PPHE Hotel Group — Mind the gap

As an international real estate hospitality company, PPHE is principally a developer, owner and operator of upscale and lifestyle hotels in gateway cities and regional centres as well as hotels, resorts and campsites in select resort destinations. Its portfolio comprises 28 hotels (c 7,300 rooms) under the brands Park Plaza Hotels (exclusive partnership with Radisson Hotel Group in EMEA) and art’otel (owned). Its first premium boutique hotel Holmes (previously Park Plaza Sherlock Holmes) opens in May. Its subsidiary Arena Hospitality also operates nine hotels and resorts (c 1,400 rooms) and eight campsites (c 6,000 pitches and mobile homes) in Croatia. The openings pipeline (c 700 rooms by 2023) includes an owned art’otel at Hoxton, London, art’otel management contracts at other high-profile regeneration areas, Battersea Power Station, London and Hudson Yards, New York (part owned) and an owned unbranded hotel in Belgrade (subject to completion of transaction). PPHE transferred last year to a Premium Listing on the London Stock Exchange; it floated on AIM in 2007, moving to the Official List in 2011.

According to our estimates, the current share price implies a capitalisation yield on PPHE properties of 7.0% (after adjusting for the value of Hoxton project and PPHE's hotel management business). This compares with a weighted average prime yield in the company’s markets of c 5%. Since the properties are predominantly in prime locations and well invested, we believe this suggests the market is not fully discounting the actual value of the portfolio. It is instructive to examine a sum-of-the-parts valuation, which includes PPHE’s net property value estimate provided by independent valuation (currently at £24.57 per share) based on forecast earnings at the property level, as well as our valuation of the company’s Management and Central Services division. We understand that US Hotel REITs may be currently traded at a discount to NAV of up to 20%. By applying this discount, we arrive at PPHE’s value per share of £23.18.

Sensitivities

Financials

Our estimated 2019 net debt of £508m is well within long-term bank facilities of about £700m, which mature substantially in 2026–28. With regard to expansion, PPHE has a well-established policy and track record of borrowing within a 65% loan-to-value requirement of its banks. Management is confident it can leverage on its assets for future development projects.

The company seeks to reduce the seasonality of its business by optimising its guest mix (particularly business against leisure) and its impact on profit by securing as flexible a cost base as possible (seasonal employees in Croatia may be employed in year-round operations in Germany and Hungary). It also enjoys substantial recurrent revenue through agreements with business travel agencies and large corporates for discounted room rates.

PPHE has developed a collection of popular (typical Booking.com guest score of 8.5 out of 10), full-service, four-star, deluxe and boutique hotels with a good geographic spread and guest mix (c 50% business customers). With a focus on European cities (gateway and regional), there is particular representation in the important lodging markets of London, Amsterdam and Berlin, where the hotels are predominantly owned and operated under the Park Plaza brand. The repositioning of Riverbank close to existing company properties, headed by flagship Westminster Bridge, one of Europe’s leading conference hotels, enhances a unique ability to offer over 1,000 rooms in one area for events in central London and most advantageously on the vibrant South Bank. In turn, in Amsterdam its landmark Victoria has newly completed transformative investment. Consolidation of resort activities (hotels, self-catering apartment complexes and campsites) in Croatia in 2017 has brought material exposure to a tourism market with strong fundamentals as well as reshaping in terms of business and seasonality.

Flexible model

The breadth of ownership interests and contractual arrangements in PPHE’s hotels allows the company to maximise opportunities from the varied markets in which it operates and may enter. As shown in Exhibit 1, ownership (including long-term finance leases) accounts for about 90% of room stock and almost all UK and Netherlands operations. It also applies to the company’s largest current development project, art’otel london hoxton. Although it is capital intensive, ownership offers scope for asset appreciation, especially in key gateway cities in Europe, and management has a strong record in real estate development and a self-professed entrepreneurial spirit. Operating leases (15 to 25 years) cover only two properties in Germany and Hungary (art’otel budapest was recently renewed for 20 years), while the sole management contract (County Hall, London) runs until 2033. Franchise arrangements account for barely 3% of overall room stock (two hotels); revenue comes from brand royalty or licensing fees (c 3.5% of hotel revenues), one-off fees on opening under the company’s brands and ancillary services.

