"What Hospitality Business Are you REALLY in?" ~ Alexander Mirza
When I joined Starwood in 2000 and Hilton Hotels Corporation in 2005, both companies generated about 40% of their EBITDA from a relatively small number of owned and leased properties. In Hilton’s case, the top 10 owned Hiltons accounted for roughly 30% of the company’s $2.5B EBITDA.
In Starwood’s case, it was a real estate company that grew out of a paired share REIT and acquired brands such as Sheraton and Westin. “Riding the cycle” was key pillar of Starwood’s strategy.
Owning real estate in Manhattan enabled Starwood to successfully launch W hotels where the company had a large sales and marketing infrastructure. The brand was subsequently scaled through management agreements globally over many decades.
Years later, Marriott, a company that has long been deceptively capital intensive, learned a hard lesson about the strategic value of real estate when its first attempt at launching the Edition brand failed in large part due to their asset-light approach. Marriott subsequently invested hundreds of millions into building the first two Edition properties.
There is no question owning real estate is key to turning around a brand. Owning over $15 billion in real estate also helped Hilton successfully turn its brand around by investing in renovations in New York, San Francisco, Chicago, Honolulu and other markets at the same time. Hilton was a brick and mortar real estate company that acquired Promus in 1999 and diversified its cash flows through franchising. Hilton developed and owned the first Hilton Garden Inn and scaled the brand by franchising thereafter.
A lot has changed since those formative years. Over the past decade Hilton has sold off most of its real estate, in a combination of one-off asset sales and then a REIT. Today under 10% of Hilton’s EBITDA comes from owned and leased properties.
It has now become an orthodoxy or widely held belief, at least in North America and the U.K., that the “asset-light” branded hotel management company is the superior business model. To be fair, there are a number of complex tax and legal considerations that encourage North American based brands to sell off their real estate as well as efficient markets for REITS and PE funds to own these assets. Therefore, U.S. equity markets generally reward brands for generating returns on invested capital (ROIC), at least over long periods of time and punish those with aging assets, deferred maintenance capital and leases on their balance sheet.
But look deeper and you will see a different set of facts. The exception to the rule is Hyatt, whose “asset-right” model is similar to the original Hilton model. Only 6% of owned and leased Hyatt assets generate 57% of its EBITDA. It has $4 billion book value of assets, roughly the same as Starbucks. Is this the result of its unique corporate structure or because its strategy is to generate large enough cash flows to control its financial destiny?
And then there is the Kimpton model, where the brand was developed by dedicated real estate funds. Banyan Tree, Yotel and others have attempted to replicate this dedicated fund growth model. This is a variant of the asset-heavy model and requires the management team to spend its time reviewing assets and behaving and thinking like short-term real estate owners.
One ironic fact is that so-called “asset-light” hotel chains invest considerable and increasing sums in technology. When Hilton Americas acquired its international brother, it invested over $1B into integrating and upgrading technology platforms. Major chains such as Hilton, Marriott, IHG, Wyndham, Hyatt and Starwood are investing approximately $3B annually into technology-related initiatives. In fact, the hotel industry will forge ahead in 2017 with the biggest technology budgets ever with almost 6% or $35B invested in technology next year.
Does that sound like asset-light to you? Everyone in our business talks about adding value to real estate, but are we really in the technology business rather than the real estate business?
Furthermore, the real estate version of the asset-light trend is certainly not being replicated in Asia. Consider these facts: Peninsula Hotels generates 100% of its income from owned real estate; Shangri la Hotels generates 95% from owned real estate; and Mandarin Oriental generates 84% of its EBITDA from owned assets concentrated in a few gateway cities. Interestingly, these Asian hotel stocks trade at the same EBITDA multiples as their U.S. And U.K. peers.
And the trend has also certainly not caught on in restaurants or gaming, even in the U.S. In restaurants, McDonald’s, which owns only 18% of its restaurants, generates 75% of its EBITDA from real estate investments and Starbucks owns and leases 53% of its stores with a $4 billion balance sheet. In gaming, MGM, Wynn and Sands generate 100% of their EBITDA from owned real estate.
Getting back to hotel brands, this leads one to ask the following questions:
- How should we define asset light? Should it include technology and marketing investments?
- Is asset light simply a North American strategy to optimize tax and corporate structure or is it a superior business model?
- Does it matter whether it’s a luxury brand or mass market brand?
- To what extent, if at all, does being asset heavy help during the stages where a full service or “high end” brand is developed and launched?
- Should real estate be purely opportunistic or is it a key pillar of hotel brand development strategy and for that matter, corporate strategy?
I welcome your thoughts and comments on these questions and more on my LinkedIn.
- Alex Mirza, Co-Founder & CEO, Cachet Hospitality Group