November 27, 2008 - Hotels Keep Door Shut to Big Rate Cuts

By Roger Blitz, Financial Times

US travellers hoping that the global financial crisis would herald bargain Thanksgiving weekend hotel deals have been finding them hard to come by. However grim the outlook for the hospitality industry, the world's leading hotel groups say they will hang on to their rates come hell or high water.

The impact of the 9/11 terrorist attacks on the industry is the reason why. Stephen Holmes, chairman and chief executive of Wyndham Worldwide, which operates 7,000 hotels, recalled how the collapse in trade prompted hoteliers to slash rates in a bid to drum up business. Not only did it fail to do so, it also made it impossible to restore rates to pre-9/11 levels when the recovery was underway.

"Since the financial success of a hotel is largely driven by the hotel's ability to 'yield manage', which means balancing price with occupancy, aggressive discounting is not a good formula and often leads to failure," he told an audience of travel executives in Las Vegas last week.

The hospitality industry is braced for pain. Revenue per available room - the industry benchmark - fell 7 per cent in October in the US, compared to the prior year, and is getting worse, according to Smith Travel Research. The week ending November 15 saw a decline of 13.2 per cent.

Hotel groups expect some easing of rates, but will fight against drastic reductions. Average daily rates in US hotels in October fell 0.5 per cent, the first fall since June 2003. But empty hotel rooms can be preferable to big drops in rates.

That puts a strain on the relationship between hotel owners and the groups that operate them, such as Wyndham, InterContinental Hotels Group, Starwood and Marriott.

Hotel groups have "de-risked" their businesses by adopting an "asset-light" strategy, selling off the bricks and mortar to a range of buyers and in return becoming the owners' operators under long-term agreements.

But with the share prices of hotel groups suffering - shares in leading groups have fallen 50-75 per cent in the past 12 months - one hotel owner has raised doubts about the strategy.

"All of these asset-light strategies haven't really worked," said Javier Faus of Meridia Capital, a Barcelona-based private equity company that owns hotels run by Crowne Plaza and Ritz-Carlton and Six Senses resorts. "The market is penalising big time all of these operating companies," Mr Faus told a Deloitte hotel investment conference in London. "This should open the eyes of where we are going in the industry. We have transferred risk to owners. The manager is left with no risk. Has that helped these hotels' equity? No."

This is a market that does not discriminate between hotel owners and operators, as shown by the tumbling share prices of US real estate investment trusts such as Strategic Hotels and Host Hotels.

But according to Arthur de Haast, chief executive of Jones Lang LaSalle Hotels, the operators are not as exposed as owners to big changes in income. "Net profit of owned hotels could be falling 20-30 per cent over the next several months. The operators have insulated themselves to a degree from volatility," said Mr de Haast.

"The question is, did they sell off to the right partners who used sensible financing structures? They don't want to be finding that a number of hotels are in financial difficulty."

Nor do they want to see a slowing in their development pipelines which underpin their growth strategies. But with credit markets frozen, this is now happening. Even though a declining market might be a good time to halt supply, the market is treating this negatively.

"For IHG, the triple whammy is declining demand, rising supply and falling property values," said Nigel Parson of London-based analysts Evolution Securities. "That should combine to form an ugly 2009."

IHG, the world's biggest group by hotel rooms, said its business model was robust. Its owners understand the importance of yield management, said Leslie McGibbon of IHG, and know that IHG has a marketing war chest of $1bn. "You might see an acceleration of non-branded hotels falling to brands," he said.

The big shadow looming over the industry is debt. "The real concern in the marketplace is whether these owners will be able to refinance," said David Mongeau of Avington, an M&A hotel specialist.