S-1/A 1 d565367ds1a.htm AMENDMENT NO. 7 TO FORM S-1 Amendment No. 7 to Form S-1
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As filed with the Securities and Exchange Commission on October 30, 2013

Registration No. 333-190052

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

Amendment No. 7

to

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

Extended Stay America, Inc.

(Exact name of registrant as specified in its charter)

  

ESH Hospitality, Inc.*

(Exact name of registrant as specified in its charter)

 

 

 

Delaware    Delaware

(State or other jurisdiction of

incorporation or organization)

  

(State or other jurisdiction of

incorporation or organization)

7011    6798

(Primary Standard Industrial

Classification Code Number)

  

(Primary Standard Industrial

Classification Code Number)

46-3140312    27-3559821

(I.R.S. Employer

Identification Number)

  

(I.R.S. Employer

Identification Number)

11525 N. Community House Road, Suite 100

Charlotte, North Carolina 28277

(980) 345-1600

(Address, including zip code, and telephone number, including area code, of registrants’ principal executive offices)

 

 

Ross W. McCanless, Esq.

Chief Legal Officer

11525 N. Community House Road, Suite 100

Charlotte, North Carolina 28277

(980) 345-1600

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Stuart H. Gelfond, Esq.

Paul D. Tropp, Esq.

Fried, Frank, Harris, Shriver & Jacobson LLP

One New York Plaza

New York, New York 10004

(212) 859-8000

 

David J. Goldschmidt, Esq.

Laura A. Kaufmann Belkhayat, Esq.

Skadden, Arps, Slate, Meagher & Flom LLP

Four Times Square

New York, New York 10036

(212) 735-3000

 

 

* This registrant is currently a Delaware limited liability company named ESH Hospitality LLC and will be converted into a Delaware corporation and renamed prior to the completion of the offering.

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

  

Amount to be

Registered(1)

   Proposed Maximum
Aggregate
Offering Price per
Share(1)(2)
  

Propose Maximum
Aggregate

Offering Price(1)(2)

 

Amount of

Registration Fee(3)

Common Stock, par value $0.01 per share, of Extended Stay America, Inc. and Class B Common Stock, par value $0.01 per share, of ESH Hospitality, Inc., which are attached and trade together as a Share

   32,487,500    $21.00    $682,237,500   $88,633

 

 

(1) Includes Shares that may be purchased by the underwriters upon the exercise of their over-allotment option. See “Underwriting (Conflicts of Interest).”
(2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a) of the Securities Act of 1933, as amended.
(3) $65,160 previously paid.

 

 

The Registrants hereby amend this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrants shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion, Dated October 30, 2013

28,250,000 Shares

 

LOGO

Extended Stay America, Inc.

ESH Hospitality, Inc.

 

 

This is our initial public offering. We are offering 28,250,000 shares of paired common stock, each comprised of one share of common stock of Extended Stay America, Inc. and one share of Class B common stock of ESH Hospitality, Inc., which are attached and trade together. We refer to these paired shares collectively in this prospectus as the “Shares.”

ESH Hospitality, Inc. has elected and intends to continue to qualify to be taxed as a real estate investment trust, or REIT, for U.S. federal income tax purposes. The Shares offered by this prospectus are subject to restrictions on ownership and transfer that are intended to, among other purposes, assist us in qualifying for and maintaining ESH Hospitality, Inc.’s qualification as a REIT. The charters of Extended Stay America, Inc. and ESH Hospitality, Inc. will generally limit ownership (actual or constructive) to no more than 9.8% of the outstanding shares of any class or series of capital stock. The 244,994,445 shares of ESH REIT’s Class A common stock held entirely by the Company, which includes shares the Company will purchase from ESH REIT with a majority of the net proceeds it will receive from this offering, are excluded from the ownership restrictions. See “Description of Our Capital Stock—Limits on Ownership of Stock and Restrictions on Transfer.”

Prior to this offering, there has been no public market for the Shares. It is currently estimated that the initial public offering price per Share will be between $18.00 and $21.00. The Shares have been approved for listing, subject to official notice of issuance, on the New York Stock Exchange under the symbol “STAY.”

 

 

Investing in the Shares involves a high degree of risk. See “Risk Factors” beginning on page 24 of this prospectus to read about the factors you should consider before buying the Shares.

 

 

 

     Per Share      Total  

Initial public offering price

   $                    $                

Underwriting discount(1)

   $         $     

Proceeds, before expenses, to us

   $         $     

 

(1) See “Underwriting (Conflicts of Interest)” for a detailed description of compensation payable to the underwriters.

The underwriters have the option to purchase up to an additional 4,237,500 Shares from us at the initial public offering price less the underwriting discount within 30 days from the date of this prospectus solely to cover over-allotments, if any.

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the Shares against payment in New York, New York on                     , 2013.

 

 

 

Deutsche Bank Securities   Goldman, Sachs & Co.   J.P. Morgan

 

 

 

Citigroup   BofA Merrill Lynch   Barclays   Morgan Stanley   Macquarie Capital

 

 

 

Blackstone Capital Markets   Baird   Houlihan Lokey   Stifel

Prospectus dated                     , 2013.


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LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page  

Basis of Presentation

     ii   

Market and Industry Data

     iv   

Trademarks, Service Marks and Tradenames

     iv   

Certain Defined Terms

     iv   

Prospectus Summary

     1   

Risk Factors

     24   

Cautionary Note Regarding Forward-Looking Statements

     55   

Use of Proceeds

     57   

Company Distribution Policy

     58   

ESH REIT Distribution Policy

     59   

Capitalization

     64   

Pre-IPO Transactions

     66   

Dilution

     68   

Unaudited Pro Forma Condensed Consolidated Financial Statements of the Company

     70   

Unaudited Pro Forma Condensed Consolidated Financial Statements of ESH REIT

     80   

Selected Historical Financial and Other Data

     90   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     96   

Our Industry

     145   

Business

     149   

Management

     162   

Executive Compensation

     170   

Principal Stockholders

     195   

Investment Policies and Policies With Respect to Certain Activities of ESH REIT

     200   

Certain Relationships and Related Party Transactions

     202   

Description of Certain Indebtedness

     206   

Description of Our Capital Stock

     213   

Shares Eligible for Future Sale

     223   

Material United States Federal Income Tax Considerations

     225   

Underwriting (Conflicts of Interest)

     252   

Legal Matters

     259   

Experts

     259   

Where You Can Find More Information

     259   

Index to Financial Statements

     F-1   

 

 

Through and including                     , 2013 (the 25th day after the date of this prospectus), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

 

You should rely only on the information contained in this prospectus and any free writing prospectus that we authorize to be delivered to you. We have not and the underwriters have not authorized any person to provide you with any additional or different information. If anyone provides you with additional, different or inconsistent information, you should not rely on it. This prospectus is not an offer to sell, nor is it an offer to buy, these securities in any jurisdiction where an offer or sale is not permitted. The information contained in this prospectus is current only as of its date.

 

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BASIS OF PRESENTATION

Prior to the completion of this offering, we will effect the Pre-IPO Transactions (as defined in “Pre-IPO Transactions”). Unless otherwise indicated or the context requires, all information in this prospectus reflects the consummation of the Pre-IPO Transactions. For periods after the consummation of the Pre-IPO Transactions, “Extended Stay,” “Extended Stay America,” “we,” “our” and “us” refer to the Company (as defined below), ESH REIT (as defined below) and their subsidiaries considered for purposes of this offering as a single enterprise. For periods prior to the consummation of the Pre-IPO Transactions, “Extended Stay,” “Extended Stay America,” “we,” “our” and “us” refer to ESH REIT, ESH Strategies (as defined below), HVM (as defined below) and each of their respective subsidiaries, considered for purposes of this offering as a single enterprise. For a discussion of the pre-IPO restructuring transactions, see “Pre-IPO Transactions.”

Unless otherwise indicated or the context requires:

 

   

Predecessor. On October 8, 2010 (the “Acquisition Date”), ESH REIT and ESH Strategies, collectively, acquired substantially all of the assets and operations of Homestead Village LLC (the “Predecessor”) that were auctioned off by the former debtors of the Predecessor in its Chapter 11 reorganization. “ESH REIT Predecessor” refers to the assets and operations of Homestead Village LLC acquired by ESH REIT on the Acquisition Date.

 

   

Successor. For purposes of the financial statements contained in this prospectus, ESH REIT and ESH Strategies, together on a combined basis, are the “Successor” to the Predecessor by virtue of the fact that they collectively succeeded to principally all of the assets and operations of the Predecessor. As a result, the historical consolidated and combined financial results of ESH REIT and ESH Strategies are presented alongside those of the Predecessor. The acquisition was accounted for as a business combination in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805, “Business Combinations.”

 

   

ESH REIT. For the period after the Acquisition Date and prior to the consummation of the Pre-IPO Transactions, the term “ESH REIT” refers to ESH Hospitality LLC, a Delaware limited liability company that has elected to be taxed as a REIT, and its subsidiaries, including its three taxable REIT subsidiaries (the “Operating Lessees”). For the period following the consummation of the Pre-IPO Transactions, “ESH REIT” refers to ESH Hospitality, Inc., a Delaware corporation and successor to ESH Hospitality LLC, and its subsidiaries, which will no longer include the Operating Lessees. Following the Pre-IPO Transactions, ESH REIT will be a majority-owned, consolidated subsidiary of the Company.

 

   

ESH Strategies. The term “ESH Strategies” refers to ESH Hospitality Strategies LLC, a Delaware limited liability company, and its subsidiaries. ESH Strategies owns the intellectual property related to our business. Following the Pre-IPO Transactions, ESH Strategies will be owned by the Company.

 

   

HVM. For the period after the Acquisition Date and prior to the consummation of the Pre-IPO Transactions, ESH REIT leased its hotel properties to the Operating Lessees, and each Operating Lessee engaged HVM LLC (“HVM”) as an eligible independent contractor within the meaning of Section 856(d)(9) of the Internal Revenue Code of 1986, as amended (the “Code”), to manage the leased hotel properties on behalf of the Operating Lessees. Following the Pre-IPO Transactions, ESA Management LLC (“New HVM”) and its subsidiaries will manage the hotel properties and will be owned by the Company.

 

   

Company. The term “Company” refers to Extended Stay America, Inc., a Delaware corporation, and those entities that will be owned or controlled by the Company (excluding ESH REIT) after giving effect to the Pre-IPO Transactions, which will include the New Operating Lessees (as defined in “Pre-IPO Transactions”), ESH Strategies and New HVM.

 

   

Sponsors. The term “Sponsors” collectively refers to Centerbridge Partners, L.P., Paulson & Co. Inc. and the Blackstone Group, L.P. and their affiliates. See “Prospectus Summary—Our Sponsors.”

 

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Shares. The terms “Shares” and “paired Shares” mean the shares of common stock, par value $0.01 per share, of the Company together with the shares of Class B common stock, par value $0.01 per share, of ESH REIT, which are attached and trade as a single unit and includes the Shares offered hereby.

See “Prospectus Summary—Corporate Structure” for simplified structure charts reflecting our structure immediately before and after giving effect to the Pre-IPO Transactions.

This prospectus contains the following historical financial statements:

 

   

Company. Prior to the completion of the Pre-IPO Transactions, the Company has not had significant operations. The Company’s balance sheet as of July 9, 2013 is included elsewhere in this prospectus.

 

   

ESH REIT and ESH Strategies (for period on or after October 8, 2010) and Predecessor (for period on or prior to October 7, 2010). These historical consolidated and combined financial statements contain the financial results of ESH REIT and ESH Strategies after the Acquisition Date and the Predecessor’s historical combined financial statements for the period from January 1, 2010 through October 7, 2010.

 

   

ESH REIT (for period on or after October 8, 2010) and ESH REIT Predecessor (for period on or prior to October 7, 2010). The historical combined financial statements of ESH REIT Predecessor were prepared by combining the financial results of the entities that owned the hotel properties and the assets and operating companies of the Predecessor, other than those acquired by ESH Strategies, and represent the assets and entities consolidated in the financial statements of ESH REIT after the Acquisition Date. The historical consolidated financial statements of ESH REIT after the Acquisition Date include the financial position, results of operations, comprehensive income and cash flows of ESH REIT, including the Operating Lessees, as well as HVM on a consolidated basis, giving effect to noncontrolling interests.

Upon consummation of the Pre-IPO Transactions, the Operating Lessees and HVM will no longer be consolidated in ESH REIT’s financial statements. Instead, the activity and operations formerly conducted by the Operating Lessees and HVM will be conducted by the New Operating Lessees (as defined in “Pre-IPO Transactions”) and New HVM as subsidiaries owned by the Company, which will also own ESH Strategies. Accordingly, following the Pre-IPO Transactions, the Company’s financial statements, and not ESH REIT’s financial statements, will reflect the financial results of these entities.

For ease of presentation:

 

   

When we refer to our ownership of hotel properties, we are referring to the hotel properties owned by subsidiaries of ESH REIT. As described herein, following the Pre-IPO Transactions, ESH REIT will be a majority-owned, consolidated subsidiary of the Company.

 

   

When we refer to our operation of hotel properties, we are referring to the management of properties by HVM. As described herein, following the Pre-IPO Transactions, New HVM and its subsidiaries will be owned by the Company and will operate the hotel properties.

 

   

When we refer to our brands, we are referring to intellectual property related to our business owned by ESH Strategies. As described herein, following the Pre-IPO Transactions, ESH Strategies will be owned by the Company.

 

   

When we refer to our management team or our executives or officers, we are referring to HVM’s management team or HVM’s executives or officers. Following the Pre-IPO Transactions, HVM’s management team (and executives and officers) will become the management team of the Company and ESH REIT, as described in “Management.”

 

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MARKET AND INDUSTRY DATA

The data included in this prospectus regarding the lodging industry, including trends in the market and our position and the position of our competitors within the lodging industry, are based on a variety of sources, including independent industry publications, government publications and other published independent sources, information obtained from customers, distributors, suppliers, trade and business organizations and publicly available information (including the reports and other information our competitors file with the Securities and Exchange Commission, which we did not participate in preparing), as well as our good faith estimates, which have been derived from management’s knowledge and experience in the areas in which our business operates. We have not verified the accuracy or completeness of the data or any assumptions underlying the data. Estimates of market size and relative positions in a market are difficult to develop and inherently uncertain. Accordingly, investors should not place undue weight on the industry and market share data presented in this prospectus.

Certain information in this prospectus is provided by Smith Travel Research, Inc., an independent company that tracks historical hotel performance in most markets throughout the world (“Smith Travel Research”), and The Highland Group, an independent company that provides research on the overall hotel and extended stay hotel markets (“The Highland Group”). Smith Travel Research, Inc. and The Highland Group are not parties to this offering and do not endorse or provide any guidance to this transaction or any proposed investment in Extended Stay America, Inc. or ESH Hospitality, Inc.

TRADEMARKS, SERVICE MARKS AND TRADENAMES

The Company owns a number of registered trademarks, service marks, trade names and logos in connection with our business in the United States and in certain foreign jurisdictions, including but not limited to Extended Stay America®, Extended Stay Canada™ and Crossland®. Solely for convenience, the trademarks, service marks, trade names and logos referred to in this prospectus are without the ® and ™ symbols, but such references are not intended to indicate, in any way, that the Company will not assert, to the fullest extent under applicable law, its rights or the rights of the applicable licensors to these trademarks, service marks and trade names. This prospectus contains additional trademarks, service marks and trade names of others, which are the property of their respective owners. All trademarks, service marks and trade names appearing in this prospectus are, to our knowledge, the property of their respective owners.

CERTAIN DEFINED TERMS

The following are definitions of certain key lodging operating metrics used in this prospectus:

“ADR” or “average daily rate” means hotel room revenues divided by total number of rooms sold in a given period.

“Extended stay market” means the market of hotels with a fully equipped kitchenette in each guest room, which accept reservations and do not require a lease, as defined by The Highland Group.

“Hotel operating profit” means the sum of room and other hotel revenues less hotel operating expenses and “hotel operating margin” means the ratio of hotel operating profit divided by the sum of room and other hotel revenues.

“Mid-price extended stay segment” means the segment of the extended stay market that generally operates at a daily rate between $40 and $90, as defined by The Highland Group.

“Occupancy” or “occupancy rate” means the total number of rooms sold in a given period divided by the total number of rooms available at a hotel or group of hotels.

“RevPAR” or “revenue per available room” means the product of average daily room rate multiplied by the average daily occupancy achieved for a hotel or group of hotels in a given period. RevPAR does

 

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not include other ancillary revenues, such as food and beverage revenues or parking, telephone or other guest service revenues generated by a hotel.

“RevPAR Index” is stated as a percentage and is calculated for a hotel by comparing the hotel’s RevPAR to the aggregate RevPAR of a group of competing hotels generally in the same market. RevPAR Index is a weighted average of the individual property results. We subscribe to Smith Travel Research, which collects and compiles the data used to calculate RevPAR Index. We select the competing hotels included in the RevPAR Index, subject to Smith Travel Research’s guidelines.

The following terms when used in connection with our company-wide initiatives to renovate and make improvements to our hotel properties have the following meanings in this prospectus (in all cases, unless the context otherwise requires or where otherwise indicated):

“Hotel renovations” or “Platinum renovation package” refer to upgrades that typically include remodeling of common areas, new paint, carpet, signage, tile or vinyl flooring and counters in bathrooms and kitchens, as well as the refurbishment of furniture, replacement of aged mattresses and installation of new flat screen televisions, artwork, lighting and bedspreads.

“Post-Renovation Period” means the twelve-month period starting the month after the completion of the Ramp-Up Period.

“Pre-Renovation Period” means the twelve-month period ending the month prior to the commencement of renovations.

“Ramp-Up Period” means, typically, the additional three-month period for a renovated hotel to return to occupancy levels approximating Pre-Renovation Period levels following the Renovation Period.

“Renovation Period” means the approximately three-month period it takes to complete a Platinum hotel renovation, during which the hotel experiences temporary disruption and weakened performance.

“Room refreshes” or “Silver refresh package” refer to upgrades that typically include the replacement of aged mattresses and installation of new flat screen televisions, lighting, bedspreads and signage.

 

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PROSPECTUS SUMMARY

This summary highlights certain significant aspects of our business and this offering. This is a summary of information contained elsewhere in this prospectus, is not complete and does not contain all of the information you should consider before making your investment decision. You should carefully read the entire prospectus, including the information presented under the section entitled “Risk Factors” and the financial statements and related notes, before making an investment decision. This summary contains forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements as a result of certain factors, including those set forth in “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.” When making an investment decision, you should also read the discussion under “Basis of Presentation” and “Certain Defined Terms” above for the definition of certain terms used in this prospectus and a description of certain transactions and other matters described in this prospectus.

Our Company

We are the largest owner/operator of company-branded hotels in North America. Our business operates in the extended stay lodging industry, and we own and operate 682 hotel properties comprising approximately 75,900 rooms located in 44 states across the United States and in Canada. We own and operate 630 of our hotels under the core brand, Extended Stay America, which serves the mid-price extended stay segment, and accounts for approximately half of the segment by number of rooms in the United States. In addition, we own and operate three Extended Stay Canada hotels, 49 hotels in the economy extended stay segment under the Crossland Economy Studios and Hometown Inn brands, and also manage two Extended Stay America hotels. For the year ended December 31, 2012, we had total revenues of $1.0 billion, Adjusted EBITDA of $434.3 million and net income of $22.3 million. See “Summary Historical and Unaudited Pro Forma Consolidated and Combined Financial and Other Data” for a definition of Adjusted EBITDA and a reconciliation to net income.

Our extended stay hotels are designed to provide an affordable and attractive alternative to traditional lodging or apartment accommodations and are targeted toward self-sufficient, value-conscious guests. Our hotels feature fully-furnished rooms with in-room kitchens, complimentary grab-and-go breakfast, free WiFi, flat screen TVs and limited housekeeping service, which is typically provided on a weekly basis. Our guests include business travelers, professionals on temporary work or training assignments, persons relocating, temporarily displaced or purchasing a home and anyone else in need of temporary housing. These guests generally rent accommodations on a weekly or longer term basis.

We believe that extended stay hotels generally have higher operating margins and lower occupancy break-even thresholds compared to traditional hotels, primarily as a result of the efficiencies of a longer average length of stay with lower guest turnover and lower operating expenses. In 2012, our average length of stay was approximately 28 days, while the average length of stay for traditional hotels was approximately 2.5 days, and our average occupancy was 73.3% as compared to that of the overall U.S. lodging industry, which was 61.4%. For the same time period, our hotels generated property-level hotel operating margins greater than 50% compared to approximately 32% for the overall U.S. lodging industry, calculated based on comparable data from Smith Travel Research.

We were founded in January 1995 as a developer, owner and operator of extended stay hotels. Following a period focused primarily on new development, we became a consolidator of hotel properties by selectively acquiring extended stay companies and hotels, ultimately creating the largest mid-price extended stay company in the United States. We were acquired out of bankruptcy by the Sponsors in 2010. We now operate an extended stay hospitality platform with approximately 10,400 employees and are led by a management team with extensive public company experience in hospitality, consumer retail and service businesses.

 

 

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Our Recent Operating History

When they acquired us, our Sponsors recognized that despite our unparalleled scale in the mid-price extended stay segment, national footprint and high quality, predominantly coastal locations, our RevPAR was significantly lower than our nearest competitors in the mid-price extended stay segment. Our Sponsors believed this difference was due to several factors, including (i) under-capitalized hotels across the portfolio due to the severe constraints on our access to capital prior to the Acquisition Date as a result of financial distress and an over-leveraged capital structure, (ii) a lack of brand awareness and strategy as a result of no clear, national brand identity with five disparate brands and limited marketing initiatives and (iii) an operating platform that lacked industry standard practices, including sophisticated revenue management systems. In response, we recruited a highly qualified management team with extensive experience in real estate, hospitality, consumer-facing and brand-based businesses.

Our chief executive officer, James L. Donald, has over 35 years of experience in multiple-unit consumer-facing and brand-based industries, including as the president and chief executive officer of Starbucks. Our chief financial officer, Peter J. Crage, has over 20 years of experience in the leisure industry, including most recently as the chief financial officer of Cedar Fair Entertainment Company, a regional amusement-resort company. Our chief marketing officer, Thomas Seddon, has over 20 years of experience in the hospitality industry, including most recently as the chief marketing officer of InterContinental Hotels Group.

Our new management team has implemented significant improvements in the business, including improving the quality of our hotels through significant capital investment, initiating and substantially completing the rebranding of our mid-price extended stay hotel properties under the core Extended Stay America brand, increasing marketing to improve brand awareness and developing a company-wide culture and processes around service excellence. Together, we believe these initiatives will increase demand and attract guests who are willing to pay a higher rate for an improved product and service offering, will enable us to narrow the significant RevPAR difference that exists between us and our nearest competitors in the mid-price extended stay segment and continue to position us to grow our business.

Our performance has improved significantly since the Acquisition Date, which we believe is in large part due to the industry recovery. However, we are beginning to realize the benefits of our recently implemented capital, brand and marketing initiatives, and we believe these initiatives will continue to drive our internal growth. Since the Acquisition Date, we have:

 

   

Increased our ADR 25.7% from $41.63 to $52.34 for the twelve months ended September 30, 2010 and June 30, 2013, respectively;

 

   

Increased our RevPAR 25.0% from $31.00 to $38.74 for the twelve months ended September 30, 2010 and June 30, 2013, respectively;

 

   

Invested $455.1 million of capital into our properties as of June 30, 2013 as part of a $626.4 million capital program that will include the renovation of 633 properties; and

 

   

Realized Adjusted EBITDA growth of 43.9% for the twelve months ended June 30, 2013 compared to the year ended December 31, 2010 and Adjusted EBITDA growth of 21.9% for the six months ended June 30, 2013 compared to the six months ended June 30, 2012.

Our Competitive Strengths

We believe that our scale, national footprint, high quality portfolio, low cost operating model and highly qualified management team differentiate us from other lodging competitors and position us to execute our business and growth strategies. Our competitive strengths include the following:

The Market Leader in the Mid-Price Extended Stay Segment. We are the largest owner/operator by number of hotel rooms in the mid-price extended stay segment, which we believe is an underserved segment in

 

 

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the overall U.S. lodging industry with a meaningful share of extended stay demand staying in traditional hotels. The extended stay segment has experienced continued growth, even through several economic downturns, as evidenced by 20 consecutive years of growth in rooms sold. In 2012, the overall extended stay market represented approximately 7.4% of U.S. room supply; however, stays longer than five nights represented approximately 22% of total U.S. room demand. We own approximately 69,300 mid-price extended stay hotel rooms in the United States, which account for approximately half of the mid-price extended stay rooms and over two times the number of rooms than our next largest mid-price extended stay competitor. We believe our scale, combined with our recent branding and marketing initiatives focused on our core Extended Stay America brand, enables us to operate with a clear national brand identity. We also believe that we are uniquely positioned to benefit from economies of scale that translate into advantages in revenue generation, purchasing goods and services and leveraging central operating costs efficiently.

National Footprint with High Quality Locations. We believe we have high quality real estate locations with strong demand drivers, with more than 50% of our portfolio located in the 25 most populated metropolitan statistical areas (“MSAs”) in the United States. For the twelve months ended June 30, 2013, we generated approximately two-thirds of our hotel operating profit from hotels in coastal states, which we consider to be supply-constrained markets. For example, we own and operate 85 hotel properties in California, while our next largest operating competitor in the mid-price extended stay segment had only 15 hotels in California as of December 31, 2012. Our broad and diversified footprint, with no single property representing more than 1.0% of our total revenues, also reduces the risk of volatility due to local market conditions.

Fully Integrated Business Provides Significant Operational Control. Our fully integrated owner/operator model is unique relative to our main lodging competitors, which are primarily franchise businesses that generally own and control only a small portion of their hotels. We believe that our ability to control our real estate and operate nearly all of our hotels under a single brand will allow us to adapt more rapidly than our competitors to meet the ongoing needs of our guests and drive performance throughout economic cycles. Importantly, we are able to implement brand and service enhancements across our portfolio without the lengthy consultation process common to a typical franchise model, allowing for a higher speed of change. As an example, we have substantially completed a rebranding of 633 hotels in less than two years, which we believe represents one of the largest hotel rebrandings over such a short time period. Our decision to strategically invest in unifying our brands and improving our amenity offering early in the current lodging cycle allows for an extended period in which we can benefit from our investment. We believe our model provides a sustainable competitive advantage for growth and has proven successful for leading consumer branded companies, such as Starbucks, Walmart or Target, that have demonstrated the strength of an integrated owner/operator model in delivering a consistent customer experience.

High Operating Margins Drive Attractive Cash Flow Characteristics. We have historically generated high hotel operating margins and attractive cash flows. Our revenues are principally room revenues, which typically have higher margins relative to ancillary revenues, such as food and beverage revenues. Our hotels also have low fixed operating costs, including low fixed overhead and labor costs, compared to traditional hotels that have higher guest turnover and/or larger public and meeting spaces, and as a result have higher fixed operating costs. Our high hotel operating margins drive strong free cash flow, which we can use to reinvest in our business, distribute to shareholders or repay debt. Furthermore, we expect that our revenue enhancing strategies, which are primarily directed toward improving ADR, will produce revenues with high incremental operating margins.

Highly Qualified Management Team. Our executive management team has extensive experience in real estate, hospitality and consumer-facing and brand-based companies, including Starbucks, Cedar Fair Entertainment Company, InterContinental Hotels Group, La Quinta Inns, Morgans Hotels, Subway, Albertson’s, Pathmark, Safeway, Walmart and Lowe’s. Our chief executive officer, James L. Donald, has over 35 years of experience in consumer-facing and brand-based industries, including as the president and chief executive officer

 

 

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of Starbucks. Our chief financial officer, Peter J. Crage, has over 20 years of experience in the leisure industry, including most recently as the chief financial officer of Cedar Fair Entertainment Company, a regional amusement-resort company. Our chief marketing officer, Thomas Seddon, has over 20 years of experience in the hospitality industry, including most recently as the chief marketing officer of InterContinental Hotels Group.

