RADH - Radisson Hotel Group

[compounding]

Sale would be a bit bittersweet given that trailing EBITDA probably far below EBITDA in 3 years... that being said if its a bidding war and we get a decent multiple then bird in hand I guess... also removes a lot of the mid-term risks (execution, recession etc)

 

If a competitive auction for the shares ensues, the unrealized earnings potential will probably be reflected in the price (with adjustments for risks of course), since a potential buyer will factor in the potential for improvement in their financial projections.

 

Kind of weird that the company issued a large bond offering a few days before the leak, and that a strategic partnership with Hainan Airlines was announced the same day as the leak. I don't have any insights into the bond covenants, but it would probably have been beneficial to issue the bond with a different owner. The positive way to interpret it is, I guess, that management is focused on executing the business plan, and that any development with regards to HNA's ownership is a separate matter.

 

edit: re-read the investor day plan, and the size of the bond offering makes sense

[alwaysinvert]

There are some pretty interesting passages in the bond prospectus

 

The operating leverage and high degree of variability in our lease structure provides significant upside from an

improving market and new hotel openings while providing flexibility and resilience in potential downside scenarios.

Nearly all our leases include a variable component or are capped, providing us with added protection in the event of

an economic downturn. In the Fiscal Year 2017, 73% of our leased hotels paid the variable component of the lease

contract. Of the six hotels without a cap or variable leases, five of those hotels are located in top locations (primarily in

city centers and near airports) in Tier 1 cities. Moreover, 51% of revenue from leases in the Fiscal Year 2017 was

derived from hotels in prime locations in top cities in the Nordic Region, the United Kingdom and Germany, which are

less susceptible to economic volatility than certain developing markets. Although the responsibility to maintain each

hotel property typically falls on us under our lease agreements, our management believes that our capital expenditure

requirements are relatively flexible, as 80% of investments require a decision with only six months’ notice and can

usually be reduced or rescheduled subject to certain conditions.

 

Management believes we are well protected against a potential downturn compared to our position at the time of the

last global recession in 2009. For example, our fee business represented 13.8% of our revenue from hotel operations

before other central activities in Fiscal Year 2017, up from to approximately 11% in Fiscal Year 2009. In the last twelve

months ended March 31, 2018 only six of the hotels in our lease portfolio were loss making with a combined Pro

forma Adjusted EBITDA of negative €3.2 million, compared to 36 loss-making hotels with a combined Pro forma

Adjusted EBITDA of approximately negative €29 million in 2009. With the goal of improving the quality of our portfolio,

we have exited 26 leased hotels since 2009 at an aggregate cost of approximately €45 million. Our revenue

management capabilities, which were non-existent in 2009, have now been built up to fully cover our business

requirements. Our lease coverage ratio, measured as Pro forma Adjusted EBITDAR as a proportion of Pro forma

adjusted total rent, has increased from approximately 1.1 times in Fiscal Year 2009 to 1.4 times for the last twelve

months ended March 31, 2018. By the end of 2019, we expect the quality of our portfolio to have improved

considerably, whereas in 2009 our capital expenditures in refurbishment investments were lagging behind by

approximately €100 million to €110 million. Our positioning in our local markets has also improved since 2009, with a

revenue generation index of 111 in the last twelve months ended March 31, 2018, compared to only 95 in Fiscal Year

2009. Our pipeline of hotels under development was comprised of 23,718 rooms as of March 31, 2018, compared to

approximately 22,500 rooms at the end of 2009

 

 

Our asset-light business model, with a flexible cost base and performance-linked revenue streams, generates

attractive cash flow from operating activities. Over the past three years ended December 31, 2017, our operating

activities have generated cash flow of €85.8 million for 2015, €33.9 million for 2016 and €72.4 million for 2017, for a

total cash flow over this period of €192.0 million. In addition, we have a flexible cost base, with 58% of our costs linked

to revenues. Through a number of concrete cost-saving and revenue-improving initiatives being implemented as part

of our Five-Year Operating Plan, we expect our cash flow generation to significantly improve over the intermediate to

long-term. We expect our Recurring Adjusted Free Cash Flow over the next five years to be approximately €90 million

annually, assuming recurring capital expenditures at the average of amounts incurred in Fiscal Years 2016-2017

(approximately €27 million), no change in working capital to reflect the mid-point of guidance (+/-€5 million) and no

future growth in Adjusted Radisson EBITDA. In addition, changes to our working capital have a low impact on cash

flow and we have a maintenance capital expenditure which is expected to remain flat at around €20 million for the

period between 2018 and 2022.

