Accor Hotels

Asset-light is asset-right

International hotel chains are difficult to operate and require specialist skills – marketing, customer service, e-commerce & digital offerings, brand management, staff training and retention etc. Moreover, it is a cyclical business with wild swings in business performance. Check the steep falls in occupancy and Revenue per Available Room (REVPAR) during recessions (most recently in 2008).

Considering the specialist skills required, and the importance of building a brand, it makes sense that most large international hotel chains, in the last decade, have moved to the asset-light business model – franchising and managing hotels for fee versus owning real estate. For example, Marriott and InterContinental (IHG) hardly own any real estate, with almost all their income stream now derived from franchising and managing hotels (real estate is owned by others - typically property investors). The most recent example of a large hotel chain moving to the asset-light model is Hilton – which announced just a week ago that it will spin-off its real estate holdings into a REIT, leaving Hilton as primarily a hotel management company.

The asset-light model makes a lot of sense. If you specialise in running hotels, you should concentrate on that. Owning real estate is a different ballgame and ties up significant amount of capital. The asset-light approach of franchising and managing hotels is highly cash generative with high ROCE, and allows the manager to focus on growing the brand and the business. Furthermore, for a cyclical business, it makes sense to have most of its costs as variable, which the asset-light model achieves.

Therefore, when Sebastien Bazin, chairman and chief executive of Accor, the French based global hotels group, was appointed two years ago, Accor’s shareholders widely expected him to announce the asset-light strategy as part of his revamp initiative. Instead, what they got was a halfhearted approach splitting the business internally into two divisions – Hotel Services and Hotel Invest – without any real economic spin-off or sale of real estate. Accor owns and leases approx. 33% of its hotel portfolio (1,288 of its 3,873 hotel portfolio). Accor call’s its strategy asset-right (pun intended I guess). But management has not provided any details behind why this strategy is right instead of an asset-light model? If Accor’s shareholders want property exposure, they have other/better ways of getting it. They would much prefer Accor to focus on improving margins in its operations and improve its digital and e-commerce offerings (it lags behind competition on both fronts).

Furthermore, most of its competitors, have adopted the asset-light approach and sold their real estate returning billions back to their shareholders. Accor should to do the same, or provide a valid reason – backed by some numbers – for why its current strategy is right (or asset-right as it calls it). 

Valuation

IHG, with its asset light approach, trades at an EV/EBIT multiple of 13.3; and Accor with its asset rich approach also trades at an EV/EBIT multiple of 13.7. On this basis there doesn’t appear to be a need for change. Accor appears to be doing fine with its current strategy. But this does not provide the full picture.

A good thing about Accor is that it reports two sets of numbers – one for its Hotel Services business, and one for its Hotel Investment business. Hotel Services’ numbers reflect a 100% asset-light profile (Hotel Services receives 100% of its revenues from franchising and managing Accor’s 3,873 hotels – including the 1,288 owned).  Dig into the two sets of numbers a little more, and the justification for the asset-light approach becomes clearer. Here is a brief comparison between Accor and IHG.

Accor reported a fair value of €6.9 billion for its owned & leased hotel portfolio as at 31 December 2015. The owned and leased portfolio generated NOI (EBITDA less Maintenance Capex) of €437 million for FY 2015, implying a cap rate of 6.33% [NOI/Market value]. Considering that nearly 85% of its owned portfolio is located in the mature markets of France, Europe and America (1,086 of the 1,288 owned hotels), this valuation appears reasonable (if anything, one could argue this is conservative given how strongly Accor’s operations have performed of late and the prevailing low interest rate environment).

As an additional check, hotel REITs trade at an LTM EV / EBITDA multiple 17X-18X and estimated 2016 EV/EBITDA multiple of 11X (for example, Jeffries has recently cut the multiple of 11X due to expected increased competition from low cost competitors such as Airbnb and others). If use the EV / EBITDA multiples as comparable for valuing Accor’s owned portfolio, we get a value of between €7.1 billion (11X EV / EBITDA) to €11.1 billion (17X EV / EBITDA), both of which are greater than the current €6.9 billion value I have used.

Accor’s Enterprise Value is €9.2 billion, giving an implied value for its hotel operations of €2.3 billion (€9.2bln EV less €6.9bln hotel portfolio). The Hotel Services division generated EBIT of €359m for FY15, giving an implied EV/EBIT multiple of just over 6.

IHG, which runs an almost 100% asset-light model (it only owns 7 of the 5,032 hotels it manages), generated FY15 EBIT of $680m; of this $27m came from its owned hotels. Valuing IHG’s owned hotels one the same basis as Accor (i.e., at 6.33% cap rate), give a value for IHG’s hotel portfolio of $426m. IHG’s Enterprise value is just over $9billion; giving an implied value for its operations of $8.6 billion. This implies that IHG's  operating business is valued at an EV/EBIT multiple of 13 ($9.025 billion EV/$653 million EBIT).

The market seems to be applying more than a 50% discount to Accor’s operating business. In my opinion this is not deliberate; the more likely reason is that market is unable to clearly separate out Accor’s operating business from its real estate assets (note that the EV/EBIT multiple for Accor’s entire business, at 13, is similar to the multiple for IHG).