Our Business and Growth Strategies

We have three main goals: improving the overall experience for our customers; creating an exceptional workplace for our associates; and increasing shareholder value. Our first goal is to become the most recognized and popular brand in the extended stay market by combining great practical value in our hotels with a passionate service attitude that makes customers feel like a guest in our home. Our second goal is to provide an exceptional workplace for our associates, operating with a set of shared values. These two goals are essential to achieving our third goal of creating superior value for shareholders. We believe that accomplishing these goals will enable us to increase ADR and to narrow the significant RevPAR difference that exists between us and our nearest competitors in the mid-price extended stay segment, which we believe will result in higher hotel operating margins and profitability. We estimate that in 2012 each $1 increase in ADR across our portfolio would have increased our EBITDA by approximately $17 to $19 million, assuming all other variables remained constant. We strive to achieve these goals through the following strategies:

Capitalize on Strategic Investment in Portfolio. We are in the advanced stages of executing a phased capital investment program across our portfolio in order to drive incremental market share gains. We expect to spend more than $625 million of capital from the Acquisition Date through the end of the first quarter of 2014, pursuant to our hotel reinvestment program, as well as maintenance and deferred capital expenditures. As of June 30, 2013, we have made significant progress on these initiatives and have spent approximately $455.1 million. The capital investments include our hotel reinvestment program of approximately $383.3 million, of which $262.6 million has been spent as of June 30, 2013. This program is dedicated to our revenue enhancing Platinum renovation and Silver refresh programs to upgrade 633, or approximately 93%, of our hotels. During this period we will also spend $171.2 million on maintenance capital expenditures, of which $122.2 million has been spent as of June 30, 2013. Additionally, we will spend $71.9 million on capital expenditures to address deferred maintenance that existed prior to the Acquisition Date, of which $70.3 million had been spent as of June 30, 2013. Given the capital spend to date, we believe we have addressed the most significant deferred maintenance needs of our hotels.

We believe that our capital investments are driving significant room rate and EBITDA growth and incremental RevPAR market share gains. For example, as of June 30, 2013, we owned 42 hotels for which we had results for the Post-Renovation Period. These hotels demonstrated RevPAR growth of 28.2% and RevPAR Index growth of 7.5% in the Post-Renovation Period as compared to the Pre-Renovation Period. Furthermore, the majority of the growth was achieved through increases in ADR, which grew 26.3% over the time period. As such, we believe that our capital investment program is not only improving the quality of our hotels and allowing us to increase market share but also yielding attractive financial returns.

While we have already begun to realize the benefits of these initiatives, we expect that a significant amount of the return from our capital investments will still be realized. Additionally, we may have additional opportunities to expand our hotel reinvestment program as we identify additional hotels for upgrade. In addition, while we attribute this growth primarily to our capital reinvestment program, we also believe that this improvement has benefited from the implementation of our other initiatives, including the rebranding, increased marketing and service initiatives. The primary focus of this expansionary investment has been on our mid-price Extended Stay America hotels and we will continue to invest in our economy-price Crossland Economy Studios hotels as appropriate.

Implement Marketing Strategy and Increase Brand Awareness. We have made strategic investments in marketing initiatives, which we believe will increase awareness and market penetration of our brands. In addition

 

 

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to tripling our marketing spend in 2012 compared to the prior year by spending in excess of $25 million in the consolidation of our core Extended Stay America brand, we have also invested in excess of $15 million for signage replacement. The consolidation under a single Extended Stay America banner, redesigning of our logo and anticipated launch of our customer loyalty program are examples of our strategy to attract new guests. Additionally, our brand consolidation will allow us to concentrate our advertising efforts on a single brand rather than spreading them across several brands, which we believe will improve our ability to raise awareness of our product offering among both individual travelers and corporations. Over time, we believe our strengthened brand awareness will allow us to further build customer loyalty and increase demand. The strategic brand investment has and will continue to focus on improvements for our Extended Stay America brand, while our Crossland Economy Studios hotels are largely supported by company-wide initiatives, including local sales activity and online promotional spending.

Increase Revenues through Optimized Customer Mix. We believe there is an opportunity to increase ADR by optimizing customer mix and increasing the proportion of shorter duration guests (those with an average length of stay of less than 30 days). Such guests typically generate higher ADR as compared to our guests who have longer duration stays. This strategy involves both building demand for our hotels and optimizing the yield from our room inventory. We will also target more corporate customers who are willing to pay a higher rate for our improved portfolio and value proposition. In order to facilitate these initiatives, we plan to invest in new technology platforms, including automated revenue management systems, a customer relationship management (“CRM”) program and a loyalty program.

The following table illustrates how our customer mix and discount level changed from 2007 to 2012, and what our 2012 ADR would have been if customer mix and discount had been at 2007 levels, all other factors being equal:

 

     2007     2012     2012 with
2007 mix
and
discount
 

30+ night mix(3)

     44     54     44

Discount for 30+ nights(3)

     16     23     16

Average ADR

   $ 56.23 (1)    $ 49.77 (2)    $ 52.62   

 

(1) Overall ADR data for 2007 represents all 684 comparable operated hotels
(2) Overall ADR data for 2012 represents 665 hotels for full year plus 17 acquired hotels for 19 days
(3) Customer mix data and discount data calculated for comparable 684 operated hotels in each period

Improve Margins by Upgrading Our Operational Practices. We intend to drive profitability and cash flows by improving operating efficiencies in our business and implementing industry standard practices in areas in which we have been less sophisticated than some of our competitors across both our Extended Stay America and Crossland Economy Studios brands. We have identified specific areas for operating improvements that include enhancement of our central reservation system, procurement systems, human resources management tools and technology to manage back office administration and workflow. We have tightened cost controls and implemented strict cash management practices at our hotel properties to significantly reduce cash leakage and to improve overall property margins and flow-through to cash flow. We believe implementing these industry-tested techniques offers a low risk path to margin improvement.

Pursue Disciplined Expansion of Our Footprint through Select Acquisitions and Conversions. We believe extended stay hotel ownership is highly fragmented. We believe we can increase our scale by opportunistically acquiring hotels after careful evaluation of potential returns, condition of the hotels, duration of current license agreements and the anticipated capital requirements to upgrade or convert the hotel to meet our brand standards.

 

 

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Our growth and expansion is not limited by radius restrictions associated with franchise agreements, which allows us to add new hotels to meet additional demand within existing markets in which we already operate. In addition, we believe that our scale and experience in the mid-price extended stay segment will allow us to achieve operational and overhead cost synergies in hotel properties that we acquire. We believe these growth opportunities will be primarily in the mid-price extended stay segment with our Extended Stay America brand.

Smith Travel Research’s hotel census database divides the United States into 628 sub-markets, or tracts. Our analysis of this data shows that an Extended Stay America hotel is currently present in only 50% of these tracts, while our competitors are present as follows:

 

Extended Stay America present

     313         50

Extended Stay America not present, other mid-price extended stay brand present

     153         24

No mid-price extended stay hotel, but other segment extended stay hotel present

     86         14

No extended stay hotel present

     76         12
  

 

 

    

 

 

 

Total U.S. Sub-Markets (“Tracts”)

     628         100
  

 

 

    

 

 

 

 

Source: Smith Travel Research, Company analysis

We believe this indicates that there are many markets that we are not currently in that may support extended stay hotels, in addition to the opportunities we have to grow further in markets where we are already present.

Build a Culture Centered Around Executional Excellence. We have undertaken several company-wide initiatives to improve our guest experience and establish an employee culture centered on high quality and differentiated customer service. We have focused our efforts toward attracting, engaging and retaining a high quality workforce across our platform that we believe will allow us to achieve sustainable long-term success. Our culture is built around motivating and inspiring associate behavior through open communication with senior management that we believe fosters a high performance environment designed to meet our business objectives. Management believes these initiatives have started to produce a very positive response from our guests. For example, we have seen an increase in the quantity and an improvement in sentiment of reviews posted about our hotels, with a thirteen-fold increase in the number of our hotels receiving Trip Advisor’s Certificate of Excellence from 2012 to 2013.

Our Industry

U.S. Lodging Industry

The lodging industry is a significant part of the U.S. economy, generating over $162.8 billion of revenues in 2012 and comprising approximately 4.9 million hotel rooms as of June 30, 2013, according to Smith Travel Research. Lodging industry performance is generally tied to both macro-economic and micro-economic trends in the United States and, similar to other industries, experiences both positive and negative operating cycles. Since the 2008 to 2009 recession, demand in the U.S. lodging industry has begun to recover while supply growth has remained at historically low rates. According to PricewaterhouseCoopers (“PwC”), room supply is expected to grow 0.8% in 2013 and 1.0% in 2014, which is still well below historical annual supply growth of 1.7% over the last 15 years. RevPAR has grown in the U.S. lodging industry for each year starting in 2010 and PwC predicts that RevPAR for the overall U.S. lodging industry will grow 5.9% in 2013 and 6.2% in 2014.

 

 

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U.S. Extended Stay Segment

Extended stay hotels represent a growing segment within the U.S. lodging industry with approximately 355,700 rooms that generated approximately $7.6 billion of revenues for the year ended December 31, 2012 according to The Highland Group. The extended stay segment tends to follow the cyclicality of the overall lodging industry.

Extended stay hotels are further differentiated by price point into economy, mid-price and upscale segments. Our business is focused primarily on the mid-price extended stay segment, which comprised approximately 39% of the supply of extended stay rooms in 2012. RevPAR growth for the mid-price extended stay segment has outpaced the U.S. lodging industry as a whole since 2009 as well as the economy and upscale extended stay segments. The mid-price extended stay segment rebounded from an industry trough with RevPAR growth of 24.7% between 2009 and 2012, which was higher than the overall U.S. lodging industry as well as the economy and upscale extended stay segments, each of which grew at 21.8%, 17.1% and 21.2%, respectively, for the same period.

We believe the extended stay segment is an underserved segment of the overall U.S. lodging industry with the majority of extended stay demand served by traditional hotels. In 2012, the overall extended stay market represented approximately 7.4% of U.S. room supply; however, stays longer than five nights represented approximately 22% of total U.S. room demand. Furthermore, the extended stay segment has experienced continued growth, even through several economic downturns, as evidenced by 20 consecutive years of growth in rooms sold. As the extended stay segment continues to increase in size and customer awareness, we believe that more guests will opt for extended stay hotels as an alternative to traditional hotels.

Based on industry sources, we believe that the lodging industry will experience continued industry growth for at least the next several years as a result of moderate demand growth combined with historically low levels of room supply growth. We believe that we are well-positioned to benefit from this industry and overall economic growth, which should drive revenue and cash flow growth for us.

 

 

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Recent Developments

Preliminary Consolidated and Combined Financial and Other Data for the Three and Nine Months Ended September 30, 2013 and 2012 and as of September 30, 2013

The following information for the three and nine months ended September 30, 2013 and 2012 and as of September 30, 2013 sets forth preliminary summary financial and operating data for Extended Stay. Other than any subsequent events occurring after the date of this preliminary prospectus that may impact the third quarter results, our third quarter financial results presented below are not expected to change. Our results of operations for the three and nine months ended September 30, 2013 and 2012 are not necessarily indicative of results that may be expected for any future period.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(Dollars in millions, other than ADR and RevPAR)

   2013     2012     2013     2012  

Statement of Operations Data:

    

Room revenues

   $ 308.1      $ 274.1      $ 849.7      $ 740.6   

Other hotel revenues

     5.3        4.7        13.6        12.8   

Management fees, license fees and other revenue

     0.3        2.5        0.8        7.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     313.7        281.3        864.1        760.9   

Total operating expenses

     241.3        191.9        605.8        540.9   

Income before income taxes

     47.0        36.4        101.0        62.2   

Net income

     46.6        33.3        98.0        55.3   

Net income attributable to controlling interests

   $ 46.2      $ 33.1      $ 97.2      $ 55.4   

Other financial data:

        

Cash flows provided by (used in):

        

Operating activities

   $ 108.8      $ 105.4      $ 276.0      $ 193.6   

Investing activities

     (31.8     (144.3     (195.1     (241.6

Financing activities

     (18.6     (9.9     (20.7     (21.8

Capital expenditures(a)

     (39.2     (94.5     (117.8     (197.7

EBITDA(b)

     142.7        122.8        383.4        313.9   

Adjusted EBITDA(b)

     148.4        125.4        396.1        328.4   

Hotel operating profit(c)

     168.5        144.4        455.3        383.5   

Hotel operating margin(c)

     53.8     51.8     52.7     50.9

Operating data:

        

Rooms (at period end)

     75,928        73,657        75,928        73,657   

Average occupancy rate

     78.7     79.0     75.5     74.5

ADR

   $ 56.01      $ 51.25      $ 54.31      $ 49.28   

RevPAR

   $ 44.09      $ 40.50      $ 40.98      $ 36.74   

Balance sheet data:(d)

        

Cash and cash equivalents

   $ 163.5         

Restricted cash

     147.7         

Property and equipment, net

     4,092.4         

Total assets

     4,612.2         

Mortgage loans payable

     2,525.5         

Mezzanine loans payable

     1,080.0         

Total liabilities

     3,778.6         

Total combined equity

     833.6         

Total liabilities and combined equity

   $ 4,612.2         

 

 

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(a) We have invested a total of $492.7 million of capital into our properties from October 8, 2010 through September 30, 2013 as part of our ongoing capital investment program.

 

(b) EBITDA and Adjusted EBITDA are non-GAAP measures we use to measure operating performance. The following table reconciles net income to EBITDA and Adjusted EBITDA for the three and nine months ended September 30, 2013 and 2012 (in millions). For more information about our use of EBITDA and Adjusted EBITDA, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Consolidated and Combined Non-GAAP Financial Measures—EBITDA and Adjusted EBITDA.”

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2013     2012     2013     2012  

Net income

   $ 46.6      $ 33.3      $ 98.0      $ 55.3   

Interest expense

     53.0        53.2        157.9        158.8   

Income tax expense

     0.4        3.1        3.0        6.8   

Depreciation and amortization

     42.7        33.2        124.5        93.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

     142.7        122.8        383.4        313.9   

Restructuring expenses

     —          —          0.6        5.8   

Acquisition transaction expenses

     —          —          0.1        —     

Impairment of long-lived assets

     1.9        —          3.3        —     

Non-cash equity-based compensation

     0.6        1.6        3.4        3.2   

Other expenses

     3.2 (1)      1.0 (2)      5.3 (3)      5.5 (4) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 148.4      $ 125.4      $ 396.1      $ 328.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) For the three months ended September 30, 2013, includes costs related to preparations for our initial public offering, consisting primarily of the Pre-IPO Transactions, of $3.2 million.
(2) For the three months ended September 30, 2012, includes costs related to preparations for our initial public offering, consisting primarily of the Pre-IPO Transactions, of $0.3 million and consulting fees related to implementation of our new strategic initiatives, including services related to pricing and yield management policy, of $0.7 million.
(3) For the nine months ended September 30, 2013, includes costs related to preparations for our initial public offering, consisting primarily of the Pre-IPO Transactions, of $5.3 million.
(4) For the nine months ended September 30, 2012, includes costs related to preparations for our initial public offering, consisting primarily of the Pre-IPO Transactions, of $0.8 million and consulting fees related to implementation of our new strategic initiatives, including services related to pricing and yield management policy, of $4.7 million.

 

 

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(c) Hotel operating profit and hotel operating margin are non-GAAP measures we use to evaluate the operating profitability of our hotels. The following table reconciles our room revenues, other hotel revenues and hotel operating expenses to hotel operating profit and hotel operating margin for the three and nine months ended September 30, 2013 and 2013 (in millions). For more information about our use of EBITDA and Adjusted EBITDA, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Consolidated and Combined Non-GAAP Financial Measures—Hotel Operating Profit and Hotel Operating Margin.”

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2013     2012     2013     2012  

Room revenues

   $ 308.1      $ 274.1      $ 849.7      $ 740.6   

Other hotel revenues

     5.3        4.7        13.6        12.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total hotel revenues

     313.4        278.8        863.3        753.4   

Hotel operating expenses

     144.9        134.4        408.0        369.9   
  

 

 

   

 

 

   

 

 

   

 

 

 

Hotel operating profit

   $ 168.5      $ 144.4      $ 455.3      $ 383.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Hotel operating margin

     53.8     51.8     52.7     50.9
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(d) Subsequent to September 30, 2013 and prior to the completion of the Pre-IPO Transactions and this offering, ESH REIT expects to make a regular REIT distribution with respect to the third quarter of approximately $60.0 million to its current owners.

Our Sponsors

Centerbridge Partners, L.P. (“Centerbridge”), which was established in 2005 and commenced operations in 2006, is a private investment firm focused on traditional private equity and credit investing and is headquartered in New York City. The firm employs over 50 investment professionals and, as of August 1, 2013, managed approximately $20 billion in capital. The Centerbridge team has in-depth industry experience across a variety of sectors, including hospitality, restaurants, retail, consumer, business services, communications, financial institutions, healthcare, industrial, media, real estate and transportation. Limited partners in Centerbridge’s funds include many of the world’s most prominent endowments, state and corporate pension funds and charitable trusts.

Paulson & Co. Inc. (“Paulson”) is an investment management firm specializing in event-driven strategies, including merger arbitrage, bankruptcy reorganizations and distressed credit, structured credit, recapitalizations, restructurings and other corporate events. As of August 1, 2013, Paulson managed approximately $18 billion in assets and employed approximately 120 employees in offices located in New York, London and Hong Kong.

The Blackstone Group, L.P. (“Blackstone”) is one of the world’s leading investment and advisory firms. Blackstone’s alternative asset management businesses include the management of corporate private equity funds, real estate funds, hedge fund solutions, credit-oriented funds and closed-end mutual funds. Blackstone also provides various financial advisory services, including financial and strategic advisory, restructuring and reorganization advisory and fund placement services. Through its different investment businesses, as of August 1, 2013, Blackstone had assets under management of approximately $230 billion.

The Pre-IPO Transactions

ESH Hospitality Holdings LLC, a Delaware limited liability company (“Holdings”), owns all of ESH REIT’s outstanding common units. The Sponsors own an approximately 99% interest in Holdings and the remaining interests are owned by certain present and former members of the board of managers of Holdings and

 

 

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employees of HVM. The Operating Lessees are each taxable REIT subsidiaries that lease the hotel properties from ESH REIT pursuant to operating leases. HVM is an eligible independent contractor, within the meaning of Section 856(d)(9) of the Code, that manages the hotel properties pursuant to management agreements with the Operating Lessees. Subsidiaries of ESH Strategies own the trademarks and license their use to the Operating Lessees pursuant to trademark license agreements.

The Company is a newly formed entity, formed for the purpose of effecting the Pre-IPO Transactions, and has engaged in no business or activities other than in connection with the Pre-IPO Transactions.

The Pre-IPO Transactions contemplate that the existing business will be restructured and reorganized such that Holdings will liquidate and distribute to the Sponsors substantially all of the common stock of ESH REIT; the Company will acquire the Operating Lessees, ESH Strategies and the operations of HVM; the shareholders of ESH REIT will transfer to the Company all of the Class A common stock of ESH REIT; and 100% of the common stock of the Company and all of the Class B common stock of ESH REIT will be paired, forming the paired common stock offered pursuant to this prospectus. The Pre-IPO Transactions contemplate the series of transactions necessary to implement the restructuring described above, which, other than the Company’s acquisition of ESH Strategies, which will occur prior to the completion of this offering, are expected to occur at various times prior to the effective time of this offering. See “Pre-IPO Transactions.”

Following the Pre-IPO Transactions, the Company, through its direct wholly-owned subsidiaries, will lease the hotel properties from ESH REIT, will own the trademarks related to the business and will self-manage the hotel properties. In addition, the Company will own all of the Class A common stock of ESH REIT, which will represent 55% of the outstanding common stock of ESH REIT. The Company will use the majority of the proceeds it receives in this offering, and may use proceeds it receives in any future offerings, to purchase additional shares of Class A common stock of ESH REIT as may be necessary to ensure that the Class A common stock of ESH REIT owned by the Company represents 55% of the outstanding common stock of ESH REIT.

We believe that our business following the Pre-IPO Transactions will be more operationally efficient because all of the assets and operations of our business, other than ownership of the hotel properties, will be housed in one publicly traded entity. Ownership of Shares will give investors an ownership interest in our hotel properties through ESH REIT and in the operation of our business through the Company. We expect that the Pre-IPO Transactions will facilitate the growth of our business and permit us to offer equity-based compensation that will permit us to attract and retain top management talent. Finally, the structure permits us to retain some, though not all, of the REIT benefits of our prior structure (e.g., while ESH REIT should continue to be taxed as a REIT for U.S. federal income tax purposes, all dividends paid by ESH REIT to the Company will be subject to the corporate level tax, effectively eliminating a majority of the tax benefit of REIT status for the combined companies taken as a whole).

Except where otherwise expressly indicated or the context otherwise requires, this prospectus reflects the completion of the Pre-IPO Transactions.

 

 

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Corporate Structure

The chart below summarizes our current corporate structure before giving effect to the Pre-IPO Transactions:

 

LOGO

 

 

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The chart below summarizes our corporate structure after giving effect to this offering and the Pre-IPO Transactions. The percentage ownerships in the chart reflect the percentage of total common equity by number of shares for the entities shown:

 

LOGO

 

 

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Company Distribution Policy

The payment of any distributions will be at the discretion of the Company’s board of directors. Any such distributions will be made subject to the Company’s compliance with applicable law and will depend on, among other things, the receipt by the Company of dividends from ESH REIT in respect of the Class A common stock, the Company’s results of operations and financial condition, the Company’s level of indebtedness, capital requirements, capital contributions to ESH REIT, contractual restrictions, restrictions in any future debt agreements of the Company or ESH REIT and in any preferred stock and other factors that the Company’s board of directors may deem relevant. See “Company Distribution Policy” for a discussion of the distribution policies of the Company.

ESH REIT Distribution Policy

Following the completion of this offering, ESH REIT intends to make regular quarterly cash distributions to its stockholders (including the Company), as more fully described below. To qualify as a REIT, ESH REIT must distribute annually to its stockholders an amount at least equal to:

 

   

90% of its REIT taxable income, computed without regard to the deduction for dividends paid and excluding any net capital gain; plus

 

   

90% of the excess of its net income, if any, from foreclosure property over the tax imposed on such income by the Code; less

 

   

the sum of certain items of non-cash income that exceeds a percentage of ESH REIT’s income.

ESH REIT will be subject to income tax on its taxable income that is not distributed and to an excise tax to the extent that certain percentages of its taxable income are not distributed by specified dates. ESH REIT generally expects to distribute approximately 95% of its REIT taxable income. ESH REIT will be subject to U.S. federal corporate income tax on its undistributed REIT taxable income and net capital gain and may be subject to U.S. federal excise tax. See “Material United States Federal Income Tax Considerations.” Income as computed for purposes of the forgoing tax rules will not necessarily correspond to ESH REIT’s income before income taxes as determined under GAAP for financial reporting purposes.

In cases in which the terms of any of the Company’s or ESH REIT’s existing or future indebtedness bars the payment of cash dividends, ESH REIT may declare and pay taxable stock dividends in order to maintain its REIT status.

ESH REIT’s distributions will be authorized by the ESH REIT board of directors and declared based on a variety of factors. See “ESH REIT Distribution Policy” for a discussion of the distribution policies of ESH REIT.

Risks Related to the Lodging Industry and Our Business

Investing in the Shares involves a high degree of risk. You should carefully consider the following risks as well as the risks described under “Risk Factors” and the other information contained in this prospectus, including the financial statements and related notes, before investing in the Shares.

 

   

We are subject to the operating risks common to the lodging industry, including events beyond our control that disproportionately affect the travel industry, such as war, terrorist attacks, travel-related health concerns, transportation and fuel prices, interruptions in transportation systems, travel-related accidents, fires, natural disasters and severe weather.

 

   

As of June 30, 2013, on a pro forma basis, ESH REIT and its subsidiaries would have had total indebtedness of approximately $3.15 billion. The agreements governing its indebtedness may restrict, and the future indebtedness of the Company or ESH REIT may restrict, the Company, ESH REIT and their subsidiaries, reduce operational flexibility and create default risks, including precluding the payment of cash dividends by the Company and ESH REIT.

 

 

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Mortgage and mezzanine debt obligations expose us to the possibility of foreclosure, which could result in the loss of any hotel property subject to mortgage or mezzanine debt.

 

   

Our business depends on the quality and reputation of our brands, and any deterioration in the quality or reputation of our brands or the lodging industry could materially adversely affect our market share, reputation, business, financial condition and results of operations.

 

   

We could incur significant costs related to government regulation and litigation over environmental, health and safety matters.

 

   

Compliance with the laws and regulations that apply to our hotel properties could materially adversely affect our ability to make future acquisitions or renovations, result in significant costs or delays and adversely affect our business strategies.

 

   

We operate in a highly competitive industry.

 

   

The lodging industry is cyclical and a worsening of general economic conditions or low levels of economic growth could materially adversely affect our business, financial condition, results of operations and our ability to pay dividends to our stockholders.

 

   

If we fail to implement our business strategies, our business, financial condition and results of operations could be materially adversely affected.

 

   

Our capital expenditures and business strategies may not result in our expected improvements in our business.

 

   

We are exposed to the risks resulting from real estate ownership, which could increase our costs, reduce our profitability and limit our ability to respond to market conditions.

 

   

Economic and other conditions may materially adversely affect the valuation of our hotel properties resulting in impairment charges that could have a material adverse effect on our business, results of operations and earnings.

 

   

Failure of ESH REIT to qualify as a REIT or remain qualified as a REIT would cause it to be taxed as a regular C corporation, which would expose it to substantial tax liability and could substantially reduce the amount of cash available to pay dividends to its stockholders.

 

   

Our structure has been infrequently utilized by public companies and has not been employed by a public company since a similar structure was employed by a public company in 2006, and the IRS could challenge ESH REIT’s qualification as a REIT.

 

   

ESH REIT’s board of directors could terminate its status as a REIT, subjecting ESH REIT’s taxable income to U.S. federal income taxation, which would increase its liabilities for taxes.

 

   

ESH REIT has no operating history as a publicly traded REIT and may not be successful in operating as a publicly traded REIT, which may adversely affect its ability to make distributions to its stockholders.

 

   

When this offering is completed, affiliates of Centerbridge, Paulson and Blackstone will each beneficially own approximately 27.8% of the Shares (27.2%, if the underwriters’ option to purchase additional Shares is exercised in full), and their interests may conflict with or differ from your interests as a stockholder.

 

   

Following the completion of this offering, the Sponsors will have the right to nominate four of the seven directors of the Company and three of the five directors of ESH REIT and will therefore have significant control over the operation of our business. The Sponsors interests may conflict with or differ from your interests as a stockholder.

 

 

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We are a “controlled company” within the meaning of the NYSE rules and, as a result, will qualify for, and may rely on, exemptions from certain corporate governance guidelines, including, the requirements that a majority of the boards of directors of the Company and ESH REIT consist of independent directors, the requirement that each of the Company and ESH REIT have a nominating/corporate governance committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities, and the requirement that each of the Company and ESH REIT have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities.

 

   

The Sponsors will collectively hold approximately 167 million Shares following the completion of this offering. Future sales or the possibility of future sales of a substantial amount of the Shares by the Sponsors may depress the price of the Shares.

