PPHE Hotel Group — Update 12 December 2016

PPHE is an owner and operator of full-service, four-star, deluxe and boutique hotels in gateway cities, regional centres and select resort destinations, predominantly in Europe. Its portfolio comprises 25 hotels (c 5,500 rooms), marketed under the brands Park Plaza Hotels & Resorts (exclusive partnership with Carlson Hotels Worldwide in EMEA) and art’otel (owned). It is also majority owner of Arenaturist, a leading Croatian hospitality group (c 2,800 rooms). Current development projects are primarily in London with the opening of c 900 rooms by the end of this year and c 500 rooms in 2019. PPHE was floated on AIM in 2007 on its formation from a combination of the hotel assets of its two largest shareholders and moved to the Official List of the London Stock Exchange in 2011.

In terms of the key EV/EBITDA indicator, PPHE, at under 9x 2017e, appears inexpensive. However, differing business models among competitors, eg the increasing popularity of “asset-light” and associated low indebtedness, and geographical coverage do not make for easy comparison. In any case some discount is justified in view of PPHE’s relatively brief record, its scale of net debt (albeit well within facility) and the presence of effectively a majority shareholder with a history of related-party transactions. We look rather at the very substantial share price discount to “fair value” NAV (c 63%) or 14% to book value (both as reported at 30 June 2016).

Our estimated 2016 net debt of £579m is well within the company’s long-term bank facilities of about £690m, which mature substantially in 2026-28. With regard to expansion, PPHE has a well-established policy and track record of borrowing within a 65% loan-to-value requirement of its banks. For example, the recent refinancings of two London and six Netherlands hotels implied an asset value at least £130m ahead of their book value at December 2015. Management is confident that it can leverage on its assets by opening similar facilities for future development projects.

The company seeks to reduce the seasonality of its business by optimising its guest mix (particularly business against leisure) and its impact on profit by securing as flexible a cost base as possible. It also enjoys substantial recurrent revenue through agreements with business travel agencies and large corporates for discounted room rates.

Gateway focus

PPHE has developed a collection of popular, full-service, four-star, deluxe and boutique hotels with a good geographic spread and guest mix (c 50% business customers). With a focus on European cities (gateway and regional), there is particular representation in the important lodging markets of London, Amsterdam and Berlin, where the hotels are predominantly owned and operated under the Park Plaza brand. The advent of Westminster Bridge in 2010 brought a step-change not only in company financials but in commercial and marketing opportunity as its flagship is one of Europe’s leading conference hotels (currently top in London by “Popularity”, per TripAdvisor). Consolidation of resort activities in Croatia brings a re-shaping in terms of business and seasonality.

Flexible model

The breadth of ownership interests and contractual arrangements in PPHE’s hotels allows the company to maximise opportunities from the varied markets in which it operates and may enter. As shown in Exhibit 1, ownership accounts for about 80% of room stock and almost all UK and Netherlands operations. It also applies to all but one of the company’s current projects (c 1,400 rooms). Although it is capital intensive, ownership offers scope for asset appreciation, especially in key gateway cities in Europe, and management has a strong record in real estate development and a self-professed entrepreneurial spirit. Most PPHE hotels in Germany and Hungary are under long-term operating leases (15 to 25 years), while the sole management contract (Park Plaza County Hall) runs until 2033. Franchise arrangements cover just 6% of overall room stock (three hotels); revenue comes from brand royalty or licensing fees (c 3.5% of hotel revenues), one-off fees on opening under the company’s brands and ancillary services.

