Blackstone and Starwood Funds to Take Extended Stay Private in All-Cash Deal with Possible Special Dividend

By Stuart E. Leblang, Michael J. Kliegman,  and Amy S. Elliott

On March 15, Extended Stay America, Inc., which trades as paired shares together with its real estate investment trust (REIT) ESH Hospitality, Inc. under the NASDAQ ticker symbol STAY (together, Extended Stay), announced that it had agreed to be acquired in an all-cash transaction by funds managed by Blackstone Real Estate Partners (Blackstone) and Starwood Capital Group (Starwood).  Assuming the deal is approved by Extended Stay shareholders, it is expected to close in the second quarter of 2021. ¹ 

In exchange for each Extended Stay paired share, the funds will pay $19.50 in cash.  Although Extended Stay is not expected to pay its regular quarterly distribution in the second quarter of 2021, the merger agreement provides that Extended Stay may end up paying a special distribution of as much as $1.75 per paired share immediately before the deal close, reducing the cash consideration paid out in the deal by the same. ² At least one major shareholder has already expressed its opposition to the deal. ³ 

The REIT is 58.5 percent owned by Extended Stay America, Inc., so that for each dollar of dividends paid by the REIT (which generally pays out substantially all of its annual earnings as dividends), 58.5 percent is subject to full corporate tax. ⁴ Only the 41.5 percent paid directly to the public shareholders enjoys the “pass-through” tax benefits of a REIT.

The acquisition will be effected by way of two successive reverse mergers.  First, Blackstone Real Estate Partners IX, L.P. (an affiliate of Blackstone), SAR Public Holdings, L.L.C. and Starwood Distressed Opportunity Fund XII Global, L.P. (both affiliates of Starwood) will form three joint venture entities, owned 50/50 between Blackstone and Starwood:  Parent, its subsidiary MergerCo 1 and its subsidiary MergerCo 2.

In the first merger, MergerCo 1 will merge with and into Extended Stay America, Inc., with Extended Stay America, Inc. surviving.  In the second merger, MergerCo 2 will merge with and into ESH Hospitality, Inc., with ESH Hospitality, Inc. surviving.  Cash consideration will be issued to the public shareholders in exchange for their shares in the two companies, Parent will own 100 percent of Extended Stay America, Inc., which will continue to hold its 58.5 percent interest in the REIT.  It is intended that ESH Hospitality, Inc. will continue to be treated as a REIT for federal income tax purposes.

Tax Treatment of the Special Dividend

Section 7.16(b) of the merger agreement ⁵ indicates that, at the direction of the buyer, a special dividend will be declared prior to closing, based on the estimated amount of current and accumulated earnings and profits (E&P) of the non-REIT Extended Stay America, Inc. calculated through the portion of the taxable year that includes the closing.  It generally will not exceed the lesser of either $1.75 per paired share or the aggregate amount of cash available to the non- REIT.

From the perspective of the shareholders, it is fairly clear that this pre-closing special distribution will be treated as a dividend for U.S. tax purposes.  For foreign investors, the dividend will be subject to withholding tax of 30 percent, except to the extent reduced by an applicable tax treaty.

^{[1] Press Release, Extended Stay, Blackstone and Starwood Capital Group to Acquire Extended Stay America (March 15, 2021) (https://www.sec.gov/Archives/edgar/data/1581164/000114036121008551/brhc10021811_ex99-1.htm).}

^{[2] Id.}

^{[3] Press Release, Tarsadia Capital, LLC, Tarsadia Capital Believes Proposed Acquisition of Extended Stay America by Blackstone and Starwood Severely Undervalues STAY and Is Opportunistically Timed (March 22, 2021) (https://www.businesswire.com/news/home/20210322005234/en/Tarsadia-Capital-Believes-Proposed-Acquisition-of- Extended-Stay-America-by-Blackstone-and-Starwood-Severely-Undervalues-STAY-and-Is-Opportunistically-Timed).}

^{[4] As of March 14, 2021, Extended Stay America, Inc. beneficially owned 58.52% of all shares of Class B Common Stock of ESH Hospitality, Inc., according to this Schedule 13D filed March 18, 2021 (https://www.sec.gov/Archives/edgar/data/1581164/000089534521000355/ff190311_13da-extendedstay.htm).}

^{[5] Agreement and Plan of Merger among Parent, MergerCo 1, MergerCo 2 and Extended Stay (among others) dated as of March 14, 2021 (Merger Agreement) (https://www.sec.gov/Archives/edgar/data/1507563/000114036121008551/brhc10021811_ex2- 1.htm).}