Strong branding

Apart from several Croatian resort properties that use the locally known Arena brand, all hotels (except for the newly-repositioned Holmes) are branded Park Plaza (c 70% of rooms) or art’otel. While distinct in terms of target customers and property size (the former targets the business as well as leisure market and favours larger properties, ie typically 200+ rooms), both brands address the growing ‘affordable luxury’ segment (high quality at attractive rates). Outside Europe, the Middle East and Africa, where the company holds an exclusive right to use the brand in perpetuity under its agreement with Radisson Hotel Group, there are 18 Park Plaza properties (2,100 rooms) in operation and under development in Asia Pacific.

art’otel is an established ‘lifestyle’ brand, targeting those with an interest in art and culture by aspiring to be represented at key cultural hot-spots. In keeping with a new social environment and desire for differentiation, such ‘lifestyle’ hotels are increasingly seen as an attractive and strategic market by most hotel groups. For example, AccorHotels has delivered on its 2016 optimism that the segment may double within five years by developing the most comprehensive branded portfolio including 10% of global pipeline. At art’otel, contemporary architectural styling is married with art-inspired interiors (each property is dedicated to a particular artist, eg Warhol at berlin kudamm). Amsterdam, only the second development since PPHE’s acquisition of the brand in 2007, opened in 2013 to wide acclaim, with sites in London (Hoxton and Battersea Power Station) and New York due to open in 2022/23. While ownership of the brand is subject to a perpetual licence in favour of the brand founder elsewhere in Europe (France, Germany, Italy, Spain, Austria and Switzerland), there is reassurance that any such hotel will be managed by the group.

Bumper distribution

Inclusion in the reservation and distribution systems of Radisson Hotel Group, one of the largest hospitality and travel companies in the world, continues to be very positive for PPHE and is its largest hidden asset. As well as customer referrals, it provides reliance on a far larger and more sophisticated system than potentially in-house, ie in operation and under development over 220,000 rooms (1,400 hotels) in 115 countries and powerful brands, notably Radisson Blu. There should also be opportunity from Radisson Hotel Group’s recent acquisition by Jin Jiang International, a leading Chinese hospitality and travel group, such as direct access to the world’s largest and fast-growing outbound travel market and to Jin Jiang’s loyalty programme of 100m members. Together, Jin Jiang and Radisson Hotel Group form the second largest hotel group worldwide.

There is substantial benefit from access to the alliance’s market-leading loyalty programmes for guests, business travel agents, meeting planners and corporates. With over 20m members, guest loyalty programme Radisson Rewards (rebranded from Club Carlson in March 2018) was an important part of previous owner Carlson’s strategic commitment to help hotels increase revenue. PPHE confirms that increased loyalty apart, room rates from members tend to be higher than from non-members.

E-commerce initiatives, boosted by this relationship, include email marketing, online advertising and building affiliate networks. The company’s social media fan base, which is well ahead of that of other hotel brands of similar size, continues to be actively managed.

PPHE is notably upfront about intended value creation. Key to its business model is asset ownership as it affords control over investment, quality and realisation of value, driving growth in EPRA NAV per share by 18% CAGR since 2010, based on Savills valuation. Meanwhile since 2014 there has been double-digit CAGR gain in revenue and EBITDA. Typically land and buildings with significant potential are targeted for purchase, then redeveloped and in due course refinanced to release capital for future growth. A notable example of this was the 2017 sale and finance leaseback of Waterloo, that year’s largest London hotel opening, which endorsed PPHE as developer and asset owner via an effective c 100% return in just four years, complemented by agreeing a long-term finance lease on attractive terms (low yield of 3.5%). This followed acquisition in 2013 of a redundant office building (Hercules House), which was developed by 2017 into a 494 room hotel. The total cost of the project was £125m (c £250,000 per key). The sale and leaseback saw the freehold of the property sold for £161.5m and the agreement of a 199-year lease at an initial rent of £5.6m pa. Independent valuation in 2018 of the remaining leasehold interest at £84m thereby resulted in the creation of £120m value (c £3 per share).

