Industry Update
Opinion Article22 June 2020

Independent Hotel Owners Should Look At Integrating Their Assets Into A Portfolio

Co-written by Alex Sogno, CEO - Senior Hotel Asset Manager at Global Asset Solutions and Vani van Nielen, Larina Maira Laube, Eliana Levine, Marie-Amélie PONS Roinson and Paloma Guerra Ecole Hôtelière de Lausanne Students and Alumna

By Gustav Bjoern, Senior Hotel Investment Banker at Global Asset Solutions

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Stronger together! Merge to survive… and thrive!

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For hotel owners and investors, access to friendly capital, shared resources and additional capital appreciation provided by entering assets into a partnership - that famous "portfolio effect", can these days be what stands between survival and losing control. This is especially true for independent hotel companies that currently have no reliable, interest-aligned external source of assistance, other than what local governments are doing to help financially. They are alone because they are either un-affiliated or have an over-the-counter franchise agreement which essentially only provides a sales channel.

What direct and indirect obligations and ties the different help packages come with, is a separate issue; however, some European governments find it appropriate to impose distribution and dividends controls, approval of appointments to management and director boards, as well as the basic management task of the division of labour. There is no such thing as a free lunch - not even from governments.

One way of securing access to shared recourses, capital, knowledge, and advise from truly interest aligned sources, is for owners to pool their assets. Become partners and shareholders in a new structure that would own the assets, and as such the equity, and ultimately, be liable for the debt and third-party agreements. In short, create a portfolio without exchanging a penny - outside of closing cost.

Most hotel owners are passionate about their properties - they may tell you that they are not, but they are! They acquired it, they invested into it, they shaped the business plan, they hired the staff - maybe they fired a few as well - they have seen it grow and become successful. Rightfully so, any company owner is proud of his/her achievement. Please remember, you have only lost your investment if you truly part way with your asset. While losing the immediate control of the specific hotel, owners will gain shared control of a company that owns many hotels.

1. Turning apples into pears and vice-versa


In the immediate term, the main reason for joining forces and merging assets into a new partnership is gaining a) perceived capital strength and b) actual capital strength, by accessing knowledge, systems and efficiencies that can help make savings on undistributed and fixed expenses and thus create a new P&L, strengthening projected NOI.

As such, merging assets, just to merge assets would make little sense. Merging the "right" assets would not only mean looking at the real estate (property, FF&E, capital stack etc.), but also the individual management and system setups, the people running the individual hotels and the databases. A full due diligence process is required to make sure that the exercise will add, not destroy value.

Given that each individual company brings separate value propositions into the partnership, valuing the individual equity positions means agreeing on a valuation approach, including the impact of a) the debt, b) fee structures, c) cash flows, including any lease obligations, d) reserves and e) rights, on the value of the cash flow, over time.

Further, the new partners have to agree on the impact of a) location, b) market, c) condition of the building, d) legal and zoning status of the building, on the value of the pure real estate, i.e. the capitalization rate over time.

To outline a couple of examples: 1) a property in an inferior location and market have a franchise agreement, which allows for a concession of certain fees during the down-cycle, while another property in a superior location and market, may have one allowing only for deferral of those fees, to be collected during the up-cycle. Or vice versa. How is that fee structure valued? 2) one loan agreement has an earn-out triggered by a certain performance hurdle, while another does not. How is that potential capital appreciation trigger valued? 3) one loan matures before the other. How is that capital risk valued?

When an appropriate valuation approach is agreed, owners will have to agree a new shareholders' agreement that allows for acceptable 1) divestment, 2) exchange of shares 3) capital injection, 4) possible dilution of ownership etc. All major capital and strategic decisions, affecting the short- to the long-term performance of the individual hotels as well as the company are governed by the rules set out in such an agreement. As such, no single shareholder (unless he/she is big enough) can decide the fate of the single asset or the company as a whole.

