La Quinta Holdings(LQ) announced last month that it “is pursuing the separation of its businesses into two stand-alone publicly traded companies, which could involve spinning off our owned real estate assets as a separate company.” La Quinta further stated “There is no assurance that the separation of the Company’s business will occur. ”
CEO Keith Cline waxed on with standard spinoff boilerplate about strategic clarity and so forth
“We are pursuing the possibility of separating our real estate business from our franchise and management businesses, which could prove to be the most logical next step as we continue to execute on our key strategic initiatives and create value for our stakeholders,” said Keith Cline, President and Chief Executive Officer of La Quinta. “This separation of our businesses could enable greater strategic clarity and allow us to take advantage of growth opportunities that naturally flow from each business model. This could also enable shareholders to own and value each business independently, allowing each company to attract the investor base most appropriate for its distinct investment profile.”
La Quinta, which owns or franchises 885 hotels in the U.S., Canada, Mexico and Honduras, has engaged J.P. Morgan as financial advisor to the company and Simpson Thacher & Bartlett LLP as legal advisor to the company.
Why such equivocation? As we have discussed previously, recent tax code changes severely restrict the ability of companies to spin off their real estate in a tax efficient manner. Prior to these new regulations, companies were permitted to spin off their real estate as a REIT, tax free. That is, the spin off would be tax free to shareholders, and the new entity, as a REIT, would not pay taxes at the corporate level. Now, both the parent and the child in a tax free spinoff are precluded from REIT status for ten years post spinoff. Further complicating things for La Quinta is that it is less than five years removed from its 2014 IPO.
So, what might La Quinta be thinking? The conference call held with analysts on January 19 to discuss the proposed transaction sheds some light on the possible structure.
Our expectation is that the spin of our real estate into a separate company would be a taxable transaction and we are focused on minimizing tax leakage. As we have talked about in the past, we have the ability to elect REIT status once the active trade or business role is satisfied. However, separating the businesses in this fashion may allow us to satisfy that role earlier than previously anticipated. We are well positioned to consider this opportunity which we believe drives value for our key stakeholders and could be the most logical next step as we continue to execute our key strategic initiatives to further enhance our brand.
Though La Quinta is not revealing all of the details regarding its position, it appears the key aspect of the transaction that they believe will allow it to conform with current regulations is the taxable nature of the spinoff. It is unclear what will allow them to elect REIT status with what appears to be less than five years of active trade or business role.
Smedes Rose: Okay, and then I just wanted to make sure we understand. It sounds like you’re contemplating this as a taxable transaction but then the property company would elect REIT status later on, or can you just review that because then it sounds like maybe you didn’t have to wait the full five years to go into the REIT status?
Keith Cline: Right. As we talked about, this five year active trade or business rule it is clearly still in play and without getting into a lot of the details of the hows and the whys, we do believe that by spinning our property company out of La Quinta Holdings, Inc. in this fashion, it could allow us to satisfy that five year rule earlier and, as I mentioned, we believe this could be as early as January 1st of next year. Obviously transactions like this, if you look at similar transactions, it typically takes seven to ten months and given that we’re announcing it today, that puts us in that window. So, could establish REIT status as early as the beginning of next year.
It is clear that La Quinta is trying to thread the needle and being intentionally vague. We particularly like the euphemistic “tax leakage”. Or, what everyone else calls “paying taxes”
Jared Shogaian: So, Keith, you’ve talked about obviously it’s premature to talk about some of the cost impacts from this transaction but do you have an idea at least of what the tax consequence would be and you just prefer not to share it at this time? And if not, is it possible that the tax impact would just be severe enough to cause you to consider pulling back from the transaction?
Keith Cline: No, I think given all the work that we’ve put into it, if the tax consequences of doing this would work against maximizing value, we wouldn’t be having this conversation today. The reason that I can’t get into the detail is there are simply just too many moving parts right now on sharing that level of detail and I’d hate to put a number out there and then have to go back and change expectations so, we’re putting a lot of effort into minimizing leakage and it’s just simply just too early to get into those details.
With all this talk about minimizing leakage you’d think that La Quinta was manufacturing diapers. In any event, there is certainly something brewing here. If La Quinta and its advisers are successful with this transaction, we can expect to see a rash of similar transactions rushing to market. Assuming, of course, that a radical overhaul of our tax system does not render moot the need for such complexity.
Disclosure: The author holds no shares of any stock mentioned
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