Rezidor Hotel Group: Do Chinese Read Sun Tzu?

Background

Rezidor Hotel Group (“Rezidor”) is a hotel company operating Carlson Rezidor Hotel Group’s (“Carlson”) hotels in EMEA region under master franchise agreement.

HNA Tourism Group (“HNA”), a part giant Chinese conglomerate HNA Group (“HNA”), bought the US based Carlson in end of 2016.

As Carlson owned 50 % of Rezidor prior to the transaction, the change of ownership in Carlson lead to change of ownership in Rezidor, which forced HNA to make a public mandatory offer of rest of Rezidor.

The price HNA offered from Rezidor was 35 SEK a share. Rezidor’s board recommended shareholders to decline the offer due to “financial reason” (=too low price). Despite board recommendation to say no for the offer, 20 % of shareholders decided to sell their stake, making HNA 70 % owner of Rezidor.

After that, the Rezidor’s stock price have declined significantly to about 23-26 SEK share.

The decline in the stock price below the HNA’s 35 SEK offer price is probably explained by uncertainty regarding HNA’s intentions towards minorities, HNA’s highly publicized debt problems and episode relating to a delayed payment for the shareholders who accepted the mandatory offer (HNA had to ask permission from Chinese authorities to get money out of China to make the payment).

Valuation

The whole situation between Rezidor, Carlson and HNA looks quite hairy. But despite the apparent difficulties, the decline in the stock price has resulted quite interesting valuation levels:

According to 4-traders, the forward P/E multiple for 2017E is 12x and for 2018E about 8x. EV/EBITDA multiples for same years are 4,4x and 3,8x.

These are really low absolute multiples, especially given that the 4-traders database’s consensus estimate, which is sourced from Thompson-Reuters, predicts significant growth for the coming years for Rezidor.

According to the estimates, the business seems to have good growth prospects and profitability, which I broadly agree. For, of the international hotels chains, Rezidor has the biggest new hotel pipeline in Africa and Middle-East, and various restructuring programs are starting to kick in.

The valuation looks also very attractive relative to comps:

The forward P/E multiples for the comps for 2018E vary between 16-33x and forward EBITDA multiples for 2018E between 8-19x, both at least double the Rezidor’s levels.

As Carlson and Rezidor have been in business for long time with well known Radisson-brands, and the combination as a whole is one of the top 10 or so international hotel companies in the world, and as said, Rezidor is probably the largest hotel operator in the Middle East and Africa region, the Rezidor’s valuation discount relative to peers cannot be explained by it being some backwater hotel company from middle of nowhere or by significantly worse competitive position.

One possible explanation for the Rezidor’s lower valuation could be the master franchise agreement with Carlson, which is valid until 2052 and has an extension option.

But with so long duration in the contract and the extension option, for valuation purposes the Rezidor’s business can thought as if it was a “going concern”.

And even if it’s assumed that the business would end at the maturity, the valuation difference between going concern and 34 year fixed contract is not big enough to come even close explaining the differences in the valuation multiples (10%-20% in all else equal scenarios, depending of assumptions).

Other possible explanation for the lower valuation multiple relative to the peers could be differences in hotel portfolio distribution between leased, managed and franchised hotels.

About half of Rezidor’s segment EBITDA comes from leased hotels and other half from managed and franchised hotels.

From the comps, Scandic has all lease portfolio and it’s trading at 8xEBITDA’18E.

Intercontinental and Hilton have more or less 100% managed and franchised hotel portfolios, both trading at about 15xEBITDA’18E.

Assuming “hotel portfolio type weighted peer EBITDA-multiple” (50%*8+50%*15=11,5) for the estimated ~110 MEUR EBITDA for 2018 (from the 4-traders consensus data), Rezidor’s fair valuation would be 11,5×110=1265 MEUR.

With the current 414 MEUR market cap and net debt free balance sheet, the upside with the portfolio composition adjusted peer EBITDA-multiple based valuation for Rezidor is about 3x –> the structure of the hotel portfolio is not likely explanation for the big valuation discount relative to the peers either.

