M&A in the hotel industry is increasing. This week, Prince Hotels, an Australian subsidiary of Japan’s Seibu Holdings, acquired the StayWell Hospitality Group. The deal will result in 18 hotels already under management and another 12 currently under construction. Seibu/Prince and the StayWell team congratulate each other. The properties are spread across 21 cities in seven countries. TTG Asia covered this deal:
Due diligence is a daunting task, both financially and in scope. A prospective buyer must conduct due diligence in commercial, legal, and financial, as well as tax, technical/physical, and any other advice that may be given, such as M&A or corporate advice or antitrust/competition analysis.
It isn’t easy to cover all of this ground, but in a highly competitive environment, your efforts must be efficient and focused.
Hotel and hospitality specialists
Our team of corporate and commercial lawyers focuses exclusively on the Asia Pacific hotel and hospitality industry. We have a deep and unique understanding of the underlying transactions and assets, including hotel leases and management agreements. Together with the management team, these instruments determine any platform’s earning capability and downside risk.
In the past, we have done due diligence on several hotel businesses and spent three months reviewing what is now an extremely complex platform worth US$700m. We know where to look and what to concentrate our efforts on. We wanted to share our observations and lessons learned.
Identifying the key drivers of value
The group’s earnings will drive the acquisition price, but some properties will produce a higher fee income than others. Prioritize the most lucrative properties within the estate in a diligence process that is time constrained. When layered on top of an estate’s segmentation, the analysis of remaining tenure will highlight which part will be driving the overall business performance over the medium and short term.
This work will also influence how to deal with conditions when the landlord or owner’s consent is required to change control. If the target hotel falls within a protected area or exclusivity, these may be on both the buyer’s and the target’s sides.
In some branded management companies, value is created (or lost) at the property level and via the distribution and loyalty system. This is a critical area as hotel owners and managers are focusing more than ever on distribution costs and the net guest stay revenue.
Hotel Management Agreements
Their development teams, especially in areas where the target group was growing, would have felt pressure to increase inventory. In markets with high competition, they would have had to offer incentives such as soft loans, critical money, income guarantees/underwrites, stand-asides for fees, and brand exclusivity. These arrangements may be designed to take into account specific accounting treatments. We have seen that these structures’ true nature and purpose need to be understood, even in individual hotel deals. The risk of not correctly describing these arrangements can be significant when it comes to a portfolio purchase.
The actual financial and commercial impact of these deals, including operating hotels and pipelines, should be determined and mapped, as well as the capital they could tie up.
Hotel Operating Leases
While not a standard structure in the Asia Pacific, certain management groups have been tenants of operating leases due to a legacy or relationship from a specific transaction or relationship. More recently, a lease commitment was the price for securing an important property.
Buyers will want to understand the lease term, rent increases (including historical rent reviews to determine any overhang), and exit/end-of-lease obligations. Under these structures, the target will also be the owner of the leased hotel and the employer of all staff. They must also provide the working capital and may own some FF&E and operating supplies.
These obligations are material and may take time for a team of managers or an acquirer who is used to understanding hotel management contract structures.
Operating leases that include base rent commitments may not be the best instrument for hotel operators listed on public exchanges. These leases create contingent liabilities that drag down the value of stocks/shares. Suppose the target is a platform listed on a stock exchange with significant leased property. In that case, it may be necessary to bring in a third party to assume the lease liability or to grant management contracts to the operator, either as part of the deal or as an immediate follow-on.
They will exist in the future, but they are only on paper. Global operators rarely enforce contractual obligations where developers cannot meet project deadlines. Are these deals real? Are they likely, contingent, approved, or funded? Are the sponsors/developers reliable? Local knowledge, contacts, and connections are essential for a thorough assessment. In addition to the HMAs mentioned above, buyers will want to know the economics of the pipeline deals.
Assumptions & Synergies
Question any assumptions that you may have made. We looked at an apartment platform with a vital condo/management rights component. Individual apartment owners could opt out of this arrangement by giving 90 days’ notice without penalty. This knowledge would cause most buyers to consider the possibility of a significant attrition rate across this inventory, especially if a deal involved a brand change.