In
our Hotel valuation models we generally compute WACC with Cost of
Equity based on re-levered industry Beta and target's risk premium
specifics and after-tax cost of debt as we use NOPAT and Unlevered
Operating FCF. As all these parameters differ should we value the
company that owns the real estate or the company that manages the
hotel. Let's see them both.
Beta
and WACC in the Hotel Industry: the Real Estate asset
The
first entity that we might be asked to value is the company that owns
the property of the Hotel, say that owns the Real Estate where the
Hotel operates. Generally this entity represents the interests of an
investor such as a Bank, an Insurance company, a Real Estate fund or
any sort of institutional investor with a typical Real Estate type of
return expectation. This investor requires a low and stable cash flow
so that it may leverage up its investment and expects a long term
capital appreciation. WACC for these investor is lower than WACC of
the leisure and hotel industry. We usually calculate WACC for the
company that owns the property of the Hotel based on appropriate real
estate Beta for the country and region where the hotel is located.
Then we adjust this general expected return to consider four specific
risk premiums associated with the target: location of the building,
quality of the building, type of tenant, type of contract. We
calculate a scoring for each of these parameters that produces a risk
calculated in basis points.
As
leverage level and cost of debt are key value drivers in the
valuation for the company that owns the property of the Hotel, we
should also calculate the appropriate re-levered Beta and investigate
about the long term cost of debt, based both on current mortgages and
long term contracts. In addition we also consider the interest rate
swap curve to understand how the Hotel's cost of financing may change
in the long term.
Beta
and WACC in the Hotel Industry: the Hotel management company
The
second different entity is the Hotel management company, which is the
company that operates the Hotel and pays a rent or a lease to the
Real estate owner. This company may represent the interest of a vast
type of investors, including international operators specialized in
the Hotel industry but also individual operators running a few or
even a single hotel, often supported by a management contract with an
international hotel operator chain. WACC for the Hotel management
company is rather high as this entity runs the full industry risk and
has no Real Estate asset protection. But let's come to numbers.
To
calculate the appropriate Beta and WACC we may start from industry
data. In first quarter 2015 industry average unlevered Beta was 0.83
in the US plus UK (that we personally calculated based on Reuters
data on companies such as Marriott International, Starwood Hotel &
Resort, Hilton Hotel Corp, Intercontinental Hotel Group Plc) and 0.79
in Europe (that we calculated based on Reuters data on companies such
as Accor SA and NH Hotel Group).
Country
risk may be simply based on 10 year gov bonds yield and a liquidity
premium should also be applied
Once
calculated the hotel market risk in the specific country, we deal
with target's specifics.
Risk
might be higher than the market if the target hotel does not own a
strong Hotel brand that assures recurring business. We usually
calculate the appropriate WACC for the Hotel management company
starting with industry Beta and considering in addition the following
specific risk premiums for the target Hotel: the attractiveness of
the location, clientele loyalty (the type of clientele, recurring
clients, competitive advantages vs other hotels nearby), type of
contract with the real estate owner and type of contract with the
international hotel chain. We calculate a scoring for each of these
parameters that produces a risk calculated in basis points.
Finally
leverage is added to both obtain re-levered beta and cost of equity
and of course the final target WACC. Take into consideration however
that leverage for an Hotel management company may be very low and the
Cost of Debt portion of WACC might be close to irrelevant.