Corporate Information

Extended Stay America, Inc. was incorporated in Delaware on July 8, 2013. ESH Hospitality LLC was formed as a limited liability company in Delaware on September 16, 2010 and will convert to a corporation prior to the completion of this offering. Our principal executive offices are located at 11525 N. Community House Road, Suite 100, Charlotte, North Carolina 28277, and our telephone number is (980) 345-1600. Extended Stay maintains a website at www.extendedstayamerica.com. The information contained on, or that can be accessed through, Extended Stay’s website is not incorporated by reference in, and is not a part of, this prospectus.

 

 

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THE OFFERING

 

Issuers

Extended Stay America, Inc. (the “Company”)

ESH Hospitality, Inc. (“ESH REIT”)

 

Description of Shares

Each Share consists of one share of common stock, par value $0.01 per share, of the Company that is attached to and trades as a single unit with one share of Class B common stock, par value $0.01 per share, of ESH REIT. See “Description of Our Capital Stock.”

 

Shares offered by us

28,250,000 Shares.

 

Shares to be outstanding immediately after the offering

200,450,000 Shares.

 

Underwriters’ option to purchase additional Shares from us to cover over-allotments

4,237,500 Shares.

 

Percentage of outstanding Shares to be owned by the Sponsors immediately after the offering

83.4%.

 

Use of proceeds

The net proceeds we will receive from the sale of 28,250,000 Shares in this offering, after deducting underwriter discounts and commissions and estimated offering expenses payable by us, will be approximately $509.0 million. The proceeds will be divided among the Company and ESH REIT based on their estimated valuations.

 

  The Company will use the majority of proceeds it receives to purchase additional shares of ESH REIT Class A common stock from ESH REIT in order to maintain its ownership of 55% of the outstanding common stock of ESH REIT, with any remaining balance to be used for general corporate purposes.

 

  ESH REIT intends to use the net proceeds from this offering and the sale of Class A common stock to the Company and cash on hand to repay certain of ESH REIT’s indebtedness. See “Use of Proceeds.”

 

Proposed New York Stock Exchange (“NYSE”) symbol

“STAY.”

 

Ownership limitation

The Shares are subject to ownership limitations. See “Description of Our Capital Stock—Limits on Ownership of Stock and Restrictions on Transfer.”

 

Conflicts of Interest

Affiliates of Blackstone Advisory Partners L.P. own, in the aggregate, in excess of 10% of the Company’s and ESH REIT’s issued and outstanding common stock. Because Blackstone Advisory Partners L.P. is an underwriter and its affiliates own, in the aggregate, in

 

 

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excess of 10% of the Company’s and ESH REIT’s issued and outstanding common stock, Blackstone Advisory Partners L.P. is deemed to have a “conflict of interest” under Rule 5121 (“Rule 5121”) of the Financial Industry Regulatory Authority, Inc. Additionally, affiliates of Blackstone Advisory Partners L.P. will receive in excess of 5% of offering proceeds in repayment of debt. Accordingly, this offering is being made in compliance with the requirements of Rule 5121. Pursuant to that rule, the appointment of a “qualified independent underwriter” is not required in connection with this offering as the members primarily responsible for managing the public offering do not have a conflict of interest, are not affiliates of any member that has a conflict of interest and meet the requirements of paragraph (c)(12)(E) of Rule 5121. Blackstone Advisory Partners L.P. will not confirm sales of the securities to any account over which it exercises discretionary authority without the specific written approval of the account holder. See “Underwriting (Conflicts of Interest).” No single entity or individual affiliated with Blackstone Advisory Partners L.P. owns, directly or indirectly, actually or constructively (by virtue of certain attribution provisions of the Code) 9.8% or more of the Company’s or ESH REIT’s issued and outstanding stock.

 

Risk factors

See “Risk Factors” for a discussion of factors that you should carefully consider before deciding to invest in Shares.

The number of Shares to be outstanding after the offering assumes no exercise of the underwriters’ option to purchase up to an additional 4,237,500 Shares from us solely to cover over-allotments.

 

 

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SUMMARY HISTORICAL AND UNAUDITED PRO FORMA CONSOLIDATED AND COMBINED FINANCIAL AND OTHER DATA

The following table sets forth summary financial and operating data on a historical basis for Extended Stay and on a pro forma basis after giving effect to the Pre-IPO Transactions and the application of the net proceeds of this offering.

The summary historical consolidated and combined financial data for the years ended December 31, 2012 and 2011 and for the period from October 8, 2010 through December 31, 2010 and as of December 31, 2012 and 2011 have been derived from the audited consolidated and combined financial statements of the Successor included elsewhere in this prospectus. The consolidated and combined balance sheet as of December 31, 2010 has been derived from the consolidated and combined financial statements of the Successor not included elsewhere in this prospectus. The summary historical financial data for the period from January 1, 2010 through October 7, 2010 has been derived from the audited consolidated financial statements of the Predecessor included elsewhere in this prospectus. The summary historical consolidated and combined financial data for the six months ended June 30, 2013 and 2012 and as of June 30, 2013 have been derived from the unaudited condensed consolidated and combined financial statements of the Successor included elsewhere in this prospectus. The unaudited condensed consolidated and combined financial statements have been prepared on the same basis as the audited consolidated and combined financial statements, and in the opinion of our management, reflect all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results for those periods. The results for any interim period are not necessarily indicative of the results that may be expected for a full year. The following information should be read in conjunction with, and is qualified by reference to, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical audited and unaudited financial statements and related notes and other financial information included herein.

The summary unaudited pro forma condensed consolidated financial data for the year ended December 31, 2012 and for the six months ended June 30, 2013 and as of June 30, 2013 is derived from our unaudited pro forma condensed consolidated financial statements included elsewhere in this prospectus and is presented as if this offering and the Pre-IPO Transactions all had occurred on June 30, 2013 for the purposes of the unaudited pro forma condensed consolidated balance sheet and on January 1, 2012 for the purposes of the unaudited pro forma condensed statements of operations. The summary unaudited pro forma condensed consolidated financial data presented below is that of the Company and its consolidated subsidiaries, including ESH REIT, after giving effect to the Pre-IPO Transactions and the application of the net proceeds of this offering, and therefore the summary unaudited pro forma condensed consolidated financial data is comparable to the financial data of the Successor and not ESH REIT on a standalone basis. The summary unaudited pro forma condensed consolidated financial data is not necessarily indicative of the actual financial position of the Company as of June 30, 2013 or what the actual results of operations of the Company would have been assuming this offering and our Pre-IPO Transactions had been completed on the first day of the periods presented, nor for the periods presented is it indicative of the results of operations of future periods. See “Unaudited Pro Forma Condensed Consolidated Financial Statements of the Company” for a complete description of the adjustments and assumptions underlying the summary unaudited pro forma condensed consolidated financial data.

On October 8, 2010, the Successor acquired substantially all of the businesses, assets and operations of the Predecessor that were auctioned off by the former debtors of the Predecessor, which was in Chapter 11 reorganization. ESH REIT and ESH Strategies are the “Successor” to the Predecessor by virtue of the fact that they succeeded to principally all of the assets and operations of the Predecessor. As a result, the historical consolidated and combined financial results of ESH REIT and ESH Strategies are presented alongside those of the Predecessor herein. The acquisition was accounted for as a business combination in accordance with FASB ASC 805, “Business Combinations.” Certain financial information of the Successor is not comparable to that of

 

 

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the Predecessor. This information includes, but may not be limited to, depreciation and amortization expense, restructuring and acquisition transaction expenses, interest expense, income tax expense and reorganization gain, net.

 

    Extended Stay America, Inc.          Successor          Predecessor  
    Pro Forma          Historical          Historical  

(Dollars in millions, other
than ADR and RevPAR)

  Six
Months
Ended

June 30,
2013
    Year
Ended
December 31,
2012
         Six
Months
Ended

June 30,
2013
    Six
Months
Ended

June 30,
2012
    Year
Ended
December  31,
2012
    Year
Ended
December  31,
2011
    Period
from
October  8,

2010
through
December 31,
2010
         Period
from
January  1,

2010
through

October  7,
2010
 

Statement of operations data:

                       

Room revenues

  $ 541.6      $ 984.3          $ 541.6      $ 466.5      $ 984.3      $ 913.0      $ 188.7          $ 659.9   

Other hotel revenues

    8.2        16.9            8.2        8.1        16.9        18.7        4.1            13.2   

Management fees, license fees and other revenue

    0.6        10.3            0.6        4.9        10.3        11.0        2.6            7.5   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Total revenues

    550.4        1,011.5            550.4        479.5        1,011.5        942.7        195.4            680.6   

Total operating expenses

    391.6        727.5            391.6        349.0        727.5        677.3        169.6            759.0   

Income (loss) before reorganization gain (loss) and income taxes

    75.7        63.7            54.0        25.8        26.9        53.7        (23.6         (244.1

Net income (loss)

    54.1        31.7            51.5        22.0        22.3        46.6        (22.1         3,306.8   

Net income (loss) attributable to controlling interests

    47.7        4.1            51.0        22.3        20.7        45.6        (22.5         1,789.6   
   

Other financial data:

                       

Cash flows provided by (used in):

                       

Operating activities

          $ 167.2      $ 88.2      $ 201.1      $ 180.6      $ 15.6          $ 106.6   

Investing activities

            (163.3     (97.3     (223.8     (43.4     (3,920.0         (41.7

Financing activities

            (2.1     (11.9     27.6        (50.1     3,914.5            (1.6

Capital expenditures

            (78.6     (103.2     (271.5     (106.1     (11.6         (38.0

EBITDA(a)

            240.8        191.3        414.5        386.6        53.0            3,644.0   

Adjusted EBITDA(a)

            247.7        203.2        434.3        409.8        74.8            258.1   

Hotel operating profit(b)

            286.7        239.1        507.6        468.3        91.0            321.8   

Hotel operating margin(b)

            52.2     50.4     50.7     50.3     47.2         47.8

Paired Share income(c)

                       

Paired Share income per paired Share(c)

                       
   

Operating data:

                       

Rooms (at period end)

            75,928        73,657        75,928        73,657        73,657            73,657   

Average occupancy rate

            73.8     72.3     73.3     75.1     72.3         75.9

ADR

          $ 53.39      $ 48.19      $ 49.77      $ 45.20      $ 42.10          $ 42.07   

RevPAR

          $ 39.40      $ 34.83      $ 36.46      $ 33.96      $ 30.44          $ 31.93   
                     
    Extended Stay
America, Inc.
               Successor            
    Pro Forma                Historical            

(Dollars in millions)

  June 30,
2013
               June 30,
2013
          December 31,
2012
    December 31,
2011
    December 31,
2010
           

Balance sheet data:(1)

                     

Cash and cash equivalents

  $ 105.0            $ 105.0        $ 103.6      $ 98.6        $     11.4       

Restricted cash

    154.8              154.8          61.6        236.7        253.2       

Property and equipment, net

    4,098.1              4,098.1          4,110.6        3,844.1        3,860.6       

Total assets

    4,568.6              4,566.4          4,491.7        4,357.3        4,351.6       

Mortgage loans payable

    2,520.0              2,525.6          2,525.7        1,980.2        2,004.3       

Mezzanine loans payable

    594.4              1,080.0          1,080.0        700.0        700.0       

Total liabilities

    3,266.7              3,761.4          3,738.9        2,805.9        2,824.1       

Total combined equity

    1,280.6              805.0          752.8        1,551.4        1,527.5       

Total liabilities and combined equity

    4,568.6            $ 4,566.4        $ 4,491.7      $ 4,357.3        $4,351.6       

 

(1) In August 2013, ESH REIT paid a regular REIT distribution with respect to the second quarter of $18.4 million to its current owners. Subsequent to September 30, 2013 and prior to the completion of the Pre-IPO Transactions and this offering, ESH REIT expects to make a regular REIT distribution with respect to the third quarter of approximately $60.0 million to its current owners.

 

(a) EBITDA and Adjusted EBITDA. Earnings before interest expense, income taxes, depreciation and amortization (“EBITDA”) is a commonly used measure in many industries. We adjust EBITDA when evaluating our performance because we believe that the adjustment for certain items, such as restructuring and acquisition transaction expenses, impairment charges related to long-lived assets, bankruptcy-related gains and expenses, non-cash equity-based compensation and other items not indicative of ongoing operating performance, provides useful supplemental information to investors regarding our ongoing operating performance. We believe that EBITDA and Adjusted EBITDA provide useful information to investors regarding our results of operations that help us and our investors evaluate the ongoing operating performance of our hotels and facilitate comparisons between us and other lodging companies, hotel owners and other capital-intensive companies.

 

 

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EBITDA and Adjusted EBITDA, as presented, may not be comparable to measures calculated by other companies. This information should not be considered as an alternative to net income (loss), earnings per share, cash flow from operations or any other operating performance measure calculated in accordance with GAAP. Cash expenditures for various real estate or hotel assets such as capital expenditures, interest expense and other items have been and will continue to be incurred and are not reflected in EBITDA or Adjusted EBITDA. Management compensates for these limitations by separately considering the impact of these excluded items to the extent they are material to operating decisions or assessments of operating performance. Our historical consolidated and combined statements of operations and cash flows include interest expense, capital expenditures and other excluded items, all of which should be considered when evaluating our performance, in addition to our non-GAAP financial measures. Additionally, EBITDA and Adjusted EBITDA should not solely be considered as a measure of our liquidity or indicative of funds available to fund our cash needs, including our ability to pay dividends. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Consolidated and Combined Non-GAAP Financial Measures—EBITDA and Adjusted EBITDA.”

The following table provides a reconciliation of net income (loss) to EBITDA and Adjusted EBITDA for the six months ended June 30, 2013 and the year ended December 31, 2012 on a pro forma basis, and for the six months ended June 30, 2013 and 2012, the years ended December 31, 2012 and 2011, the period from October 8, 2010 through December 31, 2010 and the period from January 1, 2010 through October 7, 2010 (in millions):

 

    Extended Stay America, Inc.          Successor          Predecessor  
    Pro Forma          Historical          Historical  
    Six Months
Ended
June 30,
2013
    Year
Ended
December 31,
2012
         Six
Months
Ended
June 30,
2013
    Six
Months
Ended
June 30,
2012
    Year
Ended
December 31,
2012
    Year
Ended
December 31,
2011
    Period from
October 8,
2010

through
December 31,
2010
         Period from
January  1,
2010

through
October 7,
2010
 

Net income (loss)

  $ 54.1      $ 31.7          $ 51.5      $ 22.0      $ 22.3      $ 46.6      $ (22.1       $ 3,306.8   

Interest expense

    83.2        220.9            104.9        105.6        257.7        212.5        49.6            167.0   

Income tax expense (benefit)

    21.6        32.0            2.5        3.8        4.6        7.1        (1.5         (120.4

Depreciation and amortization

    81.9        129.9            81.9        59.9        129.9        120.4        27.0            290.6   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

EBITDA

    240.8        414.5            240.8        191.3        414.5        386.6        53.0            3,644.0   

Restructuring expenses

    0.6        5.8            0.6        5.8        5.8        10.5        —              —     

Acquisition transaction expenses

    0.1        1.7            0.1        —          1.7        0.6        21.5            —     

Impairment of long-lived assets

    1.4        1.4            1.4        —          1.4        —          —              44.6   

Bankruptcy-related (gain) expense, net

    —          —              —          —          —          —          —              (3,430.5

Non-cash equity-based compensation

    2.7        4.4            2.7        1.6        4.4        4.7        0.3            —     

Other expenses

    2.1 (1)      6.5 (3)          2.1 (1)      4.5 (2)      6.5 (3)      7.4 (4)      —              —     
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Adjusted EBITDA

  $ 247.7      $ 434.3          $ 247.7      $ 203.2      $ 434.3      $ 409.8      $ 74.8          $ 258.1   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

 

(1) For the six months ended June 30, 2013, includes costs related to preparations for our initial public offering, consisting primarily of the Pre-IPO Transactions, of $2.1 million.
(2) For the six months ended June 30, 2012, includes costs related to preparations for our initial public offering, consisting primarily of the Pre-IPO Transactions, of $0.5 million and consulting fees related to implementation of our new strategic initiatives, including services related to pricing and yield management policy, of $4.0 million.
(3) For the year ended December 31, 2012, includes costs related to preparations for our initial public offering, consisting primarily of the Pre-IPO Transactions, of $1.6 million and consulting fees related to implementation of our new strategic initiatives, including services related to pricing and yield management policy, of $4.9 million.
(4) For the year ended December 31, 2011, includes consulting fees related to implementation of our new strategic initiatives, including services related to pricing and yield management policy, of $7.4 million.

 

(b) Hotel Operating Profit and Hotel Operating Margin. Hotel operating profit and hotel operating margin measure owned hotel-level operating results prior to debt service, depreciation and amortization and general and administrative expenses and are supplemental measures of aggregate hotel-level profitability. Both measures are used by us to evaluate the operating profitability of our hotels. We define hotel operating profit as the sum of room and other hotel revenues less hotel operating expenses and hotel operating margin as the ratio of hotel operating profit divided by the sum of room and other hotel revenues. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Consolidated and Combined Non-GAAP Financial Measures—Hotel Operating Profit and Hotel Operating Margin.”

 

 

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The following table provides a reconciliation of our room revenues, other hotel revenues and hotel operating expenses to hotel operating profit and hotel operating margin for the six months ended June 30, 2013 and the year ended December 31, 2012 on a pro forma basis, and for the six months ended June 30, 2013 and 2012, the years ended December 31, 2012 and 2011, the period from October 8, 2010 through December 31, 2010 and the period from January 1, 2010 through October 7, 2010 (in millions):

 

    Extended Stay America, Inc.          Successor          Predecessor  
    Pro Forma          Historical          Historical  
    Six Months
Ended
June 30,
2013
    Year
Ended
December  31,
2012
         Six
Months
Ended
June 30,
2013
    Six
Months
Ended
June 30,
2012
    Year
Ended
December  31,
2012
    Year
Ended
December  31,
2011
    Period
from
October  8,
2010

through
December 31,
2010
         Period
from
January 1,
2010
through
October 7,
2010
 

Room revenues

  $ 541.6      $ 984.3          $ 541.6      $ 466.5      $ 984.3      $ 913.0      $  188.7          $   659.9   

Other hotel revenues

    8.2        16.9            8.2        8.1        16.9        18.7        4.1            13.2   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Total hotel revenues

    549.8        1,001.2            549.8        474.6        1,001.2        931.7        192.8            673.1   

Hotel operating expenses

    263.1        493.6            263.1        235.5        493.6        463.4        101.8            351.3   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Hotel operating profit

  $ 286.7      $ 507.6          $   286.7      $   239.1      $ 507.6      $   468.3      $ 91.0          $ 321.8   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Hotel operating margin

    52.2     50.7         52.2     50.4     50.7     50.3     47.2         47.8
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

 

(c) Paired Share Income and Paired Share Income per Paired Share. We present paired Share income and paired Share income per paired Share as supplemental measures of the Company’s operating performance in our periodic reports. We believe that paired Share income and paired Share income per paired Share are useful measures for investors since our paired Shares, directly through the common stock of the Company and Class B common stock of ESH REIT and indirectly through the Company’s ownership of the Class A common stock of ESH REIT, entitle holders of the paired Shares to participate in 100% of the common equity and earnings of both the Company and ESH REIT. As required by GAAP, the Company’s net income attributable to common shareholders excludes earnings attributable to ESH REIT’s Class B common shares, a noncontrolling interest. Based on the limitation on transfer provided for in each of the Company’s and ESH REIT’s charters, shares of common stock of the Company and shares of Class B common stock of ESH REIT will be transferrable and tradeable only in combination as units, each unit consisting of one share of the Company’s common stock and one share of ESH REIT Class B common stock. As a result, we believe that paired Share income and paired Share income per paired Share represent useful measures to holders of the paired Shares.

We define paired Share income as the sum of net income attributable to common shareholders of the Company and the noncontrolling interests of the Company attributable to the Class B common shares of ESH REIT. We define paired Share income per paired Share as paired Share income divided by the number of paired Shares outstanding on a basic and diluted basis. Until such time as the number of outstanding common shares of the Company and Class B common shares of ESH REIT differ, which we currently do not expect, we believe paired Share income per paired Share is useful to investors as it represents the economic risks and rewards related to an investment in the paired Shares. We also believe that paired Share income and paired Share income per paired Share provide meaningful indicators of the Company’s operating performance in addition to separate or individual analyses of net income attributable to common shareholders of the Company and net income attributable to Class B common shareholders of ESH REIT, each of which may be impacted by specific GAAP requirements, including the recognition of contingent rental revenue related to leases, which generally results in lower rental revenue at ESH REIT compared to total cash received for the first three fiscal quarters of the year, and may not necessarily reflect how cash flows are generated on an individual entity basis during such periods.

 

 

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Paired Share income and paired Share income per paired Share should not be considered as an alternative to net income of the Company, net income of ESH REIT, earnings per share of the common stock of the Company, earnings per share of the Class A or Class B common stock of ESH REIT, or any other operating measure calculated in accordance with GAAP. The following table provides a reconciliation of net income attributable to common shareholders of the Company to paired Share income and a calculation of paired Share income per paired Share for the six months ended June 30, 2013 and the year ended December 31, 2012 on a pro forma basis:

 

     Extended Stay America, Inc.  
     Pro Forma(3)  
     Six Months Ended
June 30, 2013
     Year Ended
December 31,  2012
 
     (in thousands, except per share amounts)  

Net income attributable to common shareholders of the Company

   $ 47,680       $ 4,110   

Noncontrolling interests attributable to Class B common shares of ESH REIT(1)

     5,528         25,888   
  

 

 

    

 

 

 

Paired Share income

   $ 53,208       $ 29,998   
  

 

 

    

 

 

 

Paired Share income per paired Share basic(2)

   $ 0.27       $ 0.15   
  

 

 

    

 

 

 

Paired Share income per paired Share diluted(2)

   $ 0.27       $ 0.15   
  

 

 

    

 

 

 

Pro forma weighted average paired Shares(2)
outstanding-basic

     198,630         197,993   
  

 

 

    

 

 

 

Pro forma weighted average paired Shares(2)
outstanding-diluted

     200,096         199,888   
  

 

 

    

 

 

 

 

(1)

Noncontrolling interests attributable to Class B common shares of ESH REIT is calculated by multiplying ESH REIT’s net income attributable to controlling interests by 45%, the Class B common shares’ ownership of ESH REIT. See “Unaudited Pro Forma Condensed Consolidated Financial Statements of ESH REIT.”

(2) 

One paired Share consists of one share of common stock of the Company and one share of Class B common stock of ESH REIT, which are attached and traded together until the limitation on transfer provided for in Article VI of each of the Company’s and ESH REIT’s charter is terminated. See “Description of Our Capital Stock—Pairing Arrangement.”

(3)

See “Unaudited Pro Forma Condensed Consolidated Financial Statements of the Company.”

 

 

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RISK FACTORS

An investment in the Shares involves a high degree of risk. You should carefully consider the following risks as well as the other information included in this prospectus, including under “Unaudited Pro Forma Condensed Consolidated Financial Statements of the Company,” “Unaudited Pro Forma Condensed Consolidated Financial Statements of ESH REIT,” “Selected Historical Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated and combined financial statements, as applicable, and related notes included elsewhere in this prospectus, before investing in the Shares. Any of the following risks could materially and adversely affect our business, financial condition or results of operations and our ability to pay dividends to our stockholders. In such a case the trading price of the Shares could decline, and you may lose all or part of your investment in us.

Risks Related to the Lodging Industry

We operate in a highly competitive industry.

The lodging industry is highly competitive. We compete with traditional hotels and lodging facilities (including limited service hotels), other purpose built extended stay hotels (including those owned and operated by major hospitality chains with well-established and recognized brands and individually-owned extended stay hotels) and alternative lodging (including serviced apartments). We expect that competition within the mid-price and economy segments of the extended stay lodging market will continue as we face increased competition from third-party internet travel intermediaries, such as Priceline.com, Expedia.com and Travelocity.com, and specialized intermediaries that locate and reserve hotel rooms for corporate lodgers. We compete based on a number of factors, including room rates, quality of accommodations, service levels, convenience of location, reputation, reservation systems, brand recognition and supply and availability of alternative lodging. See “Business—Competition.” To maintain our rates, we may face pressure to offer increased services and amenities at our hotel properties, comparable to those offered at traditional hotels, which could increase our operating costs and reduce our profitability. We do not expect to increase our rates to match our competitors, and a number of our competitors have a significant number of individuals participating in their guest loyalty programs, which may enable them to attract more customers and more effectively retain such customers. Our competitors may also have greater financial and marketing resources than we do, which could allow them to reduce their rates, offer greater convenience, services or amenities, build new hotels in direct competition with our existing hotels, improve their properties, expand and improve their marketing efforts, all of which could have a material adverse effect on our business, financial condition and results of operations.

The lodging industry, including the extended stay segment, is cyclical and a worsening of general economic conditions or low levels of economic growth could materially adversely affect our business, financial condition, results of operations and our ability to pay dividends to our stockholders.

The performance of the lodging industry, including the extended stay segment, is closely linked to the performance of the general economy and is sensitive to business and personal discretionary spending levels. Declines in corporate budgets and spending and consumer demand due to adverse general economic conditions, risks affecting or reducing travel patterns, lower consumer confidence and high unemployment or adverse political conditions can lower the revenues and profitability of our hotels.

Changes in consumer demand and general business cycles can subject, and have subjected, our revenues to significant volatility. The majority of our expenses are relatively fixed. These fixed expenses include labor costs, interest, rent, property taxes, insurance and utilities, all of which may increase at a greater rate than our revenues. The expenses of owning and operating hotels are not significantly reduced when circumstances such as market and economic factors and competition cause a reduction in revenues. Where cost-cutting efforts are insufficient to offset declines in revenues, we could experience a material decline in margins and reduced cash flows or losses. If we are unable to decrease our expenses significantly or rapidly when demand for our hotels decreases,

 

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the decline in our revenues could have a materially adverse effect on our net cash flows and profitability. This effect can be especially pronounced during periods of economic contraction or slow economic growth, such as the recent economic recession.

In addition to general economic conditions, new hotel room supply is an important factor that can affect the lodging industry’s performance and overbuilding has the potential to further exacerbate the negative effect of an economic downturn or precipitate a cycle turn. Room rates and occupancy, and thus RevPAR, tend to increase when demand growth exceeds supply growth. Decline in hotel room demand, or a continued growth in hotel room supply, could result in revenues that are substantially below expectations or result in losses, which could have a material adverse effect on our business, financial condition, results of operations and our ability to pay dividends to our stockholders. See “Our Industry” for a description of increases in hotel room supply.

The extended stay segment has tended to follow the overall cyclicality of the lodging industry. In periods of declining demand, competition for guests may result in more reliance on longer-term guests, who generally pay lower rates than shorter-term guests, which could reduce revenues and margins. Equally, in periods of increasing demand, a transition to shorter-term guests paying higher rates might result in increased hotel expenses for amenities considered necessary to attract those guests, such as daily rather than weekly housekeeping, potentially reducing margins.

Uncertainty regarding the rate and pace of recovery from the recent economic downturn and the impact any such recovery may have on the lodging industry makes it difficult to predict future profitability levels. A slowing of the current economic recovery or new economic weakness could materially adversely affect our revenues and profitability.

We are subject to the operating risks common to the lodging industry.