PPHE’s confirmed three-year openings pipeline (Exhibit 2) is headed by a project of potentially even greater stature (budgeted cost £180m). In Hoxton, the west end of Shoreditch, the company looks to emulate its success in South Bank regeneration in an area of rapid economic growth, particularly in the tech, media, fashion and other creative industries. Indeed its ‘edgy’ reputation (‘a haunt for artists, oddballs, inventors of a new paradigm of urban experience,’ per Condé Nast Traveller) suggests a venue highly suited to the UK introduction of the lifestyle art’otel concept. Development starts now on an innovative cylindrical 27-storey (32,000 sqm) mixed-use scheme. Newly improved planning consent covers a hotel (343 rooms/suites), five floors of offices and five floors for mixed use including a gym, an art gallery and event space. Opening is due in 2023.

PPHE also has a clear aim to use its reputed brands to become a leading hotel operator in upscale and lifestyle hotel segments. Hoxton should be complemented by planned art’otel openings at similarly high-profile urban redevelopments, namely Battersea Power Station in London (160 rooms) and Hudson Yards in New York (98 rooms). At the former, restoration of the Power Station building is expected to complete late next year. Of one million square feet of commercial space available in the building, over half has been let to Apple for their new London Campus and to No18, a business members club owned by IWG. The first phase of the wider redevelopment on the 42-acre site, Circus West Village, is open with independent restaurants, shops, bars and leisure facilities, while a new zone one London Underground station on the Northern Line will provide good transport links to the rest of the capital. The year 2022 should also see the opening of art’otel in West Chelsea on Manhattan’s West Side, next to Hudson Yards, the largest private real estate development in the US (over 18m square feet of commercial and residential space). As with Hoxton, the brand is in keeping with a district reputed for art, fashion and innovation and the scheme is mixed-use (55 residential condominiums).

In line with its model of broad contractual interests, in contrast to Hoxton, both art’otels will be management contracts with capital commitment by PPHE limited to $18m pre-construction joint venture costs in the case of Hudson Yards.

The proposed move into Serbia is in line with Arena’s longstanding ambition to develop in central and south-eastern Europe. While it is not a development project, 88 Rooms in Belgrade is attractive in terms of yield both as an already successful hotel (Booking.com guest score 9.1) and its potential in a growth market like that of Croatia.

However, this is only the confirmed openings pipeline. Further significant deals are to be expected as the company is explicit about its active search for new assets in both key cities and resorts; in 2018 alone, some 145 opportunities were identified. It is equally forthright about its reluctance to pay up, specifying that proposals were submitted for barely 10%. Consolidation in London and Amsterdam is targeted but deterred by intense competition and hence unreasonable prices, while interest is admitted in new locations such as Porto, Paris and Lisbon.

Financial flexibility is evident in c £150m at December 2018 designated by the company as excess cash to fund further growth. Also, management does not regard debt as a restriction to growth as long as it can be serviced and is secured judiciously against likely appreciating assets; it has a well-established policy and track record of borrowing within a 50% to 65% loan-to-value requirement of its banks, eg 2016 refinancing of the bulk of its owned estate in London and the Netherlands. Impressively, growth since its IPO in 2007 has been funded without raising equity.

Development is also substantially by investment in existing assets. In addition to renovations there is a strong confirmed pipeline of projects that PPHE calls repositionings (Exhibit 3), namely major investment programmes involving reconfiguration and aiming for a step-change in performance:

2018 was notable for completion of more sizeable multi-year repositionings at Riverbank (£54m cost, including an additional 185 rooms) and Victoria Amsterdam (£20m) with targeted EBITDA growth of 40% and 25% respectively. Less expensive (£8m) but potentially with even sharper returns (aiming for EBITDA to more than double), an all-glamping offer, Arena One 99, was introduced to the former Pomer campsite in Croatia.

PPHE’s senior management (see below) is based at the company’s head offices in Amsterdam and London and backed by highly experienced local management.

PPHE’s current share price is markedly below its last reported EPRA NAV per share of £24.57. We have thus analysed whether this discount to NAV is justified by the location of PPHE's assets and the fact that the company is not a pure-play property investor as it manages hotels and operates some under operating lease agreements. From a valuation perspective, we believe it is instructive to examine the average capitalisation yield on PPHE’s property portfolio implied by the current share price. This is an important parameter for investors as it measures the attractiveness of PPHE’s current market valuation from the perspective of hotel earnings afforded by the company. Our first step is to estimate hotel net operating income (NOI), based on reported 2018 group EBITDAR excluding earnings from the management and central services division. We adjust as follows:

Our next step is to divide NOI by the implied value of PPHE’s hotel properties based on the current share price. To arrive at the latter, we take the market cap and add the last-reported net debt figure (at December 2018) after excluding the proportion attributable to Arena minority shareholders. We have also excluded PPHE’s non-real estate assets and liabilities (net working capital items in particular) and the value of the Hoxton project (£82.5m according to the recent valuation by Savills).

