BURNED BY THE ITT BATTLE?

By Daniel Kadlec

Remember the Greek mythological figure Icarus who flew too close to the sun on wings of wax? The modern-day version is Barry Sternlicht, the highflying CEO of Starwood Lodging Trust, which is in a vicious proxy contest this week with Hilton Hotels for control of ITT Corp. By topping Hilton's offer with a $10.2 billion bid for ITT, Sternlicht has thrust himself into what had been a very personal battle between Hilton CEO Stephen Bollenbach and ITT boss Rand Araskog--and thus into the public spotlight. Sternlicht is a Wall Street darling. His stock, including dividends, has soared 86% in the past year. But even for a darling, the heat of bright lights is no place to be when your company employs a rare and mysterious tax structure, as does Sternlicht's. That structure is the wax in his wings, and, win or lose ITT, its benefits could melt away and send Starwood, Icarus-like, tumbling from the stratosphere.

That's not to say Sternlicht has built an empire on a tax loophole, or that his stock would completely deflate. He's a respected hotel owner-operator who has already cut a $1.6 billion deal for Westin Hotels and has franchise agreements with major chains, including Hilton. It's not even clear that Starwood's structure gives him an unfair edge. Bollenbach says it does; Sternlicht says it doesn't. Ken Kies, chief of staff for the congressional Joint Taxation Committee, is concerned enough to be looking, but he says chances of a change anytime soon "are about zero."

That's why investors believe in the unusual tax structure. How else to explain Starwood's unnatural premium in the market? Its shares trade at 64 times recent earnings--nearly triple the multiple of hotel and casino giant ITT. Starwood is growing faster. That helps. But the tax setup accounts for a good bit of the premium, and that's critical, because if the setup is ever struck down or found to be of little value, some of the premium would evaporate. Just what is this magical tax structure? Starwood is a Real Estate Investment Trust that owns hotels and is paired with a sister company that manages hotels. The details are more confusing than the odds on a craps table. Suffice it to say there are only five companies in the U.S. with the same setup, and there can be no others without an act of Congress. (The five were grandfathered when "paired-share" REITs were outlawed in 1984.)

The chief concern, as it relates to the battle over ITT, is that the structure seems to generate so much potential tax and other savings that Starwood can afford to outbid all comers. When Sternlicht was snapping up smaller companies, heavyweights like Bollenbach took note but didn't fuss. Now that Sternlicht is going after bigger quarry, he's on Bollenbach's radar, and the fuss has just begun. The Hilton boss has been lobbying against the paired-share structure. By opting to go after a big name like ITT, Sternlicht has created a personal Catch-22. If the scrutiny he's invited shows that his paired-share status is an unfair edge, lawmakers may impose limits; if it shows relatively little value, investors may lose enthusiasm. Either way, Starwood's wings melt a bit.

Daniel Kadlec is TIME's Wall Street columnist. Reach him at kadlec@time.com