Hospitality Franchise Systems, Inc.

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Hospitality Franchise Systems, Inc.

339 Jefferson Road
P.O. Box 278
Parsippany, New Jersey 07054-0278
U.S.A.
(201) 428-9700
Fax: (201) 428-7307

Private Company
Incorporated: 1990
Employees: 1,600
Sales: $257 million
Stock Exchanges: New York
SICs: 7011 Hotels and Motels; 5812 Eating Places; 6794
Patent Owners and Lessors

Hospitality Franchise Systems, Inc., (HFS) is the world’s largest hotel franchiser, as measured by number of rooms and properties. Its chief franchise systems include Days Inns, Ramada, Howard Johnson, Super 8, Park Inns, and Village Lodges. It is also engaged in the gambling industry and offers various lodging-related fee services. The company’s short history is characterized by rampant growth.

HFS was formed in 1990 by The Blackstone Group, a New York-based investment bank. Blackstone hired 50-year-old Henry Silverman, an attorney and investment banker with experience in the lodging industry, to run its merchant banking group. Blackstone formed HFS with the intent of purchasing ailing or undervalued franchise brands or the rights to those chain’s brand names. It planned to generate profits by charging its member hotels up-front and annual franchise fees; Rather than own the hotels, it would simply provide marketing, reservation, and other value-added administrative services. In addition, it would target hotels that offered moderate- and low-priced rooms.

To the casual observer, Blackstone’s entry into the lodging market may have seemed poorly timed. The U.S. hotel industry had just experienced its greatest period of expansion in history. By the early 1990s, in fact, there were more than three million hotel rooms in the nation, and about 30 percent of those had been built since the early 1980s. By the late 1980s it was clear to hotel industry participants that the market was quickly fading. Indeed, after increasing at a rate of approximately four percent a year throughout the middle and late 1980s, the number of newly constructed hotel rooms plummeted. By the early 1990s the growth rate had plunged to less than one percent, and most of the new rooms were built in the Las Vegas area.

The decline of the U.S. lodging industry was the result of several factors. First, the Tax Reform Act of 1986 gradually diminished the tax-favored status of commercial real estate developments, such as hotels, and decreased investment capital for new construction. Second, and more important, was a decline in demand. As the economy slowed in the late 1980s and early 1990s, both business and personal traveling declined. Many hoteliers that had expanded their chains during the 1980s with expectations of high demand and a preferred tax status suddenly found themselves burdened with half-empty, unprofitable properties that they could not sell.

By forming HFS, The Blackstone Group hoped to exploit what it viewed as opportunities amidst turmoil in the lodging industry. Fewer than one-third of all U.S. hotels going into the 1990s were affiliated with a national or regional chain. As a result, their operating costs were generally very high compared to members of national chains, which benefited from economies of scale. National chains could provide national advertising campaigns, centralized and automated reservation and billing departments, quality assurance programs, administrative support, and management training. Furthermore, HFS believed that the majority of the hotels that were affiliated with a chain could benefit from joining an even larger organization. Because so many hoteliers were strapped for cash by the early 1990s, HFS reasoned that it could sell large numbers of franchised rooms at low prices and profit, despite sluggish demand for hotel rooms.

In July of 1990, HFS made its first acquisitions by purchasing the Howard Johnson franchise system and the rights to operate the domestic U.S. Ramada franchise system. HFS bought the troubled properties from Prime Motor Inns for a scant $170 million. Prime Motor Inns was one of the fastest growing hotel chains in the nation during the 1980s and had accrued an impressive list of holdings by the end of the decade. However, it had also racked up over $500 million in debt, causing it to seek refuge in bankruptcy court when the market finally soured. The profitability of its Ramada and Howard Johnson subsidiaries had deteriorated significantly by 1990—the Ramada chain was even losing money.