To conclude, we have estimated the value of PPHE’s hotel management business to isolate the value of its hotel properties. These activities are represented by the management and central services division, which generated £42m revenue (before eliminations) and £10.3m EBITDA in 2018. We have valued the business using a DCF method based on a WACC (calculated separately for each year) of 7.3–7.8% and a terminal growth rate of 1.5%, arriving at a fair value of £161m. We have allowed for art’otel hoxton but not for the two new art’otel management contracts. This clearly illustrates that the management business represents incremental value on top of the NAV of PPHE’s properties.

As a sense check to our DCF valuation of management and central services, we have conducted a comparative valuation based on global peers with relatively asset-light models, including Wyndham Hotels & Resorts, IHG, AccorHotels, Marriott and Hilton. Our estimated average EV/EBITDAR ratio adjusted for capitalised operating lease liabilities for this peer group is 14.4x for 2018 (used in the absence of available EBITDAR consensus). When applying this multiple to PPHE’s management and central services division’s 2018 EBITDA (adjusted for refurbishments and asset ramp up), we arrive at a fair value of £152m. We acknowledge that our selected peers possess a much stronger brand and market presence than PPHE. However, as our DCF-derived fair value also captures growth prospects associated with the new management contracts, we include the average for both methods in our yield calculations at £156.2m (360p per PPHE share, see Exhibit 5).

Therefore we obtain an implied capitalisation yield of 7.0%. We estimate the prevailing weighted average prime capitalisation yield in the property markets where the company operates is c 5% and thus visibly below PPHE’s implied capitalisation yield, suggesting the market is not fully reflecting the value of the company’s properties.

Given the lack of European listed hotel REITs, we also compare PPHE’s implied yield to the average levels for US hotel REITs focused on upscale and upper scale segments. Our calculations (summarised in Exhibit 6) indicate these peers trade at an average implied capitalisation yield of 8.0%, which is slightly higher than our estimate for PPHE.

However, we note there are considerable differences in market yields between London (about two-thirds of PPHE’s portfolio value at end 2018) and major central business district locations in the US. The average national-level capitalisation rate in full service segments stood at 7.68% in H218, according to a recent capitalisation rate survey conducted by CBRE. This compares with a prime yield of 4.05% for London according to GVA’s UK Hotel Market Outlook in autumn 2018.

An alternative way to look at PPHE’s valuation is to examine its return on EPRA NAV of £24.57 per share as implied by the company’s EPRA EPS, which was just 4.6% at end 2018. However, we note that PPHE’s EPRA NAV includes the Hoxton project, which has yet to generate profit. Moreover, PPHE has a high cash balance while looking for projects for acquisition. The company estimates that after adjusting for these, the return on EPRA NAV is 5.6%. We also note that PPHE’s 2018 figure was affected by renovations. Based on our EPRA EPS forecasts and assuming a flat EPRA NAV, the return increases to 6.0% in 2020 and 6.7% in 2021. Indeed, since the current share price is below EPRA NAV per share, we have also calculated the implied return on the market cap (based on the company’s adjustments for excess cash and Hoxton project), which stands at 9.1% based on 2018 earnings. This confirms our conclusions from implied capitalisation yield analysis.

Based on the above calculations as well as Savills/Zagreb Nekretnine’s EPRA NAV estimate, we may conduct a sum-of-the-parts valuation (see Exhibit 7). After adjusting for net debt, minorities and non-real estate assets, we obtain a value of 2,807p per share. Importantly, these calculations are based on the assumption that the market is applying no discount to the NAV valuation of the properties. However, we acknowledge that US hotel REITs are trading now at a discount to NAV of around 5–20%. Therefore, if we were conservatively to apply a 20% discount to PPHE’s net property value, we would arrive at 2,318p, which still provides material upside to the share price.