Management

After accounting for the master franchise agreement, the main difference between Rezidor and comparable international hotel chains comes down to the ownership structure.

HNA owns 70 % of Rezidor and 100 % of Carlson.

HNA is a giant Chinese conglomerate that has been growing with debt fueled acquisitions around the world.

It for example owns major positions in Deutche Bank and Hilton and has bought global technology wholesaler Ingram Micro among few airports and financial companies around the world.

The ownership of the HNA is unclear, some Chinese billionaires which might or might not have connections to the Chinese Communist party.

The basic story in the news is that everything it does is shady, and the people involved are shady, but somehow it has unlimited amount of money and connections to do deals of trophy assets around the world, seemingly without any central strategy.

There are two ways the concentrated ownership structure can manifest problems for Rezidor’s minority shareholders and thus effect the valuation multiples;

1) Majority owner loot the company

As HNA owns 100 % of Carlson and 70 % of Rezidor, and thus effectively controls both, there is incentive to move costs from Carlson to Rezidor and income from Rezidor to Carlson.

While there are probably ways to move cash past minorities to the majority owner, there are some practical limitations that make it seem like a low probability event:

A) Illegal

As independent legal entities, transactions between Carlson and Rezidor are governed by mutually binding contracts, probably mainly by the master franchise agreement.

If management, board or shareholder meeting would decide to change the contracts governing the important transactions between Rezidor and Carlson so that it would benefit majority shareholder at cost of minority shareholders, under my non-professional legal interpretation it would be illegal under the “shareholders equality principle”, as defined in the laws governing limited liability companies (at least in Finland).

I don’t know but if such proposal would come to board’s or shareholder meeting’s table, the majority shareholders or their board representatives couldn’t participate in the decision making, or their votes wouldn’t count, leaving the decision for independent directors or minority shareholders, who would surely vote any such proposals down immediately.

B) Small benefit

HNA owns 100 % of Carlson and 70 % of Rezidor, so they already get 100 % of whether profits Carlson makes and 70 % of whether profits Rezidor makes. The maximum incremental profit HNA could make by abusing minorities is to get the last 30 % of profits to their hands.

That’s small benefit relative to HNA’s debt problems and relative to the potential repercussions if done illegally, as explained next.

C) Repercussions from (western) financial backers

HNA is under tight scrutiny by their financiers due to very high debt load and rumored liquidity problems.

Financiers, which directly through HNA include many Chinese banks and indirectly through their wholly, majority and minority owned subsidiaries probably many western financial institutions.

If HNA would change contracts between Carlson and Rezidor so that Rezidor’s minorities’ position would be illegally weakened to benefit the majority owner, the information would quickly spread to the financiers who, especially the “western” financiers who are not insiders with the HNA’s owners/Communist party, would probably start to suspect whether HNA will also “illegally weaken” their position too i.e. stop paying their debt back or any other trick in their sleeve.

And when you have big debt load and are under liquidity squeeze, the trust of financiers is pretty much the only asset you have which should not be weakened under any circumstance, especially if the potential gain is small (as it would be in Rezidor’s case).

Imagine for example that significant number of HNA empire’s western subsidiaries’ suppliers, customers and financiers would start suspect whether the HNA owned subsidiaries will keep meeting their commitments as agreed in the contracts or governed by law or good by business practices.

Suppliers would start to demand prepayments or stop cooperation altogether, financiers would demand higher interest or not provide new loans and customers would stop prepaying or move to other service providers.

In such liquidity squeeze scenario in the western subsidiaries, the cash flow from them to the parent HNA’s Chinese headquarters would stop or be significantly weakened.

The potential benefit of behaving badly in their small overseas outpost somewhere in the western frontiers (like the Sweden listed Rezidor in this case) for HNA empire would be very small relative to the the worst case domino effect it could lead to.

I have not read Sun Tzu but I’m sure there is something about hurting yourself in the foot.

In addition to the practical limitations to loot the minorities that make it seem like a low probability event, there are few actions by the majority owner that make it seem even less probable:

A) Dividends and debt swap

HNA became the majority owner of Carlson and Rezidor in the end of 2016.

