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Hotelier’s Strategic Shift Pays Off

InterContinental Hotel Group is lightening its load. The London-based hotelier, the largest in the world, announced in late August that second-quarter earnings doubled largely on the strength of an aggressive asset disposition campaign while simultaneously ramping up its franchise and management business. Net income in the recent quarter was roughly $309 million, compared with $93 million during the same period a year ago.

“InterContinental has, in our view, done an excellent job in turning around what we believe was once an under-managed subsidiary of a wider leisure conglomerate,” JP Morgan analysts reported on Aug. 22.

Behind those earnings is a strategic shift from owning hotels outright into expanding their network of franchised and managed hotels. With 540,000 guest rooms in 3,650 hotels, InterContinental already operates the most rooms of any hotel company. It also has more than 130,000 rooms in its development pipeline.

The company has sold 175 hotels and returned roughly $4 billion to shareholders in the three years since it broke away from beverage maker Six Continents to form its own company. Those returned proceeds slightly exceeded the company’s entire market capitalization in 2003.

Why has InterContinental been shedding assets? The franchise and management business provides a less volatile, higher-quality income stream that insulates InterContinental from the ups and downs of the hotel and real estate industries, according to Leslie McGibbon, the company’s vice president of global corporate affairs. “If you’re collecting a fee, rather than taking all of the profit or all of the loss, it’s far less cyclical.”

InterContinental will continue to own a handful of flagship hotels in key markets, including New York, Paris, London and Hong Kong. The company doesn’t want to risk losing the management of those properties because they would be difficult to replace, McGibbon says.

Most of the capital that was once tied up in real estate has gone back to shareholders. The company plans to announce further disbursements to shareholders by the time it reports 2006 results next February. InterContinental prefers to let others take the real estate risk while the hotel group focuses on operations. At present, the company has more than 1,000 hotels under development with partners.

“Working with development partners enables us to grow faster,” McGibbon says. “That pool of capital, in 1,000 hotels, represents around $11 billion of other people’s money. Obviously, to go and find $11 billion on your own would be a far harder process than accessing lots of different owners.”

InterContinental’s efforts to exit the real estate business have been tested and proven by other brands, according to Clyde Guinn, senior vice president with Stanford Hotels Inc., a San Francisco-based owner and operator of hotels. “Wall Street is pressuring hotels to get out of real estate and focus on management,” he says.

“The three components of the hotel business are real estate, branding, and daily management and marketing at the local level,” Guinn says. “I do not know of a company that, on a sustained basis, has been able to do all three of those very well.”

In the mid 1990s, for example, Marriott found it challenging to refinance many of the hotels and resorts it had developed. That set into motion a campaign to divest itself of much of its real estate while eying franchise and management fees for revenue.

An offshoot of Marriott’s shift to fee-based operations was a steadier income stream. More recently, in fact, the Hilton and Starwood lodging groups have followed a similar path, pushed to divest real estate by shareholders and analysts who felt the companies shouldn’t leave capital tied up in properties with soaring fixed costs. Operating expenses for hotels also grew by 6.5% in 2005, reports PKF Hospitality Research, which was double the 3.3% rate of inflation for the year.

Expect more dispositions in the near future, too. Guinn of Stanford Hotels believes that the hotel industry will continue to offload real estate onto investors with real estate expertise because there is little skill overlap between real estate and the rest of the lodging business.

TAGS: Hotel
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