Changes in general and local economic and market conditions and other factors beyond our control as well as the business, financial, operating and other risks common to the lodging industry and inherent to the ownership of hotels could materially adversely affect demand for lodging products and services. This includes demand for rooms at hotel properties that we own, operate or acquire. These factors include:

 

   

changes in the relative mix of extended stay brands in various industry price categories;

 

   

over-building of hotels in our markets;

 

   

changes in the desirability of particular geographic locations, lodging preferences and travel patterns of customers;

 

   

dependence on corporate and commercial travelers and on tourism;

 

   

decreased corporate budgets and spending and cancellations, deferrals or renegotiations of group business;

 

   

high levels of unemployment and depressed housing prices;

 

   

increases in operating costs due to inflation and other factors that may not be offset by increased room rates;

 

   

increases in the cost, or the lack of availability, of capital to operate, maintain and renovate our hotel properties;

 

   

potential increases in labor costs, including as a result of increases to federal and state minimum wage levels, unionization of the labor force and increasing health care insurance expense;

 

   

changes in taxes and governmental regulations that influence or set wages, prices, interest rates or construction and maintenance procedures and costs;

 

   

the costs and administrative burdens associated with compliance with applicable laws and regulations; and

 

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events beyond our control that may disproportionately affect the travel industry, such as war, terrorist attacks, travel-related health concerns, transportation and fuel prices, interruptions in transportation systems, travel-related accidents, fires, natural disasters and severe weather.

These factors can adversely affect, and from time to time have materially adversely affected, individual hotel properties, particular regions or business as a whole. How we manage any one or more of these factors, or any crisis, could limit or reduce demand and the rates we are able to charge for rooms or services, which could materially adversely affect our operating results and growth. These factors may be exacerbated by the relatively illiquid nature of our real estate holdings, which will limit our ability to vary our portfolio in response to changes in economic and other conditions.

Our revenues are subject to seasonal fluctuations.

The lodging industry is seasonal in nature. Our occupancy rates and revenues generally are lower than average during the first and fourth quarter of each calendar year. Quarterly variations in revenues at our hotel properties could materially adversely affect our near-term operating revenues and cash flows, which in turn could have a material adverse effect on our business, financial condition and results of operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Seasonality.”

Risks Related to Our Business

If we fail to implement our business strategies, our business, financial condition and results of operations could be materially adversely affected.

Our financial performance and success depend in large part on our ability to successfully implement our business strategies. See “Business—Our Business Strategy.” We cannot assure you that we will be able to successfully implement our business strategies, realize any benefit from our strategies or be able to continue improving our results of operations. We may spend significant amounts in connection with our business strategies, which would result in increased costs but may not result in increased revenues or improved results of operations.

Implementation of our business strategies could be affected by a number of factors beyond our control, such as increased competition, legal and regulatory developments, general economic conditions or an increase in operating costs. Any failure to successfully implement our business strategies could materially adversely affect our business, financial condition and results of operations. We may, in addition, decide to alter or discontinue certain aspects of our business strategies at any time.

Our capital expenditures may not result in our expected improvements in our business.

We expect to spend more than $625 million of capital from the Acquisition Date through the end of the first quarter of 2014. The capital investments include our hotel reinvestment program of approximately $383.3 million of which $262.6 million has been spent as of June 30, 2013. This program is dedicated to our Platinum renovation and Silver refresh programs. During this period we will also spend $171.2 million on maintenance capital expenditures, of which $122.2 million has been spent as of June 30, 2013. Additionally, we will spend $71.9 million on capital expenditures to address deferred maintenance that existed prior to the Acquisition Date, of which $70.3 million has been spent as of June 30, 2013. As of June 30, 2013, we have spent approximately $455.1 million on these initiatives. In addition to the $120.7 million expected costs remaining for our current hotel renovations and room refreshes, we expect to spend in excess of an additional $100 million on further renovation phases during 2014 and 2015. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Expenditures.” The realization of returns on our investments in line with our expectations is dependent on a number of factors, including, but not limited to, general economic conditions, events beyond our control, whether our assumptions in making the investment were correct and changes in the factors underlying our investment decision, such as changes in the tastes and preferences of our customers. We can provide no assurance that we will continue to see returns on our previous capital expenditure investments,

 

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that we will realize our expected returns on our current investments, or any returns at all, or that our future investments will result in our expected returns on investments, returns that are consistent with our prior returns on capital expenditure investments, or any returns at all. Growth that we do realize as a result of our capital expenditures is expected to stabilize over time. A failure to realize our expected returns on our investments in our hotel properties could materially adversely affect our business, financial condition and results of operations.

Access to capital, timing, budgeting and other risks associated with the ongoing need for capital expenditures at our hotel properties could materially adversely affect our financial condition and limit our ability to compete effectively and pay dividends to our stockholders.

The lodging industry is a capital intensive business that requires significant capital expenditures to own and operate hotel properties. In addition, we must maintain, renovate and improve our hotel properties, and we are currently in the process of performing significant renovations to the majority of our hotel properties in order to remain competitive, maintain the value and brand standards of our hotel properties and comply with applicable laws and regulations. This creates an ongoing need for cash and, to the extent we cannot fund expenditures from cash generated by operations, funds must be borrowed or otherwise obtained. We also intend to pay regular dividends, which means we may not retain cash for future capital expenditures. Access to the capital that we need to renovate and maintain our existing hotel properties and to acquire new hotel properties is critical to the continued growth of our business and our revenues. The availability of capital or the conditions under which we can obtain capital can have a significant impact on the overall level, cost and pace of future renovation or development and therefore the ability to grow our revenues. As of June 30, 2013, on a pro forma basis, ESH REIT and its subsidiaries would have had total indebtedness of approximately $3.15 billion. ESH REIT’s substantial indebtedness may impair its ability to borrow additional amounts. Our ability to access additional capital could also be limited by the terms of ESH REIT’s indebtedness and the revolving credit facilities that the Company and ESH REIT expect to enter into concurrently with the consummation of this offering, which restrict or will restrict our ability to incur debt under certain circumstances. In particular, the 2012 Mortgage Loan and the 2012 Mezzanine Loans prohibit any further encumbrances on the collateral securing that indebtedness, which is comprised of substantially all of our hotels. In the past, reduced investments in our properties resulted in declining performance of our business.

Additionally, our ongoing operational requirements and capital expenditures subject us to the following risks:

 

   

potential environmental problems, such as the need to remove or abate asbestos-containing materials;

 

   

design defects, construction cost overruns (including labor and materials) and delays;

 

   

difficulty obtaining zoning, occupancy and other required permits or authorizations;

 

   

the possibility that revenues will be reduced temporarily while rooms offered are out of service due to capital improvement projects; and

 

   

a possible shortage of available cash to fund capital improvements and the related possibility that financing for these capital improvements may not be available on affordable terms or at all.

If the cost of funding renovations or enhancements exceeds budgeted amounts, and/or the time period for renovation is longer than initially anticipated, our profits could be reduced. If we are forced to spend larger amounts of cash from operations than anticipated to operate, maintain or renovate existing hotel properties, then our ability to use cash for other purposes, including paying dividends to our stockholders or the potential acquisition of hotel properties, could be limited and our profits could be reduced. Similarly, if we cannot access the capital we need to fund our operations or implement our business strategies, we may need to postpone or cancel planned maintenance, renovations or improvements plans, which could impair our ability to compete effectively and harm our business, financial condition and results of operations.

 

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We are exposed to the risks resulting from real estate ownership, which could increase our costs, reduce our profitability and limit our ability to respond to market conditions.

Our principal assets consist of real property. Our real estate ownership subjects us to additional risks not applicable to those competitors in the lodging industry that only manage or franchise hotel properties, including:

 

   

the illiquid nature of real estate, which may limit our ability to promptly sell one or more hotels in our portfolio in response to changing financial conditions;

 

   

adverse changes in economic and market conditions;

 

   

real estate, insurance, zoning, tax, environmental and eminent domain laws, including the condemnation of our properties;

 

   

fluctuations in real estate values or potential impairments in the value of our assets;

 

   

the ongoing need for capital improvements and expenditures to maintain, renovate or upgrade hotel properties;

 

   

risks associated with mortgage debt, including the possibility of default, fluctuating interest rate levels and the availability of replacement financing;

 

   

risks associated with the possibility that expense increases will outpace revenue increases and that in the event of an economic downturn, the high proportion of fixed expenses among our costs will make it difficult to reduce our expenses to the extent required to offset declining revenues;

 

   

changes in laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance; and

 

   

events beyond our control, such as war, terrorist attacks and force majeure events, including earthquakes, tornados, hurricanes, fires or floods.

Economic and other conditions may materially adversely affect the valuation of our hotel properties resulting in impairment charges that could have a material adverse effect on our business, results of operations and earnings.

We hold goodwill, intangible assets and a significant amount of long-lived assets. We evaluate our tangible and intangible assets annually for impairment, or more frequently based on various triggers, including when a property has current or projected operating losses or when other material trends, contingencies or changes in circumstances indicate that a triggering event has occurred, such that an asset’s value may not be recoverable. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates.” During times of economic distress, declining demand and declining earnings often result in declining asset values. As a result, we have incurred and we may in the future incur impairment charges, which in the future could be material and adversely affect our results of operations and earnings.

ESH REIT has a significant amount of debt and the agreements governing its indebtedness place, and any future indebtedness of the Company or ESH REIT may place, restrictions on the Company, ESH REIT and their subsidiaries, reducing operational flexibility and creating default risks.

ESH REIT has a significant amount of debt. As of June 30, 2013, on a pro forma basis, ESH REIT and its subsidiaries would have had total indebtedness of approximately $3.15 billion and a debt-to-equity ratio of 2.6x. In the future, the Company or ESH REIT may incur additional indebtedness, including under the revolving credit facilities that the Company and ESH REIT expect to enter into concurrently with the consummation of this offering and intercompany indebtedness, to finance future hotel acquisitions, renovation and improvement activities and for other corporate purposes. A substantial level of indebtedness could have an adverse effect on our business, results of operations and financial condition because it could, among other things:

 

   

require us to dedicate a substantial portion of our cash flows to make principal and interest payments on indebtedness, thereby reducing our cash flows available to fund working capital, capital expenditures and other general corporate purposes, including our ability to pay cash dividends to our stockholders;

 

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increase our vulnerability to general adverse economic and industry conditions and limit our flexibility in planning for, or reacting to, changes in our business and our industry;

 

   

limit our ability to borrow additional funds or refinance indebtedness on favorable terms or at all to expand our business or ease liquidity constraints; and

 

   

place us at a competitive disadvantage relative to competitors that have less indebtedness or greater resources.

We cannot assure you that our business will generate sufficient cash flows to enable us to pay ESH REIT’s indebtedness, fund our other liquidity needs or pay dividends to our stockholders. If ESH REIT is unable to meet its debt service obligations, the 2012 Mortgage Loan and the 2012 Mezzanine Loans (each as defined below) will prevent ESH REIT from paying cash dividends with respect to its stock. In such case, in order to satisfy the REIT distribution requirements imposed by the Code, ESH REIT may distribute taxable stock dividends to its stockholders in the form of additional shares of its stock.

If we fail to generate sufficient cash flows to meet ESH REIT’s debt service obligations, we expect that ESH REIT will need to refinance all or a portion of its debt on or before maturity. We cannot assure you that ESH REIT will be able to refinance any of its debt on attractive terms on or before maturity, commercially reasonable terms or at all, particularly because of its increased levels of debt and because of restrictions on debt prepayment and additional debt incurrence contained in the agreements governing ESH REIT’s existing debt. Our future results of operations and ESH REIT’s ability to service, extend or refinance its indebtedness will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control.

In addition, the agreements governing ESH REIT’s indebtedness contain, and the agreements that will govern the Company revolving credit facility and ESH REIT revolving credit facility will contain, covenants that place restrictions on the Company, ESH REIT and their respective subsidiaries. These covenants may restrict, among other activities, the Company’s, ESH REIT’s and their respective subsidiaries’ ability to:

 

   

merge, consolidate or transfer all or substantially all of the Company’s, ESH REIT’s or their respective subsidiaries’ assets;

 

   

sell, transfer, pledge or encumber the Company’s or ESH REIT’s stock or the ownership interests of their respective subsidiaries;

 

   

incur additional debt;

 

   

enter into, terminate or modify leases for our hotel properties;

 

   

make certain expenditures, including capital expenditures;

 

   

pay dividends on or repurchase the Company’s or ESH REIT’s capital stock; and

 

   

enter into certain transactions with affiliates.

In addition, the occurrence of (i) an event of default under any of the 2012 Mortgage Loan or the 2012 Mezzanine Loans, (ii) a debt yield trigger event (a Debt Yield (as defined in the 2012 Mortgage Loan) of less than 9.0%) or (iii) a guarantor bankruptcy event would result in a Cash Trap Event (as defined in the 2012 Mortgage Loan). During the period of a Cash Trap Event, any excess cash flow, after all monthly requirements are fully funded (including the payment of budgeted management fees and operating expenses), would be held by the loan service agent as additional collateral for the 2012 Mortgage Loan, which would prevent ESH REIT from making cash dividends. As of June 30, 2013, our Debt Yield was 12.9% and a Cash Trap Event was not in effect.

The occurrence of a debt yield “Trigger Event” (a Debt Yield (as defined in the Company revolving credit facility) of less than 11.50%, increasing to 12.00% after the first anniversary of entering into Company revolving credit facility, as of the last day of any calendar month), a Default or an Event of Default (each as defined in the Company revolving credit facility) would require the Company to prepay advances existing under the Company

 

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revolving credit facility and cash collateralize outstanding letters of credit. The Company may cure a trigger event by (a) repaying advances and cash collateralizing outstanding letters of credit and (b) maintaining the threshold Debt Yield level for three consecutive months following the month in which the trigger event occurred. During a Trigger Event a Default or an Event of Default, the Company will be restricted from making cash dividends.

The occurrence of a debt yield “Trigger Event” (a Debt Yield (as defined in the ESH REIT revolving credit facility) of less than 11.00%, increasing to 11.50% after the first anniversary of entering into ESH REIT revolving credit facility, as of the last day of any calendar month), a Default or an Event of Default (each as defined in the ESH REIT revolving credit facility) would require ESH REIT to prepay advances existing under ESH REIT revolving credit facility and cash collateralize outstanding letters of credit. ESH REIT may cure a trigger event by (a) repaying advances and cash collateralizing outstanding letters of credit and (b) maintaining the threshold Debt Yield level for three consecutive months following the month in which the trigger event occurred. During a Trigger Event a Default or an Event of Default, ESH REIT will be restricted from making cash dividends (subject to certain exceptions to be agreed).

These covenants could impair our ability to grow our business, take advantage of attractive business opportunities or successfully compete. For a description of the covenants imposed by the agreements governing ESH REIT’s indebtedness, see “Description of Certain Indebtedness.” ESH REIT’s ability to comply with the financial and other restrictive covenants may be affected by events beyond its control, including general economic, financial and industry conditions. A breach of any of the covenants under any of the agreements governing ESH REIT’s indebtedness could result in an event of default. Cross-default provisions in the debt agreements could cause an event of default under one debt agreement to trigger an event of default under other debt agreements. Upon the occurrence of an event of default under any of ESH REIT’s debt agreements, the lenders could elect to declare all outstanding debt under such agreements to be immediately due and payable. If ESH REIT was unable to repay or refinance the accelerated debt, the lenders could proceed against any assets pledged to secure that debt, which could include the foreclosure on some or all of the hotel properties securing such indebtedness. Furthermore, the agreements governing any future indebtedness of the Company or ESH REIT will likely contain covenants that place restrictions on the Company, ESH REIT and their subsidiaries. See “Description of Certain Indebtedness.”

Mortgage and mezzanine debt obligations expose us to the possibility of foreclosure, which could result in the loss of any hotel property subject to mortgage or mezzanine debt.

The 2012 Mortgage Loan (as defined below) is secured by mortgages on 680 of our 682 owned hotel properties and related assets. Another mortgage loan is secured by two of our hotel properties and related assets and several mezzanine loans are secured by pledges of direct and indirect equity in the 2012 Mortgage Loan obligors. Incurring mortgage and other secured debt obligations increases our risk of property losses because defaults on secured indebtedness may result in foreclosure actions initiated by lenders and ultimately our loss of the hotel properties or other properties securing such loans. If ESH REIT were in default under a mortgage loan or mezzanine loan, we could lose some or all of the hotel properties securing, directly or indirectly, such loan to foreclosure. For tax purposes, a foreclosure of our hotel properties would be treated as a sale of the hotel for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the hotel, it would recognize taxable income on foreclosure, but would not receive any cash proceeds, which could hinder ESH REIT’s ability to meet the REIT distribution requirements imposed by the Code. ESH REIT may assume or incur new mortgage indebtedness on hotel properties that it acquires in the future. Any default under any one of ESH REIT’s mortgage debt obligations may increase its risk of default on its other indebtedness.

 

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Our business depends on the quality and reputation of our brands, and any deterioration in the quality or reputation of our brands or the lodging industry could materially adversely affect our market share, reputation, business, financial condition and results of operations.

Our brands and our reputation are among our most important assets. We have consolidated the substantial majority of our hotels under the Extended Stay America brand. Our ability to attract and retain guests depends, in part, upon the external perceptions of Extended Stay America and Crossland Economy Studios, the quality of our hotels and services and our corporate and management integrity. An incident involving the potential safety or security of our guests or employees, or negative publicity regarding safety or security at our competitors’ properties or in respect of our third-party vendors and the industry, and any media coverage resulting therefrom, may harm our brands and our reputation, cause a loss of consumer confidence in Extended Stay America and the industry, and materially adversely affect our results of operations. The considerable expansion in the use of social media and online review sites over recent years has compounded the potential scope and speed of any negative publicity that could be generated by such incidents. Adverse incidents have occurred in the past and may occur in the future.

In addition, we believe that the Company’s trademarks and other intellectual property are fundamental to the reputation of our brands. The Company develops, maintains, licenses and polices a substantial portfolio of trademarks and other intellectual property rights. To the extent necessary, the Company enforces its intellectual property rights to protect the value of its trademarks, our development activities, to protect our good name, to promote its brand name recognition, to enhance our competitiveness and to otherwise support our business goals and objectives. The Company relies on trademark laws to protect its proprietary rights. Monitoring for unauthorized use of the Company’s intellectual property is difficult. Litigation may be necessary to enforce the Company’s intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources, may result in counterclaims or other claims against the Company and could significantly harm our results of operations. From time to time, the Company applies to have certain trademarks registered. There is no guarantee that such trademark registrations will be granted. We cannot assure you that all of the steps the Company has taken to protect its trademarks will be adequate to prevent imitation of its trademarks by others. The unauthorized reproduction of the Company’s trademarks could diminish the value of our brands and its market acceptance, competitive advantages or goodwill, which could materially adversely affect our business and financial condition.

We could incur significant costs related to government regulation and litigation over environmental, health and safety matters.

Our hotel properties are subject to various federal, state and local environmental laws that impose liability for contamination. Under these laws, governmental entities have the authority to require us, as the current or former owner of the property, to perform or pay for the clean-up of contamination (including hazardous substances, waste or petroleum products) at or emanating from the property and to pay for natural resource damage arising from contamination. These laws often impose liability without regard to whether the owner or operator knew of or caused the contamination. Such liability can be joint and several, so that each covered person can be responsible for all of the costs involved, even if more than one person may have been responsible for the contamination. We can also be liable to private parties for costs of remediation, personal injury and death and/or property damage resulting from contamination at or emanating from our hotel properties. Moreover, environmental contamination can affect the value of a property and, therefore, an owner’s ability to borrow funds using the property as collateral or to sell the property on favorable terms or at all. Furthermore, persons who sent waste to a waste disposal facility, such as a landfill or an incinerator, may be liable for costs associated with cleanup of that facility.

In addition, our hotels (including our real property, operations and equipment) are subject to various federal, state and local environmental, health and safety regulatory requirements that address a wide variety of issues, including, but not limited to, the use, management and disposal of hazardous substances and wastes, air emissions, discharges of waste materials (such as refuge or sewage), the registration, maintenance and operation of our boilers and storage tanks, asbestos and lead-based paint. Some of our hotels also routinely handle and use hazardous or regulated substances and wastes as part of their operations, which are subject to regulation (for example, swimming

 

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pool chemicals or biological waste). Our hotels incur costs to comply with these environmental, health and safety laws and regulations and if these regulatory requirements are not met or become more stringent in the future or unforeseen events result in the discharge of dangerous or toxic substances at our hotel properties, we could be subject to increased costs of compliance, fines and penalties for non-compliance and material liability from third parties for harm to the environment, damage to real property or personal injury and death.

In particular, certain hotels we currently own or those we acquire in the future contain, may contain, or may have contained, asbestos-containing material (“ACM”). Environmental, health and safety laws require that ACM be properly managed and maintained, and include requirements to undertake special precautions, such as removal or abatement, if ACM would be disturbed during maintenance, renovation or demolition of a building. These laws regarding ACM may impose fines and penalties on building owners, employers and operators for failure to comply with these requirements or expose us to third-party liability.

We may be liable for indemnification or similar payments relating to our Predecessor in accordance with the Fifth Amended Plan of Reorganization (the “Plan”), the bankruptcy court’s order confirming the Plan (the “Confirmation Order”), and under certain agreements providing for indemnification in connection with our Predecessor.

We may be liable for indemnification or similar payments relating to our Predecessor. Under its constitutive documents, other agreements or applicable law, our Predecessor had obligations to defend, indemnify, reimburse, exculpate, advance fees and expenses, or limit the liabilities of certain officers and employees for certain matters relating to our Predecessor (the “Predecessor Indemnification Obligations”). Under the Plan and the Confirmation Order, we retained Predecessor Indemnification Obligations to those officers and employees who were officers and employees both prior to and after the effective date of the Plan. We may, therefore, face liabilities with respect to such Predecessor Indemnification Obligations. In addition, we may face liabilities arising from a separate agreement providing for Predecessor Indemnification Obligations to a former officer. Currently, certain claims remain outstanding against several of our former officers and employees in litigation brought on behalf of the Litigation Trust, which could trigger our Predecessor Indemnification Obligations, and new claims may arise in the future against those we have agreed to indemnify. While we believe the likelihood that we will be required to fund any material Predecessor Indemnification Obligations is remote and we are unable to quantify the potential exposure for which we may have to provide indemnification in the future, to the extent that we are required to fund any Predecessor Indemnification Obligations, our results of operations and our liquidity and capital resources could be materially and adversely affected.

The geographic concentration of our portfolio may make us particularly susceptible to adverse economic developments in those geographic areas in which we operate a substantial portion of our hotels.

The concentration of our hotel properties in a particular geographic area may materially impact our operating results if that area is impacted by negative economic developments. As of June 30, 2013, 13.5% of our rooms were in California, 10.3% of our rooms were in Texas, 7.9% of our rooms were in Florida and 5.2% of our rooms were in Illinois. We are particularly susceptible to adverse economic or other conditions in these markets (such as periods of economic slowdown or recession, business layoffs or downsizing, industry slowdowns, relocations of businesses, increases in real estate and other taxes and the cost of complying with governmental regulations or increased regulation), as well as to natural disasters or terrorist events that occur in these markets. Our business, financial condition and results of operations would be materially adversely affected by any significant adverse developments in any of those markets. Our operations may also be materially adversely affected if competing hotels are built in these markets. Furthermore, submarkets within any of these markets may be dependent on the economic performance of a limited number of industries which drive those markets.

 

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We may seek to expand through acquisitions of other companies and hotel properties, and we may also seek to diversify through franchising; these activities may be unsuccessful or divert our management’s attention.

We intend to consider strategic and complementary acquisitions of other companies and hotel properties. In many cases, we will be competing for these opportunities with third parties that may have substantially greater financial resources than we do. Acquisitions of companies or hotel properties are subject to risks that could affect our business, including risks related to:

 

   

failing to consummate acquisitions after incurring significant transaction costs;

 

   

issuing shares of stock that could dilute the interests of our existing stockholders;

 

   

spending cash and incurring debt;

 

   

contributing hotel properties or related assets to ventures that could result in recognition of losses;

 

   

assuming unknown and contingent liabilities; or

 

   

creating additional expenses.

We cannot assure you that we will be able to successfully identify opportunities or complete transactions on commercially reasonable terms or at all, or that we will actually realize any anticipated benefits from such acquisitions. There may be high barriers to entry, including restrictive zoning laws, limited availability of hotel properties and higher costs of land, in many key markets and scarcity of available acquisition, development and investment opportunities in desirable locations. Similarly, we cannot assure you that we will be able to obtain financing for acquisitions on attractive terms or at all, or that the ability to obtain financing will not be restricted by the terms of ESH REIT’s indebtedness or any future indebtedness of ESH REIT or the Company. In addition, the pairing arrangement may prevent our use of common tax-free acquisition structures, which may increase the cost and difficulty of acquiring other businesses and hotel properties and inhibit our ability to expand through acquisitions.

The success of any such acquisition will also depend, in part, on our ability to integrate the acquisition with our existing operations. We may experience difficulty with integrating acquired companies, hotel properties or other assets, including difficulties relating to:

 

   

acquiring hotel properties with undisclosed defects in design or construction or requiring unanticipated capital improvements;

 

   

entering new markets;

 

   

coordinating sales, distribution and marketing functions;

 

   

integrating information technology systems; and

 

   

preserving the important licensing, distribution, marketing, customer, labor and other relationships of the acquired assets.

After giving effect to the Pre-IPO Transactions, we will own and operate substantially all of the hotel properties associated with our brands. In the future, we may seek to realize the benefits of franchising and franchise certain of our hotel properties pursuant to agreements with third-party franchisees. We currently do not have experience operating a significant franchising business and expect that the development and implementation of any franchise system will likely require significant capital expenditures and could divert management’s attention from other business concerns, each of which could have a material adverse effect on our business, financial condition and results of operations. The viability of any franchising business will depend on our ability to establish and maintain good relationships with franchisees. If we enter the franchising business, we may be exposed to additional risks, including, but not limited to, the financial condition and access to capital of franchisees, reputational harm due to the action of franchisees and litigation as a result of disagreements with franchisees. At this time we cannot guarantee that we will seek to expand or diversify our business through franchising in the near future.

 

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In addition, any such acquisition or franchising activity could demand significant attention from our management that would otherwise be available for our regular operations, which could have a material adverse effect on our business.

An increase in the use of third-party internet intermediaries to book online hotel reservations could materially adversely affect our business, financial condition and results of operations.

Some of the rooms at our hotels are booked through third-party internet travel intermediaries and other online travel service providers. These intermediaries primarily focus on leisure travel and also provide offerings for corporate travel and group meetings. Intermediaries use a variety of aggressive online marketing methods to attract customers, including the purchase, by certain companies, of trademarked online keywords such as “Extended Stay” from internet search engines to steer customers toward their websites. These intermediaries hope that consumers will eventually develop brand loyalties to their reservation system rather than to our brands. Accordingly, our business, financial condition and results of operations could be harmed if travel intermediaries succeed in significantly shifting loyalties from our brands to their reservation systems and diverting bookings away from our website or through their fees increasing the overall cost of internet bookings for our hotels.

A failure by our intermediaries to attract or retain their customer bases could lower demand for hotel rooms and, in turn, reduce our revenues. Additionally, if bookings by these third-party intermediaries increase, these intermediaries may be able to obtain higher commissions or other significant contract concessions from us, increasing the overall cost of these third-party distribution channels. Some of our distribution agreements with these companies are not exclusive, have a short term, are terminable at will or are subject to early termination provisions. The loss of distributors, increased distribution costs or the renewal of distribution agreements on significantly less favorable terms could adversely impact our business.

We are reliant upon technology and the disruption or malfunction in our information technology systems could materially adversely affect our business.