Fully branded

Apart from several Croatian resort properties that use the well-known Arenaturist brand, all hotels are branded Park Plaza & Resorts (c 75% of rooms) or art’otel. While distinct in terms of target customers and property size (the former targets the business as well as leisure market and favours larger properties, ie typically up to 300 rooms), both brands address the growing “affordable luxury” segment (high quality at attractive rates). Outside Europe, the Middle East and Africa, where the company holds an exclusive right to use the brand in perpetuity under its agreement with Carlson, there are 20 Park Plaza properties in operation and under development, predominantly in China and India.

art’otel is an established “lifestyle” brand, targeting those with an interest in art and culture by aspiring to be represented at key cultural hot-spots throughout Europe. In keeping with a new social environment and desire for differentiation, such “lifestyle” hotels are increasingly seen as an attractive and strategic market by most hotel groups. For example, AccorHotels has newly suggested that the market may double over the next three to five years and has thus committed 10% of its pipeline against 1% previously. At art’otel, contemporary architectural styling is married with art-inspired interiors (each property is dedicated to a particular artist, eg Warhol at berlin kudamm). Amsterdam, only the second development since PPHE’s acquisition of the brand in 2007, opened in 2013 to wide acclaim, with sites in London (Hoxton and Battersea Power Station) due to open in 2019. While ownership of the brand is subject to a perpetual licence in favour of the brand founder elsewhere in Europe (France, Germany, Italy, Spain, Austria and Switzerland), there is reassurance that any such hotel will be managed by the group.

Powerful relationship with Carlson

Inclusion in the reservation and distribution systems of Carlson Rezidor Hotel Group (the marketing and purchasing alliance between Carlson, one of the largest hospitality and travel companies in the world, and Rezidor, its hotel subsidiary) continues to be very positive for PPHE. As well as customer referrals, it provides reliance on a far larger and more sophisticated system than potentially in-house, ie in operation and under development over 220,000 rooms (1,400 hotels) in 115 countries and growing rapidly with 120 signings (almost 20,000 rooms) in 2015, and powerful brands, notably Radisson Blu. There should be further opportunity from the proposed combination of Carlson’s hotel interests with HNA Tourism of China.

There is substantial benefit from access to the alliance’s market-leading loyalty programmes for guests, business travel agents (“Look to Book”), meeting planners and corporates. Guest loyalty programme Club Carlson has been an important part of Carlson’s strategic commitment to help hotels increase revenue. Membership is over 15m, up c 70% since 2012. It was ranked among the best three hotel rewards programmes for 2015-16 by U.S. News and World Report. PPHE confirms that increased loyalty apart, room rates from members tend to be higher than from non-members.

E-commerce initiatives, boosted by the Carlson relationship, include email marketing, online advertising and building affiliate networks, such as with airlines and car rental companies. The company’s social media fan base, which is well ahead of that of other hotel brands of similar size, continues to be actively managed.

PPHE has a clear aim to use its reputed brands to become a leading hotel operator in upscale and lifestyle hotel segments. In this regard a confirmed development pipeline is set to add c 1,400 rooms (c 17% of current stock) in existing markets over the next three years (see Exhibit 2), thereby consolidating the company’s strong position in London with c 3,500 rooms (leading owner-operator glh has c 5,000). The proximity of the Waterloo site to existing company properties brings a unique ability to offer 1,000 rooms in one area for events in central London. Projected spend there is c £70m, suggesting a total build per key (including land costs of c £25m) of about £140,000, which compares well with the London market. The Park Royal project is on a two-acre mixed-use development site in West London next to Park Royal Business Park (over 1,000 businesses) and close to Wembley Stadium, the SSE Arena and the Westfield Shopping Centre; it has good transport links, fronting the A40 and opposite Park Royal Underground station. In the longer term, it is particularly creditable that PPHE and art’otel have been selected as operator and brand at the landmark Battersea Power Station development (42 acre site, 25,000 people living and working on site with 40m visits expected each year). Elsewhere, in Hoxton, planning continues for an innovative cylindrical shaped 18-storey hotel within the South Shoreditch Conservation Area. Competition is fierce for scarce quality assets, but PPHE’s gateway strategy is proven and there should be opportunity to sell advantageously, if wanted.

