By Aradhana Khowala Managing Director
The key to a successful buy side diligence exercise is focussing on the mostly invisible parts of the iceberg so you can effectively validate if the deal is right for you.
"The danger with fancy brochures is they can convert into rather poor valuation models"
Any investor considering a hotel acquisition needs to validate the key assumptions being made about the transaction and ensure there are no skeletons in the closet that can impact the future of the business. Analysing and validating those financial, operational and strategic assumptions as part of a buy side due diligence process which requires one to focus on the mostly invisible parts of an iceberg might seem like an expensive way of buying peace of mind but it can be a very effective way to verify if the hotel and the deal is a right fit for you. Here are seven easy steps to assure you get what you pay for.
A core mandate of any buy side due diligence exercise has to be to not only improve your understanding of all the relevant issues as a potential new owner but also highlight the strengths of the asset as well as focus on the weaknesses that can be fixed and opportunities that can be exploited under your new ownership. Whilst there will be some asset deals that are straightforward transactions, the stand out ones which really add value are those that involve a vision for fundamentally altering the profile of the asset. The Four Seasons Sultanahmet in Istanbul is a great example of how an interesting vision can infuse fresh, eclectic spirit to a century old prison and make it relevant and current.
Bulk of the real estate transactions in the commercial space (office, retail etc.) deals tend to be one-dimensional with clear rents and/or leases. However, a hotel asset is a completely different animal. One has to be cognizant of all the operational elements of the asset in what is a highly cyclical industry. Hence, to really understand the target hotel’s underlying business risks, operational strengths and weaknesses, and issues impacting the transaction, you want to have sector specialists on whose experience you can depend upon. It is vital that the chosen team has experience in the local market and preferably they should concentrate in the niche and segment your proposed acquisition competes in. For instance, a buy side team for a trophy asset will have different focus and priorities compared to one for a budget hotel acquisition.
It is critical that a buy-side due diligence mandate has to be customised to a specific owner/investor and transaction. All of them tend to assess the target hotel’s earnings and cash-flow quality, reviews the operational trends, key business performance metrics, working capital requirements, balance sheet commitments and finally management projections. However, your chosen due diligence partner needs to resonate and imbibe your long-term goals to ensure if and how the deal fits your overall goal. As an example if you are Chinese investor seeking to acquire a hotel in Switzerland with the aim of setting a foundation for European expansion, it is imperative to have your due diligence team factor in your overarching aim into the analysis as well as ensure compatibility with local laws and regulations be it concerning taxation, investment or employment .
A buy-side due diligence process is so important because it minimises the disparity between the information held by the buyer and the seller about the hotel asset. A hotel is not the most liquid asset and the idea is that by enhancing your understanding of the target hotel’s business there is a higher probability of the deal achieving its objectives. A rigorous and objective due diligence which covers the unavailable and sometimes hidden bits of information like the base of an iceberg also means you as an investor can focus on structuring and negotiating the deal right – steps which take considerable time and resources. You don’t want to miss anything and buy side due diligence is a good step towards ensuring just that.
In the fashion industry, the impact of makeup and role of air brushing is an open secret. Unfortunately, in the hotel industry a lot of Information Memorandum’s and fancy brochures convert into rather poor excel valuation models and one can’t be too sure of how much to discount the marketing spiel. Many acquisitions that look great on paper have a less-than-optimal outcome. Hence, to ensure you are not buying into someone else’s worries, stay objective and don’t let your love for the asset cloud or dilute the importance of a comprehensive review of the company’s business plan.
To maximize the effectiveness of the due diligence process and to ensure all bases are covered, ensure there is a checklist that covers all of the documentation and other information required to complete the process. This checklist would normally include a comprehensive and wide range of financial, legal, product, market, competition, sales, customer, regulatory, environmental, management and personnel information. It is all too common to have deals fall through right at the end because a previous assumption about structural slope or crack in the wall was not confirmed and the new revelation means a price revision or adjustment. Because your bid is based upon a set of assumptions you don’t want to deal with any last minute surprises.
Finally, like great art, some hotel deals are priceless. Because of its rarity, quality and uniqueness, its value is way beyond a simple valuation or one that comes up as justifiable based on the result of a buy side due diligence exercise. This effectively means that some assets have a value based on what someone is willing to pay for them and in some cases it might be a few or many millions more than its true value.
For these type of assets either participate in the bidding war because you can afford it or happily walk away knowing that some assets transact without and at prices way above what is reasonable or as advised by your due diligence team. As an example if the Burj in Dubai or the Ritz in London is ever for sale in the market it is not going to be bought for what it is worth but instead for what the hotel’s stand for in the respective cities.
In summary, if you are debating whether you can derive value from a buy side due diligence exercise for you next hotel acquisition, bite the bullet, get organised and remember, the more you know the better questions you can ask.
Ritz London by Cian O’Donovan on http://www.flickr.com/photos/keepingitfake/3089941877/sizes/o/
Four Seasons Sultanahmet by dlnwelch on http://www.flickr.com/photos/dlnwelch/9319708964/sizes/o/
Burj Al Arab by Frank Kehren on http://www.flickr.com/photos/fkehren/8423498995/