Finally, we have applied a propco-opco method to analyse PPHE’s value by conducting a hypothetical split into a pure property investor (propco) and an entity operating the hotels under a lease agreement (opco). We have assumed the propco value is in line with PPHE’s last reported EPRA NAV at £24.57, while the opco value was derived from a DCF model on the following assumptions: 1) average rental rate across the property portfolio of 5.5%; 2) asset value at £1,670.1m (in line with Savills/Zagreb Nekretnine’s last valuation); 3) no capex at the opco level; 4) no debt at the opco level, in line with the current status (all debt at property level); 5) WACC equal to cost of equity at 6.6–7.2%; and 6) a terminal growth rate of 1.5%. Therefore we obtain a positive opco value of £1.86 per share, which with the property value translates into a total valuation of £26.43 per share. We believe our rental rate assumption is prudent, with recent fixed income investment deals in the UK property market completed at a yield of 3.3–5.0%. For our sensitivity analysis, we have estimated the rental rate translating into the opco value at null is c 5.8%.

In summary, our implied capitalisation yield analysis and the SOTP valuation indicate that PPHE’s discount to EPRA NAV is not justified by its management business (which we believe to be a clear value contributor), while activities on operating leases are negligible in terms of valuation. This is confirmed by our propco-opco analysis, which suggests the valuation of a standalone hotel operator (which does not own the properties but uses under operating leases) would still be positive.

We understand that PPHE’s EPRA NAV (£24.57, which forms the basis of our valuation analysis) estimated by Savills and Zagreb Nekretnine is based on future cash flows generated by the respective properties and thus captures the prospective increase in hotel operating income following the recent refurbishments. As a result, if we exclude the impact of the Hoxton project ramp up and acquisitions of new projects, PPHE’s EPRA NAV should remain broadly stable or grow at a low rate (implied purely by the time value of money) over the next few years. Having said that, we believe that the market is not fully capturing the existing value of PPHE’s properties (as discussed in our valuation analysis), which implies solid upside to the current share price.

Asset quality review

We have further decided to examine if PPHE’s property portfolio may be considered ‘prime’ in terms of location and asset quality. This would confirm our statement that its current implied capitalisation yield of 7.2% seems high relative to prevailing prime yields in the market. This in turn would suggest that PPHE’s property value implied by the current share price is below its actual market value as estimated by Savills and Zagreb Nekretnine.

The company’s upscale portfolio consists of eight hotels in London (Plaza on the River and Riverbank treated separately despite the same address), of which two (Waterloo and Park Royal) are recent openings (2017) and one (Riverbank) has been substantially extended and repositioned. In addition, the repositioning of Sherlock Holmes should complete in May 2019. While Park Royal is more characteristic of a busy UK regional hotel than a central site, it is especially well located next to the largest industrial and business estate in the UK (2,000+ businesses) and close to Wembley Stadium, SSE Arena and Westfield London, the biggest shopping centre in Europe. Exposure to UK regional UK (Leeds and Nottingham) is modest (c 4% of group hotel rooms). In the Netherlands PPHE owns four hotels in Amsterdam, including landmark Victoria, newly repositioned, and Vondelpark, transformative refurbishment almost complete. Repositioning is also underway at Utrecht. Significant ownership interests in Germany include three hotels in Berlin (one earmarked for major renovation), Nuremberg (2016) and Cologne.

By contrast, operations in Croatia are in leading tourist region, Istria. Properties are a mix of hotels, holiday apartment complexes and campsites and trading is highly seasonal. Hotel classification varies from upscale Histria to budget-friendly Brioni (heritage site, to reposition by 2022), while accelerating development of campsites is highlighted by the introduction of glamping.

As most properties are in prime locations and well invested, we believe PPHE constitutes a good entry point for exposure to the London and Netherlands property market at an attractive yield level.

Strong end to 2018

Disclosure of 5% like-for-like RevPAR growth for 2018 suggests c 8% improvement in the final quarter, which is impressive as it was boosted by neither currency nor Croatia (Q4 is its low season). Therefore, in the absence of detailed regional breakdown, we may infer pronounced buoyancy in largest profit source, London (market RevPAR up 10%, per STR – Exhibit 9) as well as a benefit from significantly higher rates at newly repositioned Victoria Amsterdam. We estimate (Exhibit 8) that, allied with a ‘solid’ Q3, this spurred a broad reversal in H2 of first-half EBITDA shortfalls at core London properties and in Amsterdam. These had been attributed respectively to a demanding comparative (market RevPAR down 1% against recovery-led +10% buoyancy in H117) and renovations (estimated 7% rooms off with associated disruption). The overall rise in second-half EBITDA was driven, as in H1, by maturing Waterloo and Park Royal in their first full year.

