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Hotel chains face valuation gaps in acquiring assets in Indian markets

Shally Seth Mohile/Mumbai 12 Mar 19 | 11:58 PM

S P Jain, managing director of the Pride Group of Hotels, has been scouting for assets in Mumbai and Hyderabad his firm can acquire as the five-star hotel chain seeks to expand in India’s hospitality market. 

Jain and his team have not been able to conclude the deal with sellers in over a year though there are enough of them. Jain blames it on the wide gap between the results of the method used to evaluate an asset. 

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“The seller wants the valuation of the business done on the basis of the value of the property whereas the buyer looks at the business potential of the asset and the cash it will generate. The property valuation will always be higher than the business it generates," he says. Owing to this mismatch, one doesn’t see deals coming to fruition.

Achin Khanna, managing partner at Hotelivate, a hospitality consulting firm, says there are two reasons why transactions happen. “Either the buyer’s need is greater than the seller’s and the former sees an incremental value in acquiring the asset beyond the discounted cash flow, or when the sale is distress sale," he says.

 

The buyer may settle for a lower return on capital when he has a portfolio approach — the sum of the multiple assets within the portfolio will be greater than the individual value of these assets. Therefore, he wouldn’t mind paying a premium. From the seller’s point of view, the only time he will compromise is when it’s a distress sale and the company is in dire need of cash, says Khanna.

In order to tap the burgeoning demand and plug the gap between supply and demand, hospitality firms, specially the ones that have build-and-operate as their business model, are preferring buyouts over building greenfield projects. 

Typically, it takes between three and five years (including land acquisition) and close to 75 non-objection certificates to build a hotel ground-up.

But howsoever companies may wish, acquisitions have not been easy and Pride is not the only one struggling. Most of the other hotel chains that have an acquisition-based expansion plan are finding it tough to take their negotiations to a logical conclusion. 

Take InterGlobe Hotels, for instance, the hospitality firm which owns and operates the ibis brand of hotels. The joint venture between Indigo Airlines, InterGlobe Enterprises and French hospitality major Accor will be adding seven more hotels by 2020. The company is looking at 18-19 new cities for an expansion besides building more hotels in its existing markets such as Mumbai and Goa.

But not all of this can be greenfield and hence the company has been actively scouting for assets that are up for sale. 

“We would love to acquire, but it has to tick all the boxes," says J B Singh, president and chief executive at the firm. Singh cites valuation mismatch as one of the biggest deterrents in acquisition, besides brand fitment, size and compliance.

Quite often the seller values the asset on the basis of replacement cost, which is predicated on the current value of the underlying land, says Singh. The buyer, on the other hand, assesses the opportunity on a multiple of current Ebitda (earnings before interest, taxation, depreciation and amortisation) levels. 

Since the assets for sale are typically the ones that are underperforming, there is often a wide gap between the two valuations, he adds. 

Chalet Hotels, the hospitality arm of K Raheja Corp, is another instance. The asset manager and developer for five-star chains such as Marriott and Four Seasons, too, have been in the market for close to year and a half but hasn’t been able to conclude any deal, Sanjay Sethi, managing director and chief executive, told Business Standard in an earlier interaction. 

Nandivardhan Jain, chief executive officer at Noesis Capital, says when one is buying a hotel, one is buying a business and not just the real estate. "Both parties (buyer and seller) have to be cognizant of this," he says.

Real estate is a component of the business, not the business in itself, says Jain, pointing out that a city may be great in terms of real estate value, but it’s also important to see whether the hotels in the city can command an average room rent of Rs 7,000-8,000.

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