Currently, during the economic downturn, the need for objective business valuation is especially important. “Making investment decisions is quite difficult in conditions of instability and uncertainty in the modern economy. The causes of uncertainty lie either in the incompleteness (asymmetry) of information, or in the lack of this information. The more information is available to the market entity, the better prediction and decision can be made.” [2]
Valuating businesses in hotels’ industry is a subjective process that involves many variables and assumptions. Consequently, the final value or value range can vary greatly from one appraiser to the next. Hence, the posed problem of this article is to outline the difficulties in hotels’ valuation process within the framework of challenging tourism environment.
The topicality of this article is stipulated due to the fact that retrieving the most precise results of valuation in conditions of changing economic situation is a priority for many investors and businesses. As, the distortion of business value may lead to really serious consequences, such as significant errors in the management of company, the error when making decisions about investing in the business, wrong decisions regarding selling of buying the company. Especially, accurate business valuation is important for such industries as hotel one, where economic conditions, population incomes, purchasing power, increasing competition have a great influence on each enterprise.
The analysis for problem mentioned above required the implementation of the following stages of work:
‒ theoretical basis of business valuation process;
‒ generalization of the most widely used methods of business valuation;
‒ analysis of the market of tourism services on the examples of the biggest players in the hotel sector;
‒ business valuation of Mandarin Oriental Hotel Group
Business valuation is deliberate and orderly process of determining true value of the business in monetary terms, taking into account factors influencing the company at the specific point of time and in the conditions of particular market.
Overall, business valuation is conducted for several reasons:
‒ increasing the efficiency of current enterprise’s management;
‒ identifying the value of stock in case of buying/selling shares of the company on the stock market. In order to make the right decision and be sure in the choice, it is crucial to estimate business value, attributable to the purchased shares, and calculate possible revenues from the business;
‒ identification of enterprise’s value in case of its purchase or selling as a whole or partially. For example, when owner decides to sell business, or when one of the members of partnership wants to sell personal stock, it is necessary to estimate market value of the business or parts of its assets. Besides, in the market economy, there is often needed to estimate company while signing a contract that determines shares of co-owners in case of contract termination of death of one of the partners;
‒ merge, liquidation, acquisition, or creation of independent enterprises from holding require its market valuation;
‒ building of development business plan. During the process of strategic planning it is crucial to valuate future revenues of the company, sustainability of business and value of image;
‒ determining creditworthiness of an enterprise and value of collateral in case of crediting;
‒ insurance, during which it is necessary to identify value of assets in anticipation of losses;
‒ taxation, as business valuation is required in estimating a taxable base.
‒ conducting investing project for business development. In this case, to justify the project, it is necessary to know the original value of company.
The following section analyzes the valuation approaches applied to hotel industry on the example of Mandarin Oriental Hotel Group.
Mandarin is an international hotel investment and management group with deluxe and first class hotels, resorts and residences in sought-after destinations around the world. The Group has grown from a well-respected Asian hotel company into a global brand, with exceptional facilities and people that maximize profitability and long-term shareholder value.
Hotels valuation is complex since real estate is generally rented on a m2 basis as it generates cash flows on a m2 basis. Whereas, hotels cash flow is generated by rooms, food and beverage, gym, spa, and minor operating departments.
First, sale comparable technique can be applied to hotels’ valuation, although it is not widely used. The following section will discuss the reason behind that.
Sale comparable on a per room basis implies that a potential buyer will purchase a property at a maximum price equivalent to a sale price of the similar property with the same level of utility. In order to find the necessary data for comparisons (e.g. location, service, number of rooms, room pricing, etc.), market investigation should be conducted. The result, however, will only reveal a range of probable values calculated on the basis of market-driven price. In addition, reliable sale sources of data are limited; the environment (location, time) also represents a constraint.
Most frequently the value of hotels is determined by three methods: market approach, income approach, cost approach.
The main part of the article determines the value of Mandarin Group applying all the approaches.
Market business valuationapproach typically uses a number ofvaluation multiples. These multiples compare thebusiness market valuewith similar measure of other companies’ economic performance in the related industry.
EBITDA is the most common technique. The hotel value is determined by multiplying the EBITDA by the hotel’s multiplier that is calculated based on the hotel’s market, position, and historical performance. Total underlying EBITDA of Mandarin Group including the Group’s share of underlying EBITDA from associates and joint ventures was US $ 188.4 million as of 2015.
The same measure was taken for Marriott Hotel Group and Hilton Hotel Group, from their annual reports as of 2015, to provide a comparison.
Table 1
EBITDA for the selected Hotels, in million US$, 2015
|
Mandarin |
Marriott |
Hilton |
|
|
EBITDA |
$ 188.4 |
$ 1,718 |
$ 2,879 |
The Mandarin’s multiplier reached 11.00 in 2015 that was significantly higher than the median of its peer group: around 10.57. The company valuation of Mandarin Group according to these metrics is way above the market valuation of its sector.
The total Mandarin Group value is: Total Market Value = EBITDA * Multiplier = $ 188, 400, 000 * 11 = $ 2, 072, 400, 000
Although Mandarin’s multiplier is higher than that for other hotels, the EBITDA falls behind the competitors’ results that do not provide the greatest total market value for the Group.
Having conducted the calculations, it could be stated that this approach does not require any implicit data and does not demonstrate major visible constraints.
