Hotel Bankruptcy Spares Key Investor

By LINGLING WEI and KRIS HUDSON In one of the biggest real-estate bankruptcies in the current slump, the Extended Stay Hotels chain filed for Chapter 11 protection Monday, collapsing under the debt from its $8 billion top-of-the-market buyout in 2007. But David Lichtenstein, whose Lightstone Group LLC led the buyout group, appears to be surviving Extended Stay's meltdown relatively unscathed. Lightstone contributed only $200 million of equity and borrowed a chunk of that for the deal, according to people familiar with the matter. Under a proposed restructuring plan with major creditors, the 48-year-old Mr. Lichtenstein would avoid personal guarantees in the original loan agreement. He would also be kept on as manager of the 680-property hotel chain. Mr. Lichtenstein on Monday declined to comment. In contrast, creditors include some of the country's biggest banks and even possibly U.S. taxpayers, as one of the lenders was Bear Stearns, whose stake was taken over by the Federal Reserve after Bear collapsed in March 2008. As a result, the Fed had $744 million in par amount in various junior classes of the debt on Extended Stay; it also held $153 million in the senior debt that was packaged and sold as bonds. A New York Fed spokeswoman declined to comment. Extended Stay's problems are partly due to hard times in the hotel industry. But the hotel chain's major problem was debt. One mortgage holder who supports the plan said Mr. Lichtenstein exercised his "fiduciary duty" in filing for bankruptcy. The high-wire act marks the latest coup for Mr. Lichtenstein, the son of two Brooklyn school teachers, who came out of nowhere to build a real-estate empire. That empire was valued at $13 billion at its peak but is now struggling, a sign of the spreading carnage in the commercial real-estate industry. Still, Mr. Lichtenstein's situation shows that the architects of some of the largest deals are finding ways to limit their losses. In Mr. Lichtenstein's case it also helped that the capital structure was so complicated, enabling him to benefit from the infighting among different groups of creditors. The hotel chain is now valued at $3.3 billion, according to its filing. That figure isn't even 60% of the buyout price and even lower than the amount of the first mortgage, $4.1 billion. Extended Stay's problems are partly due to hard times in the hotel industry. But the hotel chain's major problem was debt. The buyout group larded Extended Stay with $7.4 billion in debt on the assumption that the chain's cash flow would increase sharply. At the time of the deal, it was generating $545 million a year in earnings before capital expenditures. The group and its lenders, led by Wachovia, based its underwriting on the prediction that would increase to $625 million within two years. Such optimistic assumptions were the norm in commercial real-estate during the bubble leading up to the current recession. Cheap debt was available because banks could easily sell it as commercial mortgage backed securities, or CMBS, to investors chasing yields. More than $700 billion in CMBS is outstanding, and on uncertain legal footing in bankruptcy court. Many investors thought that Extended Stay wouldn't be able to file for bankruptcy because of a "bad boy" provision in the CMBS structure. According to the loan documents, Mr. Lichtenstein would become liable personally for $100 million if Extended Stay filed for Chapter 11 protection. But Mr. Lichtenstein reached a deal with secured lenders who have been negotiating a restructuring plan. Under that deal, lenders agreed to indemnify him up to $100 million in exchange for him supporting the plan that would put the lenders in control of the hotel chain. It is unclear if he would be personally liable for the loan he borrowed to finance his equity stake. As the ones left holding the bag, investors in the junior or "mezzanine" debt sued Extended Stay and its bank lenders this month in an effort to prevent them from seizing control. —Mike Spector and Jeffrey McCracken contributed to this article. Write to Lingling Wei at lingling.wei@dowjones.com and Kris Hudson at kris.hudson@wsj.com