Hospitality M&A: a story of OpCos and PropCos

Andrew Harrington By Andrew Harrington
Uploaded 12 October 2018

Andrew Harrington of AHV Associates looks at the increasing levels of merger and acquisition activity in the hospitality sector.

As the world continues to experience relatively low interest rates, excessive liquidity and high stock prices, M&A activity has reached record levels. In the first nine months of 2018, deals worth more than US$3.3 trillion have been announced. This not only represents a 39 per cent increase from the same period in the previous year, it also eclipses the previous record set in 2007, just on the eve of the financial crisis.

Now, this M&A frenzy is not only taking place in the corporate world. Private equity and venture capital firms had at the end of 2017 over $1.1 trillion in dry powder, which represents the total allocated unspent capital available for investment.

This is a significant figure, insofar that it not only represents another record level of funds available but also the types of deals that they are interested in. Because both strategic and financial buyers are competing for the same deals, many of which are being acquired at significant premiums, some PE firms have recently been looking for different types of companies to invest into.

This is where the hospitality industry comes in. Hotel properties have only recently become mainstream assets for generalist real estate investors, while hotel operating companies have remained mostly untouched by financial investors.

However, these trends seem to be changing, with an increase number of deals being completed in recent years, starting with Blackstone's purchase of Hilton Hotels in 2007 (mostly an OpCo) and subsequent IPO in 2013. This has given rise to further transactions in hospitality M&A, ranging from 100 per cent PropCo, through to 100 per cent OpCo and everything in between.

Separation of PropCo and OpCo
Investors have often had the perception that hotel companies are a relatively risky investment, as they tend to have high levels of leverage and operate in a largely fragmented market with many competitors, added to the fact that the lodging industry is a largely cyclical sector.

Investors in quoted hospitality companies have been pressuring companies to adopt an asset-light operating model by divesting their real-estate holdings into separate entities. With the capital proceeds being used to pay dividends or repurchase shares, and/or to further fund M&A strategies or the acquisition of new assets to the pipeline.

For example, the French hotel company Accor, which has been one of the most active players in the lodging industry's M&A market, spun-off its real-estate holdings into a new entity under the name AccorInvest in 2013.

Following in the steps of its competitors, such as Hilton and IHG, it sold a majority of its real-estate arm, AccorInvest to institutional investors for $5.6bn. As part of the transaction, most of the hotels owned by AccorInvest will continue to be operated by Accor Hotels under long-term leases, management contracts and/or franchise contracts, while the cash proceeds will be used to further fuel M&A activities, and the acquisition of additional properties to the portfolio.

The idea of splitting the PropCo from the OpCo has not only been adopted by large market movers. Some smaller players in the market are also following the same strategy. B-Aparthotels, a privately- owned Belgian aparthotels owner/operator, recently divested its real-estate in order to further focus on their core business and will be using the proceeds to develop the international presence of the operating company.

In another similar type of transaction, the French real-estate firm Foncière des Régions and IHG acquired 13 Principal and DeVere hotels from Starwood Capital, in May 2018. Starwood will keep the real estate and IHG will operate the hotels, mostly under their luxury boutique hotel brand, Kimpton Hotels & Restaurants. It will enable expansion of this brand into the UK, add an additional 2,200 rooms to their portfolio and an extra 138 rooms to the pipeline.

Other transactions in the market have also focused on the particular idea of separating the OpCos and PropCos. In late 2017, a consortium led by Pandox and the Fattal Group acquired 36 hotels from the owners of Jurys Inn, Lone Star. As part of the transaction, Pandox would acquire 21 hotel properties and Fattal would retain the operating platform of all 36 properties.Leonardo and Pandox already had an established relationship, when in 2016 Pandox acquired a portfolio of 18 hotels from Fattal and the Leopard Group for €400 million and signed 25-year leases with Fattal, which continues to operate all the hotels.

OpCo M&A
Acquisitions in the OpCo space continue to be attractive to both local European companies and international companies, as a way to expand into new regions, new sub-markets, or in order to consolidate dominance or market share in current markets. This is a result of a fragmented market, where branded hotel chains only account for a third of total hotel room supply in the market.

