NEW YORK, May 16, 2016 – Baird, an employee-owned international capital markets, private equity, wealth and asset management firm, will host its annual Global Consumer, Technology & Services Conference in New York City June 7-9. The conference will bring together institutional and private equity investor attendees to hear presentations from executives representing more than 200 public and privately held companies across a range of sectors. For more information on the conference, follow @BairdConference, #RWB_CTS.
As a preview to the conference, Baird Senior Research Analyst David Loeb, who covers Hotel REITs & C-Corps, shares his thoughts on the health of the hotel sector, what’s driving M&A and consolidation, and how the industry is faring against technological threats, as well as health and safety concerns like Zika and terrorism.
As we head into the summer travel season, how do you view the overall health of the hotel sector? Are we at the top of the cycle? What do you foresee for the rest of the year?
I would say the patient is healthy, but aging. We are somewhere near the top of the cycle, which could happen this year or next. We measure the top of the cycle in terms of the long-term trend in occupancy – in other words, we’ll be at the top when supply exceeds demand, causing occupancy to fall. The cycle has been extended because the economic recovery has been relatively slow and securing a development loan (for new construction projects) has been challenging. Today we’re at record occupancy and record revenue per available room, but the last several months have been weak. The next few months should tell us if the cycle is ending now or if we have another year to go. We believe there is equilibrium between supply and demand that could stretch out for another year, but eventually that’s going to turn negative.
Hotel stocks under-performed pretty dramatically last year, as investors expected an economic slowdown or recession. Valuations were hit hard in 2015 and as a result, we were left with massive valuation disparities between public and private markets earlier this year. The stocks had a really good bounce from late January through mid-April, but have generally languished since. The real question here is the economy. We’ve seen weak GDP and a slowdown in business travel. When companies have profit pressure, they often look to cut travel costs. We have seen this trend in recent months, particularly from industries like energy, the financial sector and some parts of technology. Overall we think we’re in for a much more healthy second and third quarter, with a little bit more weakness in the fourth quarter and then a leveling off next year.
What is driving M&A and consolidation in the sector?
Our view is that consolidation in the hotel industry is being largely driven by new technological threats and the scale hotel companies need to deal with those threats. These threats include the growing popularity among leisure travelers of home rental companies like Airbnb, continued growth in online travel agents and the commissions they charge hotels, and the emergence of repricing software. Globalization is another important factor.
We’ve seen four hotel brand transactions announced – but not yet closed – in the last six months: The Marriott International, Inc. (MAR) – Starwood Hotels & Resorts Worldwide, Inc. (HOT) combination; AccorHotels acquiring FRHI Holdings Ltd., the parent company of the Fairmont, Raffles and Swissotel brands; privately held SBE Entertainment Group, owner of the SLS brand, agreeing to acquire Morgans Hotel Group Co. (MHGC), the company founded by Studio 54-creator Ian Schrager; and the Chinese company HNA Tourism Group’s planned acquisition of Carlson hotels. Despite Chinese conglomerate Anbang Insurance Group Co.’s loss to Marriott in its bidding war for Starwood, I expect we will see more acquisition overtures from Chinese groups as the Chinese look to play a bigger role in this industry. The industry is globalizing, and there is a great deal of interest in capturing the Chinese traveler within China, earning their loyalty to a brand system and then capturing them as they leave China, leave Asia, go to Europe, and eventually come to the U.S.
Can you tell us more about how the hotel industry is faring against threats from the tech industry? What worries you about repricing software?
Let’s take, for example, Airbnb, which is growing rapidly and competes with hotels for the leisure traveler particularly in select markets where there is a lot of Airbnb supply like New York City. To combat Airbnb, hotels need to make it easier and more rewarding for travelers to be loyal. That requires a large network and the ability to spread the cost of loyalty over a wider base. In that context, the Starwood/Marriott merger makes all the sense in the world because Starwood currently does not have enough properties on the map to accommodate their loyal travelers for the majority of their trips. There are Marriott-branded properties in many markets around the world, although they are less concentrated in Europe and China than Starwood, which again makes it a good match.
Battling the online travel agencies is a little bit harder, but again the more scale brands have, the more rooms hotel companies control in their brand, and the more power they have to negotiate down still-high commissions. We’re seeing the power balance beginning to shift because of the size of large hotel companies. Even Hilton Worldwide Holdings Inc. (HLT), which hasn’t done any mergers, has successfully negotiated down its online travel agent commission rates. Online travel agents are becoming less of a threat to the industry and more a source of incremental business, which is what they should have been from the beginning.
Repricing software is actually more insidious and dangerous, in our view, and poses a huge threat to the industry. There are two companies at the forefront -- tripBAM and Tingo – and what their software does is watch hotel room rates once a traveler has made his or her reservation, and then cancels and rebooks the reservation to the lowest-rated hotel within a set of acceptable properties identified by the traveler. This continues as long as rates decline until the day before the hotel stay. We are seeing a lot more hotel reservation cancellation activity, particularly close to the night of arrival. Hotel operators don’t know if it’s cancel-and-rebook software because there currently isn’t enough data analysis around the issue. Again, consolidation helps here by giving hotel companies the resources to invest in more sophisticated data processing. This will be a big issue until the industry gets comfortable with cancellation penalties, which as of yet they have not.
How are the continuing health and safety concerns posed by the Zika virus and the terror attacks in Europe affecting the profitability of hotel companies? Will these issues keep travelers home?
Zika has not yet been a huge issue because travelers can’t grasp the extent or the dangers yet, given the lack of solid information. We’ve seen a little bit of softness in the Caribbean. Terrorism has been a problem since 9/11, but we’re seeing the impact diminish and the window for that impact is getting shorter. As an example, after 9/11, travel fell significantly for two years and it had a significant negative impact on the U.S. hotel industry. Following the Paris terrorism attacks last November, Paris saw a 10% reduction in international travel in the first quarter, which was nowhere near as bad as what followed 9/11.
Travel is increasing as a secular trend. The population of the world, particularly China and the U.S., is aging rapidly and older people tend to travel more. Middle classes are growing in much of the world. People are travelling more internationally, though shifts in the relative value of currencies and economic conditions impact that trend. I don’t think anyone wants to give terrorists the power to stop us from traveling. In my view, terrorism has become a secondary consideration to the health of the global economy. Moving forward, I expect we will continue to see more travel to branded hotels because of the certainty they provide and the benefits of loyalty. If you look at the global pipeline of hotels planned or under construction, it is probably 80% branded. Yet hotel brands represent less than 50% of the hotels in the world. The brands are continuing to gain share.
About David Loeb
David Loeb joined Baird in 2006 as senior analyst and Managing Director responsible for Baird’s coverage of hotel REITs & select hotel C-corps. Prior to joining Baird, he maintained similar coverage as a Managing Director in Friedman Billings Ramsey’s research department. He also brings equity research experience from Credit Lyonnais Securities, CIBC World Markets (formerly Oppenheimer & Co., Inc.) and Bank of America. He earned a BA in psychology and sociology from Brandeis University and an MBA from Washington University.
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