With its first purchase, HFS immediately became a major player in the U.S. lodging industry. The Ramada chain brought 472 hotels with more than 77,608 rooms under HFS’s corporate umbrella. Howard Johnson added 417 properties with about 51,786 rooms. HFS incurred about $91 million in debt during its first year of operation, but was able to recoup approximately $50 million in franchise fees for a net loss of about $1.9 million—not a bad outcome considering the company’s start-up costs. HFS lost about $5 million in 1991 as it bolstered marketing efforts for its chains, began to establish a consolidated infrastructure that could also support future acquisitions, and pared its debt by about 15 percent.

In addition to trying to improve the efficiency of the hotels already in its chain, HFS sought to generate additional profits by adding independent hotels, other chain’s hotels, and new construction to the Ramada and Howard Johnson chains. During 1990 and 1991, in fact, HFS added about 22,000 rooms to the two hotel chains. It profited immediately from the additions of these properties because hotel owners that joined the franchises paid HFS an up-front fee, typically around $20,000 to $30,000. In addition, the owners agreed to pay an annual franchise fee of six percent to ten percent of gross receipts. The hotel owners benefited, of course, from access to a brand name and the reservation and marketing support proffered by HFS.

HFS’s initial success prompted its second major acquisition in January of 1992. Also in January of that year it purchased Days Inn of America, Inc., from the troubled Tollman-Hundley Lodging Corp. for $259 million. Days Inn was started by Cecil B. Day in 1970 and had quickly grown into the third largest hotel brand in the world by 1992. It added about 1,220 hotels with about 133,127 rooms to HFS, thus almost doubling HFS’s size. The Days Inn purchase proved to be a savvy buy for Silverman and his management team. Although HFS piled up a load of debt, it posted its first profit in 1992—net income (after-taxes) leaped to more than $20 million from revenues of about $200 million. By the end of 1992, HFS’s three chains included almost 2,500 hotels with about 300,000 rooms. After fewer than three years of operation, HFS had become one of the largest hotel franchisers in the world.

In addition to praise from many of its investors, Silverman and HFS also drew criticism following their rapid climb in 1992. The Days Inn acquisition represented the third time that a group associated with Silverman had purchased the chain in less than eight years, resulting in a profit of more than $ 100 million for he and his investors. The first purchase occurred in 1984 by an investment fund headed by Silverman and supported by felons-to-be Ivan Boesky, Michael Milken, and Victor Posner. They sold part of the chain to public investors at a 200 percent profit, bought it back in 1988 following the 1987 stock market crash, and then sold it a year later to Tollman-Hundley for a large profit. Now, Silverman was borrowing heavily, critics said, to buy the chain again.

Although Silverman’s deals were all legal, his detractors argued that HFS was engaging in questionable strategies. For example, its practice of growing quickly by lowering franchise fees to attract independent hotels into the chain (instead of building new ones) suggested a possible lowering of chain standards in order to generate short-term royalties. In addition, critics derided HFS’s financing strategy, claiming that it benefited certain top executives but reduced the long-term viability of the organization.

Despite criticism from a few analysts, HFS management and investors alike placed faith in the franchiser’s growth strategy. The company’s success throughout 1992 and into 1993 seemed to support their optimism. In April of 1993, in fact, HFS edged out Holiday Inns as the largest corporate hotel chain operator in the world when it purchased the rights to hotels owned by Super 8 Motels, Inc. Super 8 comprised 971 hotels totaling 59,532 rooms, for which HFS paid $125 million. Super 8 focused on serving government, senior, and family travelers, thus augmenting HFS’s strength in the economy/limited service hotel niche. Because most of its franchises were located in the Midwest, HFS believed it offered significant potential for expansion into other regions of the United States.

The business strategy adopted by HFS in the early 1990s was to significantly expand each of its franchise systems while maintaining or improving their reputation and to offer high-quality, value-added services to each chain. By accomplishing these goals, HFS expected to continually increase revenues from franchise fees, thus generating capital for new acquisitions and forays into related businesses. An integral component of HFS’s overall strategy was its state-of-the-art national reservation systems. Customers that called any of HFS’s chains were channeled to one of four national clearinghouses, where an operator would process the hotel reservation and also link customer travel requests with related services, such as airlines and rental cars. HFS provided each of its franchisees with specialized reports tracking call patterns and reservation trends, thus allowing them to improve occupancy.