The lodging industry depends upon the use of sophisticated information technology and systems, including those utilized for reservations, property management, procurement and operation of our administrative systems. For example, we depend on our central reservation system, which allows bookings of hotel rooms directly, via telephone through our call centers, by travel agents, online through our website and through our online reservation partners. We operate third-party systems, making us reliant on third-party service providers, data communication networks and software upgrades, maintenance and support. Many of our information technology systems are outdated and require substantial upgrading. These technologies are costly and are expected to require refinements that may cause disruptions to many of our key information and technology systems. If we are unable to replace or introduce information technology and other systems as quickly as our competitors or within budgeted costs or schedules, or if we are unable to achieve the intended benefits of any new information technology or other systems, our results of operations could be adversely affected and our ability to compete effectively could be diminished.

Further, we have from time to time experienced disruptions of these systems, and disruptions of the operation of these systems as a result of failures related to our internal or our service provider systems and support may occur in the future. Information technology systems that we rely upon are also vulnerable to damage or interruption from:

 

   

events beyond our control, such as war, terrorist attacks and force majeure events, including earthquakes, tornados, hurricanes, fires or floods;

 

   

power losses, computer systems failures, internet and telecommunications or data network failures, service provider negligence, improper operation by or supervision of employees, user error, physical and electronic losses of data and similar events; and

 

   

computer viruses, cyber attacks, penetration by individuals seeking to disrupt operations or misappropriate information and other breaches of security.

 

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The occurrence of any of these problems at any of our information technology facilities, any of our call centers or any third party service providers could cause interruptions or delays in our business or loss of data, or render us unable to process reservations. In addition, if our information technology systems are unable to provide the information communications capacity that we need, or if our information technology systems suffer problems caused by installing system enhancements, we could experience similar failures or interruptions. If our information technology systems fail and our redundant systems or disaster recovery plans are not adequate to address such failures, or if our property and business interruption insurance does not sufficiently compensate us for any losses that we may incur, our revenues and profits could be reduced and the reputation of our brands and our business could be harmed.

Cyber risk and the failure to maintain the integrity of internal or customer data could result in faulty business decisions and harm our reputation or subject us to costs, fines or lawsuits, or limit our ability to accept credit cards.

Our businesses require the collection, transmission and retention of large volumes of internal and customer data, including credit card numbers and other personally identifiable information of our customers, in various information technology systems that we maintain and in those maintained by third parties with whom we contract to provide services. We and our service providers also maintain personally identifiable information about our employees. The integrity and protection of that customer, employee and company data is critical to us. If that data is inaccurate or incomplete, we could make faulty decisions. Further, our customers and employees have a high expectation that we and our service providers will adequately protect their personal information. The information, security and privacy requirements imposed by governmental regulation are increasingly demanding. Our systems may not be able to satisfy these changing requirements and customer and employee expectations, or may require significant additional investments or time in order to do so. Efforts to hack or breach security measures, failures of systems or software to operate as designed or intended, viruses, operator error or inadvertent releases of data all threaten our and our service provider’s information systems and records. Our reliance on computer, internet-based and mobile systems and communications and the frequency and sophistication of efforts by hackers to gain unauthorized access to such systems have increased significantly in recent years. A breach in the security of our information technology systems or those of our service providers could lead to an interruption in the operation of our systems, resulting in operational inefficiencies and a loss of profits. Additionally, a significant theft, loss or misappropriation of, or access to, customers’ or other proprietary data or other breach of our information technology systems could result in fines, legal claims or legal proceedings, including regulatory investigations and actions, or liability for failure to comply with privacy and information security laws, which could disrupt our operations, damage our reputation and expose us to claims from customers, financial institutions, regulators, payment card associations, employees and other persons, any of which could have a material adverse effect on our financial condition and results of operations.

In addition, we are subject to the Payment Card Industry Data Security Standard (the “PCI DSS”), a set of requirements administered by the Payment Card Industry Security Standards Council, an independent body created by the major credit card brands, and designed to ensure that companies handling credit card information maintain a secure environment. We are not currently in compliance with the PCI DSS and accordingly have been subject to monthly penalties imposed by VISA. We expect to come into compliance in the next seven to ten months, however there can be no assurance that we will successfully do so. If we fail to achieve PCI DSS compliance, we could become subject to substantially increased penalties or lose our ability to accept credit card payments. As approximately 79.0% of our room revenue for the six months ended June 30, 2013 was paid by credit card, loss of the ability to accept credit cards for payment would likely create a significant disruption to our operations, could reduce our occupancy levels and could have a material adverse effect on our business, financial condition and results of operations.

Changes in privacy laws could adversely affect our ability to market our products effectively.

We rely on a variety of direct marketing techniques, including telemarketing, email, marketing and postal mailings. Any future restrictions in laws such as the Telemarketing Sales Rule, CAN-SPAM Act and various

 

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state laws or new federal laws regarding marketing and solicitation or data protection laws that govern these activities could adversely affect the continuing effectiveness of telemarketing, email and postal mailing techniques and could force changes in our marketing strategies. If this occurs, we may not be able to develop adequate alternative marketing strategies, which could impact the amount and timing of our revenues. We also obtain access to potential customers from travel service providers and other companies with whom we have substantial relationships and market to some individuals on these lists directly or by including our marketing message in the other company’s marketing materials. If access to these lists was prohibited or otherwise restricted, our ability to develop new customers and introduce them to our products could be impaired.

We are exposed to a variety of risks associated with safety, security and crisis management.

There is a constant need to protect the safety and security of our guests, employees and assets against natural and man-made threats. These include but are not limited to exceptional events such as extreme weather, civil or political unrest, violence and terrorism, serious and organized crime, fraud, employee dishonesty, cyber crime, fire and day-to-day accidents, incidents and petty crime, which impact the guest or employee experience, could cause loss of life, sickness or injury and result in compensation claims, fines from regulatory bodies, litigation and impact our reputation. Serious incidents or a combination of events could escalate into a crisis, which if managed poorly could further expose our brands to reputational damage, which could have a material adverse effect on our business, financial condition and results of operations.

Our hotel properties may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem.

When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing as exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold at any of our hotel properties could require us to undertake a costly remediation program to contain or remove the mold from the affected property. In addition, the presence of significant mold could expose us to liability from our guests, employees and others if property damage or health concerns arise.

Compliance with the laws and regulations that apply to our hotel properties could materially adversely affect our ability to make future acquisitions or renovations, result in significant costs or delays and adversely affect our business strategies.

Our hotels are subject to various local laws and regulatory requirements that address our ability to obtain licenses for our operations. In particular, we are subject to permitting and licensing requirements, which can restrict the use of our hotel properties and increase the cost of acquisition, renovation and operation of our hotels. In addition, federal and state laws and regulations, including laws such as the Americans with Disabilities Act of 1990 (the “ADA”), impose further restrictions on our operations. Under the ADA, all public accommodations must meet federal requirements related to access and use by disabled persons. We may be subject to audits or investigations of all of our hotels to determine our compliance. Some of our hotels may not be fully compliant with the ADA. If one or more of the hotels in our portfolio is not in compliance with the ADA or any other regulatory requirements, we may be required to incur additional costs to bring the property into compliance and we might be required to pay damages or governmental fines. In addition, the obligation to make readily achievable accommodations is an ongoing one. Existing requirements may change and future requirements may require us to make significant unanticipated capital expenditures that could materially adversely affect our business, financial condition, liquidity, results of operations and cash flows.

 

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Hospitality companies have been the target of class actions and other lawsuits alleging violations of federal and state law and other claims, and we may be subject to legal claims.

Our operating income and profits may be reduced by legal or governmental proceedings brought by or on behalf of our employees, customers or other third parties. In recent years, a number of hospitality companies have been subject to lawsuits, including class action lawsuits, alleging violations of federal and state law regarding workplace and employment matters, discrimination and other alleged violations of law. A number of these lawsuits have resulted in the payment of substantial damages by the defendants. Similar lawsuits have been instituted against us from time to time, and we cannot assure you that we will not incur substantial damages and expenses resulting from lawsuits of this type or other claims, which could have a material adverse effect on our business, financial condition and results of operations.

Changes in federal, state, local or foreign tax regulation or disputes with tax authorities could materially adversely affect our business, financial condition and profitability by increasing our tax costs.

The determination of our provision for income taxes and other tax liabilities requires estimations and significant judgments and there are many transactions and calculations where the ultimate tax determination is uncertain. We are subject to taxation at the federal, state or provincial and local levels in the United States and Canada. Our future tax rates could be adversely affected by changes in composition of earnings in jurisdictions with differing tax rates, changes in the valuation of our deferred tax assets and liabilities and substantive changes to tax rules and the application thereof by United States federal, state, local and foreign governments, all of which could result in materially higher corporate taxes than would be incurred under existing tax law or interpretation and could adversely affect our profitability. Further, our determination of our tax liability is always subject to audit and review by applicable domestic and foreign tax authorities. Any adverse outcome of any such audit or review could have an adverse effect on our business and reduce our profits to the extent potential tax liabilities exceed our reserves, and the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made.

In addition, the recent economic downturn has reduced tax revenues for United States federal, state and local governments and as a result tax authorities have increased their efforts to raise revenues through changes in tax laws and audits. Increased efforts by tax authorities to raise revenues through changes in tax laws and audits could materially increase our effective tax rate.

Increases in ESH REIT’s property taxes could materially adversely affect our profitability and ability to pay dividends to our stockholders.

Hotel properties are subject to real and personal property taxes. These taxes may increase as tax rates change and as ESH REIT’s hotel properties are assessed or reassessed by taxing authorities. In particular, ESH REIT’s property taxes could increase following acquisitions as acquired properties are reassessed. In recent periods, state and local governments have been seeking to increase property taxes. If property taxes increase, our business, financial condition, results of operations and ESH REIT’s ability to make distributions to its stockholders could be materially adversely affected.

Our insurance may not fully compensate us for damage to or losses involving our hotel properties.

We maintain comprehensive insurance on each of our hotel properties, including liability, fire and extended coverage, in the types and amounts we believe are adequate and customary in our industry. Nevertheless, there are some types of losses, generally of a catastrophic nature, such as hurricanes, earthquakes, fires, floods, terrorist acts or liabilities that result from breaches in the security of our information technology systems, that may be uninsurable or too expensive to justify obtaining insurance. Additionally, market forces beyond our control could limit the scope of insurance coverage that we can obtain or restrict our ability to obtain insurance

 

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coverage at reasonable rates. As a result, we may not be successful in obtaining insurance without increases in cost or decreases in coverage levels. We use our discretion in determining amounts, coverage limits and deductibility provisions of insurance, with a view to obtaining appropriate insurance on our hotel properties at a reasonable cost and on suitable terms. In the event of significant damage or loss, our insurance coverage may not be sufficient to cover the full current market value or replacement value of our investment in a property, and in some cases could result in certain losses being totally uninsured. In addition, inflation, changes in building codes and zoning ordinances, environmental considerations and other factors might make it impossible or impractical to use insurance proceeds to replace or repair a property that has been damaged or destroyed. Under these and other circumstances, insurance proceeds may not be adequate to restore our economic position with respect to a damaged or destroyed property. Accordingly, ESH REIT could lose some or all of the capital it has invested in a property, as well as the anticipated future revenue from the property, and ESH REIT could remain obligated for guarantees, debt or other financial obligations of the property. ESH REIT’s debt instruments, consisting of Mortgage Loans secured by our hotel properties and Mezzanine Loans contain, and the revolving credit facilities we expect the Company and ESH REIT to enter into concurrently with the consummation of this offering will contain, customary covenants requiring us to maintain insurance. Although we believe that we currently maintain sufficient insurance coverage to satisfy these obligations, there is no assurance that in the future we will be able to procure coverage at a reasonable cost. In addition, there can be no assurance that the lenders under these instruments will not take the position that the Company or ESH REIT does not have sufficient insurance coverage and therefore is in breach of these debt instruments allowing the lenders to declare an event of default and accelerate repayment of debt.

We are dependent upon our ability to attract and retain key officers and other highly qualified personnel.

Our success and our ability to implement our business strategies will depend in large part upon the efforts and skills of our senior management and our ability to attract and retain key officers and other highly qualified personnel. Competition for such personnel is intense. There can be no assurance that we will continue to be successful in attracting and retaining qualified personnel. If we lose or suffer an extended interruption in the services of one or more of our key officers, our business, financial condition and results of operations could be materially adversely affected. Accordingly, there can be no assurance that our senior management will be able to successfully execute and implement our business and operating strategies.

We have a new management team that does not have experience in the extended stay segment.

During the past several years we have substantially changed our management team. Our chief executive officer started in February 2012, our chief financial officer started in July 2011 and our chief operating officer started in September 2013, and each had no extended stay hotel industry experience prior to joining HVM. It is important to our success that the new members of the management team quickly understand the extended stay hotel industry. If they are unable to do so, our business, financial conditions and results of operations could be materially adversely affected.

Labor shortages could restrict our ability to operate our hotels or implement our business strategies or result in increased labor costs that could reduce our profitability.

Our success depends in large part on our ability to attract, retain, train, manage and engage our employees. Our hotels are staffed 24 hours a day, seven days a week by thousands of employees around the country. If we are unable to attract, retain, train, manage and engage skilled employees, our ability to manage and staff our hotel properties adequately could be impaired, which could reduce customer satisfaction and harm our reputation. Staffing shortages could also hinder our ability to implement our business strategy. Because payroll costs are a major component of the operating expenses at our hotel properties, a shortage of skilled labor could also require higher wages that would increase our labor costs, which could reduce our profitability and limit our ability to pay dividends to stockholders. In addition, increases in minimum wage rates could result in significantly increased costs for us and result in reduced margins and profitability.

 

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Attempts by labor organizations to organize groups of our employees or changes in labor laws could disrupt our operations, increase our labor costs or interfere with the ability of our management to focus on implementing our business strategies.

We may become subject to collective bargaining agreements, similar agreements or regulations enforced by governmental entities in the future. Changes in the federal regulatory scheme could make it easier for unions to organize groups of our employees. If relationships with our employees or other field personnel become adverse, our hotel properties could experience labor disruptions such as strikes, lockouts and public demonstrations. Additionally, if such changes take effect, our employees or other field personnel could be subject to organizational efforts, which could potentially lead to disruptions or require our management’s time to address unionization issues. Labor regulation could also lead to higher wage and benefit costs, changes in work rules that raise operating expenses and legal costs, and limit our ability to take cost saving measures during economic downturns. These or similar agreements, legislation or changes in regulations could disrupt our operations, hinder our ability to cross-train and cross-promote our employees due to prescribed work rules and job classifications, reduce our profitability or interfere with the ability of our management to focus on executing our business and operating strategies.

Adverse judgments or settlements resulting from legal proceedings in which we may be involved in the normal course of our business could reduce our profitability or limit our ability to operate our business.

In the normal course of our business, we are often involved in various legal proceedings. We cannot predict with certainty the cost of defense, the cost of prosecution or the ultimate outcome of these legal proceedings. Additionally, we could become the subject of future claims by third parties, including guests who use our hotels, our employees, our stockholders or regulators. Any significant adverse determinations, judgments or settlements could reduce our profitability and could materially adversely affect our business, financial condition and results of operations or limit our ability to operate our business. Further, we may incur costs related to claims for which we have appropriate third party indemnity, but such third parties fail to fulfill their contractual obligations. See “Business—Legal Proceedings.”

Risks Related to ESH REIT and its Status as a REIT

Failure of ESH REIT to qualify as a REIT or remain qualified as a REIT would cause it to be taxed as a regular C corporation, which would expose it to substantial tax liability and could substantially reduce the amount of cash available to pay dividends to its stockholders.

ESH REIT elected to be taxed as a REIT for U.S. federal income tax purposes effective as of October 7, 2010. We believe ESH REIT has been organized and operated in such a manner so as to qualify as a REIT and ESH REIT currently intends to continue to operate as a REIT. However, qualification as a REIT involves the application of highly technical and complex provisions of the Code, for which only a limited number of judicial and administrative interpretations exist. The complexity of these provisions is greater in the case of a REIT that owns hotels and leases them to a corporation with which a portion of its stock is paired. As a result, ESH REIT is likely to encounter a greater number of interpretive issues under the REIT qualification rules, and more such issues which lack clear guidance, than are other REITs. Even an inadvertent or technical mistake could jeopardize ESH REIT’s REIT qualification.

Although we do not intend to request a ruling from the Internal Revenue Service (“IRS”) as to our REIT qualification, ESH REIT expects to receive an opinion of Fried, Frank, Harris, Shriver & Jacobson LLP (“Fried Frank”) to the effect that ESH REIT has been organized in conformity with the requirements for qualification as a REIT under the Code, and ESH REIT’s current and proposed method of operation, as described in this prospectus and in representations made to Fried Frank, should enable it to meet the requirements for qualification and taxation as a REIT under the Code. Investors should be aware, however, that opinions of counsel are not binding on the IRS or any court. The opinion of Fried Frank represents only the view of Fried Frank, based on its review and analysis of existing law. The opinion of Fried Frank will rely upon certain representations as to factual matters and covenants

 

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expected to be made by ESH REIT and the Company, including representations relating to the values of assets, the sources of income, ESH REIT not being considered to own (actually or constructively) stock of any corporate lessee (including the Company) possessing 10 percent or more of the voting power or value of all classes of stock of the corporate lessee, and the value of the Class B common stock of ESH REIT stock being less than 50% of the value of all the shares of ESH REIT stock. The opinion of Fried Frank will rely upon representations received from the Sponsors regarding the ownership structure of the Sponsor-managed funds and the actual and constructive ownership of the Sponsor-managed funds, including a representation that, to the best of the Sponsor’s knowledge, no entity owns, actually or constructively, 10 percent or more of the value of the shares of ESH REIT or the Company as a result of shares of ESH REIT or the Company being attributed to such entity from one or more owners of such entity. The opinion is expressed as of the date issued. Fried Frank has no obligation to advise ESH REIT or its owners of any subsequent change in the matters stated, represented or assumed or of any subsequent change in applicable law. Furthermore, both the validity of the opinion of Fried Frank and ESH REIT’s qualification on a going forward basis to be taxed as a REIT will depend on its satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements, including the application of the constructive ownership rules to partnership allocations in respect of profits interests, as to which there is no guidance and the IRS or a court may disagree with the view taken by Fried Frank in rendering its opinion. The results of ESH REIT’s satisfaction of such REIT qualification requirements will not be monitored by Fried Frank. ESH REIT’s ability to satisfy the asset tests depends upon an analysis of the characterization and fair market values of its assets, some of which are not susceptible to a precise determination, and for which ESH REIT will not obtain independent appraisals. Moreover, new tax legislation, administrative guidance or court decisions, in each instance potentially applicable with retroactive effect, could make it more difficult or impossible for ESH REIT to qualify as a REIT. Given the highly complex nature of the rules governing REITs, the ongoing factual determinations and the possibility of future changes in the law or our circumstances, ESH REIT might not satisfy all requirements applicable to REITs for any particular taxable year. See “Material United States Federal Income Tax Considerations—Taxation of ESH REIT.”

If ESH REIT failed to qualify as a REIT in any taxable year, and no available relief provision applied, it would be subject to U.S. federal income tax, including any applicable alternative minimum tax, on its taxable income at regular corporate rates, and distributions to holders of its stock would not be deductible by it in computing its taxable income. ESH REIT may also be subject to additional state and local taxes if it fails to qualify as a REIT. Any such corporate tax liability could be substantial and would reduce the amount of cash available for investment, debt service and distribution to holders of its stock, which in turn could have a material adverse effect on the value and market price of the Shares. To the extent that distributions to shareholders by ESH REIT have been made on the belief that ESH REIT qualified as a REIT, ESH REIT might be required to borrow funds or to liquidate certain of its investments to pay the applicable tax. If, for any reason, ESH REIT failed to qualify as a REIT and it was not entitled to relief under certain Code provisions, it would be subject to a material tax liability and unable to elect REIT status for the four taxable years following the year during which it ceased to so qualify, which could materially adversely affect our business and operating strategies and the market value of the Shares.

Failure to qualify as a REIT could result from a number of factors, including, without limitation:

 

   

the leases of ESH REIT’s hotels to the Company are not respected as true leases for U.S. federal income tax purposes;

 

   

rents received from the Company are treated as rents received from a “related party tenant”;

 

   

ESH REIT is not respected as an entity separate from the Company or the REIT qualification tests are applied to ESH REIT on a combined basis with the Company; or

 

   

failure to satisfy the REIT distribution requirements due to restrictions under ESH REIT’s indebtedness.

In addition, if ESH REIT fails to qualify as a REIT, it will no longer be required to make distributions as a condition to REIT qualification and all of its distributions to holders of its common stock, after payment of

 

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corporate level tax as noted above, would be taxable as regular C corporation dividends to the extent of ESH REIT’s current and accumulated earnings and profits. Thus, if ESH REIT failed to qualify as a REIT, dividends paid to ESH REIT’s stockholders currently taxed as individuals would be qualified dividend income, currently taxed at preferential rates, and ESH REIT’s stockholders currently taxed as corporations (including the Company) would be entitled to the dividends received deduction with respect to such dividends, subject in each case to applicable limitations under the Code. As a result of all these factors, ESH REIT’s failure to qualify as a REIT could impair our business and operating strategies and materially adversely affect the market price of the Shares.

If rents received by ESH REIT from the Company are treated as rent received from a “related party tenant,” ESH REIT will fail to qualify as a REIT.

To qualify as “rents from real property” for purposes of the two gross income tests applicable to REITs, ESH REIT must not own, actually or constructively (by virtue of certain attribution provisions of the Code), 10% or more (by vote or value) of the stock of any corporate lessee or 10% or more of the assets or net profits of any non-corporate lessee (a “related party tenant”). For periods prior to the Pre-IPO Transactions, ESH REIT owned 100% of the corporate lessees of its hotels but depended upon an exception to the related party rent rule for leases of “qualified lodging facilities” to taxable REIT subsidiaries managed by an “eligible independent contractor.” For periods after the consummation of the Pre-IPO Transactions, ESH REIT will lease substantially all of its hotels to the Company and the exception described in the preceding sentence will no longer be available. The Company will be treated as a related party tenant for purposes of the gross income tests if ESH REIT owns, actually or constructively (by virtue of certain attribution provisions of the Code), 10% or more of the stock (by vote or value) of the Company. The Company does not believe that it is a related party tenant of ESH REIT.

Prior to the Pre-IPO Transactions, certain Sponsor-managed funds and investors in the Sponsor-managed funds owned more than 10% of the interests in ESH REIT. As a result, if no action were taken, under the constructive ownership rules the stock of the Company could be attributed to ESH REIT, and the Company could be viewed as a related party tenant. In advance of the Pre-IPO Transactions, the Sponsors undertook certain steps intended to reduce the interest of such funds and the direct and indirect investors in the Sponsor-managed funds such that after the Pre-IPO Transactions, ESH REIT will not be considered to own, actually or constructively (by virtue of certain attribution provisions of the Code), stock in the Company representing 10% or more (by vote or value) of the Company’s outstanding stock. The ownership attribution rules that apply for purposes of the 10% threshold are complex, and it is uncertain as to how they apply in many circumstances, including how they apply to Shares held by our current owners. Despite the restructuring, a contrary interpretation of these rules could result in treating ESH REIT as owning, actually or constructively (by virtue of certain attribution provisions of the Code) stock in the Company representing 10% or more (by vote or value) of the Company’s outstanding stock. In particular, there is no clear guidance as to the application of these constructive ownership rules to partnership allocations in respect of profits interests, including certain profits interests in the direct or indirect owners of Shares, and as a result there can be no assurance that the Company’s rental payments to ESH REIT will qualify as “rent from real property,” in which case ESH REIT would fail to qualify for REIT status. In the absence of guidance on this issue, the Fried Frank opinion will take the view that a partner’s profits interest in a partnership is determined based on the maximum amount of partnership profits potentially allocable to such partner on a cumulative basis. If such interpretation is incorrect, the Company could be treated as a “related party tenant” of ESH REIT, in which case ESH REIT would fail to qualify for REIT status. Moreover, events beyond our knowledge or control could result in a stockholder, including an investor in the Sponsors, owning or being deemed to own 10% or more of the paired common stock. The ownership attribution rules that apply for purposes of the 10% threshold are complex and may cause the outstanding shares owned by a group of related individuals or entities to be deemed to be constructively owned by one individual or entity. As a result, for instance, the acquisition of less than 10% of the outstanding paired common stock (or the acquisition of an interest in an entity which owns paired common stock) by an individual or entity could cause that individual or entity to be treated as owning in excess of 10% of ESH REIT. In addition, a person may be treated as owning 10% or more of the value of stock of ESH REIT by virtue of owning an interest in an entity other than a Sponsor-managed fund that owns an

 

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interest in ESH REIT. Although ESH REIT intends to make timely annual demands of certain shareholders of record to disclose the beneficial owners of Shares issued in their name, as required by the Treasury Regulations, monitoring actual or constructive ownership of the Shares, including by investors in the Sponsors, after completion of the Pre-IPO Transactions on a continuous basis is not feasible. The charters of the Company and ESH REIT contain restrictions on the amount of shares of stock of either entity so that no person can own, actually or constructively (by virtue of certain attribution provisions of the Code), more than 9.8% of the outstanding shares of any class or series of stock of either ESH REIT or the Company. The Class A common stock of ESH REIT and the 125 shares of preferred stock of ESH REIT are not subject to the 9.8% ownership limitation under the charter of ESH REIT. However, given the breadth of the Code’s constructive ownership rules and the fact that it is not feasible for ESH REIT and the Company to continuously monitor actual and constructive ownership of paired common stock, there can be no assurance that such restrictions will be effective in preventing any person from actually or constructively acquiring 9.8% or more of the outstanding shares of any class or series of stock of the Company or ESH REIT. If the Company were treated as a “related party tenant” of ESH REIT, ESH REIT would not be able to satisfy either of the two gross income tests applicable to REITs and would fail to qualify for REIT status. If ESH REIT failed to qualify as a REIT and it was not entitled to relief under certain Code provisions, it would be subject to a material tax liability and unable to elect REIT status for the four taxable years following the year during which it ceased to so qualify. In addition, it is unlikely ESH REIT would avail itself of certain relief provisions under the Code customarily available to a REIT that has failed to satisfy a REIT requirement but wants to retain its REIT status. If a REIT fails to satisfy either of the two gross income requirements, such relief provisions require payment of a punitive tax in an amount equal to 100% of the estimated profits of the REIT attributable to the amount of gross income by which the REIT failed the gross income tests. See “Material United States Federal Income Tax Considerations—Failure to Satisfy the Gross Income Tests.” Since substantially all ESH REIT’s gross income will be rent paid pursuant to the operating leases with the Company, a substantial part of ESH REIT’s total profits could become subject to such 100% tax under such relief provisions of the Code if this rent failed to qualify under the two gross income tests. In that event, ESH REIT would not likely pursue any of the relief provisions available to REITs under certain provisions of the Code.

Our structure has been infrequently utilized by public companies and has not been employed by a public company since a similar structure was employed by a public company in 2006, and the IRS could challenge ESH REIT’s qualification as a REIT.