 

The implementation of our Five-Year Operating Plan, though still in its early stages, is on track and has already begun

to bear fruit. We successfully exited eight leases in 2017 and restructured our existing contracts in two hotels. We

have reduced the number of loss-making leased hotels from 22 in 2017 to 6, of which eight were exited at the end of

the year. Our eight lease exits in Fiscal Year 2017 resulted in an increase of our Radisson EBITDA of €1.3 million in

Q1 2018. We expect that we will have six loss-making leased hotels in 2018. It is also noteworthy that our business

plan is flexible and the performance of our projects are regularly monitored. To the extent that we need to halt or

amend one of our projects for a reason which is financial or otherwise, this is generally possible with a 6 months’

notice. Out of 18 renovations planned for 2018, we have already completed three renovations in line with the expected

capital expenditures and four renovations are currently in progress below the expected capital expenditure.

 

Of course, also relevant stuff with a more negative spin in the risk factors but can't quote it all. The industry overview is good too.

 

http://www.radissonhospitalityab.com/static-files/d710cfcc-dde4-4588-885c-b233c4b88864

[alwaysinvert]

After reading and digesting the Q2 report, my contention is that you would be hard-pressed to find better evidence that the turnaround plan is working. I seldom hear a management being as bullish (among the kinds of companies I follow) and with the numbers to back it up. The stock basically only seems to trade on HNA news and had almost no reaction to a very strong Q2, but I still believe the fundamentals will out.

 

 

 

[alwaysinvert]

Some probably not so good news: https://www.bloomberg.com/news/articles/2018-08-09/jin-jiang-to-buy-majority-stake-in-hna-s-radisson-hospitality

[whistlerbumps]

It will be interesting to see how the board responds to this bid given that they did not recommend SEK 35 for HNA.  Price for remaining 30% probably needs to be a bit higher to get this done.  At least it removes risk of HNA bankruptcy.

[alwaysinvert]

It will be interesting to see how the board responds to this bid given that they did not recommend SEK 35 for HNA.  Price for remaining 30% probably needs to be a bit higher to get this done.  At least it removes risk of HNA bankruptcy.

 

The board is now HNA dominated which it wasn't at the point of the last bid, so it's not same situation. It will be interesting to see how they handle it with their fiduciary duty, though. I hope it won't cost as much in consulting fees for the company as it did last time, that was ridiculous.

 

If Jin Jiang puts the bid at the minimum required level (from what we know now 35 kr or 20 day avg trading price, whichever is higher) they are presumably not going to get many additional shares with that bid. Maybe they will take that free punt for some additional shares or maybe they want to clear away the listed stub more quickly with a premium bid. Who knows at this point?

 

What we can suspect is that this deal was not done in a competitive auction, especially given that the buyer is another Chinese company. Any reasonably fair valuation of RADH is way higher than 35.

[whistlerbumps]

Agreed definitely not a competitive auction.  Certainly will be interesting to see whether Jin Jiang wants to get off the the listed market previously.

 

Even with the new board, I think it would be difficult to justify recommending 35 given EBITDA is much higher than 1 year ago.  We will see though.

[whistlerbumps]

It sounds like only independent board members will provide the recommendation on the JJ bid so HNA board members will not have a say.  This improves the probability that the board recommendation is withheld without a materially higher price.

 

More importantly, the inability to squeeze out without getting over 90% should force JJ to offer a materially higher price if they want to take Radisson fully private.