Croatia arguably disappointed with a slight dip in H2 profit against our growth expectation but a bumper 2017 summer was a hard act to follow (Exhibit 10) and unhelpful weather (prolonged heatwave in northern Europe) delayed holiday decisions across most European markets but in particular campsite custom, which tends to be last minute. Also the new glamping offer, while well received, opened too late to contribute materially. Encouragingly, the region moved marginally into profit in H1 (usually lossmaking) thanks to a favourable calendar, improved shoulder season trading and investment in artificial football pitches at sports-oriented year-round Belvedere Medulin.

On a smaller scale, Germany and Hungary grew H2 EBITDA by c 20% owing to the maturing (both leisure and business) of 2016 opening Nuremberg, weather-led city break demand and termination of its loss-making lease for art’otel dresden.

2019 resilience

As evident in a ‘strong’ Q1 (like-for-like RevPAR and revenue up 8%), the current period should see continued material payoff from recent transformative investment in London and Amsterdam, offset in part by repositioning Sherlock Holmes London into premium boutique Holmes (reopening late May) and Vondelpark Amsterdam (completion by H2). In particular, while Waterloo and Park Royal are approaching maturity (we still expect near double-digit EBITDA gain), the benefit of a full year of repositioned Riverbank suggests our core London assumption of +1% RevPAR may be cautious. Security and Brexit uncertainty are concerns, but the London hotel market has shown admirable resilience (Q1 RevPAR up almost 4% and 6%, for STR and AccorHotels respectively) and would gain from increased tourism on sterling weakness. PPHE is cheered that its in-sourcing of housekeeping services across the UK is meeting key staffing challenges. Greater measurable worries are room supply, which is above its long-term trend, slower economic growth and rising operating costs. GL, London's largest hotel owner/operator, has newly reiterated that it continues to ‘maintain a cautious outlook’, while, per PwC, 2019 market RevPAR gain may be marginal.

There is justifiable confidence about the Netherlands in view of both strong fundamentals and investment payoff. The Netherlands Board of Tourism and Conventions forecast c60% rise in national inbound tourism by 2030, the ‘hotels freeze’ (halt to city-centre development), infrastructure improvements and a possible ‘Brexit dividend’ have contributed to Amsterdam continuing to be regarded as the most attractive destination in Europe for hotel investment, according to Deloitte. Company-specific positives are a first full year of enhanced Victoria and second-half return of Vondelpark and Utrecht. We look for an 8% increase in RevPAR and for EBITDA to rise by at least double that rate.

Further growth is expected in Croatia, boosted by expansion of operations at Pula airport and the maturing of the £8m Arena One 99 luxury glamping development (awarded best tourist product of 2018 by Istria Tourism Board). There should also be initial returns from repositioning of Kažela campsite with new infrastructure, facilities and premium mobile homes.

The joker in the pack remains expansion, which is being actively examined, even if management is understandably reluctant to pay up, viz. the recent London Grange deal (1,300 rooms) at c £750,000 per key.

More of the same in 2020

Solid core trading and investment payoff should again favour next year, hence our forecast of a further mid single-digit rise in EBITDA. Costs may be expected still to be an issue (not only in London, as well known, but in Croatia, as recently highlighted by Arena). A profit catalyst would be expansion although returns from a development project would necessarily take time to accrue.

Cash flow

The sharp rise in net bank debt in 2018 (£480m up from £408m) reflects in particular buying in its Hoxton joint venture (£35m) and sustained high capex (£67m). However, this is well within long-term bank facilities of c £700m, which have an average term to maturity of almost eight years, interest cover of 4x and average cost of 3%. Acquisition apart, we envisage only a small increase in current-year debt thanks to similarly high capex and pre-construction costs for art’otel new york (£14m). As discussed, with regard to expansion, PPHE has a well-established policy and track record of borrowing within a 65% loan-to-value requirement of its banks. Management is confident it can leverage on its assets by opening similar facilities for future projects.