Moving further, the P/E ratio method is widely used in practice when applying income business valuation approach. The P/E ratio is the price per share divided by the earnings per share and shows how many years’ worth of earnings are paid for in the share price.
Table 2
Share’s price to earnings ratio of the selected hotels, 2015
|
Criterion |
Mandarin |
Marriott |
Hilton |
|
P/E |
20.53 |
20.47 |
13.90 |
In other words, the price earnings ratio shows what the market is willing to pay for a stock based on its current earnings. Companies with higher future earnings are usually expected to issue higher dividends or have appreciating stock in the future. So, Mandarin Group represents a promising investment since it possesses the highest P/E ratio in comparison with other big influential businesses.
The main drawback of the approach is the absence of real total value of the business, since the only result is the comparison of the similar businesses that is nor sufficient enough.
Income capitalization is another technique used by income valuation approach. The hotel’s value is derived by applying a discount rate for estimated future cash flows. Trading potential and operating results of the property plus terminal value of the asset and risks associated with the investment should be calculated under this technique that represents a challenging case without access to company’s databases. However, since time value of money is taken into consideration, the final result would create a realistic and trusting overview.
Finally, cost approach tries to determine what it would cost to set up the business if it were being started now. Traditional way of calculating replacement costs does not seem to be the best alternative. In the last decade, technology has advanced and innovations in construction have made building today cheaper than yesterday. Labor cost structure has changed as well as furniture and equipment prices. Also, difficulties in analyzing data of historical hotels, and choosing the most appropriate type of depreciation are limitations of this method. Taking these issues into consideration, the technique proves not to be the one for the most accurate calculation.
To be more or less accurate, the valuation could focus on a company's net asset value (NAV), or the fair-market value of its total assets minus its total liabilities, to determine what it would cost to recreate the business. There is some room for interpretation in terms of deciding which of the company's assets and liabilities to include in the valuation, and how to measure the worth of each.
NAV = (assets — liabilities) / number of outstanding shares
As per Consolidated Balance Sheet at 31st December 2015 of Mandarin Hotel, total assets accounted for $1,882.8 million, while liabilities reached the amount of $1,231.7 million. The number of outstanding shares made up $ 1,199.6 million.
So, NAV for Mandarin Hotel is: (1,882.8–1,231.7)/ 1,199.6 = $ 0.54
Net asset values are like stock prices in that they measure the value of one share of a fund. Nevertheless, they give investors just a way to compare a fund's performance with market or industry benchmarks (such as the Standard & Poor's 500 or an industry index), but not a total value itself. So, the difference between assets and liabilities, known as owner’s equity could reveal the value of the business. In the case of Mandarin Group, the owner’s equity, or the value of the business bases on the cost approach is $ 1,882.8 M -$ 1,231.7 M = $ 651.1 million.
An important note is that since the assets are not reported on the balance sheet at their current fair market value, owner's equity appearing on the balance sheet is not an indication of the fair market value of the company.
To conclude, according to JLL’s Global Market Perspective Q1 2016, 2015 was marked as the second-highest year on record for hotel transactions globally, topping US$85 billion and posting 50 % growth in 2014. With 2015 surpassing all expectations in terms of the amount of capital flowing into the hotel sector, transaction volumes are expected to reach US$70 billion in 2016, marking the second-highest level of the cycle. Having such a significant growth, investors will definitely need to evaluate all the potential transactions as precise as possible.
According to calculations above, market valuation approach is based on the officially revealed data that indicates key financial parameter, and the result yields the total value that is easy to interpret and compare, that is why, the method could be ranked as the most preferable valuation approach.
However, it should be noted that to conduct the most accurate and realistic business valuation, especially of such a diversified and capital — intensive industry as hotel market, one needs to understand in depth the market and asset potential as well as hotel specific operation, management, and historical performance.
References:
- Mandarian Oriental Hotel Group Annual Report 2015/ URL: http://photos.mandarinoriental.com/is/content/MandarinOriental/corporate-15arMOIL?_ga=1.101500229.532567896.1473319373
- Perepelitsa D. G. “The problem of making investment decisions under conditions of limited information” /Internet magazine «Science of Science» («НАУКОВЕДЕНИЕ») Vol. 7, № 3 (2015)/ URL: http://naukovedenie.ru/PDF/35EVN315.pdf
- ValueAdder, Business Valuation/ URL: http://www.valuadder.com/glossary/business-valuation-formula.html
- Marriott Annual Report 2015/ URL: http://files.shareholder.com/downloads/MAR/2829013031x0x884644/934434D3–0551–4E9D-94EF-687390A5AE6F/2015_AR.pdf
- Hilton Annual Report 2015/ URL: http://ir.hiltonworldwide.com/~/media/Files/H/Hilton-Worldwide-IR-V2/annual-report/2015-annual-report1.pdf
- Google Finance/ URL:https://www.google.com/finance?q=BKK %3AMANRIN&ei=ByPgV7nPF4HhsAGuv73ABA
- Infinancials/ Market Multipliers/ URL: http://www.eurofinancials.com/fe-EN/20028WU/Mandarin-Oriental-International- Limited/market-valuation
- JLL’s Global Market Perspective Q1 2016/ URL: http://www.hospitalitynet.org/news/4074717.html