[whistlerbumps]

When HNA bid, the board did not recommend their price which was just over 7x EBITDA.  So let's assume it needs to be at least 8x EBITDA to get board recommendation which would help get to 90.  I think 8x EBITDA is  about SEK 50 so would think the bid would have to be somewhere near there to get to the 90% threshold.

[alwaysinvert]

A presentation of RADH from the summer.

radisson-presentation.pdf

[alwaysinvert]

I don't know the guy behind Laughing Water Capital, but he presents a solid case for RADH in this letter.

Laughing-Water-Capital-Q3-2018.pdf

[DeepValuePlay]

I don't know the guy behind Laughing Water Capital, but he presents a solid case for RADH in this letter.

 

Thank you alwaysinvert! This was a very interesting read.

[writser]

Yep, good read. One place where I am a bit skeptical is his timeline to completion. First of all, it wouldn't be the first time that a Chinese deal is delayed / cancelled / restructured. It also wouldn't be the first time EU approval takes a bit longer than expected. Also, consider what happened when HNA bought it's stake: deal completion: 7 december. Announcement of tender offer: 22 december. Approval of tender offer: 2 february. Initial deadline: 10 march. Extended deadline: 7 april. Let's not even start about settlement :) (though it's probably unfair to assume it will takes as long again with Jin Jiang). Preparing and running a tender offer wil take a few months usually. I think a more conservative estimate of time until settlement is 5-6 months.

 

I'm also skeptical about a Chinese buyer voluntarily paying way more than strictly necessary. A 20% chance of a 50% higher offer doesn't seem conservative to me - I think it's quite optimistic actually. If I was the buyer I'd first run a mandatory tender offer at 35 to shake out weak hands. Free money. Who cares if the board rejects it - you can try again later at a small premium. I don't see any incentive for Jin Jiang to hurry - they're supposedly buying for the long term and with a 70% stake they can do whatever they want anyway. Also, a controlling stake now changed hands twice at 35 SEK and shares haven't traded above 40 SEK for years. You could make a reasonable case that a 38 SEK bid isn't that bad.  Yes - there are some issues with having a bunch of whining Swedish minority holders but saving 90 million dollar makes up for a lot of whining.

 

And even if you take the weighted average of the 'conservative' scenario in the letter upside is ~8% or ~17% annualized with my timeline. Which certainly looks interesting but not a no-brainer given the that there still are some risks. Probably an above-average idea but I'm not completely sold yet. Feel free to try to convince me.

[alwaysinvert]

You have some good objections, writser, and I have pondered much of what you are writing about myself. I don't completely disagree with your higher level of skepticism, but let me try and address some of it anyway.

 

One place where I am a bit skeptical is his timeline to completion.

 

True, you should always be skeptical of timeline and you would be well-advised to allow for delays if you are looking at it purely as a merger arbitrage. However, they aren't allowed to delay the payout for as long this time around. The rules were changed due to last time.

 

If I was the buyer I'd first run a mandatory tender offer at 35 to shake out weak hands. Free money.

 

There is a good case to be made for that, obviously, and it is the clear base case.

 

However, due to the low free float I would be very surprised if they got more than 5-10% of the stock with a minimum bid this time around. They would also risk some activism and maybe ultimately a years long drawn out process. Meanwhile, there is a real chance that the turnaround at the company makes a great difference during that time. Would a Chinese government-owned company want to risk playing rough with minority shareholders in another country? HNA didn't and it seems more unlikely that Jin Jiang would do it to me.

 

Let's say that they would save 30% of the price for 10% of the stock and have to wait a year more to complete the deal, having to eat the costs of having a listed stub, two layers of management and so on and the risk of the stub increasing quite a bit in value or meeting further problems buying it out further down the line. It doesn't seem clear-cut to me if you analyze it like that. Could very well be penny wise, pound foolish.

 

 

Probably an above-average idea but I'm not completely sold yet. Feel free to try to convince me.