As mentioned earlier, Accor has been on an acquisition spree in the recent years. Between 2017 and 2018, Accor signed a letter of intent to acquire a 50% stake, with an option to buy the rest of the company, in SBE to expand its luxury hotels offering, as well consolidate its presence in Latin America and the Middle East. It also acquired the Mantra Group for AUS$1.2 billion to expand its footprint in Oceania, and 50 per cent of South Africa-based Mantis. Additionally, it announced it would acquire a 50 per cent stake in Orient Express, which operates a number of luxury hotel products in Europe.

The Nordic region's largest hotel operator, Scandic, has been diversifying its hotels operations away from its largest market, Sweden, through acquisitions. In December 2017, they completed the $137m acquisition of Restel, the largest hotel operator in Finland. With this acquisition, Scandic further consolidated its position in the region, while also giving it access to a market where it was underrepresented.

IHG purchased a 51 per cent stake in Regent Hotels & Resorts, a luxury hotel operator, for $39m with an option to buy the rest of the shares in 2026. Intercontinental is hoping that Regent will be its five-star brand to compete with the traditional brands, such as the Ritz-Carlton and the Waldorf-Astoria, but also against luxury operators like the Mandarin Oriental.

Private equity and family office investments
Historically, private equity and family offices tended to invest into mainstream assets such as commercial and residential real-estate. As hotels became more and more mainstream, PE firms overtook REITs as the largest investors into this real-estate class. Along with investing into PropCos, these firms also started strategically investing into operating platforms which could manage and/or convert some of their real estate holdings into operational assets.

For example, in 2016, Finnish private equity firm CapMan acquired a 37 per cent stake in Forenom, a leading Swedish aparthotel operator. With the backing of CapMan, Forenom has made several acquisitions since 2017. First it acquired Oslo Apartments SA to expand into the Norwegian Market. Then in February 2018, they reached an agreement with the SATO Group on the acquisition of HotelHome, to strengthen their position in Finland. Then in March, they purchased StayAt to further consolidate their market share in Sweden. And finally, in April they acquired Apartment HS to become the market leader in the Swedish serviced apartments submarket.

In February 2018, Brookfield invested £430 million to acquire SACO from Oaktree Capital Management. SACO is one of the largest serviced apartment operators/owners in the UK, with 39 operational assets in the UK and one in Amsterdam, nine of which are freehold. Additionally, it has an Airbnb style platform that hosts over 30,000 units worldwide. Included in the pipeline, were more than 900 rooms that will be freehold and flagged as Locke Aparthotels.

Starwood Capital made a strategic US$250 million investment in Yotel, acquiring a 30 per cent stake. Starwood has deployed the additional capital to secure real-estate for Yotel to achieve growth potential and accelerate worldwide expansion plans. They have already secured sites in Edinburgh, Glasgow and Amsterdam all expected to open by 2019, while there exists the possibility of converting some of Starwood's existing properties into Yotel hotels.

In May 2018, Schroder Real Estate acquired Algonquin, a pan-European hotel investor and operator based in Belgium, to expand and grow Schroder's private assets and alternatives business. Algonquin had at the moment of acquisition a portfolio of 43 assets and 7,500 rooms. Algonquin's model typically involves co-investing directly from their balance sheet into assets with other investors, while operating any assets they invest into.

Conclusions
Many hotel groups have chosen to solely focus on the operational side of their businesses, by divesting their real estate assets. The cash proceeds are then reinvested to support expansion plans, or distributed to the shareholders. While other hotel groups that own and operate hotels, have been taken over by two acquirers are the same time, one that acquires the real-estate and one to operate the properties.

Generally hotel group M&A is centred around acquiring other operating companies, that allow them to continue expanding geographically, penetrating new sub-markets, or consolidating their presence in established market.

Some private equity and family offices are investing into OpCos to support their growth strategies, while some are also deploying additional capital in the acquisition of real-estate to be used by their hospitality platforms. OpCos, on their side, are taking advantage of the large availability of capital, as well as the operational expertise of their investors.

Andrew Harrington is a partner at AHV Associates, a London-based award-winning boutique investment bank focused on advising private companies across a range of M&A and advisory assignments. This article was prompted by a presentation he gave at an International Hospitality Media networking event. You can see the presentation here.

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