Our structure has been infrequently utilized by public companies and has not been employed by a public company since a similar structure was employed by a public company in 2006, and there is little guidance on the tax treatment of a paired share arrangement. Section 269B of the Code provides that the determination of whether an entity qualifies as a REIT must be made on a combined basis if the entity is “stapled” to another entity. ESH REIT and the Company will be considered “stapled entities” if more than 50% of the value of the beneficial ownership of shares of ESH REIT is paired with the shares of the Company. We believe that the value of the Class B common stock does not represent more than 50% of the value of all of the shares of stock of ESH REIT and, accordingly, that ESH REIT and the Company are not “stapled entities” for purposes of Section 269B of the Code. Our belief that the value of the Class B common stock of ESH REIT does not represent more than 50% of the value of all of the shares of stock of ESH REIT is based on a relative valuation prepared by Duff & Phelps, LLC that, as of the effective date, the fair market value of all outstanding shares of the Class B common stock of ESH REIT will represent less than 50% of the fair market value of all of the outstanding shares of stock of ESH REIT. However, valuation is an inherently subjective matter, and the IRS could assert that Section 269B of the Code applies based on its view of the relative value of the classes of stock of ESH REIT so that ESH REIT and the Company are “stapled entities.” In addition, the IRS could also assert that ESH REIT and the Company should be treated as one entity under general tax principles. In each case such assertion, if successful, would result in the loss of ESH REIT’s status as a REIT. If ESH REIT failed to qualify as a REIT under this rule and it was not entitled to relief under certain Code provisions, it would be subject to a material tax liability and unable to elect REIT status for the four taxable years following the year during which it ceased to so qualify. In addition, if ESH REIT and the Company were treated as a single entity under the Code, such single entity’s income and assets would fundamentally differ from the type of income and assets required to qualify as a REIT. Thus, even if

 

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a relief provision under certain Code provisions were available, the Company and ESH REIT would likely need to further restructure their operations and/or ownership structure in order for ESH REIT to qualify as a REIT under the Code, and there is no assurance that any such restructuring could be accomplished.

Additionally, the IRS could challenge the REIT status of ESH REIT on the basis that the Class B common stock is not freely transferrable. Such assertion, if successful, would result in the loss of ESH REIT’s REIT status. If ESH REIT failed to qualify as a REIT under this rule and it was not entitled to relief under certain Code provisions, it would be subject to a material tax liability and unable to elect REIT status for the four taxable years following the year during which it ceased to so qualify. Finally, the IRS could also assert that the Company should be treated as owning all of the common stock of ESH REIT. If upheld, such an assertion would effectively eliminate the benefit of REIT status for ESH REIT. No advance ruling has been or will be sought from the IRS regarding ESH REIT’s qualification as a REIT or any other matter discussed in this prospectus.

The ownership limits that apply to REITs, as prescribed by the Code and by ESH REIT’s charter, may inhibit market activity in the Shares and restrict our business combination opportunities.

In order for ESH REIT to qualify to be taxed as a REIT, not more than 50% in value of the outstanding shares of its stock may be owned, beneficially or constructively, by five or fewer individuals, as defined in the Code to include certain entities, at any time during the last half of each taxable year after the first year for which it elected to qualify to be taxed as a REIT. Subject to certain exceptions, ESH REIT’s charter will authorize its board of directors to take such actions as are necessary and desirable to preserve its qualification to be taxed as a REIT. ESH REIT’s charter will also provide that, unless exempted by the board of directors, no person may own more than 9.8% of the outstanding shares of any class or series of its stock. See “Description of Our Capital Stock—Restrictions on Ownership and Transfer” and “Material United States Federal Income Tax Considerations.” The constructive ownership rules are complex and may cause shares of stock owned directly or constructively (by virtue of certain attribution provisions of the Code) by a group of related individuals or entities to be constructively owned by one individual or entity. These ownership limits could delay or prevent a transaction or a change in control of us that might involve a premium price for Shares or otherwise be in the best interests of our stockholders.

If ESH REIT’s leases with the Company are not respected as true leases for U.S. federal income tax purposes, ESH REIT would fail to qualify as a REIT.

To qualify as a REIT, ESH REIT is required to satisfy two gross income tests, pursuant to which specified percentages of its gross income must be passive income, such as rent. For the rent paid pursuant to the operating leases with the Company, which should comprise substantially all of ESH REIT’s gross income, to constitute qualifying rental income for purposes of the gross income tests, the leases must be respected as true leases for U.S. federal income tax purposes and must not be treated as service contracts, joint ventures or some other type of arrangement. ESH REIT has structured the leases, and intends to structure any future leases, so that the leases will be respected as true leases for U.S. federal income tax purposes, but there can be no assurance that the IRS will not challenge this treatment or that a court would not sustain such a challenge. If the leases were not respected as true leases for U.S. federal income tax purposes, ESH REIT would not be able to satisfy either of the two gross income tests applicable to REITs and would fail to qualify for REIT status. If ESH REIT failed to qualify as a REIT and it was not entitled to relief under certain Code provisions, it would be subject to a material tax liability and unable to elect REIT status for the four taxable years following the year during which it ceased to so qualify.

If rents received by ESH REIT from the Company do not reflect arm’s length terms, the IRS could seek to recharacterize the rents.

In connection with the Pre-IPO Transactions and this offering, ESH REIT and the Company will reset the rates of rent payable by the Company to ESH REIT under the operating leases. The new rates of rent are intended to reflect arm’s length terms. However, transfer pricing is an inherently subjective matter, and the IRS could,

 

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under Section 482 of the Code, assert that the rates of rent between the Company and ESH REIT do not reflect arm’s length terms. If the IRS was successful in asserting that the rates of rent were not on arm’s length terms, it could adversely impact our REIT qualification or our effective tax rate and tax liability.

The IRS could seek to recharacterize the Pre-IPO Transactions.

The Pre-IPO Transactions were undertaken to implement the current structure and are intended to permit ESH REIT to continue to qualify as a REIT. There can be no assurance that the IRS will not seek to recharacterize or reorder the Pre-IPO Transactions, which if successful, could result in the loss of ESH REIT’s REIT status.

ESH REIT has no operating history as a publicly traded REIT and may not be successful in operating as a publicly traded REIT, which may adversely affect its ability to make distributions to its stockholders.

ESH REIT has no operating history as a publicly traded REIT. The REIT rules and regulations are highly technical and complex. ESH REIT cannot assure you that its management team’s past experience will be sufficient to successfully operate ESH REIT as a publicly traded REIT, implement appropriate operating and investment policies and comply with Code or Treasury Regulations that are applicable to it. Failure to comply with the income, asset and other requirements imposed by the REIT rules and regulations could prevent ESH REIT from qualifying as a REIT and could force it to pay unexpected taxes and penalties, which may adversely affect its ability to make distributions to its stockholders.

Even if ESH REIT continues to qualify as a REIT, it may face other tax liabilities that could reduce our cash flows.

Even if ESH REIT continues to qualify for taxation as a REIT, it may be subject to certain U.S. federal, state and local taxes on its income and assets including, but not limited to, taxes on any undistributed income and property and transfer taxes. In order to maintain its status as a REIT, each year ESH REIT must distribute to holders of its common stock at least 90% of its REIT taxable income, determined before the deductions for dividends paid and excluding any net capital gain. To the extent that ESH REIT satisfies this distribution requirement, but distributes less than 100% of its taxable income and net capital gain, it will be subject to U.S. federal corporate income tax on its undistributed REIT taxable income and net capital gain. In addition, ESH REIT will be subject to a 4% nondeductible excise tax if the actual amount that it pays out to holders of its common stock in a calendar year is less than a minimum amount specified under the Code. ESH REIT generally expects to distribute approximately 95% of its REIT taxable income. Thus, ESH REIT will be subject to U.S. federal corporate income tax on its undistributed REIT taxable income and net capital gain and may be subject to U.S. federal excise tax. Any of these taxes would decrease cash available for distributions to holders of its common stock, and lower distributions of cash could adversely affect the market price of the Shares.

The REIT distribution requirements could adversely affect ESH REIT’s liquidity and may force ESH REIT to borrow funds or sell assets during unfavorable market conditions or make taxable distributions of its capital stock.

In order to meet the REIT distribution requirements and avoid the payment of income and excise taxes, ESH REIT may need to borrow funds on a short-term basis or sell assets, even if the then-prevailing market conditions are not favorable for these borrowings or sales. ESH REIT’s cash flows may be insufficient to fund required REIT distributions as a result of differences in timing between the actual receipt of income and the recognition of income for U.S. federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of reserves or required debt service obligations or amortization payments. The insufficiency of ESH REIT’s cash flows to cover its distribution requirements could have an adverse effect on its ability to incur additional indebtedness or sell equity securities in order to fund distributions required to maintain its qualification as a REIT.

 

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ESH REIT may from time to time make distributions to its stockholders in the form of its taxable stock dividends, which could result in stockholders incurring tax liability without receiving sufficient cash to pay such tax.

Although it has no current intention to do so, ESH REIT may in the future distribute taxable stock dividends to its stockholders in the form of additional shares of its stock. ESH REIT might distribute additional shares of its Class A common stock, shares of Class B common stock and/or shares of its preferred stock to the Company and/or shares of its Class B common stock to the holders of its Class B common stock. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of ESH REIT’s current and accumulated earnings and profits for U.S. federal income tax purposes. As a result, stockholders may be required to pay income taxes with respect to such dividends in excess of the cash dividends received. If a U.S. stockholder sells ESH REIT common or preferred shares that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of the Shares at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, ESH REIT may be required to withhold U.S. federal income tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in its common shares.

Dividends paid by REITs do not qualify for the reduced tax rates available for some dividends.

Certain dividends known as qualified dividends payable to U.S. stockholders that are individuals, trusts or estates currently are subject to the same tax rates as long-term capital gains, which are significantly lower than the maximum rates for ordinary income. Dividends paid by REITs, however, generally are not eligible for such reduced rates. Although these rules do not adversely affect the taxation of REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs and the Shares.

Applicable REIT laws may restrict certain business activities and increase our overall tax liability.

As a REIT, ESH REIT is subject to various restrictions on the types of income it can earn, assets it can own and activities in which it can engage. Business activities that could be impacted by applicable REIT laws include, but are not limited to, activities such as developing alternative uses of real estate, including the development and/or sale of hotel properties. Due to these restrictions, we anticipate that we will conduct certain business activities, including those mentioned above, through the Company. The Company is taxable as a regular C corporation and is subject to U.S. federal, state, local and, if applicable, foreign taxation on its taxable income. To qualify as a REIT, ESH REIT must satisfy certain asset, income, organizational, distribution, stockholder ownership and other requirements on an ongoing basis. In order to meet these tests, ESH REIT may be required to forego investments it might otherwise make. Thus, ESH REIT’s compliance with the REIT requirements may hinder our business and operating strategies, financial condition and results of operations.

Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.

The REIT provisions of the Code substantially limit ESH REIT’s ability to hedge its assets and liabilities. Any income from a hedging transaction that ESH REIT enters into primarily to manage risk of currency fluctuations or to manage risk of interest rate changes with respect to borrowings made or to be made to acquire or carry real estate assets does not constitute “gross income” for purposes of the 75% or 95% gross income tests that apply to REITs, provided that certain identification requirements are met. To the extent that ESH REIT enters into other types of hedging transactions or fails to properly identify such transaction as a hedge, the income is likely to be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, ESH REIT may be required to limit its use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of ESH REIT’s hedging activities because its TRS may

 

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be subject to tax on gains or expose ESH REIT to greater risks associated with changes in interest rates than it would otherwise choose to bear. In addition, losses in a TRS will generally not provide any tax benefit, except that such losses could theoretically be carried back or forward against past or future taxable income in the TRS.

The application of FIRPTA to non-U.S. holders of Class B common stock of ESH REIT is not clear.

A non-U.S. person disposing of a U.S. real property interest (“USRPI”), including shares of a U.S. corporation whose assets consist principally of USRPIs, is generally subject to tax under the Foreign Investment in Real Property Tax Act (“FIRPTA”), on the gain recognized on the disposition, in which case they would also be required to file U.S. tax returns with respect to such gain. FIRPTA does not apply, however, to the disposition of stock in a REIT if the REIT is a “domestically controlled REIT.” We intend to take the position that ESH REIT is a domestically controlled REIT under the Code. However, there can be no assurance that the IRS will not challenge this treatment or that a court would not sustain such a challenge. If ESH REIT were to fail to qualify as a “domestically controlled REIT,” gains realized by a non-U.S. holder on a sale of Class B common stock would be subject to tax under FIRPTA unless the Class B common stock was regularly traded on an established securities market (such as the NYSE) and the non-U.S. holder did not at any time during a specified testing period directly or indirectly own more than 5% of the value of the outstanding Class B common stock. While there is no authority addressing whether a component of a paired interest will be considered to be regularly traded on an established securities market by virtue of the paired interest being considered to be regularly traded on an established securities market, we intend to take the position that the Class B common stock of ESH REIT is traded on an established securities market following this offering.

Non-U.S. holders of Class B common stock of ESH REIT may be subject to tax under FIRPTA on distributions.

Non-U.S. holders of Class B common stock may incur tax on distributions that are attributable to gain from a sale or exchange of a USRPI by ESH REIT under FIRPTA. A USRPI includes certain interests in real property and stock in corporations at least 50% of whose assets consist of USRPIs. Under FIRPTA, a non-U.S. stockholder is taxed on distributions attributable to gain from sales of USRPIs as if such gain were effectively connected with a U.S. trade or business of the non-U.S. stockholder, in which case they would also be required to file U.S. tax returns with respect to such gains. A non-U.S. stockholder thus would be taxed on such a distribution at the normal capital gains rates applicable to U.S. stockholders, subject to applicable alternative minimum tax and a special alternative minimum tax in the case of a nonresident alien individual. A non-U.S. corporate stockholder not entitled to treaty relief or exemption also may be subject to the 30% branch profits tax on such a distribution.

If the Class B common stock is regularly traded on an established securities market located in the United States, capital gain distributions on the Class B common stock that are attributable to ESH REIT’s sale of real property will be treated as ordinary dividends rather than as gain from the sale of a USRPI as long as the non-U.S. stockholder did not own more than 5% of the Class B common stock at any time during the one-year period preceding the distribution. As a result, non-U.S. stockholders generally will be subject to withholding tax on such capital gain distributions in the same manner as they are subject to withholding tax on ordinary dividends. As noted above, we intend to take the position that the Class B common stock will be regularly traded on an established securities market located in the United States following this offering. If the Class B common stock is not considered to be regularly traded on an established securities market located in the United States or the non-U.S. stockholder owned more than 5% of the Class B common stock at any time during the one-year period preceding the distribution, capital gain distributions that are attributable to ESH REIT’s sale of real property would be subject to tax under FIRPTA, as described in the preceding paragraph. In such case, ESH REIT must withhold 35% of any distribution that ESH REIT could designate as a capital gain dividend. A non-U.S. stockholder may receive a credit against its tax liability for the amount ESH REIT withholds. Moreover, if a non-U.S. stockholder disposes of ESH REIT common stock during the 30-day period preceding a dividend payment, and such non-U.S. stockholder (or a person related to such non-U.S. stockholder) acquires or enters into a

 

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contract or option to acquire the Class B common stock within 61 days of the first day of the 30-day period described above, and any portion of such dividend payment would, but for the disposition, be treated as a USRPI capital gain to such non-U.S. stockholder, then such non-U.S. stockholder shall be treated as having USRPI capital gain in an amount that, but for the disposition, would have been treated as USRPI capital gain.

Risks Related to the Company

The Company is subject to tax at regular corporate rates.

The Company is subject to U.S. federal income tax, including any applicable alternative minimum tax, on its taxable income at regular corporate rates, and distributions to holders of Company common stock are not deductible by it in computing its taxable income. In calculating its taxable income, the Company must include as income any dividends received from ESH REIT. Distributions to holders of Company common stock are taxable as dividends to the extent of current and accumulated earnings and profits. Dividends paid by the Company to noncorporate U.S. stockholders that constitute qualified dividend income will be taxable to the stockholder at the preferential rates applicable to long-term capital gains provided the stockholder meets certain holding period requirements. Distributions in excess of the Company’s current and accumulated earnings and profits would generally be considered a return of capital for U.S. federal income tax purposes to the extent of the holder’s adjusted tax basis in their shares. A return of capital is not taxable, but it has the effect of reducing the holder’s adjusted tax basis in their shares. If distributions exceed the adjusted tax basis of a holder’s shares, they will be treated as gain from the sale or exchange of such stock.

The application of FIRPTA could adversely affect non-U.S. holders of the Shares.

The Company is expected to be a United States real property holding corporation under the Code. As a result, under FIRPTA, certain non-U.S. holders of Company common stock may be subject to U.S. federal income tax on gain from the disposition of such stock, in which case they would also be required to file U.S. tax returns with respect to such gain. Whether these FIRPTA provisions apply depends on the amount of Company common stock that such non-U.S. holder holds and whether, at the time they dispose of their shares, Company common stock is regularly traded on an established securities market (such as the NYSE) within the meaning of the applicable Treasury Regulations. While there is no authority addressing whether a component of a paired interest will be considered to be traded on an established securities market by virtue of the paired interest being considered to be traded on an established securities market, we intend to take the position that the common stock of the Company is traded on an established securities market. So long as the Company common stock is regularly traded as noted above, only a non-U.S. holder who has held, actually or constructively, more than 5% of the Company’s common stock at any time during the applicable testing period may be subject to U.S. federal income tax on the disposition of such common stock under FIRPTA. In addition, a separate valuation of the Class B common stock of ESH REIT and common stock of the Company may not be available. As a result, the portion of any gain on the disposition of a Share that is attributable to shares of common stock of the Company, and subject to FIRPTA, may be difficult to determine.

If ESH REIT was to lose its REIT status, it could materially adversely affect the Company.

The Company will receive a substantial portion of its income in the form of distributions from ESH REIT. If ESH REIT was not treated as a REIT, it would be subject to U.S. federal income tax, including any applicable alternative minimum tax, on its taxable income at regular corporate rates, and distributions to holders of its stock, including the Company, would not be deductible by it in computing its taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to holders of its stock, including the Company, and would likely reduce the value of the ESH REIT Class A common stock held by the Company, which in turn could have a material adverse effect on the value of the Company’s stock. See “—Risks Related to ESH REIT and its Status as a REIT.”

 

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Risks Related to the Shares and this Offering

There is no existing market for the Shares, and we do not know if one will develop to provide you with adequate liquidity. If our stock price fluctuates after this offering, you could lose a significant part of your investment.

Prior to this offering, there has not been a public market for the Shares. Additionally, the structure of the Shares is not typical and may trade at a discount to the combined value. We cannot predict the extent to which investor interest in Extended Stay will lead to the development of a trading market on the NYSE or otherwise or how active and liquid that market may come to be. If an active trading market does not develop, you may have difficulty selling any of the Shares that you buy. Negotiations between us and the underwriters will determine the initial public offering price for the shares, which may not be indicative of prices that will prevail in the open market following this offering. Consequently, you may not be able to sell Shares at prices equal to or greater than the price you paid in this offering. The market price of the Shares may be influenced by many factors including:

 

   

announcements of new hotels or services or significant price reductions by us or our competitors;

 

   

changes in tax law or interpretations thereof;

 

   

the failure of securities analysts to cover the Shares after this offering or changes in analysts’ financial estimates;

 

   

variations in quarterly results of operations;

 

   

default on ESH REIT’s indebtedness or foreclosure of our hotel properties;

 

   

economic, legal and regulatory factors unrelated to our performance;

 

   

increased competition;

 

   

future sales of the Shares or the perception that such sales may occur;

 

   

investor perceptions of us and the lodging industry;

 

   

events beyond our control, such as war, terrorist attacks, travel-related health concerns, transportation and fuel prices, travel-related accidents, natural disasters and severe weather; and

 

   

the other factors listed in this “Risk Factors” section.

As a result of these factors, investors in the Shares may not be able to resell their shares at or above the initial offering price. In addition, our stock price may be volatile. The stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of companies like us. Accordingly, these broad market and industry factors may significantly reduce the market price of the Shares, regardless of our operating performance.

You will incur immediate and substantial dilution in the net tangible book value of the Shares you purchase in this offering.

Prior investors have paid substantially less per Share for the Shares than the price in this offering. The initial public offering price of the Shares is substantially higher than the net tangible book value per share of our outstanding Shares prior to completion of the offering. Accordingly, based on an initial public offering price of $19.50 per Share (the mid-point of the range set forth on the cover page of this prospectus), if you purchase the Shares in this offering, you will pay more for your Shares than the amounts paid by our existing stockholders for their shares and you will suffer immediate dilution of approximately $13.86 per Share in net tangible book value of the Shares. See “Dilution.”

 

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Certain of our stockholders each beneficially own a substantial amount of the Shares and will continue to have substantial control over us after this offering and their interests may conflict with or differ from your interests as a stockholder.

When this offering is completed, affiliates of Centerbridge, Paulson and Blackstone will each beneficially own approximately 27.8% of the Shares (27.2%, if the underwriters’ option to purchase additional Shares is exercised in full), with no individual entity owning, actually or constructively, more than 9.8% as provided in the respective charters of the Company and ESH REIT, and we expect that we will be a “controlled company” within the meaning of the NYSE rules and ESH REIT will continue to be controlled by virtue of its ownership by the Company, regardless of the Sponsors’ ownership. In addition, four directors of the Company and three directors of ESH REIT will be designated by the Sponsors pursuant to a stockholders agreement between the Company, ESH REIT and the Sponsors to be entered into upon consummation of this offering. Further, the Sponsors will be entitled to consent rights on specified matters pursuant to the stockholders agreement. As a result, the Sponsors will be able to exert a significant degree of influence or actual control over our management and affairs and over matters requiring stockholder approval, including the election of directors, a merger, consolidation or sale of all or substantially all of our assets and other significant business or corporate transactions. These stockholders may have interests that are different from yours and may vote in a way with which you disagree and which may be adverse to your interests. In addition, this concentration of ownership could have the effect of delaying or preventing a change in control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which could cause the market price of the Shares to decline or prevent our stockholders from realizing a premium over the market price for their Shares.

Additionally, each of the Sponsors is in the business of making investments in companies and may acquire and hold, and in a few instances have acquired and held, interests in businesses that compete directly or indirectly with us. One or more of the Sponsors may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. The Company’s and ESH REIT’s charters will provide that none of the Sponsors, any of their affiliates or any director who is not employed by us (including any non-employee director who serves as one of our officers in both his director and officer capacities) or his or her affiliates will have any duty to refrain from engaging, directly or indirectly, in the same business activities or similar business activities or lines of business in which we operate.

As restrictions on resale end or if the Sponsors exercise their registration rights, a significant number of Shares could become eligible for resale following this offering. As a result, the market price of our stock could decline if the Sponsors sell their Shares or are perceived by the market as intending to sell them. See “—Future sales or the possibility of future sales of a substantial amount of the Shares may depress the price of Shares,” “Description of Our Capital Stock—Registration Rights Agreement” and “Shares Eligible for Future Sale.”

Future sales or the possibility of future sales of a substantial amount of the Shares may depress the price of the Shares.

Future sales or the availability for sale of substantial amounts of the Shares in the public market could adversely affect the prevailing market price of the Shares and could impair our ability to raise capital through future sales of equity securities.

The charters of the Company and ESH REIT authorize us to issue 3,500,000,000 Shares, of which 200,450,000 Shares will be outstanding upon consummation of this offering. This number includes 28,250,000 Shares that we are selling in this offering, which will be freely transferable without restriction or further registration under the Securities Act of 1933, as amended (the “Securities Act”). We expect that the remaining 172,200,000 Shares, including the Shares owned by certain of our existing stockholders and our executive officers and directors, will be restricted from immediate resale under the federal securities laws and the lock-up agreements between our current stockholders and the underwriters, but may be sold in the near future. See “Underwriting (Conflicts of Interest).” Following the expiration of the applicable lock-up period, all these Shares

 

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will be eligible for resale under Rule 144 or Rule 701 of the Securities Act, subject to volume limitations and applicable holding period requirements. In addition, the Sponsors will have the ability to cause us to register the resale of their shares. See “Shares Eligible for Future Sale” for a discussion of the Shares that may be sold into the public market in the future.

We may issue Shares or other securities from time to time as consideration for future acquisitions and investments. If any such acquisition or investment is significant, the number of Shares, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be substantial. We may also grant registration rights covering those Shares or other securities in connection with any such acquisitions and investments.

Following this offering, we intend to file a registration statement on Form S-8 covering up to 8,000,000 Shares in connection with our employee benefit plans.

We cannot predict the size of future issuances of the Shares or the effect, if any, that future issuances and sales of the Shares will have on the market price of the Shares. Sales of substantial amounts of the Shares (including Shares issued in connection with an acquisition), or the perception that such sales could occur, may adversely affect prevailing market prices for the Shares.

Under our equity incentive plans, the granting entity will need to compensate the non-granting entity for the issuance of its component share of the Shares.

The Extended Stay America, Inc. 2013 Long-Term Incentive Plan (“Company 2013 LTIP”) and the ESH Hospitality, Inc. 2013 Long-Term Incentive Plan (“ESH REIT 2013 LTIP,” each a “2013 LTIP”) contemplate grants of Shares to employees, officers and directors of the Company and ESH REIT (each a “Granting Entity”), as applicable. Each Granting Entity will make awards to eligible participants under its respective 2013 LTIP in respect of Shares, subject to the non-Granting Entity’s approval of the terms of each award made under the Granting Entity’s 2013 LTIP, and the non-Granting Entity’s agreement to issue its component of the Share (i.e., with respect to the Company, a share of common stock, and with respect to ESH REIT, a share of Class B common stock) to the grantee at the time of delivery of its component of the Share.

The Granting Entity will compensate the non-Granting Entity generally in cash for its issuance of its component of the Share for the fair market value at the time of issuance. In some cases, the applicable Granting Entity may have to pay more for a share of the non-Granting Entity than it would have otherwise paid at the time of grant as the result of an increase in the value of a Share between the time of grant and the time of exercise or settlement, which would result in additional expense for the Granting Entity. In addition, the Company may need to acquire additional shares of Class A common stock of ESH REIT at the time of issuance of the shares of Class B common stock of ESH REIT in order to maintain its 55% interest in ESH REIT.

As currently contemplated, under the 2013 LTIPs, a grant of RSUs will result in the recognition of total compensation expense equal to the grant date fair value of such grant. Compensation expense related to a grant is expected to be recognized on a straight-line basis over the requisite service period of each grant. However, as it relates to the Company’s financial statements, with respect to grants issued to directors of ESH REIT, such compensation expense is expected to be recognized on a mark-to-market basis each period rather than on a straight-line basis.

If securities analysts do not publish research or reports about Extended Stay, or if they issue unfavorable commentary about us or our industry or downgrade the Shares, the price of the Shares could decline.

The trading market for the Shares will depend in part on the research and reports that third-party securities analysts publish about Extended Stay and the lodging industry. One or more analysts could downgrade the Shares or issue other negative commentary about Extended Stay or our industry. In addition, we may be unable or slow to attract research coverage. Alternatively, if one or more of these analysts cease coverage of Extended Stay, we could lose visibility in the market. As a result of one or more of these factors, the trading price of the Shares could decline.

 

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Delaware law and our organizational documents may impede or discourage a takeover, which could deprive our stockholders of the opportunity to receive a premium for their shares.

The Company and ESH REIT are Delaware corporations, and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of us, even if a change of control would be beneficial to our existing stockholders. In addition, provisions of the Company’s and ESH REIT’s charters and bylaws may make it more difficult for, or prevent a third party from, acquiring control of us without the approval of our boards of directors. These provisions include, among others:

 

   

the ability of our boards of directors to designate one or more series of preferred stock and issue shares of preferred stock without stockholder approval;

 

   

actions by stockholders may not be taken by written consent, except that any action required or permitted to be taken by our stockholders may be effected by written consent until such time as the Sponsors cease to own 50% or more of the outstanding Shares;

 

   

the sole power of a majority of the boards of directors to fix the number of directors;

 

   

advance notice requirements for nominating directors or introducing other business to be conducted at stockholder meetings, provided that such notice will not be applicable to the Sponsors so long as they own at least 50% of the outstanding Shares; and

 

   

the limited ability of stockholders to call special meetings while the Sponsors own at least 50% of the outstanding Shares;

 

   

the affirmative supermajority vote of our stockholders to amend anti-takeover provisions in our charters and bylaws.

The foregoing factors, as well as the significant ownership of Shares by the Sponsors, and certain covenant restrictions under ESH REIT’s indebtedness could impede a merger, takeover or other business combination or discourage a potential investor from making a tender offer for the Shares, which, under certain circumstances, could reduce the market price of the Shares. See “Description of Our Capital Stock.”