 

Notwithstanding our seemingly very slight differences in evaluating the likeliness of different scenarios, I think the main difference between us is that I don't see it as a pure merger arbitrage situation. I never did, not the last time around either (and that could certainly have been wrong of me, it's not like the stock has performed amazingly and it dipped quite a bit in between).

 

At this point I view it as this: I get to see probably two quarters of business development (first one tomorrow), maybe three basically for free. The turnaround has started above expectations and hotels seem to be still doing well in Europe. There is a put on the stock at 35 and I can check if the turnaround keeps chugging along with very low price risk. I have almost only upside volatility during this period. I always have the option of selling in the market or selling to Jin Jiang. The stock can rise from results and it can rise from a premium bid. I far from expect a premium bid, but then again I don't view the situation merely in terms of merger arbitrage.

 

This is by the way what I thought before reading Laughing Water Capital. He didn't change my opinion really, but he articulated the case well. 

[writser]

Thanks. I see your side of the argument. Astute observation that I'm only looking at the merger side of things. Indeed I haven't really tried to slap a price onto the company on a standalone basis. Guessing from what I've read so far it is cheapish but I've been too lazy to try and do the valuation work. Upside volatility is probably limited as well given the pending offer but it's a free bonus. It's too late anyway to do anything. I'll have a look tomorrow. Good luck.

[whistlerbumps]

I think the big difference is the longer the wait, the higher EBITDA could be as the strategic plan takes hold.  Thus it might be smart to get this done quickly before EBITDA grows significantly.

[Packer16]

The assumption you are making is the turnaround plan is going to cause an increase in cash flow.  We are late in the cycle with a leverage hotel property so I am not convinced that a turnaround will turn that much over the short/mid term.  It may occur I just think where we are in the cycle makes the timing more uncertain.  If we were in the early part of the cycle IMO this would be more likely.  Also, if you look at the AIQ buy-out you had a Chinese state firm squeeze out minorities.  You do have more protection in Sweden but IMO the most likely scenario will be what happened with AIQ.  Jin Jiang will offer the minimum price of 35 SKr & wait.  With the overhang of a control shareholder, the stock will trade at a buy under discount & at the appropriate time they can take under the minorities.  Just another scenario to consider & what happened to AIQ.

 

Packer

[Homestead31]

definitely possible that jin jiang only bids $35.  but also possible they don't. 

 

i am not familiar with AIQ, and your points about this being a cyclical industry are well taken.

 

but, was AIQ a turnaround in progress? 

 

Jin Jiang will have to make their initial bid within 4 weeks of deal close.  If i'm not mistaken, after that, they can't bid again for 6 months, although they can buy shares below the initial bid price.

 

So it will be summer of 2019 earliest before Jin Jiang can bid again for a large chunk.  If you look at the 5 year plan - which is already showing great signs of success (EBITDA up 32.8% 9 mos YoY) - you can kind of guess what the results might look like by next summer, and argue that absent a macro event the stock should be much higher, meaning that Jin Jiang would have to pay up at that point.

 

Again - it is totally possible that they just bid $35 and then let the stub hang out there, but so what?  from where the stock is here your downside to 35 is less than 1%, and your upside could be 20% or more.

 

How many investments are out there that offer 20:1 odds?

 

Statistically, you should take that bet every time.

[writser]

Again - it is totally possible that they just bid $35 and then let the stub hang out there, but so what?  from where the stock is here your downside to 35 is less than 1%, and your upside could be 20% or more.

 

How many investments are out there that offer 20:1 odds?

 

Statistically, you should take that bet every time.

 

You are confusing odds with payout.

[alwaysinvert]

If i'm not mistaken, after that, they can't bid again for 6 months, although they can buy shares below the initial bid price.

 

 

They can't bid more than 35 for 6 months after the settlement date without then compensating the earlier sellers (which would of course completely defeat the purpose of a minimum bid), so their wait is probably even longer than you suggest. More like autumn at the earliest, if you allow for a couple of weeks for the settlement and  a few likely extensions of the acceptance period. They also have up to a month after year-end to make the initial bid.