There should also be significant opportunity as a result of PPHE’s newly increased investment in Croatia. This brought control (66% holding) of Zagreb-quoted Arenaturist, a long-established hospitality group consisting of seven hotels (four under the Park Plaza brand), six holiday apartment complexes and eight campsites, all in prime seaside locations in the south of Istria. The business has been managed by PPHE since 2008. Apart from the promise of enhanced involvement in a long-term growth market (see Exhibit 3), management looks to develop Arenaturist across Central and South-Eastern Europe under the Park Plaza brand. Meanwhile it has recently agreed to acquire the freeholds of art’otels cologne and berlin kudamm, currently leased by PPHE.

With other projects under consideration, management does not regard debt as a restriction to growth as long as it can be serviced and is secured judiciously against likely appreciating assets. This is evident in a recent successful record of refinancing the bulk of its owned estate in London and the Netherlands on a loan-to-value ratio of c 50-65% on total committed facilities (average LTV 56%). Also under review is a potential release of part of the value of the hotel assets, while retaining operational control (sale and leaseback is not favoured).

PPHE’s senior management (see below), which is based at the company’s head offices in Amsterdam and London, is backed by highly-experienced local management.

PPHE is a relatively small hotel group, but one that is trading well in the UK and in terms of its international brands. We look at primarily Europe-based international hotel groups for comparative guidance. As well as size differences, structural variations in business models, eg the increased popularity of ‘asset-light’ structures and associated low indebtedness, and geographical coverage, mean that comparisons are inexact. We explore valuation on two metrics: asset value and EBITDA.

We look first at investor perception of PPHE’s property assets. With c 80% of room stock under ownership, this is a key metric and, in our view, the predominant one. The market valuation (price to book 0.8x) appears at a considerable discount to those of similarly asset-backed operations such as Mandarin Oriental (1.3x) and Dalata (1.7x). While at a premium to Millennium & Copthorne (0.5x) and to GL (0.7x), we suggest that this is a function of company-specific issues, notably concern respectively about Asian markets and the oil price (oil-related income forming a significant part of GL’s results). NH (1.1x) and Meliá (1.6x) are also relevant to PPHE valuation, given their residual estates, but the largely asset-light models of AccorHotels, Rezidor and Whitbread are not.

On a fair value basis, PPHE’s share price discount to adjusted NAV is even wider at 0.4x. Here we adjust the reported net assets for independent valuations in respect of the various property refinancings in H116. Fair value adjustment of £445m, as reported in H1, results in an adjusted NAV of c £18.50 per share with a further material uplift expected as the new London hotels come on stream.

As a complement to our hotel industry comparison, we consider in Exhibit 6 the valuation of quoted property companies (freehold hotels, offices and residential property). We select companies with high-quality assets in prime city locations in the US, UK, France, Germany, Hong Kong and Singapore. We limit our scope to companies with market cap of US$0.25-5bn and (for the purpose of market valuations unaffected by liquidity issues) a free float of 75% or over.

The range of valuation is broad, as this is not an exact science, but the range of share price relationship to NAV (very largely between 0.5x and 1.5x) may be viewed as supportive to PPHE. The appropriate comparison with PPHE is on a fair value basis (0.4x), as property companies report on this basis. Of the 28 companies in our sample size, 26 are trading at above this level.

The company’s 2017e EV/EBITDA rating of 8.6x appears below average (9.4x) in the range of 5-13x for the companies shown in Exhibit 5. Arguably the majors should stand at a premium in view of their scale, brand strength and record. The rating may also reflect PPHE’s limited liquidity.

The imminent London openings may be expected to spark new interest and hence greater investor awareness of the company’s focus and strong record on asset appreciation. Despite understandable security and geopolitical concerns, the consultancy HVS remains “cautiously optimistic” about the appeal of the European market to global investors over the medium to long term. Brexit uncertainty may have contributed to much lower hotel transaction activity than in any of the last three years but foreign investors and visitors will surely take advantage of sterling depreciation. Significantly, press speculation suggests the 582-room DoubleTree by Hilton Tower of London has just been sold for £300m, ie £515,000 per key. Chinese groups continue to invest heavily in hotel chains, notably HNA Tourism in Hilton following NH Hotels and Carlson Hotels and Jin Jiang in AccorHotels and Louvre Hotels, not least in expectation of a significant increase in the number of Chinese travellers to Europe. We are reassured by latest Q316 reports from the European hotel industry, which suggest resilience away from immediately affected areas such as Paris, Brussels and London. The enduring appeal of trophy hotel assets should spill over while, importantly, our forecasts do not take account of the likely full benefit of PPHE’s current real estate activity. Resort locations in an apparent ‘safe haven’ like Croatia should benefit from displaced demand from North Africa and Turkey.