In addition to its reservation system, HFS boosted the value of its franchises through marketing programs. Each of its companies had a separate marketing team to research and develop national and regional marketing initiatives, but the teams all benefited from lower shared costs related to volume purchases of printed materials and media advertising. HFS developed a quality assurance program to complement its marketing efforts by insuring that all franchise members adhered to brand-specific quality controls that created consistency for all hotels within each brand. HFS’s training system educated each of its franchisees on how to get the most out of its reservation system and marketing programs.

One of the most important means of luring new hotels into its franchise system was its preferred vendor arrangements. Through volume buying, HFS allowed many of its franchise members to slash costs related to goods and services for everything from toilet paper to food. HFS also provided telephone support, via toll-free numbers, for each of its franchisees. In addition, it assisted existing hotels that were converting to a franchise with the design and construction services necessary to bring the unit up to its standards. The end result of HFS’s various support services was that its hotel owners were typically able to improve occupancy and reduce operating costs, thus improving profitability compared to most independent hoteliers.

In June of 1993, shortly after acquiring Super 8, HFS added Park Inn International to its line-up. With 39 properties and 4,683 rooms in 13 states, Park Inn was a relatively small chain. HFS planned to market Super 8 and Park Inn chains separately and hoped to realize strong national growth for both brand names. Its expansion strategy resulted in an increase in the number of Super 8 franchisees of more than 12 percent during 1993, to more than 1,060. Meanwhile, HFS successfully enlarged its other chains, as well. The Ramada chain, for example, swelled to 676 hotels with 107,000 rooms by the end of 1993, and Howard Johnson increased to 566 properties with 63,000 rooms. Days Inn grew similarly, expanding to 1,441 hotels with 145,000 rooms.

By the end of 1993, HFS had 3,783 hotels with 383,931 rooms in its systems. Although it had accrued a weighty $350 million in long-term debt, HFS managed to boost sales 27 percent in 1993, to $257 million, as net income climbed 34 percent to $21.5 million. Also during 1993, Silverman and co-managers took HFS truly public, selling all ownership shares held by The Blackstone Group on the stock market. It also increased the average occupancy rate of its hotels and was able to boost royalty fees for new members of its franchises.

HFS continued to grow each of its franchises early in 1994; by April it had about 4,000 hotels sending franchise fees to the home office. Furthermore, the company began branching out into new arenas. It formed several strategic alliances with transportation and food service companies in 1993 and 1994, such as Greyhound, Pizza Hut, and Carlson Hospitality Group, which owned several restaurants and hotels. The agreements provided services to franchise members, such as free in-room pizza delivery and reduced bus rates for HFS franchise guests. Also notable was HFS’s entry into the gaming (gambling) market in 1993 and 1994. It began using its existing infrastructure to provide marketing and financing services to casino operators. In addition to those services, HFS was investing in several gambling-related ventures.

In late 1994, HFS formed National Gaming Corp. to handle the company’s casino and entertainment projects. National Gaming will be responsible for the financing, development, and operation of casino gaming and entertainment facilities.

As it entered the mid-1990s, HFS appeared positioned to benefit from a projected increase in hotel room rates resulting from a dearth of new development in the early 1990s. Future demographics also boded well for long-term growth, as noted in the company’s annual report: “Our basic business plan is driven by an inescapable demographic fact: the American population is getting older, and as people age, they tend to travel more for leisure than business and to trade down to lower price points; the hotels, motels, and casinos under the HFS umbrella.”

Principal Subsidiaries

Days Inns of America, Inc.; Howard Johnson Franchise Systems, Inc.; Ramada Franchise Systems, Inc.; Super 8 Motels, Inc.; Parks Inns International, Inc.; Villager Franchise Systems, Inc.; HFS Gaming Group.