If HNA would have wanted to channel cash out of Rezidor past minorities directly to themselves, they could have stopped paying dividends and then channel the cash out of the company by some other way. They did not do so.

Recently, HNA pledged about 5 % of the Rezidor’s shares to financiers to secure loan.

If they wold have wanted, they could have taken the cash out of Rezidor or take the loan for Rezidor’s name, and then channel the cash to the parent HNA either illegally past the minorities or legally by paying “special dividend”, but they did not do it.

That they did not decide to benefit the majority shareholder at the cost of minority shareholders in these occasions when they had clear opportunity do so, at least apparently, is in my mind evidence against the thesis that there would be high probability for such scenarios in the future

E) Management seems to be focused on the business

After HNA took over Carlson and Rezidor, they immediately started restructuring programs to improve the business. Carlson has had it own initiatives and Rezidor their own.

For example Rezidor will be publishing their “five-year plan” for investors in January. There is also new joint committee to coordinate Rezidor’s and Carlson’s global business activities, like IT, marketing and growth (the new goal is to be among the top 3 hotel companies in the future).

If HNA’s goal would be just looting minorities instead growing the business, it’s doubtful that they would be using so much effort to various development activities.

And listening to Rezidor’s management conference calls after HNA became the main owner, and comments from Carlson’s manager in the article linked earlier, I get feeling that both respect the HNA people and think that they are the real deal.

Both for example point to potential revenue synergies with other parts of HNA empire, namely various airline, airport, hotel etc. holdings, which could be utilized in channeling more Chinese tourists to Carlson’s/Rezidor’s hotels and expansion in Africa, one of the fastest growing hotel markets in the world.

2) Majority owner’s debt problems spreads to Carlson and Rezidor

As said, HNA has a lot of debt and is under liquidity squeeze.

While Rezidor and Carlson are independent legal entities, it could be possible that their suppliers, financiers and customers would perceive that they cannot or don’t want to keep their commitments by associating HNA’s liquidity problems to them.

This could happen if the suppliers, financiers or customers would perceive that the cash produced by Carlson/Rezidor flows to the problematic HNA parent company instead to them.

This could happen without any illegal or questionable activities, just perception anyone associated with Chinese/HNA are not trustworthy.

If such perception would spread to Rezidor/Carlson, doing business would become almost impossible and thus cash flows and value of both companies would decline.

Like the “looting scenario”, spreading of the HNA’s problems to Carlson/Rezidor seems unlikely because both are independent legal entities from HNA and thus they are not responsible of HNA’s debt, and because, at least so far, there are no signs that HNA would be channeling cash flows from their subsidiaries to benefit them at the cost of their financiers, suppliers or customers (or minority owners).

Conclusion

As Rezidor’s valuation multiple is about third of the peer companies, market seem to put very high probability for some combination of the “Majority looting the minorities” and “Majority owners debt problems spreading to subsidiaries” -scenarios (as there doesn’t seem to be big business related differences between the peer companies and Rezidor).

As seen from the simplified scenario analysis valuation sheet below, if there is

A) 50 % probability that Rezidor is “normal company” and its fair value is based on the “hotel portfolio weighted peer valuation EBITDA multiple”,

B) 25 % probability that HNA “semi-loots” 50 % of the “as if normal value” of Rezidor to themselves, and

C) 25 % probability that HNA loots 100 % of the “as if normal value” of Rezidor to themselves,

then Rezidor’s “probability weighted value” is 46,3 SEK/share or almost 90 % higher than the 24,7 SEK stock price currently:

But per my thinking, the practical limitations preventing HNA for looting the minorities, and the HNA’s past actions indicating they don’t want to do so, make it seem much more likely than a coin flip that Rezidor is closer to the “normal” company rather than being a target for some form of looting, thus indicating that the upside is even higher than the valuation sheet implies.

The one thing market might be missing due to the turmoil regarding HNA and the uncertainty about their intentions regarding minorities is the successful turnaround in the core business in recent years, that is starting to show in the profits in this and next couple of years.

Another positive aspect of the situation is that there are some “smart money” involved. Special situation and distressed investing specialized investor Polygon Global Partners is among the top 3 owners and has member in the nomination committee.

Potential catalyst of the situation is that HNA’s problems get worse and they have to sell their stake in Carlson/Rezidor to pay down debt. While being “partner” with potential forced seller is not the best place, the current valuation is so low that there would probably be some upside even in forced selling scenario.

And if HNA settles its debt issues, it will probably buy out the minorities and continue as independent company. Last time HNA offered the minorities 35 SEK and they didn’t sell, so in the future it could be even higher.

If neither of the scenarios materialize and HNA stabilizes its financies, there is some chance that market will start pricing Rezidor somewhere closer to the peer multiples.

Disclosure: Long ~10% position

Edit 25.12.2017 00:03: Fixed few bigger writing errors for sake of clarity.

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6 thoughts on “Rezidor Hotel Group: Do Chinese Read Sun Tzu?

  1. Hi, I like your idea. But I think you cannot compare on EV/EBITDA. Due to the asset light model with nearly none real estate ownership international large peers (for example Intercontinental) will always trade at a premium based on EV/EBITDA. They just will not have that much depreciation.

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    • Hi, I think my ”hotel portfolio composition adjusted comparable EBITDA valuation multiple valuation” takes into account the differences between portfolios.
      I used Scandic’s, ~100% leased hotels, EBITDA multiple for Rezidor’s leased hotel segment EBITDA (~50 % of total) and average of Intercontinental and Hilton, ~100 % managed&franchised, EBITDA multiples for Rezidor’s fee based i.e. managed and franchised EBITDA (50% of total).
      Rezidor doesn’t own any hotels, so it’s asset light also.

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  2. HNA delisting bid was at 35 SEK. So assuming they too control of Carson/Rezidor at that valuation, why did the sellers sell out at such low multiples (higher than current trading though)? HNA has a track record of overpaying as well.
    It does look cheap but I am curious to understand HNA initial investment and how it relates to the current “cheapness”.

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    • Both the HNA’s original acquisition price and the reason for some of the owners selling is all speculation.

      Neither is knowable so I haven’t used much time thinking about them.

      The comment of HNA’s tendency to “overpay” is also speculation and thus speculating about their original bid price and relating that to (speculative) tendency to overpay would be double speculating.

      I don’t think that is route to dependable conclusions.

      Rezidor is the largest upper up scale hotel chain in Europe (so bigger than Hilton, Marriot, Intercontinental). The adjusted P/E is now 10, about half or third of the comps.

      The question is, I think, whether the discount is big enough to assume for qualitative negatives relative to the comp set:

      1) Chinese majority owner (with much more ambitious and detailed growth and cooperation plan than the old majority owner Carlson family ever had)

      2) Bad historical operating performance.

      One risk is of course the cycle (revpars at last cycle peak level) but that is same for everybody so it should not effect relative valuation multiples.

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      • Even though it had a much higher free float and and it was controlled by Carlson (and not some shady Chinese conglomerate) Rezidor only briefly reached 45 SEK a couple of times since the 2008/9 financial crisis.
        Just trying to figure out the historical underperformance and how cheap it really is and if the new management’s plan could be a game changer (together with some trigger related to HNA financial problems) I have a small position but need to know more in order to make it a larger position.

        Liked by 1 person

      • Yeah, I think thinking the operating performance is the approach that can yield some answers rather than using time on why someone sold or did not sell and what price.

        One big issue is the bad leases which has hurt the performance a lot hisorically, somw of which Rezidor has gotten rid of (by paying up).

        The management can be blamed of them, probably have done bad deals to grow the business, which blew up after the previous crisis.

        The bad leases still weigts down earnings a lot and per the resteucturing plan they are not getting out of them in the planed period.

        The bad leases will end some day though and the EBIT effect would be like 30 meur if I remember correctly.

        My interpretion of the resteucutring and cooperation plan is that Carlson didn’t care too much of develoåinh the business and now that has been changed.

        Thx for the comments!

        Like

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