occupancy and rates from other properties.

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For now, Hilton doesn't appear to be at risk of falling behind. Its before-tax cash flow is projected to be nearly $2 billion this year, enough to cover the about $1.3 billion in interest expenses on the debt used to finance the deal, according to the person close to Hilton. Even though the cash flow likely will decline next year, this person said, the company is "very confident" in its ability to service the debt. Hilton has about $2 billion in short-term liquidity including cash, something it can tap if the cash flow falls short of its interest expenses.

But the Hilton deal already has proved painful for the seven banks that provided the financing -- including Bear Stearns Cos., Bank of America Corp., Deutsche Bank AG, Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co. and Lehman Brothers Holdings Inc., as they still are struggling to sell pieces of the debt amid the persistent credit-market crisis.

What's more, it now looks like U.S. taxpayers are on the hook to Hilton's fortunes, too. That's because when J.P. Morgan Chase & Co. in March took over Bear Stearns, the Federal Reserve assumed $30 billion of Bear's illiquid assets. Part of those loans and securities is Bear's $4 billion unsold portion of the $20 billion Hilton financing package, according to people familiar with the matter.