The Company and ESH REIT may each issue shares of preferred stock in the future, which could make it difficult for another company to acquire us or could otherwise adversely affect holders of the Shares, which could depress the price of the Shares.

The Company has 21,202 shares of voting preferred stock outstanding. ESH REIT has 125 shares of 12.5% preferred stock outstanding. See “Description of Our Capital Stock.” In addition, the Company’s charter authorizes the Company to issue up to 350,000,000 shares of one or more additional series of preferred stock. ESH REIT’s charter authorizes ESH REIT to issue up to 350,000,000 shares of one or more additional series of preferred stock. The boards of directors of the Company and ESH REIT will have the authority to determine the preferences, limitations and relative rights of shares of preferred stock and to fix the number of shares constituting any series and the designation of such series, without any further vote or action by stockholders. Preferred stock could be issued with voting, liquidation, dividend and other rights superior to the rights of the Shares. The potential issuance of preferred stock may delay or prevent a change in control of us, discouraging bids for the Shares at a premium over the market price and adversely affect the market price and the voting and other rights of the holders of the Shares.

ESH REIT may be subject to adverse legislative or regulatory tax changes that could adversely affect the market price of the Shares.

At any time, the U.S. federal income tax laws governing REITs or the administrative interpretations of those laws may be amended. We cannot predict when or if any new U.S. federal income tax law, regulation, or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation, or

 

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interpretation may take effect retroactively. ESH REIT and holders of Class B common stock could be adversely affected by any such change in, or any new, U.S. federal income tax law, regulation or administrative interpretation, which could effectively eliminate our structure, and in turn, adversely affect the market price of the Shares.

There is a possibility that there will be amendments to or elimination of the pairing arrangement, which may, in turn, impact ESH REIT’s status as a REIT.

Each share of common stock of the Company is attached to and will trade together with the Class B common stock of ESH REIT. Under the Company’s and ESH REIT’s charters, each of the respective board of directors may modify or eliminate this pairing arrangement without the consent of its respective stockholders at any time if that board of directors no longer deems it in the best interests of the Company or ESH REIT, as the case may be, for their shares to continue to be attached and trade together. At this time, neither board has determined the circumstances under which the pairing arrangement would be terminated. However, circumstances that the respective board might consider in making such a determination may include, for example, the enactment of legislation that would significantly reduce or eliminate the benefits of our current structure. With respect to such determination, the respective board must fulfill at all times its respective fiduciary duties and, therefore, it is not possible to predict at this time the future circumstances under which the respective board would terminate the pairing arrangement. In addition, holders of Shares will have the option, by the vote of a majority of the Shares then outstanding, to eliminate the pairing arrangement in accordance with the respective charters of the Company and ESH REIT. The pairing arrangement will be automatically terminated upon bankruptcy of either of the Company or ESH REIT.

The Company and ESH REIT will each have the right, at their option and without the consent of the holders of the Shares, to acquire shares of Class B common stock of ESH REIT from the holders of such shares in exchange for cash, securities of the Company or ESH REIT, as the case may be, and/or any other property with a fair market value, as determined by a valuation firm or investment bank, at least equal to the fair market value of the Class B common stock of ESH REIT being exchanged. The Company and ESH REIT will each have the right, at their option and without the consent of the holders of the Shares, to acquire shares of the Company’s common stock from the holders of such shares in exchange for cash, securities of the Company or ESH REIT, as the case may be, and/or any other property with a fair market value, as determined by a valuation firm or investment bank, at least equal to the fair market value of the Company’s common stock being exchanged. Holders of the Shares could be subject to U.S. federal income tax on the exchange of shares of Class B common stock of ESH REIT or shares of common stock of the Company and may not receive cash to pay the tax from the Company or ESH REIT. See “Material United States Federal Income Tax Consequences—Taxation of Holders of Shares with Respect to ESH REIT Shares” and “Material United States Federal Income Tax Consequences—Taxation of Holders of Shares with Respect to Shares of Common Stock of the Company.”

After any such acquisition, shares of the Company’s common stock may be paired with shares of Class B common stock of ESH REIT in a different proportion, but such shares will continue to be attached and trade together. Further, the Company’s charter and ESH REIT’s charter will allow the respective boards of directors of the Company and ESH REIT to, in their sole discretion, issue unpaired shares of their capital stock. Trading in unpaired shares of the Company or ESH REIT may reduce the liquidity or value of the Shares. The Class A common stock of ESH REIT to be owned by the Company will also be freely transferable and if transferred, the transferee will hold unpaired shares of common stock of ESH REIT.

ESH REIT’s board of directors could terminate its status as a REIT, subjecting ESH REIT’s taxable income to U.S. federal income taxation, which would increase its liabilities for taxes.

Under ESH REIT’s charter, its board of directors may terminate its REIT status, without the consent of its stockholders, at any time if the board no longer deems it in the best interests of ESH REIT to continue to qualify under the Code as a REIT, subject to the stockholders’ consent rights described elsewhere in this prospectus.

 

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ESH REIT’s board of directors has not yet determined the circumstances under which ESH REIT’s status as a REIT would be terminated. However, circumstances that the board may consider in making such a determination may include, for example:

 

   

the enactment of new legislation that would significantly reduce or eliminate the benefits of being a REIT or having a paired share arrangement; or

 

   

ESH REIT no longer being able to satisfy the REIT requirements.

With respect to this determination, ESH REIT’s board must fulfill at all times its fiduciary duties and, therefore, it is not possible to predict at this time the future circumstances under which the board would terminate ESH REIT’s status as a REIT.

If ESH REIT’s status as REIT is terminated, its taxable income will be subject to U.S. federal income taxation (including any applicable alternative minimum tax) at regular corporate rates. If ESH REIT’s status was terminated and it was not entitled to relief under certain Code provisions, it would be unable to elect REIT status for the four taxable years following the year during which it ceased to so qualify.

We will be exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act.

We are in the process of evaluating our internal controls systems to allow management to report on, and our independent auditors to audit, our internal controls over financial reporting. We will be performing the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, and will be required to comply with Section 404 in full (including an auditor attestation on management’s internal controls report) in our annual reports on Form 10-K for the year ending December 31, 2014 (subject to any change in applicable SEC rules). Furthermore, upon completion of this process, we may identify control deficiencies of varying degrees of severity under applicable Securities and Exchange Commission (“SEC”) and Public Company Accounting Oversight Board (“PCAOB”) rules and regulations that remain unremediated. As a public company, we will be required to report, among other things, control deficiencies that constitute a “material weakness” or changes in internal controls that, or that are reasonably likely to, materially affect internal controls over financial reporting. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. A “significant deficiency” is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of our financial reporting.

If we fail to implement the requirements of Section 404 in a timely manner, regulatory authorities such as the SEC or the PCAOB might subject us to sanctions or investigation. If we do not implement improvements to our disclosure controls and procedures or to our internal controls in a timely manner, our independent registered public accounting firm may not be able to certify as to the effectiveness of our internal controls over financial reporting pursuant to an audit of our controls. This may subject us to adverse regulatory consequences or a loss of confidence in the reliability of our financial statements. We could also suffer a loss of confidence in the reliability of our financial statements if we or our independent registered public accounting firm reports a material weakness in our internal controls, if we do not develop and maintain effective controls and procedures or if we are otherwise unable to deliver timely and reliable financial information. Any loss of confidence in the reliability of our financial statements or other negative reaction to our failure to develop timely or adequate disclosure controls and procedures or internal controls could result in a decline in the price of the Shares. In addition, if we fail to remedy any material weakness, our financial statements may be inaccurate, we may face restricted access to the capital markets and the trading price of the Shares may be adversely affected. In the past, our auditors identified certain matters involving our internal controls over financial reporting that constituted

 

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“material weaknesses,” which have been remediated. In connection with the audit of our 2012 financial statements our auditors identified several “significant deficiencies,” and in connection with the preparation of our results for the period ended September 30, 2013, we identified an additional “significant deficiency.”

The requirements of being a public company, including compliance with the reporting requirements of the Exchange Act and the requirements of the Sarbanes-Oxley Act and the NYSE, may strain our resources, increase our costs and divert management’s attention, and we may be unable to comply with these requirements in a timely or cost-effective manner.

As a public company, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the corporate governance standards of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act and the NYSE. These requirements will place a strain on our management, systems and resources. The Exchange Act will require us to file annual, quarterly and current reports with respect to our business and financial condition within specified time periods and to prepare proxy statements with respect to the annual meetings of stockholders of the Company and ESH REIT. The Sarbanes-Oxley Act will require that we maintain effective disclosure controls and procedures and internal controls over financial reporting. The NYSE will require that we comply with various corporate governance requirements. To maintain and improve the effectiveness of our disclosure controls and procedures and internal controls over financial reporting and comply with the Exchange Act and NYSE requirements, significant resources and management oversight will be required. This may divert management’s attention from other business concerns and lead to significant costs associated with compliance, which could have a material adverse effect on us and the price of the Shares.

We also expect that it could be difficult and will be significantly more expensive to obtain directors’ and officers’ liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our boards of directors or as executive officers. Advocacy efforts by stockholders and third parties may also prompt even more changes in governance and reporting requirements. We cannot predict or estimate the amount of additional costs we may incur or the timing of these costs.

We are a “controlled company” within the meaning of the NYSE rules and, as a result, will qualify for, and may rely on, exemptions from certain corporate governance requirements.

A company of which more than 50% of the voting power is held by an individual, a group or another company is a “controlled company” within the meaning of the NYSE rules and may elect not to comply with certain corporate governance requirements of the NYSE, including:

 

   

the requirement that a majority of the boards of directors of the Company and ESH REIT consist of independent directors;

 

   

the requirement that each of the Company and ESH REIT have a nominating/corporate governance committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and

 

   

the requirement that each of the Company and ESH REIT have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities.

Following this offering, we will rely on all of the exemptions listed above. Accordingly, you will not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the NYSE.

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains “forward-looking statements” within the meaning of the federal securities laws. All statements other than statements of historical facts included in this prospectus may be forward-looking. Statements herein regarding the Pre-IPO Transactions, the expected benefits of the Pre-IPO Transactions and our ongoing hotel reinvestment program, our ability to meet ESH REIT’s debt service obligations, our future capital expenditures, our distribution strategy, our plans, objectives, goals, beliefs, business strategies, future events, business conditions, results of operations, financial position and our business outlook, business trends and other information referred to under “Prospectus Summary,” “Risk Factors,” “Company Distribution Policy,” “ESH REIT Distribution Policy,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” are forward-looking statements. When used in this prospectus, the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “will,” “look forward to” and variations of such words or similar expressions are intended to identify forward-looking statements. The forward-looking statements are not historical facts, and are based upon our current expectations, beliefs, estimates and projections, and various assumptions, many of which, by their nature, are inherently uncertain and beyond our control. Our expectations, beliefs, estimates and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that management’s expectations, beliefs, estimates and projections will result or be achieved and actual results may vary materially from what is expressed in or indicated by the forward-looking statements.

There are a number of risks, uncertainties and other important factors, many of which are beyond our control, that could cause our actual results to differ materially from the forward-looking statements contained in this prospectus. Such risks, uncertainties and other important factors include, but are not limited to:

 

   

changes in U.S. general and local economic activity and the impact of these changes on consumer demand for lodging and related services in general and for extended stay lodging in particular;

 

   

levels of spending in the business, travel and leisure industries, as well as consumer confidence;

 

   

increased competition and the over-building of hotels in our markets;

 

   

incidents or adverse publicity concerning our hotels or other extended stay hotels;

 

   

our ability to implement our business strategies profitably;

 

   

declines in occupancy and average daily rate;

 

   

our ability to retain the services of certain members of our management;

 

   

the ability of ESH REIT to qualify, and remain qualified, as a REIT under the Code;

 

   

actual or constructive ownership (including deemed ownership by virtue of certain attribution provisions under the Code) of Shares by investors who we do not control may cause ESH REIT to fail to meet the REIT income tests;

 

   

the availability of capital for renovations and future acquisitions;

 

   

the high fixed cost of hotel operations;

 

   

the seasonal and cyclical nature of the real estate and lodging businesses;

 

   

interruptions in transportation systems, which may result in reduced business or leisure travel;

 

   

events beyond our control, such as war, terrorist attacks, travel-related health concerns and natural disasters;

 

   

changes in distribution arrangements, such as through internet travel intermediaries;

 

   

our ability to keep pace with improvements in technology utilized for reservations systems and other operating systems;

 

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decreases in brand loyalty due to increasing use of internet reservation channels;

 

   

fluctuations in the supply and demand for hotel rooms;

 

   

changes in the tastes and preferences of our customers;

 

   

our ability to integrate and successfully operate any hotel properties acquired in the future and the risks associated with these hotel properties;

 

   

changes in federal, state or local tax law, including legislative, administrative, regulatory or other actions affecting REITs;

 

   

the cost of compliance with and liabilities under environmental, health and safety laws;

 

   

changes in real estate and zoning laws and increases in real property tax rates;

 

   

increases in interest rates and operating costs;

 

   

ESH REIT’s substantial indebtedness;

 

   

inadequate insurance coverage;

 

   

adverse litigation judgments or settlements; and

 

   

the Sponsors’ control of us.

There may be other factors that may cause our actual results to differ materially from the forward-looking statements, including factors disclosed under the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this prospectus. You should evaluate all forward-looking statements made in this prospectus in the context of these risks and uncertainties.

We caution you that the risks, uncertainties and other factors referenced above may not contain all of the risks, uncertainties and other factors that are important to you. In addition, we cannot assure you that we will realize the results, benefits or developments that we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our business in the way expected. All forward-looking statements in this prospectus apply only as of the date made and are expressly qualified in their entirety by the cautionary statements included in this prospectus. We undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances, except as required by law.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds of approximately $509.0 million from the sale of 28,250,000 Shares in this offering, based on the assumed initial public offering price of $19.50 per Share, which is the mid-point of the range set forth on the cover page of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. The proceeds will be divided among the Company and ESH REIT based on their estimated valuations. The Company will use the majority of the proceeds it receives to purchase Class A common stock of ESH REIT to maintain its ownership of 55% of the outstanding common stock of ESH REIT. The Company will use any remaining balance, which it estimates will be approximately $21.5 million, for general corporate purposes. ESH REIT intends to use the net proceeds from this offering and the sale of Class A common stock to the Company and cash on hand to repay indebtedness under ESH REIT’s 2012 Mezzanine Loans and assumed mortgage loan, as described below. Our management will have broad discretion over the uses of the net proceeds in this offering.

ESH REIT intends to use the proceeds received by it from this offering to repay approximately $224.8 million of its Mezzanine A Loan, $148.4 million of its Mezzanine B Loan, $112.4 million of its Mezzanine C Loan and $5.6 million of its assumed mortgage loan. As of June 30, 2013, the Mezzanine A Loan had a fixed interest rate per annum of approximately 8.3%, a total balance of $500.0 million and a maturity date of December 1, 2019. As of June 30, 2013, the Mezzanine B Loan had a fixed interest rate per annum of approximately 9.6%, a total balance of $330.0 million and a maturity date of December 1, 2019. As of June 30, 2013, the Mezzanine C Loan had a fixed interest rate per annum of approximately 11.5%, a total balance of $250.0 million and a maturity date of December 1, 2019. The borrowings under the 2012 Mezzanine Loans which will be repaid originated in the November 2012 refinancing of ESH REIT’s then existing 2010 Mezzanine Loans. Interest on the assumed mortgage loan is payable monthly on the first day of the calendar month at a rate equal to greater of the sum of the daily LIBOR plus 4.0% or 5.0%. As of June 30, 2013, the assumed mortgage loan had a total balance of approximately $5.6 million and a maturity date of October 8, 2014. See “Description of Certain Indebtedness—Mezzanine Loans.”

A $1.00 increase (decrease) in the assumed initial public offering price of $19.50 per Share, based on the mid-point of the range set forth on the cover page of this prospectus, would increase (decrease) the net proceeds to us from this offering by $25.9 million, assuming the number of Shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. An increase (decrease) of 1,000,000 Shares in the number of Shares offered by us would increase (decrease) the net proceeds to us from this offering by $17.8 million, assuming the assumed initial public offering price of $19.50 per Share, which is the mid-point of the price range set forth on the cover page of this prospectus, remains the same and after the underwriting deducting discounts and commissions and estimated offering expenses payable by us. Upon any increase or decrease in the net proceeds from this offering, ESH REIT intends to increase or decrease the amounts of its 2012 Mezzanine Loans to be repaid in the same proportion as indicated above.

We have granted the underwriters a 30-day option to purchase up to 4,237,500 additional Shares solely to cover over-allotments. The Company will use the majority of the proceeds it receives from the issuance and sale of Shares pursuant to any exercise of the underwriter’s option to purchase additional Shares to purchase Class A common stock of ESH REIT to maintain its ownership of 55% of the outstanding common stock of ESH REIT. The Company will use any remaining balance, which it estimates will be approximately $3.3 million if the over-allotment option is exercised in full, for general corporate purposes. ESH REIT intends to use the net proceeds from the issuance and sale of Shares pursuant to any exercise of the underwriter’s option to purchase additional Shares, which it estimates will be approximately $74.6 million based on the assumed initial public offering price of $19.50 per Share, if exercised in full, after deducting the underwriting discounts and commissions payable by us, and the proceeds from the sale of Class A common stock to the Company and cash on hand to repay an additional $31.6 million of its Mezzanine A Loan, $20.9 million of its Mezzanine B Loan and $15.8 million of its Mezzanine C Loan.

 

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COMPANY DISTRIBUTION POLICY

The payment of any distributions will be at the discretion of the Company’s board of directors. Any such distributions will be made subject to the Company’s compliance with applicable law and will depend on, among other things, the receipt by the Company of dividends from ESH REIT in respect of the Class A common stock, the Company’s results of operations and financial condition, the Company’s level of indebtedness, capital requirements, capital contributions to ESH REIT, contractual restrictions, restrictions in any existing or future debt agreements of the Company or ESH REIT and in any preferred stock and other factors that the Company’s board of directors may deem relevant.

The Company’s ability to pay dividends will depend on its receipt of cash dividends from ESH REIT, which may further restrict its ability to pay distributions. In particular, ESH REIT’s ability to pay distributions is restricted by the terms of its indebtedness. In cases in which the terms of any of the Company’s or ESH REIT’s existing or future indebtedness bars the payment of cash dividends, ESH REIT may declare and pay taxable stock dividends to maintain its REIT status. See “Description of Certain Indebtedness” for a description of the restrictions on the Company’s and ESH REIT’s ability to pay distributions.

See “Material United States Federal Income Tax Considerations” for a discussion of the tax treatment of distributions made by the Company to its stockholders.

 

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ESH REIT DISTRIBUTION POLICY

ESH REIT intends to make regular quarterly cash distributions to its stockholders (including the Company), as more fully described below. To qualify as a REIT, ESH REIT must distribute annually to its stockholders an amount at least equal to:

 

   

90% of its REIT taxable income, computed without regard to the deduction for dividends paid and excluding any net capital gain; plus

 

   

90% of the excess of its net income, if any, from foreclosure property over the tax imposed on such income by the Code; less

 

   

the sum of certain items of non-cash income that exceeds a percentage of ESH REIT’s income.

ESH REIT will be subject to income tax on its taxable income that is not distributed and to an excise tax to the extent that certain percentages of its taxable income are not distributed by specified dates. ESH REIT generally expects to distribute approximately 95% of its REIT taxable income. ESH REIT will be subject to U.S. federal corporate income tax on its undistributed REIT taxable income and net capital gain and may be subject to U.S. federal excise tax. See “Material United States Federal Income Tax Considerations.” Income as computed for purposes of the forgoing tax rules will not necessarily correspond to ESH REIT’s income before income taxes as determined under GAAP for financial reporting purposes.

ESH REIT’s distributions will be authorized by the ESH REIT board of directors and declared based on a variety of factors, including:

 

   

actual results of operations;

 

   

ESH REIT’s debt service requirements;

 

   

capital expenditure requirements for its hotel properties;

 

   

ESH REIT’s taxable income;

 

   

the annual distribution requirement under the REIT provisions of the Code;

 

   

contractual restrictions;

 

   

restrictions in any current or future debt agreements and in any preferred stock;

 

   

ESH REIT’s operating expenses; and

 

   

other factors that ESH REIT’s board of directors may deem relevant.

Class A common stock and Class B common stock are entitled to any dividends that ESH REIT’s board of directors may declare. Each share of Class A and Class B common stock will be entitled to the same amount of dividends per share, except that, in cases in which the terms of any of the Company’s or ESH REIT’s existing or future indebtedness bars the payment of cash dividends, ESH REIT may declare and pay taxable stock dividends in respect of the Class A common stock that differ from dividends paid in respect of the Class B common stock in order to maintain its REIT status. Accordingly, 55% of ESH REIT’s dividends will be paid to the Company on account of the Class A common stock. See “Description of Our Capital Stock.”

See “Material United States Federal Income Tax Considerations” for a discussion of the tax treatment of distributions made by ESH REIT to its stockholders.

ESH REIT’s ability to pay distributions is restricted by the terms of its indebtedness. In cases in which the terms of any of the Company’s or ESH REIT’s existing or future indebtedness bars the payment of cash dividends, ESH REIT may declare and pay taxable stock dividends in order to maintain its REIT status. See “Description of Certain Indebtedness” for a description of the restrictions on ESH REIT’s ability to pay distributions. In cases where ESH REIT distributes additional shares of its Class B common stock to the holders of its Class B common stock, the Company may correspondingly distribute a number of additional shares of its common stock, which together with the shares of Class B common stock distributed by ESH REIT will form Shares.

 

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Expected Distributions

We intend to make a pro rata distribution with respect to the period commencing upon completion of this offering and ending on December 31, 2013, based on a distribution of $0.15 per Share for a full quarter. On an annualized basis, this would be $0.60 per Share, or an annualized distribution rate of approximately 3.1% based on the assumed initial public offering price of $19.50 per Share, the mid-point of the price range.

We estimate that this initial annual distribution rate will represent approximately 89.3% of our consolidated cash available for distribution to our shareholders for the 12-month period ending June 30, 2014, after giving effect to ESH REIT’s distribution of its estimated cash available for distribution. Our intended initial annual distribution rate has been established based on our estimates of cash available for distribution for the 12-month period ending June 30, 2014, which we have calculated based on adjustments to ESH REIT’s and the Company’s pro forma net income for the 12-month period ended June 30, 2013. These estimates are based on ESH REIT’s and the Company’s respective pro forma operating results and do not take into account benefits from market improvements or our business and growth strategies, including our hotel reinvestment program, nor do they take into account any unanticipated expenditures we may have to make or any financings for such expenditures. In estimating ESH REIT’s and the Company’s cash available for distribution for the 12-month period ending June 30, 2014, we have made certain assumptions as reflected in the table and footnotes below.

Our estimates of cash available for distribution do not include the effect of any changes in our working capital. Our estimates also do not reflect the amount of cash to be used for investing activities for acquisitions and other activities, other than recurring capital expenditures. These estimates also do not reflect the amount of cash estimated to be used for financing activities. Any such investing and/or financing activities may have a material adverse effect on our estimates of cash available for distribution. Because we have made the assumptions set forth above in estimating cash available for distribution, we do not intend these estimates to be a projection or forecast of our actual results of operations, net income, Adjusted EBITDA, liquidity or financial condition and have estimated cash available for distribution for the sole purpose of determining our estimated initial annual distribution amount. Our estimates of cash available for distribution should not be considered as an alternative to cash flow from operating activities (computed in accordance with GAAP) or as an indicator of our liquidity or our ability to make distributions. In addition, the methodology upon which we made the adjustments described below is not necessarily intended to be a basis for determining future distributions.

We intend to maintain our initial distribution rate for the 12-month period following completion of this offering unless our results of operations, net income, Adjusted EBITDA, liquidity, cash flows, financial condition or prospects, economic conditions or other factors differ materially from the assumptions used in projecting our initial distribution rate. We believe that our estimates of cash available for distribution constitute a reasonable basis for setting the initial distribution rate, as substantially all of the hotels in our portfolio have been in operation for a significant period of time, and our estimates do not give effect to the internal growth we expect to generate if the lodging industry continues to recover or benefits we expect to realize from our business and growth strategies, including our hotel reinvestment program. However, we cannot assure you that our estimates will prove accurate, and actual distributions may therefore be significantly below the expected distributions. Our actual results of operations will be affected by a number of factors, including the revenue received from our hotels, our operating expenses, interest expense (including the effect of interest rates on variable rate debt) and other capital expenditures. We may, from time to time, be required, or elect, to borrow under ESH REIT’s anticipated revolving credit facility or otherwise to pay distributions.

We cannot assure you that our estimated distributions will be made or sustained or that ESH REIT’s or the Company’s boards of directors will not change their respective distribution policies in the future. Any distributions will be at the sole discretion of ESH REIT’s and the Company’s respective boards of directors, and their form, timing and amount, if any, will depend upon a number of factors, including ESH REIT’s and the Company’s actual and projected results of operations, net income, Adjusted EBITDA, liquidity, cash flows and financial condition, the revenue we actually receive from our hotels, our operating expenses, our debt service

 

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requirements, our capital expenditures, prohibitions and other limitations under our financing arrangements, our REIT taxable income, the annual REIT distribution requirements, applicable law and such other factors as ESH REIT’s and the Company’s respective boards of directors deem relevant.

ESH REIT’s and the Company’s boards of directors are independent of one another and owe separate fiduciary duties to ESH REIT and the Company. Each board of directors will separately determine the form, timing and amount of any distributions to be paid by the respective entities for any period. In the event distributions in respect of the Class B common stock of ESH REIT are not sufficient to meet our expected distributions, the expected distributions may be completed through distributions in respect of the common stock of the Company using funds distributed to the Company in respect of the Class A common stock of ESH REIT, after payment of tax on those funds. We may also be required either to fund distributions from working capital, borrow or raise equity, or to reduce such distributions. In addition, any preferred stock, such as the voting preferred stock, could have a preference on distributions. For a description of the Company’s distribution policy, see “Company Distribution Policy.” For more information regarding risk factors that could materially and adversely affect ESH REIT and the Company, please see “Risk Factors.”

The following table sets forth calculations relating to the intended initial distribution based on ESH REIT’s and the Company’s pro forma financial data, and we cannot assure you that the intended initial distribution will be made or sustained. The calculations are being made solely for the purpose of illustrating the initial distribution and are not necessarily intended to be a basis for determining future distributions. The calculations include the following material assumptions:

 

   

income and cash flows from operations for the twelve months ending June 30, 2014 will be substantially the same as pro forma income and cash flows from operations for the twelve months ended June 30, 2013; and

 

   

cash flows used in investing activities for the twelve months ending June 30, 2014 will be substantially the same as recurring capital expenditures for the twelve months ended June 30, 2013.

 

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These calculations do not assume any changes to our operations or any acquisitions or dispositions (or any transaction and pursuit costs related thereto) other than recurring capital expenditures, which would affect our cash flows, or changes in our outstanding Shares. We cannot assure you that our actual results will be as indicated in the calculations below. All dollar amounts are in thousands.

 

ESH Hospitality, Inc.   

