M&A: Three hurdles and triggers

Dealmaking in the hotel and hospitality sector is in a funk. No one can predict with any certainty when activity will return to normal or, indeed, know what the new normal will look like. That said, it is possible to recognize hurdles blocking deal flow and identify triggers which may re-start action.

Hurdle 1: Bid-offer spreads

Bid-offer spreads is the big one, already identified by many as the number one obstacle to deal flow. In this case, there appears to be a balance between buyers and sellers but disagreement around valuation persists.

As we headed into European summer, Hilltop Hospitality Advisors estimated there were over e10 billion-worth of deal opportunities in Europe. But as Tom Oakden of Hilltop says: “We would be kidding ourselves that the hotel investment market has gone to sleep in the last few months because of the holiday season. The reality is that it has been treading water for some time.”

What’s more, the funk is, in itself, making matters worse because there are so few deals giving buyers and sellers the information they need to make sensible buy or sell decisions. Tim Barbrook, head of Debt Advisory at HVS Hodges Ward Elliott, says: “Lack of market liquidity is hindering price discovery.”

The hoary-old investment truism holds that asset prices rise when there are more buyers than sellers and fall when sellers outweigh buyers. In healthy circumstances, stability and sustainable price progression comes with a balance between the two. The outcome – for now at least – is frustrating stasis.

Hurdle 2: Interest rate plateau

There is more to analysis of the interest rate cycle than reviewing the moves of the U.S. Federal Reserve, the Bank of England or the European Central Bank. There is some confidence now that interest rates have peaked or will peak in the foreseeable future. Yet while rates may stop rising, it seems unlikely they will fall to levels seen in the last decade.

The hurdle, in other words, is not so much rising interest rates as the barrier created because of the outlook for higher long-term costs of borrowing.

Hurdle 3: Relative reality check

Revenues and occupancy are returning to levels seen pre-pandemic. In a recent report published by HVS (HVS Outlook Fall 2023: Discovering A New Normal) Anne Lloyd-Jones, National Practice, and her colleague McKenna Luke, wrote: “Overall, total demand exceeded 2019 levels beginning in September 2022, and this trend continued through March 2023.” They also added, however: “Trends through the middle of the year have been mixed.”

Yet while positive trends around revenues and occupancy might spur deal activity, the figures may be less encouraging than they might appear, as HVS argues. Inflation, especially energy and wage inflation, and rising rental, building and renovation costs, are among additional factors.

Ultimately, capital returns come from bottom line profitability. Investors and dealmakers will be looking at the relative picture, in other words, as well as topline revenue and occupancy numbers.

Trigger 1: Debt deadlines

Since loans are often arranged on five-year terms, debt deals finalized just before the pandemic are coming to maturity now in a much-changed interest rate environment. Asset sales, meanwhile, provide an escape from financial distress.

Ascan Kókai, head of hotels for ECE Real Estate Partners, the Hamburg-based firm with more than e5.5 billion ($5.9 billion) under management, says: “Many loans agreed in the couple of years before the pandemic are coming up for review. This is a trigger.” Where 2019 deals were being done at all-in debt cost between 1.5% and 2.5%, he added, extensions and refinancings are being priced at levels two, three or even four times as high. That’s largely because of the sharp increases in central bank’s base rates. It is consequently harder to service existing levels of debt, more difficult to raise fresh finance, and opens funding gaps.

For Kókai, there is an important distinction to be made around the question of distress. “It’s not so much an issue around the quality of the asset but the nature of the financial structure in which it sits,” he said. “The distress is financial rather than operational.”

Trigger 2: Return on investment reviews

Investors’ priorities may prompt sales. Funds set up to manage hotel assets may be nearing the end of pre-agreed lifecycles and cash may be returnable to backers.

It is also possible that sound-value assets in a fund portfolio are sold to make across-the-board valuation numbers better, or more palatable. Some sales at good prices might improve the overall portfolio picture, or to make it easier to meet covenants.

At the same time, some managers may simply want to get bad news out of the way: crystalize losses and move on.

Trigger 3: Icebreaker action

M&A could be triggered by the completion of a single high-profile deal. If a price can be agreed between two large investment houses – ones with reputations for delivering sound returns – confidence may build across the M&A landscape.

One such icebreaker deal may be the successful sale of the UK and Ireland Center Parcs family resorts business. The Financial Times wrote in August: “Canadian private equity group Brookfield put Center Parcs up for sale earlier this year, aiming for a valuation of about £4 billion ($5 billion) for the upmarket chain, for which it paid £2.4 billion ($3 billion) in 2015… The sale has been seen as test of a potential buyer’s willingness to make a significant bet amid the economic pressures.” If Center Parcs, or some other eye-catching deal completes, more may follow.

Where there’s a will…

Predicting precisely when activity will return to levels we might consider normal is a fool’s errand. Meanwhile, regional differences mean that hurdles will vary in size according to location, while site or situation specific considerations may create triggers that help get deals over the line. For example, take the Abu Dhabi Investment Authority’s recent moves on hotels from the Melia estate in Spain. ADIA has spent e850 million ($900million) on investments in 24 properties this year, Hilltop numbers attest.

Where there is a will, or a need, or an innovative approach to financial and operational structures, there is a way to get M&A done.