Intercontinental Hotel Group: Investment Opportunity - Case Study Example

Intercontinental Hotel Group: Investment Opportunity Executive Summary The Intercontinental Hotel Group (IHG) is a reputed London based company specialising in hospitality industry. It has a portfolio of hotel properties in Europe and America which include Luxury Hotels, Business Hotels as well as Leisure Hotels and its main focus is on Business Hotels which contributes 80% of the revenue. IHG has been in business for nearly 3 decades and the management believes in steady growth and aims at 8% to 10% annual revenue growth in the long term. However, the company is now presented with a prospective opportunity to invest in a block of residential flats hence the Chairman of the Board underscores the need to invest in the project to the tune of GBP 6 million in a 50 flat property. The price is considered attractive given the poor real-estate market conditions prevailing now as a result of global economic recession. This project will further the company’s strategy of steady growth by strengthening its portfolio. Financially, the project provides a competitive return of 11.10% IRR and has a reasonable payback period of 5 years. The investment proposal also highlights synergies that can be derived from the existing sales infrastructure as well as the conservative revenue estimate with a possibility of long term asset appreciation. Table of Contents 1. Intercontinental Hotels Group - the company 2 2. Proposal 2 3 Environmental Background 3 4. Company 4 5. The Project 4 6. Source of funds 5 7. Recommendation 5 8. Financials 8 9. Investment Decision Criteria 11 10. Conclusion and Recommendation 11 1. Intercontinental Hotels Group - the company The Intercontinental Hotels Group is a London-based company specialising in hospitality industry. It runs its chain of ‘Intercontinental’ branded hotels in several cities in Europe and America. Though Intercontinental has properties comprising three broad categories, namely Luxury hotels, Business hotels and Leisure hotels, traditionally it has focused on business hotels, catering for traveling businessmen in the main commercial centres. The company reported earnings of GBP 34 million for the year 2008, with a net profit of GBP 3.20 million for the period. This was slightly better than the previous years’ figures of 30.5 million and 2.40 million respectively. We are considering an investment proposal which is in line with the company’s long term growth strategy. 2. Proposal A real estate company has promoted a block of 50 flats in East London. The building has 10 floors with 5 flats on each floor and about 95% of the project has been completed. The project is expected to be fully completed in about two months. Each flat is comprised of a two bedroom apartment fully furnished with kitchen, drawing room, furniture and other household appliances. The flats are located in a separate block with a reception area and well manicured lawns in front. The building is located within the radius of about 0.5 miles from the underground rail station and is close to a Bus stop. The nearest Underground Rail station is 3 stations away from Canary Wharf. The promoter has offered to sell the entire block for sale at an outright price of GBP 6 million. We recommend that we seriously consider this opportunity and invest in this since we strongly feel that this will be financially rewarding and is fully in line with our growth strategy. We recommend that the Board accepts this proposal and invest in this project mainly for the reasons clearly outlined below. 3. Environmental Background: Global economic recession is a prominent feature characterizing most of the developed economies during the contemporary period. Britain in particular is poised to enter the third quarter of consecutive shrinking of its output and is believed to be getting deeper into recession compared to the rest of Europe. The Pound continued its downward spiral and has lost 30% of its value against the US Dollar in the last 9 months, its steepest fall in recent history. Its weakening against Euro is the lowest in history since introduction of the European common currency. Central Banks around the world continue their efforts to stimulate economic growth using conventional methods at their disposal such as cutting down of interest rates as well as money supply. Governments across the world have passed legislations to grant economic assistance to sectors most affected by the recession, in particular Banking and Automobiles. The real estate sector was not spared either by the economic downturn with real estate prices falling nearly 17% last year. All these negative developments make growth opportunities appear bleak in the near future. Indeed, many businesses were affected and some are even facing bankruptcy. On the other hand, this economic shake-up presents a wonderful opportunity for good businesses to consolidate their position, and indeed lay the foundation for stronger growth when the economy emerges out of recession eventually. 4. Company Summary In order to fully understand the challenges and exploit the opportunities that IHG is faced with, it is imperative to look at the company in some detail. International Hotel Group was founded in 1980 with businesses in hotel industry and its particular focus has been on the hospitality sector where 80% of its revenue comes from. The company has been growing steadily owing to the management’s thorough understanding of the hospitality business and its determination to focus on its core business. For the same reason, the investors have been reciprocating with continued support. The philosophy has been to stick to hospitality with an aim of improving customer satisfaction while trying to steadily increase the customer base. This has resulted in the steady performance of the company’s stock and regular dividend payments. 5. The Project The building occupying the fully furnished flats will be ready for occupation in two months period. It will take about a month more to finish interior decoration and further customization to suit our needs that are specific to International Hotel Group. The cost of the project would be an outright purchase of GBP 6 million payable in cash. This would also entail a recurring annual cost of GBP180 000 (with annual increments), to cover maintenance and wages for the upkeep of the properties. This also includes interest costs and annual repayment of the capital over a 30 year period. The existing sales and marketing infrastructure would be leveraged to promote the properties too. 6. Source of funds The project would be funded with 75% of the investment (GBP 4.5 million) of cash from internal accruals. The remaining 25% of GBP 1.5 million will be through long term bank finance, repayable over 30 years. This will be in addition to the annual interest of Base Rate + 1%. Thus the current rate is 2% but this is expected to grow upwards as the economy steers out of recession and these assumptions have been accounted for in the cash flows. The project stands better chances of financial viability since the Payback can be achieved over a period of 5 years. Over the same period, the Internal Rate of Return works out to 11.10% which is above our internal benchmark of 10%. 