“Banks and sponsors had looked at the pandemic as a temporary issue, and now understand that it will not go”
Hospitality continues to suffer the devastating impact of the coronavirus pandemic, with the feared second wave rolling in as the summer rolled out. Deals slowed to a trickle from March, following which there was an expectation among many that distress in the industry would result in feeding frenzy for the cash-rich opportunists.
The general consensus right now is that the deal market has not kicked off - yet. There has been distress and some signs of activity, particularly where there were businesses already under pressure (such as in the casual dining market), but no widespread wave of transactions. The reasons are well rehearsed now, as businesses scrambled to survive the crisis, helped along by supportive government schemes, moratoria and (so far) abundant patience in landlord/tenant, supplier/customer and lender/borrower relationships. All those dynamics are spurred by a feeling among all stakeholders that the crisis will abate at some point and there will be a recovery, so there has been a desire to work together to get through it. The main issue is timing of the recovery, and what to do until it comes.
On the lender side, the crisis so far has been characterised by triaging emergency situations, with waivers and restructurings keeping bankers very busy. But with a cash crisis persisting and no return to normality in sight, the expectation now is of a more intense phase of discussions with borrowers. Continued lender waivers will not be a solution to continue to keep things on an even keel, particularly as governments scale back support measures for the economy. As a result, in the next couple of quarters the catalyst for activity will be banks taking, or threatening to take, real action.
As one panellist at our recent hospitality-focused webinar put it, “banks and sponsors had looked at the pandemic as a temporary issue, and now understand it may not go”. While banks have so far not been fast to react in accordance with their contractual rights (having learnt restraint following the Global Financial Crisis), difficult decisions will start being made. They will expect co-operation from sponsors and management and new cash to refresh balance sheets, however they can find it. Co-operation is still often (albeit not always) the preferred route for lenders, where they are looking for survivability of a business over 12-18 months of severely impacted cashflows. That will leave owners with hard choices on finding more cash (be it from equity, new mezzanine debt or otherwise) or crystallising the losses that come with bank action or forced sale.
One alternative to fresh equity is the still active market for ground rents (or “sale of the fee-simple” in US terms), allowing owners to split a property interest into a freehold and long leasehold interest, and selling the freehold interest at a relatively low yield (looking at around 15% of enterprise value at a 2% yield) to free up cash in the equity value. While that invariably involves refinancing the debt stack to a lower loan-to-value amounts, banks tend to like the release of liquidity with the net effect of a more sustainable business, and the long term view taken by ground rent purchasers make pre-crisis cashflows very relevant. Brown Rudnick has acted on successful ground rent structures both before and after the Covid crisis began and is actively pursuing strategies on behalf of clients to use this solution.
In the consensual M&A activity that has been happening in the hotels sub-sector, discounts are inevitable given the current increase in risk premium, and 5-15% of pre-crisis are being agreed using a variety of supportive pricing structures. In one ongoing deal, sell side has agreed to guarantee EBITDA over a number of years while retaining an interest in long term cashflows via a management role. In another (more common) structure, deferred consideration is conditional on hitting EBITDA milestones.
What is yet to be seen is the deep discounting that will be found when owners and lenders decide, or are forced, to say enough is enough, and the pace of insolvencies accelerate. One has to feel that despite the huge hit hospitality is taking, travel and leisure will return to trend eventually, in contrast to other sectors such as retail, office and logistics, where longer term structural changes are at play. In the meantime furlough schemes and enforcement moratoria are scaling down, lockdown measures returning and the pandemic is still raging. While that spells trouble for owners, the waiting game for the opportunists may be coming to an end.
Brown Rudnick recently hosted a webinar on Grabbing Opportunities, focusing on the current environment for investments in the hospitality industry, with panellists Ian Corfield at FRP, Pierpaolo Iasci from Societe Generale and BR’s own hospitality practice leaders Tuvi Keinan and Nick Vasquez. We had some great insights and learning come out of the session, with panellists sharing their practical experience on the ground. Those shared insights have helped shape and inform this article.
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