Covid creates Dilemmas for Company Owners (and Financial Advisors) By Les Nemethy

Imagine the following situation:  you are a financial advisor.  The owner of a large and very attractive hotel asks you to sell his hotel.   When you ask him about the situation with Covid-19, he states that the hotel missed a few off-season months of operation in the spring, due to Covid-19, but that the summer months are doing better than ever, thanks to internal tourism.  Moreover, there have been millions of euros of new investment into the hotel, which is repositioned as a completely superior product.  Due to the strong revenue flow and improvements, the owner expects top dollar for the hotel—no discount for Covid.   

What do you advise the owner?  Do you take the mandate under the circumstances?

Scenes like this must be playing out all over the world.  For any owner wanting to sell his or her company, Covid magnifies the uncertainties of selling a company or doing any kind of transaction–especially for a hotel– tourism being one of the most Covid-affected parts of the economy.   The whole world seems to be trying to navigate these days without a compass.

Let’s examine some of the uncertainties:
  • There could be a resurgence of Covid-19 which again shuts the hotel down.  (Travel is being freed up among many European countries, and as of time of writing, Covid cases worldwide are increasing dramatically, and as at time of writing, a resurgence is happening in Spain, France and Germany).  As hotels are valued on a multiple of earnings or cash flow, this will mean that a substantial discount would be required to sell the hotel.
  • Even if there is no local resurgence in Covid-19 which shuts down the hotel, there could be various domino effects caused by Covid—a large number of bankruptcies, banks failing, sovereign default, stock market crash, to name a few. Once again, these would directly and adversely affect the valuation of the hotel.   
  • The expiry or diminution of the massive stimulus efforts could also create a downdraft in valuations.  In certain countries, there are debt moratoria, whose expiry could create a sudden market for distressed real estate.
  • Even if none of the above happens, so long as Covid-19 is as prevalent in the world as it is, any buyer of a hotel would need to allow for a scenario whereby Covid-19 forces a future shutdown of the hotel or at least a diminution of revenues.  This also would create a discount, although some buyers would insist on a more significant discount than others.  Even if this particular hotel is performing well, most hotel investors are coming from a mindset of seeking distress purchases.
My own belief is that the risks of resurgence and domino effects are both substantial.

So where does this leave the seller? If you accept the above analysis, the chances of reaching full price—an aggressively high valuation—are close to nil.   A financial advisor who takes on a mandate with these expectations is creating a  false  expectation. The likely scenario is that a considerable amount of effort will be expended by seller and advisor in creating an information memorandum, contacting potential investors, and negotiations negotiations break down due to a significant gap in valuation.

This is probably the greatest reason why there are so few M&A transactions worldwide during Covid-19:  sellers don’t want to discount their company due to Covid-19 (usually preferring to ride things out), while buyers are typically seeking large discounts.  (There is a small universe of companies which benefit from Covid-19, where this does not apply, such as specific segments of online retailing, etc.)  There is always a gap between expectations of buyers and sellers which needs to somehow be bridged; but with Covid-19, the gap is wider than I’ve ever experienced in my 35 year M&A career.

So to resume, what do you as financial advisor tell the hotel owner?  Do you take the mandate, and just hope that things work out?  Do you try to reduce price expectations?(This was a “no go”). Do you refuse the mandate?  

You might say the hotel owner has nothing to lose by putting his hotel on the market.I would argue that an asset that is on the market for a long time becomes stale, hence less attractive to buyers; and that thousands of hours of staff time may be wasted in preparing and carrying out an unsuccessful sale process.

In my case, I advised the client to postpone the decision until spring 2021. An extra six months would give some additional perspective on where the virus is headed, and whether the aforementioned domino effects kick in.  

I can assure you it takes a great deal of discipline to refuse or postpone a mandate. I suspect the hotel owner is already talking to other financial advisors.  On the one hand, I could say that there is a lack of appreciation for financial advisors who put client interests above their own;  on the other hand, I leave open the possibility that I am wrong, and that it is the existence of different perspectives that makes a market.

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