Pro forma net income for twelve months ended December 31, 2012

   $ 57,528   

Less: Pro forma net income for the six months ended June 30, 2012

     (29,199

Add: Pro forma net income for the six months ended June 30, 2013

     12,286   
  

 

 

 

Pro forma net income for twelve months ended June 30, 2013

     40,615   

Add: Depreciation and amortization

     148,544   

Add: Acquisition transaction expenses (1)

     1,785   

Add: Impairment of long-lived assets

     2,808   

Add: Non-cash portion of debt extinguishment costs (2)

     29,141   
  

 

 

 

Estimated cash flows from operating activities for the twelve months ending June 30, 2014

     222,893   

Less: Estimated cash flows used in investing activities - recurring capital expenditures (3)

     (53,057

Less: Preferred stock dividends

     (1,696
  

 

 

 

Estimated cash available for distribution for the twelve months ending June 30, 2014

     168,140   

Estimated initial annual distribution on ESH REIT Class A common stock (4)

     92,477   

Estimated initial annual distribution on ESH REIT Class B common stock (5)

     75,663   
  

 

 

 

Total estimated initial annual distribution on ESH REIT common stock

     168,140   

Ratio of intended initial distribution to estimated cash available for distribution (6)

     100.0
Extended Stay America, Inc. (7)   

Pro forma net loss for twelve months ended December 31, 2012

   $ (2,796

Less: Pro forma net loss for the six months ended June 30, 2012

     4,862   

Add: Pro forma net income for the six months ended June 30, 2013

     697   
  

 

 

 

Pro forma net income for the twelve months ended June 30, 2013

     2,763   

Add: Depreciation and amortization

     3,391   
  

 

 

 

Estimated cash flows from operating activities for the twelve months ending June 30, 2014

     6,154   

Less: Estimated cash flows used in investing activities - recurring capital expenditures (8)

     (3,000
  

 

 

 

Net cash flow from the Company for the twelve months ending June 30, 2014

     3,154   

Add: Distribution on ESH REIT Class A common stock (4)

     92,477   

Less: Income tax on distribution (9)

     (36,621
  

 

 

 

Estimated cash available for distribution for the twelve months ending June 30, 2014

     59,010   
Consolidated   

Estimated initial annual distribution to holders of Class B common stock based on ESH REIT’s estimated cash available for distribution for the twelve months ending June 30, 2014 (5)

     75,663   

Estimated cash available for distribution from the Company for the twelve months ending June 30, 2014

     59,010   
  

 

 

 

Estimated cash available for distribution – consolidated

     134,673   

Total estimated initial annual distribution in respect of Shares (6)(10)

     120,270   

Ratio of intended initial distribution to estimated cash available for distribution – consolidated

     89.3

 

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(1) Represents transaction costs related to the acquisition of 17 hotels from HFI Acquisitions Company, LLC in December 2012.

 

(2) Represents non-cash write-off of deferred financing costs associated with ESH REIT’s November 2012 debt refinancing.

 

(3) Represents (a) estimated amount of reserves required to be funded in the 12-month period ending June 30, 2014 pursuant to management and loan agreements, as applicable, which is 4.0% of room and other hotel revenues, and is calculated based on room and other hotel revenues for the twelve months ended June 30, 2013, and (b) $10.0 million of recurring capital expenditures for information technology and other projects. We intend to finance additional capital expenditures related to property renovation projects from cash on hand, cash flow from operations and/or borrowings under our revolving credit facilities. We also may choose to delay such capital expenditures.

For a discussion of our historical capital expenditures and our anticipated future capital expenditures, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Expenditures.”

 

(4) Reflects 55% of ESH REIT’s estimated cash available for distribution payable in respect of the Class A common stock.

 

(5) Reflects 45% of ESH REIT’s estimated cash available for distribution payable in respect of the Class B common stock.

 

(6) We expect to pay the anticipated quarterly distribution of $0.15, or $0.60 annually, per Share to our shareholders principally from cash flow generated by ESH REIT. In the event distributions in respect of the Class B common stock of ESH REIT are not sufficient to meet our expected distributions, the expected distributions may be completed through distributions in respect of the common stock of the Company using funds distributed to the Company in respect of the Class A common stock of ESH REIT, after payment of tax on those funds. Alternatively, the remaining amount of the anticipated annual distribution may be paid by ESH REIT through borrowings on the ESH REIT revolving credit facility. See “Material United States Federal Income Tax Considerations” for a discussion of the tax treatment of distributions made by the Company to its stockholders.

The payment of any distributions by the Company will be independently determined at the discretion of the Company’s board of directors and will depend upon a number of factors. See “Company Distribution Policy.”

 

(7) Calculated based on net income and cash flows for the Company on a standalone basis, excluding its ownership interest in and/or the consolidation of ESH REIT.

 

(8) Represents $3.0 million of recurring capital expenditures for furniture, fixtures and equipment.

 

(9) Assumes blended federal and state tax rate of 39.6%.

 

(10) Excludes Shares that may be issued upon exercise of the underwriters’ over-allotment option. Estimated cash available for distribution – consolidated gives effect to the Company paying the additional $44.6 million anticipated distribution on the Shares through distributions on the Company’s common stock. The payment of any distributions by the Company will be independently determined at the discretion of the Company’s board of directors and will depend upon a number of factors. See “Company Distribution Policy.”

 

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CAPITALIZATION

The following table sets forth our consolidated cash and cash equivalents and restricted cash and our consolidated capitalization as of June 30, 2013:

 

   

on a historical consolidated and combined basis for the Successor; and

 

   

on a pro forma consolidated basis for Extended Stay to reflect the pro forma adjustments described in “Unaudited Pro Forma Condensed Consolidated Financial Statements of the Company” including (i) the Pre-IPO Transactions, (ii) the issuance of 28,250,000 Shares in this offering and (iii) the application of proceeds from the offering as described in “Use of Proceeds.”

You should read this table in conjunction with “Pre-IPO Transactions,” “Unaudited Pro Forma Condensed Consolidated Financial Statements of the Company,” “Selected Historical Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes included elsewhere in this prospectus.

 

     As of June 30, 2013  
     Historical     Pro Forma(1)  
     (Dollars in millions)  

Cash and cash equivalents(1)

   $ 105.0      $ 105.0   
  

 

 

   

 

 

 

Restricted cash(2)

   $ 154.8      $ 154.8   
  

 

 

   

 

 

 

Total debt(3)

   $ 3,605.6      $ 3,114.4 (4) 
  

 

 

   

 

 

 

Redeemable preferred stock(5)

     —          21.2   
  

 

 

   

 

 

 

Equity:

    

Noncontrolling interests(6)

     1.9        515.4 (4) 

Successor equity(7)

     747.3        —     

Company Common Stock, $0.01 par value per share, no shares authorized, no shares issued and outstanding on a historical basis; 3,500,000,000 shares authorized, 200,450,000 shares issued and outstanding on a pro forma basis(8)

     —          2.0   

Additional paid-in capital

     —          773.7 (4) 

Retained earnings

     56.0        (10.3 )(4) 

Accumulated other comprehensive loss

     (0.2     (0.2
  

 

 

   

 

 

 

Total equity

     805.0        1,280.6 (4) 
  

 

 

   

 

 

 

Total capitalization

   $ 4,410.6      $ 4,416.2   
  

 

 

   

 

 

 

 

(1) In August 2013, ESH REIT paid a regular REIT distribution with respect to the second quarter of $18.4 million to its current owners. Subsequent to September 30, 2013 and prior to the completion of the Pre-IPO Transactions and this offering, ESH REIT expects to make a regular REIT distribution with respect to the third quarter of approximately $60.0 million to its current owners.
(2) Restricted cash consists of amounts held in cash management and escrow accounts associated with ESH REIT’s debt financing.
(3) As of June 30, 2013, we had availability of $87.4 million under ESH REIT’s Revolving Credit Facility and $12.6 million letters of credit outstanding. The Revolving Credit Facility will terminate upon the consummation of this offering. The Company and ESH REIT expect to enter into new revolving credit facilities concurrently with the consummation of this offering. See “Description of Certain Indebtedness—Company Revolving Credit Facility” and “Description of Certain Indebtedness—ESH REIT Revolving Credit Facility.”
(4)

Each $1.00 increase (decrease) in the assumed initial public offering price of $19.50, based on the mid-point of the range set forth on the cover page of this prospectus, would decrease (increase) total debt, on a pro forma basis, by approximately $25.9 million (assuming net proceeds of at least $270 million) and increase

 

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  (decrease) total equity, on a pro forma basis, by $25.9 million, in each case assuming the number of Shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

Each increase (decrease) of 1,000,000 Shares in the number of Shares offered by us would decrease (increase) total debt, on a pro forma basis, by approximately $17.8 million (assuming net proceeds of at least $270 million) and increase (decrease) total equity, on a pro forma basis, by $17.8 million, in each case assuming the assumed initial public offering price of $19.50 per Share, which is the mid-point of the price range set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

(5) On a pro forma basis, includes shares of redeemable Company preferred stock, $1,000 per share stated value, 350,000,000 shares authorized, 21,202 shares issued and outstanding.
(6) On a pro forma basis, includes the Class B common stock of ESH REIT, which represents 45% of ESH REIT’s common equity, and 125 shares of preferred stock of ESH REIT.
(7) On a historical basis, includes 1,000 common units of ESH REIT, 125 preferred units of ESH REIT and 100,000 common units of ESH Strategies.
(8) Pro forma issued and outstanding Company common stock includes (i) the issuance of 172,200,000 shares of Company common stock in connection with the Pre-IPO Transactions and (ii) 28,250,000 shares of Company common stock, par value $0.01 per share, sold in this offering. The shares of Company common stock are paired with the Class B common stock of ESH REIT and form the Shares.

The number of shares of Company common stock outstanding on a pro forma basis as of June 30, 2013 assumes no exercise of the underwriters’ option to purchase additional Shares from us solely to cover over-allotments.

 

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PRE-IPO TRANSACTIONS

Holdings owns all of ESH REIT’s outstanding common units. The Sponsors own an approximately 99% interest in Holdings and the remaining interests are owned by certain present and former members of the board of managers of Holdings and employees of HVM. The Operating Lessees are each taxable REIT subsidiaries that lease the hotel properties from ESH REIT pursuant to operating leases. HVM is an eligible independent contractor, within the meaning of Section 856(d)(9) of the Code, that manages the hotel properties pursuant to management agreements with the Operating Lessees. Subsidiaries of ESH Strategies own the trademarks and license their use to the Operating Lessees pursuant to trademark license agreements.

The Company is a newly formed entity, formed for the purpose of effecting the Pre-IPO Transactions, and has engaged in no business or activities other than in connection with the Pre-IPO Transactions.

The Pre-IPO Transactions contemplate that the existing business will be restructured and reorganized such that Holdings will liquidate and distribute to the Sponsors substantially all of the common stock of ESH REIT; the Company will acquire the Operating Lessees, ESH Strategies and the operations of HVM; the shareholders of ESH REIT will transfer to the Company all of the Class A common stock of ESH REIT; and 100% of the common stock of the Company and all of the Class B common stock of ESH REIT will be paired, forming the Shares offered pursuant to this prospectus. The Pre-IPO Transactions contemplate the series of transactions described below, which, other than the Company’s acquisition of ESH Strategies, which will occur prior to the completion of this offering, are expected to occur at various times prior to the effective time of this offering as follows:

 

   

ESH REIT will be converted into a Delaware corporation with a single class of common stock.

 

   

Holdings will liquidate. In the initial liquidating distribution, the Sponsors will receive approximately 99% of the common stock of ESH REIT. After the initial liquidating distribution, the common stock of ESH REIT will be recapitalized into two classes of common stock: Class A common stock and Class B common stock. See “Description of Our Capital Stock.” Following the initial liquidating distribution, no person will hold (actually or constructively by virtue of certain attribution provisions of the Code) more than 9.8% of the outstanding shares of any class or series of stock of ESH REIT.

 

   

The Sponsors will acquire the Company.

 

   

Newly-formed Delaware limited liability companies wholly-owned by the Company (the “New Operating Lessees”) will acquire the Operating Lessees. In connection with the Company’s acquisition of the Operating Lessees, the operating leases will be renegotiated to reflect current fair market value terms.

 

   

A newly-formed Delaware limited liability company wholly-owned by the Company (“New HVM”) will acquire all of the assets of HVM and assume all of the liabilities of HVM. The existing management agreements with the Operating Lessees will be terminated and New HVM will enter into replacement management agreements with the Operating Lessees that are substantially the same as the existing management agreements.

 

   

The shareholders of ESH REIT (Holdings and the former holders of interests in Holdings) will contribute the Class A common stock of ESH REIT (representing 55% of the outstanding common stock of ESH REIT) to the Company in exchange for common stock of the Company. The Class B common stock of ESH REIT will be stapled to the common stock of the Company.

 

   

The Company will acquire all of the interests in ESH Strategies in exchange for preferred stock of the Company. This acquisition will occur after the effective time of this offering but prior to the consummation of this offering.

 

   

Holdings will distribute its remaining Shares in liquidation.

 

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Following the Pre-IPO Transactions, the Company, through its direct wholly-owned subsidiaries, will lease the hotel properties from ESH REIT, will own the trademarks related to the business and will self-manage the hotel properties. In addition, the Company will own all of the Class A common stock of ESH REIT, which will represent 55% of the outstanding common stock of ESH REIT. The Company will use the majority of the proceeds it receives in this offering, and may use proceeds it receives in any future offerings, to purchase additional shares of Class A common stock of ESH REIT as may be necessary to ensure that the Class A common stock of ESH REIT owned by the Company represents 55% of the outstanding common stock of ESH REIT.

We believe that our business following the Pre-IPO Transactions will be more operationally efficient because all of the assets and operations of our business, other than ownership of the hotel properties, will be housed in one publicly traded entity. Ownership of Shares will give investors an ownership interest in our hotel properties through ESH REIT and in the operation of our business through the Company. We expect that the Pre-IPO Transactions will facilitate growth of our business and permit us to offer equity-based compensation that will permit us to attract and retain top management talent. Finally, the structure permits us to retain some, though not all, of the REIT benefits of our prior structure (e.g., while ESH REIT should continue to be taxed as a REIT for U.S. federal income tax purposes, all dividends paid by ESH REIT to the Company will be subject to the corporate level tax, effectively eliminating a majority of the tax benefit of REIT status for the combined companies taken as a whole).

Except where otherwise expressly indicated or the context otherwise requires, this prospectus reflects the completion of the Pre-IPO Transactions.

 

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DILUTION

If you invest in the Shares, your interest will be diluted to the extent of the difference between the initial public offering price per share of the Shares and the net tangible book value per share of the Shares after this offering. Dilution results from the fact that the initial public offering price per Share is substantially in excess of the net tangible book value per Share attributable to the existing stockholders for our presently outstanding Shares. We calculate net tangible book value per Share by dividing the net tangible book value (total consolidated tangible assets less total consolidated liabilities) by the number of outstanding Shares.

Our historical net tangible book value as of June 30, 2013 was $638.7 million, or $3.71 per Share, based on Shares outstanding immediately prior to the closing of this offering (after giving effect to the consummation of the Pre-IPO Transactions that we will effectuate prior to the completion of this offering).

After giving effect to the sale of 28,250,000 Shares in this offering, assuming an initial public offering price of $19.50 per Share (the mid-point of the price range indicated on the cover page of this prospectus), less the underwriting discounts and commissions and the estimated offering expenses payable by us, and without taking into account any other changes in the net tangible book value after June 30, 2013, our pro forma net tangible book value at June 30, 2013 would have been $1,131.5 million, or $5.64 per Share. This represents an immediate increase in net tangible book value of $1.93 per Share to the existing stockholders and an immediate and substantial dilution in net tangible book value of $13.86 per Share to investors purchasing Shares in this offering at the assumed public offering price. The following table illustrates this dilution on a per Share basis:

 

Assumed initial public offering price per Share

      $ 19.50   

Historical net tangible book value per Share before the change attributable to new investors(1)

   $ 3.71      

Increase in net tangible book value per Share attributable to new investors

     1.93      
  

 

 

    

Pro forma net tangible book value per Share after this offering

        5.64   
     

 

 

 

Dilution per Share to new investors

      $ 13.86   
     

 

 

 

 

(1) Historical net tangible book value per Share is based on the historical book value of the Company as of June 30, 2013 divided by the number of Shares expected to be issued in the Pre-IPO Transactions.

Assuming the number of Shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions and offering expenses payable by us, a $1.00 increase or decrease in the assumed initial public offering price of $19.50 per Share, which is the mid-point of the range set forth on the cover page of this prospectus, would increase or decrease the net tangible book value attributable to new investors purchasing Shares in this offering by $0.13 per Share and the dilution to new investors by $0.87 per Share and increase or decrease the pro forma net tangible book value per Share, as adjusted to give effect to this offering, by $0.13 per Share. Assuming the assumed initial public offering price of $19.50 per Share, which is the mid-point of the price range set forth on the cover page of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions and offering expenses payable by us, an increase or decrease of 1,000,000 Shares in the number of Shares offered by us would increase or decrease the net tangible book value attributable to new investors purchasing Shares in this offering by $0.06 per Share and the dilution to new investors by $0.06 per Share and increase or decrease the pro forma net tangible book value per Share, as adjusted to give effect to this offering, by $0.06 per Share.

 

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The following table summarizes, on the pro forma basis described above as of June 30, 2013, the differences between the average price per Share paid by our existing stockholders and by investors purchasing Shares in this offering assuming an offering price at the mid-point of the range set forth on the cover page of this prospectus.

 

     Shares Purchased     Total
Consideration
    Average Price
Per Share
 
     Number      Percentage     Amount     Percent    

Existing holders

     172,200,000         85.9   $ 676,611,798 (1)      55.1   $ 3.93   

New investors

     28,250,000         14.1     550,875,000        44.9   $ 19.50   
  

 

 

    

 

 

   

 

 

   

 

 

   

Total

     200,450,000         100.0   $ 1,227,486,798        100.0   $ 6.12   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

(1) Reflects all cash distributions, including those from retained earnings. Does not reflect expected regular REIT distribution of approximately $60.0 million to current owners expected to be paid subsequent to September 30, 2013 and prior to the completion of this offering.

If the underwriters were to fully exercise their option to purchase 4,237,500 additional Shares, the percentage of Shares held by existing stockholders would be 84.1%, and the percentage of Shares held by new investors would be 15.9%.

Assuming the number of Shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions and offering expenses payable by us, a $1.00 increase or decrease in the assumed initial public offering price of $19.50 per Share, which is the mid-point of the range set forth on the cover page of this prospectus, would increase or decrease total consideration paid by new investors and total consideration paid by all stockholders by approximately $26.6 million.

Assuming the assumed initial public offering price of $19.50 per Share, which is the mid-point of the price range set forth on the cover page of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions and offering expenses payable by us, an increase or decrease of 1,000,000 Shares in the number of Shares offered by us would increase or decrease total consideration paid by new investors and total consideration paid by all stockholders by approximately $18.4 million.

To the extent that we grant options or other equity awards to our employees or directors in the future and the holders of those options or other equity awards exercise, or vest in, them or we issue other Shares, there will be further dilution to new investors.

 

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UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

OF THE COMPANY

The following unaudited pro forma condensed consolidated financial statements of the Company as of and for the six months ended June 30, 2013 and for the year ended December 31, 2012 are presented as if this offering by the Company and ESH REIT of 28,250,000 Shares (this “offering”) and the Pre-IPO Transactions had occurred on June 30, 2013 for the purposes of the unaudited pro forma condensed consolidated balance sheet and on January 1, 2012 for the purposes of the unaudited pro forma condensed consolidated statements of operations.

The unaudited pro forma condensed consolidated financial statements have been adjusted to give effect to:

 

   

The Pre-IPO Transactions;

 

   

The receipt of the net proceeds from this offering;

 

   

The repayment of certain ESH REIT indebtedness primarily from the net proceeds of this offering and the associated reduction in interest expense; and

 

   

The income tax impacts of (i) the Pre-IPO Transactions, including the change in expected distribution policy of ESH REIT, (ii) this offering and (iii) the repayment of certain of ESH REIT’s indebtedness.

The unaudited pro forma condensed consolidated statements of operations for the year ended December 31, 2012 do not reflect (i) the write-off of deferred financing costs associated with the repayment of debt of approximately $8.0 million, (ii) prepayment penalties associated with the repayment of debt of approximately $6.5 million, (iii) one-time restructuring related transfer tax charges of approximately $1.7 million and (iv) one-time restructuring related income tax benefits of approximately $5.3 million, as these costs/benefits are non-recurring items which result directly from the Pre-IPO Transactions. Additionally, the pro forma condensed consolidated statements of operations do not reflect incremental general and administrative expenses associated with being a public company, estimated to be approximately $5.5 million on an annual basis, as such costs are not currently factually supportable.

You should read the information below along with all other financial information and analysis presented in this prospectus, including the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated and combined financial statements and related notes thereto included elsewhere in this prospectus. The unaudited pro forma condensed consolidated financial statements have been derived from the Successor’s consolidated and combined financial statements as of and for the six months ended June 30, 2013 and the Successor’s consolidated and combined statement of operations for the year ended December 31, 2012 included elsewhere in this prospectus.

The unaudited pro forma condensed consolidated financial statements are not necessarily indicative of the actual financial position of the Company as of June 30, 2013 or what the actual results of operations of the Company would have been assuming this offering and our Pre-IPO Transactions had been completed on the first day of the periods presented, nor are they indicative of the results of operations of future periods. The unaudited pro forma adjustments and eliminations are based on available information and upon assumptions the Company believes are reasonable. Assumptions underlying the pro forma adjustments are described in the accompanying notes which should be read in conjunction with these unaudited pro forma condensed consolidated financial statements.

 

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EXTENDED STAY AMERICA, INC. AND SUBSIDIARIES

Unaudited Pro Forma Condensed Consolidated Balance Sheet

As of June 30, 2013

(Dollars in thousands)

 

    Extended Stay
America, Inc.
    Historical ESH
Hospitality LLC
and

Subsidiaries
and ESH
Hospitality
Strategies LLC
and
Subsidiaries
    Pre-IPO
Transactions
    This Offering     Debt Paydown     Extended Stay
America, Inc.
and
Subsidiaries
Pro Forma
 
    (A)     (A)     (B)     (C)     (D)        

ASSETS

           

Property and equipment, net

  $  —        $ 4,098,140      $ —        $ —        $ —        $ 4,098,140   

Restricted cash

    —         154,819       —         —         —         154,819   

Cash and cash equivalents

    —         104,973        (3,154     508,980        (505,826     104,973   

Intangible assets, net

    —         33,717        —         —         —         33,717   

Goodwill

    —         55,633       —         —         —         55,633   

Deferred financing costs, net

    —         59,651        —         —         137        59,788   

Accounts receivable, net

    —         29,094        —         —         —         29,094   

Other assets

    —         30,391        3,557        (1,546     —         32,402   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ —        $ 4,566,418      $ 403      $ 507,434      $ (505,689   $ 4,568,566   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

LIABILITIES AND EQUITY

           

LIABILITIES:

           

Mortgage loans payable

  $ —        $ 2,525,583      $ —       $ —       $ (5,583   $ 2,520,000   

Mezzanine loans payable

    —         1,080,000       —         —         (485,646     594,354   

Accounts payable and accrued liabilities

    —         146,118        —         —         —         146,118   

Deferred tax liability

    —         9,736        (3,475     —         —         6,261   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

    —         3,761,437       (3,475     —         (491,229     3,266,733   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

           

REDEEMABLE PREFERRED STOCK

    —          —          21,202        —          —          21,202   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EQUITY:

           

Common stock

    —         —         1,722       283        —         2,005   

Members’ capital - ESH Hospitality LLC

    —         743,397       (743,397     —         —         —    

Member’s capital - ESH Hospitality Strategies LLC

    —         3,875       (3,875     —         —         —    

Additional paid-in capital

    —         —         481,991        291,791        —         773,782   

Retained earnings (accumulated deficit)

    —         56,020        (56,020     (2,346     (7,984     (10,330

Foreign currency translation

    —         (216 )     —          —         —         (216 )
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total equity before noncontrolling interests

    —         803,076        (319,579     289,728        (7,984     765,241   

NONCONTROLLING INTERESTS

    —         1,905        302,255        217,706       (6,476 )     515,390   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total equity

    —         804,981        (17,324     507,434        (14,460     1,280,631   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

TOTAL LIABILITIES AND EQUITY

  $ —        $ 4,566,418      $ 403      $ 507,434      $ (505,689   $ 4,568,566   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes and management’s assumptions to unaudited pro forma condensed consolidated financial statements.

 

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EXTENDED STAY AMERICA, INC. AND SUBSIDIARIES

Unaudited Pro Forma Condensed Consolidated Statement of Operations

For the Six Months Ended June 30, 2013

(Dollars in thousands)

 

    Extended Stay
America, Inc.
    Historical ESH
Hospitality LLC
and Subsidiaries
and ESH
Hospitality

Strategies LLC and
Subsidiaries
    Pre-IPO
Transactions
    Debt Paydown     Extended Stay
America, Inc.
and

Subsidiaries
Pro Forma
 
    (AA)     (AA)     (BB)     (CC)        

REVENUES:

         

Room revenues

  $ —        $ 541,577      $ —        $ —        $ 541,577   

Other hotel revenues

    —          8,265        —         —         8,265   

Management fees, license fees and other revenues

    —          551        —         —         551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    —          550,393        —         —         550,393   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING EXPENSES:

         

Hotel operating expenses

    —          263,088        —         —         263,088   

General and administrative expenses

    —          44,144        —         —         44,144   

Depreciation and amortization

    —          81,854        —         —         81,854   

Managed property payroll expenses

    —          380        —         —         380   

Restructuring expenses

    —          605       —         —         605   

Acquisition transaction expenses

    —          110       —         —         110   

Impairment of long-lived assets

    —          1,388       —         —         1,388   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    —          391,569        —         —         391,569   

OTHER INCOME

    —          16       —         —         16   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

INCOME FROM OPERATIONS

    —          158,840        —         —         158,840   

INTEREST EXPENSE

    —         104,901        —         (21,721     83,180   

INTEREST INCOME

    —         (60     —         —         (60
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

INCOME BEFORE INCOME TAX EXPENSE

    —         53,999        —         21,721        75,720   

INCOME TAX EXPENSE

    —         2,543        18,815       298        21,656   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

    —         51,456        (18,815 )     21,423        54,064   

NET (INCOME) LOSS ATTRIBUTABLE TO NONCONTROLLING INTERESTS

    —         (438     4,627        (9,725 )     (5,536

PREFERRED STOCK DIVIDENDS

    —          —          (848     —          (848
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS

  $ —        $ 51,018      $ (15,036   $ 11,698      $ 47,680   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

PRO FORMA EARNINGS PER SHARE-BASIC

          $ 0.24   
         

 

 

 

PRO FORMA EARNINGS PER SHARE-DILUTED

          $ 0.24   
         

 

 

 

PRO FORMA WEIGHTED AVERAGE
SHARES OUTSTANDING-BASIC

            198,630   
         

 

 

 

PRO FORMA WEIGHTED AVERAGE
SHARES OUTSTANDING-DILUTED

            200,096   
         

 

 

 

See accompanying notes and management’s assumptions to unaudited pro forma condensed consolidated financial statements.

 

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EXTENDED STAY AMERICA, INC. AND SUBSIDIARIES

Unaudited Pro Forma Condensed Consolidated Statement of Operations

For the Year Ended December 31, 2012

(Dollars in thousands)

 

    Extended Stay
America, Inc.
    Historical ESH
Hospitality LLC
and Subsidiaries
and ESH
Hospitality

Strategies LLC
and Subsidiaries
    Pre-IPO
Transactions
    Debt Paydown     Extended Stay
America, Inc.
and

Subsidiaries
Pro Forma
 
    (AA)     (AA)     (BB)     (CC)        

REVENUES:

         

Room revenues

  $  —        $ 984,273      $ —        $ —        $ 984,273   

Other hotel revenues

    —         16,898       —         —         16,898   

Management fees, license fees and other revenues

    —         10,291       —         —         10,291   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues