M&A activity in the hotel operator sector continues to gain momentum globally. Strategic buyers have closed a number of recent high-profile transactions, such as Hyatt's acquisition of Playa Hotels & Resorts, Marriott's acquisition of citizenM, and InterContinental Hotels Group's acquisition of Ruby Hotels. In addition, private equity firms, sovereign wealth funds, and ultra-high-net-worth individuals have been active and made a number of recent strategic investments in hotel operating platforms, such as Blackstone's acquisition of Village Hotels, Partners Group's acquisition of BLUESEA Hotels, and Public Investment Fund of Saudi Arabia's and Cain International's joint investment in the Aman Group.
The strategic drivers of M&A activity for hotel operators include general market fragmentation, the benefits of scale, a multi-brand and/or multi-product platform, improved bargaining power with online travel agencies (OTAs), and expanded loyalty programs. Financial investors seek returns from the day-to-day hotel operations via ownership of the operating platform without, in many cases, the additional burden of ownership in the underlying real estate. The hotel operating sector remains quite fragmented relative to other economic sectors, offering ample opportunity for consolidation. The largest hotel operating companies account for only approximately 35% to 40% of traditional hotel rooms on a global basis, with no single operator controlling (via management or franchise agreements) more than 3%. The overall operating performance of the global hotel sector has been strong in recent years with room rates and occupancy rates, particularly at the luxury end of the market, showing tremendous growth. This outsized operating performance, relative to other real estate classes, has been a catalyst for both well-capitalized hotel operators and financial investors seeking opportunities via the acquisition of, or strategic investment in, hotel operating platforms.
Strategic Considerations
For financial investors, ownership stakes in hotel operating platforms provide direct access to the financial returns from the day-to-day hotel operations, namely the fee income generated via the managing or franchising of the underlying hotels. This additional income stream can also lead to enhanced overall investment returns when combined with ownership of the underlying real estate, particularly when compared to investments in other, less operationally intensive real estate assets, such as commercial office buildings. Hotel operators can change room rates on a moment's notice, which, if managed effectively, can be both a hedge on inflation or other operating expenses and a boon to capture higher rates amid demand spikes. This flexible, dynamic pricing model has led to strong operating margins in recent years relative to other real estate asset classes. When combined with an increased investor willingness to take operating risks in return for the potential of higher financial returns, this strong operating performance has led financial investors to increasingly take ownership stakes in hotel operating platforms.
For hotel operators, there are a number of strategic considerations, including geographic, product, and operational elements, when contemplating the acquisition of another hotel operating platform.
Geographic Considerations
- Does the target operate and/or franchise hotels in markets that are either underserved or unserved by the existing platform?
- Does the target's geographic platform, when combined with the existing platform, help mitigate the enterprise-level risks arising from potential geopolitical instability, health threats (e.g., COVID-19), or other regional demand shocks?
- Does the target enable the acquirer to achieve geographic expansion faster than organic growth or development?
Product Considerations
- Is there an "offensive gap" in the existing operating platform that the acquisition would solve? The target may have certain brands that expand the acquirer's customer base into new segments or geographies. OYO's recent acquisition of the Motel 6 and Studio 6 platform enabled OYO to strengthen and grow its presence in the US budget and economy segment on an accelerated basis relative to an organic growth strategy. As noted by PwC in their recent hospitality and leisure outlook, "operators are doubling down on experience-driven growth, using M&A to enter luxury, lifestyle and bespoke travel segments catering to high-income consumers, particularly as the upper end of the income curve continues to drive overall consumer consumption growth in the United States."
- Is there a "defensive gap" in the existing operating platform that the acquisition would solve? Hyatt's acquisition of Playa Hotels & Resorts served to fortify and expand Hyatt's strength in the growing high-end "all inclusive" space. As competition in the lifestyle category intensifies, Accor's acquisition of Ennismore put Accor in a much stronger position to compete in this growing market segment, particularly when the Ennismore platform was aligned with Accor's formidable platform-wide distribution channels and loyalty program.
Operational Considerations
- Can the acquisition help achieve operating efficiencies, including increased shared services and staffing, shared sales and marketing costs, procurement activities, and other human capital drivers such as regional expertise, leadership capabilities, and technological or other operational expertise in areas such as food and beverage operations?
- Will the scale of the post-acquisition platform shift the negotiation power or leverage in commission discussions with OTAs and other distribution channels to drive incrementally higher operating margins?
- Does the broader and/or deeper offering improve the market position of the combined platform's loyalty program?
- Will the expanded scale combined with a disproportionate decrease in corporate-level expenses through consolidation of the two corporate platforms help achieve additional operational efficiencies?
- Does the target have proprietary technologies that can be used to improve revenue management, guest awareness and personalization, and other digital capabilities?
M&A Value Drivers
Once the strategic considerations are calibrated and potential targets identified, the key items that drive enterprise value of a hotel operating platform are:
- Potential management and/or franchise agreements — the platform's development pipeline. This assessment focuses on (a) the scale and strategic value of pipeline projects, (b) the path and timing to completion and opening of the pipeline projects (a particularly important analysis given increased construction costs and higher cost of capital relative to recent investment cycles), and (c) evaluating the stakeholders involved and the probability of converting the pipeline into actual operating hotels (e.g., the realization rate).
- Existing management and/or franchise agreements — the integrity of the operating platform. At a basic level, the value of a hotel or franchise agreement is a function of the discounted present value of the fees expected to be generated over the term of the agreement. This valuation exercise is sensitive to a number of the contractual terms in the agreement, including (a) the priority or guaranteed returns for the benefit of the hotel owner, (b) the nature and scope of approval rights in connection with a potential transfer of the agreement, (c) the performance test structure (if any), and (d) any other unilateral termination rights for the benefit of the hotel owner.
- The strength of the global trademark portfolio (in the branded operator context). This assessment includes understanding (a) the scope and strength of, and possible threats to, the existing trademarks and (b) whether the reach or potential reach of the trademark portfolio could materially limit growth expectations.
- Financial synergies between the combined platforms as previously noted in the "Operational Considerations" subsection.
M&A Outlook
The M&A players expected to remain active in the hotel operator space include mid- to large-sized international hotel operators that are well-capitalized as well as private equity platforms, sovereign wealth funds, and ultra-high-net-worth individuals, in all cases, who have access to private and/or public debt markets. Hotel operators are driven to participate in M&A activity by the geographic, product, and operational considerations previously described. Private equity groups, sovereign wealth funds, and ultra-high-net-worth individuals are driven to take direct ownership stakes in hotel operating platforms to help fuel a hotel operating platform's growth and, in turn, obtain a more direct route to participate in the financial returns from the day-to-day hotel operations via the fee income generated by the management and franchise agreements. These drivers will lead to more M&A activity in the hotel operator sector, which activity will be further amplified as capital markets and global trade policies stabilize.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