The first half to June 2016 saw contrasting fortunes for PPHE’s two main profit sources, London and the Netherlands, as well as consolidation from April of operations in Croatia after buying in its joint venture. There were also significant corporate transaction costs, which we assume to have accounted for much of the overall £2.6m (7%) decline in EBITDA. While London trading was predictably subdued (-5% RevPAR was in line with market reports for the capital – see Exhibit 8), the focus on room rate (+1%) could not prevent cost pressures (eg selling and payroll) driving UK EBITDA down 14%. Netherlands again stole the show with RevPAR up 5% on a demanding comparative and EBITDA up 16%, albeit currency-boosted. Croatia’s initial EBITDA contribution was predictably minor as Q2 is its shoulder period.

Trading update confirmation of a “good” Q3 reinforces our confidence in our full-year forecasts. 9% higher like-for-like revenue in Q3 was driven by Croatia where in its peak period buoyant trading was complemented by a favourable accommodation mix (a shift to hotels and apartments from mobile homes). London held up well, which is encouraging, given continued difficult conditions (Q3 RevPAR, per STR, was flattered by the Farnborough Airshow and a later Wimbledon). Netherlands softened after a bumper first half, partly because sterling weakness depressed Amsterdam’s key feeder market from the UK.

However, caution is justifiable ahead of PPHE’s strongest trading period, Croatia apart. For London this fits recent comments by hotel groups, while October will inevitably have been well down on last year owing to no Rugby World Cup. We assume further stabilisation in the capital in view of resilient UK overseas visitor numbers (+2% post referendum, per ONS) and the lure of the UK as a cheaper destination owing to sterling weakness (PPHE is well-placed to benefit in the holiday period from its breadth of family-friendly accommodation in London). H2 EBITDA margin reduction there on a par with H1 looks reasonable in the face of continued selling cost pressures and the full impact of the Living Wage (typically, 7.5% rate increase). The delay to late Q4 in opening two hotels and the Riverbank extension brings pre-opening costs without associated revenue, but initial consolidation of Croatia’s peak trading should make up for the likely EBITDA decline in PPHE’s main profit centre.

For next year, the profit driver remains the new rooms in London since costs may be expected still to be an issue and the first inclusion of loss-making Q1 will depress Croatia. Despite likely higher demand from value-seeking tourists and domestic vacationers obliged to stay at home, American Express GBT does not expect UK room rates to rise. We assume renovations planned by PPHE in London, Amsterdam and Utrecht not to be disruptive. Returns from £115m development spend included in our forecasts may accrue in full only beyond the scope of this review. We will update forecasts once key financials of the newly-proposed Arenaturist acquisition in Germany have been clarified. Meanwhile we expect the bottom line to improve owing to advantageous rates of financing.

The likely sharp rise in net debt in 2016 (we forecast £579m up from £398m) reflects in particular a spike in capex (£90m), buying in its Croatian joint venture (£51m), a 100p special dividend (£42m) and adverse foreign exchange (£23m). However, this is well within the company’s long-term bank facilities of c £690m, which now have an average term to maturity of about nine years after the H1 property refinancings. These also allowed that special dividend payment in respect of perceived excess cash. With regard to expansion, PPHE has a well-established policy and track record of borrowing within a 65% loan-to-value requirement of its banks eg June 2016 refinancings of two London and six Dutch hotels implied an asset value c £130m ahead of their book value at December 2015. Management is confident that it can leverage on its assets by opening similar facilities for future projects.