The
“Hotel Valuation from RevPar to DCF” article that I wrote in 2009
and has been widely read and copied explained why DCF methods were
preferable to income capitalisation methods in the valuations of an
hotel. As almost everybody in this industry now agrees on this, let's
discuss now about income based DCF vs after-tax cash flow based DCF
valuations, which is still an aspect differently treated by
international hotel consulting firms.
RevPar
and income capitalisation valuation techniques limits
Price
multiples based on hotel industry indicators were a simple, powerful
and fast way to value Hotels in the past. We could apply multiples
derived from the local market relating to RevPar (Revenues Per
Available Room), GopPar (Gross Operating Profit Per Available Room)
and NoiPar (Net Operating Income Per Available Room). Multiples also
varies according to Hotel category and specific location (such as
the price per room for a four stars hotel in Venice Giudecca), that
is a smart way to summarise in one single criteria a more complex set
of Price multiples. There are however issues that strongly limited
this Hotel Valuation approach: rents and Hotel Capex among the
others. Rents are no longer a fixed amount as they may change
depending on the hotel performance, so we cannot capitalize a fixed
average profit if the rent cost is variable. Hotel Capex are
increasingly relevant both because of higher energy and tech
requirements and for the need to create proper unique styling to deal
with a stronger competition. Today everybody agrees that a DCF
methodology is more accurate than a income capitalization valuation
as it deals with these and other issues.
Income
based vs Cash Flow based DCF: what's wrong with income?
DCF
means Discounted Cash Flow so a DCF valuation discounts a stream of
cash flows: we have to calculate Revenues, Ebit, NOPAT and Unlevered
Free Cash Flow. Quite surprisingly I often incur in valuations were a
sort of gross income adjusted for Capex is discounted instead of
UFCF. What's wrong with it? The difference is that no taxes and no
working capital requirements are properly included.
Income
based vs Cash Flow based DCF: what's wrong with Taxes?
We
do not live in a no tax environment and taxation severely impacts
Hotel income: in a high taxation environment such as Italy, Hotel
have a strong local taxation for Irap that is even stronger if labour
cost is high, which is common for 4 and 5 star hotel. In addition
Hotel pay the ordinary state income Ires tax. Say that half of
Pre-tax Profit may be paid as taxes. In addition taxes will be paid
on the Terminal Value should the hotel be sold: in this case the
taxation level might be different from ordinary taxes as capital gain
rules might apply. In few words: taxation in the international hotel
business it's a mess that we must take into account as it may easily
change the final hotel valuation even more than our occupancy or
RevPar assumptions.
Income
based vs Cash Flow based DCF: what's wrong with Working Capital?
We
may avoid calculating Working Capital financial needs should we live
in a place were hotels were able to collect all their revenues
immediately: unfortunately for hotels this is not the case,
especially if any internet based booking service such as Expedia is
used. The client pays in advance, the hotel gets paid in arrears. The
time lag requires financing, which is cash flow. The impact differs
case by case and it may be relevant.
In
conclusion, DCF is a powerful methodology but it requires additional
expertize and efforts compared to traditional income based
methodologies.
Cesare
Carbonchi, President EqS Equity Studio