Hotel Leelaventure’s Rs 3,950 crore asset sale to Canada’s Brookfield Asset Management has run into a roadblock with the Securities and Exchange Board of India (SEBI) putting the transaction on hold after a complaint by minority shareholder ITC. The tobacco giant, which owns 7.9 percent in Hotel Leela, has alleged that rules on valuation and related-party transactions were not followed. At this point, it is not clear if ITC’s motive is to protect the value of its investment, or if it is interested in outbidding Brookfield.
In fact, ITC’s investment interest in this area is well known. In the past, it has invested in EIH, whose revenues are almost as much as what ITC earns from its hotel business. Along with its subsidiary Russell Credit, ITC owns 16.13 percent in EIH. At one point, it did appear that ITC would make a hostile bid for EIH. Perhaps sensing that, the promoters of EIH brought in Reliance Industries as a white knight way back in 2010.
Today, RIL owns 18.5 percent stake in EIH through its subsidiary, and it will be difficult for ITC to make a hostile bid for EIH.
Given ITC’s latent ambitions, it is pertinent to look at ITC’s standing in the hotels business.
Where does it stand?
Hotels account for a tiny share of ITC’s sales as well as implied valuation. But within the hotel industry, ITC is the second-largest chain in India.
Source: Moneycontrol Research, Company
ITC has an inventory of about 10,000 rooms, which is second only to Indian Hotels. According to numbers put out by the company, domestic industry has an availability of 66,000 rooms in the luxury and upscale segments, implying 10-15 percent market share for ITC in the premium category.
It has about 106 properties with a skew towards luxury hotels through brands ITC Hotels, WelcomHeritage Hotels and WelcomHotel. In FY19, two new properties were commissioned – ITC Kohenur and ITC Grand Goa Resort & Spa. The company is working on construction of five more – ITC Hotels at Kolkata and Ahmedabad and WelcomHotel in Amritsar, Guntur and Bhubaneswar.
Over the years, a big chunk (around 24 percent) of total capex at the company level has gone into the hotel business. In the last six years, ITC has allocated about Rs 4,000 crore as capex to this industry.
Source: Company, Moneycontrol Research
What makes this industry important now?
ITC’s industry position and scrambling for additional inventory lead us to a question: Is it worth the investment? The answer lies in multiple tailwinds in action.
In recent years, demand — from domestic as well as foreign tourists — has been rising. Various policy measures have facilitated this, which includes public services (e-visa facility) and infrastructure (air/road -connectivity). While supply of hotel rooms had been growing by around 10 percent CAGR for the last 10 years, demand is now expected to be tad higher and expected to bridge the demand-supply gap.
Consequently, occupancy rates are already firming up. Occupancy rates, which had peaked in FY07 to 72 percent, slumped to 58 percent by the FY13. In recent years, this has firmed to 67 percent, implying an industry-wide upcycle in business. In the last two fiscals, there has been an improvement in average revenue per room (ARR), which provides more credence to the upturn in business cycle.
However, ARR improvement has been rather flattish (around two percent annually). But when compared to around 20 percent CAGR during the last upcycle in 2005-08, the potential appears huge. Another way to look at it in the FY07 and FY08, EBITDA margin in the ITC’s hotel segment was about 43 percent each – almost double that of today.
What is the key challenge?
The company’s unique business model makes it an interesting play in the hospitality business. A relatively capital intensive business, in case of ITC, gets funded through the cash flows from the cigarettes business and hence is debt free unlike its peers. Strong positioning in the food & beverage part of the hotel segment helps in additional flow of revenue to the company.
Source: Moneycontrol Research, Company
The challenge for ITC is the low return on capital employed (RoCE) in this business compared to peers. High capital expenditure over the years is the key culprit.
In fact, the industry is increasingly moving towards an asset-light model, where companies look for management contracts instead of owning the property. Failure to adopt this trend led to the current plight for Hotel Leela.
Industry-wide share of managed contracts ranges from 25 percent to 60 percent. ITC has also gradually adopted it and currently earns 40 percent revenue from managed contracts and the balance from owned property. It plans to change this mix to 50:50 in the next few years. This should also help in lowering capex intensity in this segment.
Along with the turn in business cycle, this should lead to expansion in RoCE for the company. Seen in this context, the company might continue to hunt for value opportunities for investing capital.
Not a long time back, ITC bought Park Hyatt Goa Resort for Rs 541 crore during an auction under The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act. Interestingly, the previous owners of Park Hyatt had contested that valuation should have been about Rs 1,200 crore.