Finally, unless all the individual debt positions are jointly retired by a new restructuring debt facility, lenders would need to agree to, and approve the new structure and agreement. New debt would facilitate cross collateralizing the structure, which would simplify the process significantly and allow for higher proceeds. However, given the current market situation, existing loan-to-values may be too high to refinance, leaving the choice of either retiring debt or keeping some of the existing facilities in place.

The list goes on, and leads to the one single most important issue: How many shares in the new partnership (new HoldCo) are the individual equity positions worth today, all things considered?

As no property, location, management, agreement, or owner are the same, essentially, merging assets is an exercise in merging pears and apples, by turning both into alike hybrids of each other - "peapples".

2. The value of my equity


The first question, owners and investors will ask is, "given all the different parameters, is this not a waste of effort and time, which can be used on things with a higher probability of success?"

It is people that have to 1) see the point of merging and 2) has to agree on a lot of issues, many of which are close to their hearts. Some hotel owners could consider merging assets as a form of exiting their hard-earned investment, for a type of payment other than money, when entering the new structure. As such, all parties can be expected to inflate the economic potential of their particular property, thus equity, and see value that really is not there.

If the different positions are too different, the answer to the question is "yes, this will be too much of an uphill climb". Assets and setups that are too different are just too cumbersome to merge, and that probability of ending up with a fair and balanced share and rights allocation, is just too small.
However, if the positions are similar and comparable from a property and capital point of view, i.e. the capital stack, the P&L, the third-party agreements, the location, the segment, the condition of the building and legal status are comparable and similar, the transformation into "peapples", is much easier and has a bigger chance of success.

Valuing an individual equity position for the purpose of exchanging it to shares in the new structure, should address two main areas 1) the value of the cash flow of an individual asset compared to the total cash flow of the new structure and 2) the value of the real estate of an individual asset compared to the combined real estate value of the new structure.

Merging similar and "right" assets and entering a new partnership under one pretence, is only a start though. It is the long game that counts! If the partnership is too unbalanced, this unbalance will result in disagreements and destruction of value as the partners with work against each other.
Good faith, trust and a shared vision are key!

Timing will also help balance the partnership in terms of exchanging equity in individual properties into shares. Stealing a term from the lending world, the deal should be a "primary syndication" initially, with the possibility of adding new properties and shareholders. The new company should be founded and formed by say, six independent hotel property owners, who will put in their respective properties and receive shares in return. These six founding partners and initial shareholders will agree with the approaches and agreements governing the partnership and any third-party capital (debt and other), with an appointed advisor to run an objective and independent merger process. In time, it will be up to the founding partners to allow new partners into the structure; however, to reach the objective and secure access to recourses, capital, knowledge, and advise from these truly interest aligned partners, the structure need a certain critical mass from day-one.

3. Capitalizing the new structure


One of the main drivers of the "portfolio effect" is in the debt. Given the strengthened NOI, the strengthened resource and knowledge base, as well as the improved capital risk proposition through geographical, segment and asset live-cycle diversification, a new loan facility pushed down to re-finance an acquisition loan, would provide of higher leverage at a lower price point. Even during this period of COVID-19, where a vast majority of lenders are careful to the point of being closed to all new transactions secured by hotel real estate, there are large loans available (€150-€200 million +) at 40% - 50% loan-to-value/cost (value subject to haircuts). As such, the benefits of cross-collateralization are available, even cross-border.

A new loan facility would open up the possibility of re-allocating loan amounts to reflect strengths and weaknesses, making sure that the assets strongest in terms of market, location, state of repair, assumes some of the debt from the weakest assets. This will result in higher loan proceeds at a lower price and a more (for the partnership) beneficial amortization schedule.

Stronger together


The benefits of merging assets are many if the "right" assets are merged in the "right" way with the "right" attitude. At the time of reading this article - if you are a hotel owner - you, yourself only knows your current financial situation, and what needs to happen for you come out on the other side, as owner of your business, or at a minimum with an up-side certificate.

This article is meant as an idea - a seed that hopefully finds its way to fertile ground. We believe that many individuals - people and companies - are stronger together than apart.

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Gustav Bjoern

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