7. Recommendation: It is our strong belief that due to the following reasons, the project offers sound opportunities for growth. Price: The property has been promoted by a reputable promoter and the quality of the building as well as the interior decoration has been independently evaluated by our in-house experts. The structure was designed by one of the leading architects in the country and all legal requirements have been met. The property is located close to the Underground and Bus station and is within 3 miles of Canary Wharf. We feel that the price of the property is very attractive from the conviction of our internal assessment which posits to the effect that the price of GBP 6 million is at least 20% less compared to other market prices. The main reason for the low price is the desperate situation the promoter is in since the original party contracted to buy the property has gone bankrupt and we feel that we should take advantage of this distress sale. Though we have not included this in our assumptions, it is possible to workout staggered payment options with the promoters since we are one of the few potential buyers with the bargaining strength, to negotiate a deal at this time. Timing: We should take advantage of the downturn in the real estate market to buy this property. Though we cannot conclude with certainty the extent to which the property prices will further decline, we should not let go this opportunity since this price is very fair. In the long run, we feel that that this offers a good potential for capital appreciation in the form of assets. We should take advantage of our financial strength to take this opportunity, a luxury few of our competitors can afford. Property investment is always profitable in the long run. Changing customer preferences: The economy is in recession and this has prompted companies to critically review their travel expenditure with a view to minimise the burden of accruing high costs on their budgets. This will affect our hospitality business in hotels in one way or the other as business executives look at ways of reducing travels or to conduct meeting using telecommunication where possible. We should use this opportunity to promote these serviced apartments as an alternative to the business hotels since the apartments costs only a fraction of the charges for hotels. We feel that this is the primary reason to invest in this project, which would help us remain afloat during the economic recession period. Synergy with existing business We will be able to use the existing Sales and Marketing infrastructure to promote these serviced apartments. The only additional expenses will be maintenance and upkeep of the properties. We can use the low prices of the serviced apartment as an alternative to expensive hotel prices especially during the recessionary period where companies are looking to reduce travel related expenses. We can also look at opportunities to sell these to leisure accommodation to tourists during the expected increased inbound tourism into Britain, where foreigners are expected to take advantage of the low value of British pound. 8. Financials The financial details of the proposal are: Cash Outflow: Initial Cost The initial amount requested is GBP 6,000,000. This will be the cost of the outright purchase of the property. About 25% or GBP 1,500,000 will be raised from long-term bank loans at Bank rate + 1% whilst about 75% of GBP 4,500,000 will come from internal accruals. This will benefit us by putting our cash reserves to more productive use capable of generating more money in the future than lying idle where they are earning almost nil interest in the bank. We will also take advantage of the unprecedented low interest cost of borrowing from bank. Cash Outflow: Recurring annual expenses The initial recurring costs are estimated at GBP 180,000 per annum. This will include maintenance of the property with 50 rooms as well as wages for instance. This also includes the interest payment on the borrowing and annual repayment of principal. We are not assuming significant additional sales and marketing expenses since we expect to manage this using the existing infrastructure. We have also assumed 5% increase in expenses from the 3rd year onwards to take care of normal increase in cost of goods and wages. Cash Inflow: Our projected cash flows start with GBP 900,000 in the first year of operations and go on to increase to GBP 1,200,000 in the second year. From the 3rd year, the revenue figures are expected to stabilise at GBP 1,350,000 per annum. These are based on the following assumptions: The occupancy rates are assumed at 30% for the first year and a maximum of 50% from the 3rd year onwards. We think this is a conservative estimate since we are not including opportunities to target the leisure market and one-off opportunity available during the 2012 Olympics. These occupancy rates are assumed on a monthly rental of GBP 5000 for each flat of the 50 available flats. We have to keep in mind that GBP 5000 is a nominal figure since the flats will be often rented on daily or weekly rates to traveling businessmen. 9. Investment Decision Criteria The project assumes complete payback of the original investment in 5 years. We consider this sufficient and acceptable. We predicted that the Internal Rate of Return on the project is a creditable 11.10% per annum. We consider this a very good return considering the effects of subdued economic conditions and the absence of the alternative investment opportunities. 10. Conclusion and Recommendation In conclusion, we recommend the investment proposal mainly for the following reasons: The project is in line with our organization’s growth strategy, where we wish to achieve 8% to 10% annual growth in revenue in the long term The project envisages profitable deployment of our cash resources, where the bank returns are plummeting. The weakening pound is expected to attract inbound tourism for Britain The property’s price is very attractive. This is possible due to the poor market demand and in this particular case, the promoter’s hurry to find a buyer. The property has potential to provide capital appreciation in the very long term. The property is located close to Canary Wharf and hence will strengthen our business hospitality portfolio. The payback period is 5 years which is a long period enough not to strain our financial budget. The Internal Rate of Return is attractive at 11.10 percent which is above our current target of 10%. Over and above, it can be noted that investing in property is a viable opportunity in business since there are highly chances that property value will appreciate with time. For the reasons detailed above, we strongly recommend the approval of this investment proposal to acquire the block of 50 flats to add to our portfolio of Serviced Apartments as a security measure to ensure a steady growth of our business even in the face of the negative global economic recession. Read More