If we separate things out, and apply a similar multiple to Accor’s operating assets as exists for IHG, the value of Accor’s operating business should be €4.7 billion – increase of €2.5 billion from current values (or €10.8 per share).

Taxes – potentially a challenge

Spin-off’s and asset sales can be challenging from a tax perspective. In addition to a whole host of complexities around execution, tax liabilities could eat up a significant chunk of any upside. Without detailed knowledge of the applicable tax rules and the ownership structures for each hotel, it is difficult to know if tax planning opportunities exit. Furthermore, details on tax basis and available tax losses are required to calculate the tax liability (numbers which aren’t disclosed in the financials). However, using the available information, my high level estimate of after tax proceeds is as follows:

Assuming net book value approximates to tax basis, the potential tax liability for a taxable sale or spin-off of the real estate would be just over €1 billion. Adding 5% transaction and execution costs on top would net proceeds of €5.5billion on the sale of the hotel assets (assuming fair value of €6.9 billion). In my opinion, this is likely to be the worst case scenario –tax strategies and tax attributes will likely bring any tax liability to a lower number. The implied per share value after tax and costs comes to:

Taxes – potentially an opportunity

Taxes also provide a potential opportunity to achieve a higher valuation for the real estate. Most jurisdictions – certainly the main ones in Europe where most of Accor’s owned hotels are located – offer REITs as an investment vehicle for real estate. Rules have been significantly modified in recent times to allow captive or private REITs (i.e., REITs held by one or few investor’s without the need for a listing or free-float). REIT structures take out tax liability at the asset level – broadly, REITs are exempt from tax on income and gains in return for ensuring that most of the income and gains are distributed to the shareholders). France for example has captive REIT regimes – called SPPICAV’s – which exempts income and gain from being taxed provided 85% of profits and 50% of capital gains is distributed to the shareholders. Similar structures are available in other jurisdictions.

Accor could consider spinning off its hotel assets into a REIT, potentially wiping out future tax burden in the property portfolio, achieving a higher valuation for its assets. In short, not only does Accor's property portfolio could merit a significantly higher valuation to the current €6.9 billion under a REIT structure. 

Qualitative reasons for a spin-off or separation of the hotel assets

In addition to the valuation discussed above, I believe that there are at least four good qualitative reasons for Accor to pursue the asset-light strategy.

1.  Majority of Accor’s owned hotels are located in the mature markets of Europe and America. Most of the successful hotel operators who pursue the asset-light model largely operate a franchised business model in the mature markets. Franchised model is extremely lucrative – real estate and employees belong to a third party, has very low capital intensity, and enjoys a very high ROCE. Franchised model does bring its risks – e.g. risk of damage to the brand. But operating a franchised model in mature markets is a lot easier and less risky. IHG’s for example operates 84% of its hotels (mostly in mature markets of America and Europe) under a franchised model. Accor has an opportunity to free up significant capital by putting in place a franchised model for its owned hotels.

2.The hotel industry has enjoyed unprecedented growth in recent years – with key performance metrics (REVPAR and Occupancy rates) surpassing previous peaks and reported profits beating expectations. But this is a cyclical business; the next downturn may just be around the corner. Previous downturns were a catalyst for many of the well know operators to sell down real estate and pursue the asset-light strategy – improving balance sheet and profitability, and keeping them in good stead for the next downturn. For a cyclical business, it makes sense to pursue a strategy where all or most of the costs are variable – easier to control based on demand. Real estate not only ties up significant capital, but also incurs a lot of fixed costs. Furthermore, there has never been a better time to sell quality real estate – with yield hungry investors and SWF’s chasing quality assets.

3. All the well-known operators are investing heavily in digital and e-commerce initiatives and loyalty programmes – this not only ensures repeat business, but also builds customer loyalty. There is no doubt that this is going to be a key factor in the success. Accor’s EBIT margin at 26.8% in its Hotel Services division - although improving - trail those of its competitors (IHG for example achieves well above 50%) largely due to its poor digital and e-commerce systems. Accor is currently pursuing a 5 year Digital Plan with a total expected outlay of €250m. Freeing up capital by selling down real estate should help focusing on improving margins in its core operating business.

4. Accor has a ROCE of less than 10%. IHG on the other had has a ROCE of 44% using the same metric. It is worth noting that IHG’s ROCE was approx. 9% back in 2004, before it pursued the asset-light strategy. 

Spinning off its real estate should help Accor significantly improve on its ROCE and profitability. 

In conclusion

Accor’s reported results for its two divisions, and a comparison with IHG – which operates the asset-light strategy – show that market does not fairly value Accor under its current strategy. The current strategy diverts focus from what is important (improving and growing the business), ties up significant capital, and erodes profitability and return. Management’s halfhearted approach of splitting the business internally into two divisions – Hotel Services and Hotel Invest – without any real economic spin-off or sale of real estate hasn’t achieved much.

Accor’s shareholders are more than capable of deploying capital to real estate as they see fit. Accor should focus on the operating business. The time is right for Accor to now pursue the asset-light strategy, return significant capital back to its shareholders, and set itself in good stead before the next cyclical downturn hits hotel industry.

Almost all of Accor’s peers (most recently Hilton) have or are moving to the asset-light strategy. Accor doesn’t have any reason to delay this anymore.