Going private: public-to-private transactions in the UK hotel sector

Background

The 1990s saw a large number of hotel groups listed on the Stock Exchange, as they regarded the public markets as a way to raise funds for their future development. However, more recently there have been moves in the opposite direction as listed hotel groups are taken private. Why is this? What is involved? Are there any downsides?

Why go private?

The most significant factor leading hotel groups to go private is that sentiment on the Stock Exchange has moved against the hotel sector. The 9/11 attacks in 2001, war in Iraq and SARS all affected the numbers of international travellers using hotels. The resulting reductions in income led to a loss of confidence on the public markets, sending share prices downwards.

Management teams can become disillusioned. Equally it can prevent expansion or refurbishment projects: low share prices make raising share capital highly dilutive, while the public markets react badly to higher debt levels.

Traditionally, the alternatives to a public listing are limited. However, recent years have seen private equity firms raising significant funds, and all are now looking for investment opportunities. Typically, private equity firms:

• Provide substantial amounts of funding
• Take a more flexible view of debt levels and forms of debt funding
• Commit funds for future acquisitions or development.

Leaving the Stock Exchange can also bring direct cost benefits - the minimum annual cost of complying with listing obligations can easily be £500,000, and this can only rise as regulation of listed companies increases.

The downsides

Although going private has benefits, there are downsides. Companies normally join the Stock Exchange to access investors, give liquidity, and use its shares as currency for acquisitions or to reward employees. Going private means this no longer applies.

However, for many small companies this liquidity can be more theoretical than real - institutional investors often have limited interest in the lower end of the Stock Exchange and low share prices can de-value shares as a currency.

Other issues

Other issues should also be considered:

• Private equity firms are typically willing to commit to a period of three to five years, after that they will normally seek an exit. This can cause disruption as the company is 'groomed' for the exit
• The takeover offer is a clear signal to the market that the company is 'in play'. A bid backed by the existing management may be beaten by an outside bid - good news for shareholders but perhaps not the desired outcome for management
• Existing shareholders may be unwilling to sell to investors that include the management team because of the in-built conflict of interest, or to sell at a price based on the present market values
• The cost of a take-private is substantial - the costs are normally twice that of an ordinary M&A deal, usually running into millions of pounds.

Some companies - including some hotel groups – are perceived as being too big to be taken private: in 2003 the majority of deals were below £100m in value. However, as the private equity market has deepened and matured, transactions in the billions of pounds are now a reality.

What is involved?

The main stages of the process are:

• Assemble the investors and management team making the offer
• Due to the inherent conflict for the directors, before the existing management can become involved in a take-private they will need consent from the company's independent directors
• Generally, take-private offers are recommended by the company's independent directors, but, increasingly, not always
• Before giving any recommendation, the independent directors take their own advice on the proposed offer
• Any other funding required for the offer must be in place prior to making the offer
• Announce the offer and subsequently send out the formal offer document to all shareholders. The Takeover Code requires all shareholders in the company to be treated equally, particularly in the price paid per share and the information made available to them
• Finally, assuming that sufficient acceptances are received, the takeover is completed. It is unusual to get 100% acceptances, but provided certain thresholds have been reached it may be possible to compulsorily buy-out the remainder.

This is only a brief summary of the requirements and at each stage there are complex commercial, legal, tax and accounting issues to consider - all needing to take place in a reasonably short time for the transaction to succeed.

Conclusions...

It would be exaggerating to describe the trend for public-to-privates in the hotel sector as merely a passing fashion. However, there is no doubt that sentiment in the public markets will - at some point - pick up again, and many of the hotel groups currently going private may find themselves returning to the public markets.

However, recovery of confidence and a return to the public markets may be some years away. In the meantime the sector may have changed significantly through rationalisation and restructuring, and only those with secure financial backing will be able to take advantage of those opportunities. For now that largely means private ownership and so, despite the work and costs involved, hotel groups ambitious to grow may have little choice but to consider this option seriously.

If you would like to find out more about how public to privates impact upon the hotel industry please contact Louise Wallace on +44 (0) 20 7367 2181 or at louise.wallace@cms-cmck.com