 

That said, there are lots of things Jin Jiang can potentially do to make life difficult for the minority.

 

The report today would have to be described as very strong, by the way. Most significantly they completely blew out Scandic in like-for-like revenue growth in the Nordics (+9.1% vs 0.3%) . Astonishing outperformance.

[Homestead31]

Again - it is totally possible that they just bid $35 and then let the stub hang out there, but so what?  from where the stock is here your downside to 35 is less than 1%, and your upside could be 20% or more.

 

How many investments are out there that offer 20:1 odds?

 

Statistically, you should take that bet every time.

 

You are confusing odds with payout.

 

agreed - apologies - just typing quickly

 

but even if the odds are against you - which i don't think they are - probability weighting the payout is very favorable b/c the downside is so small.

[Packer16]

From my experience, I think you are missing a very real possibility of a price decline below 35.  This can happen in an offer at 35 happens & Jin Jiang lets it hang out there.  Once the 35 offer expires your floor is gone.  Is there a guarantee that Jin Jiang's subsequent offer has to be at least 35 or can it be lower?  Or can they just buy at below 35 in the market & make no subsequent offer.  They can also just wait for the subsequent bump in the road associated with a levered cyclical business. 

 

This is very similar to AIQ.  AIQ was going through a turn-around & always sold at a discount to comps because Oaktree had a majority stake.  Oaktree sold their stake to the Chinese firm & the stock price sank.  A few months later, the Chinese firm was able to take AIQ private at a large discount to the majority price paid by the Chinese firm.  I did not have enough shares to force an appraisal action as the price paid was at significant discount to market comps but they were able to argue the price based upon DCF (that became much worse than management guidance a few month before) & that a minority interest was worth less than a controlling interest.  Unless Jin Jiang is forced to pay you at least 35 (which I am unsure of past the first offer), I think the same could happen here.  Remember management's incentives is to please the new owner not the remaining minorities.

 

I am not saying this will not work out but I think there is a real possibility of the stock trading below 35 & this workout becomes more dependent upon the price that Jin Jiang wants to pay versus the economics of the business.

 

Packer

[writser]

agreed - apologies - just typing quickly

 

but even if the odds are against you - which i don't think they are - probability weighting the payout is very favorable b/c the downside is so small.

 

I was nitpicking a bit, understand your point. I agree that it's a +EV bet but you have to weigh that vs. the opportunity cost of putting your money in this for 5 months or longer. Let's say I'm targeting 15% annualized. If you take your example with 20% upside you need a ~35% chance of an initial higher bid just to get to my hurdle rate using today's closing price (and ignoring transaction costs). I think that's an optimistic assumption and it doesn't even take into account the possibility that 1) the deal can be delayed or 2) the deal will go astray. I understand Alwaysinverts' viewpoint: if you think the company is undervalued these issues are not as important but I'm not quite comfortable myself saying that this company is too cheap.

 

Also I'm a bit skeptical regarding the added bonus of good operating results: if 'the market' expects a 35 tender offer I think it's unlikely the stock will trade way higher on good fundamentals the next few months. Packer said it better than me: "this workout becomes more dependent upon the price that Jin Jiang wants to pay versus the economics of the business.".

 

Still, it's an interesting situation to follow and I might buy shares at some point.

[Homestead31]

From my experience, I think you are missing a very real possibility of a price decline below 35.  This can happen in an offer at 35 happens & Jin Jiang lets it hang out there.  Once the 35 offer expires your floor is gone.  Is there a guarantee that Jin Jiang's subsequent offer has to be at least 35 or can it be lower?  Or can they just buy at below 35 in the market & make no subsequent offer.  They can also just wait for the subsequent bump in the road associated with a levered cyclical business. 

 

This is very similar to AIQ.  AIQ was going through a turn-around & always sold at a discount to comps because Oaktree had a majority stake.  Oaktree sold their stake to the Chinese firm & the stock price sank.  A few months later, the Chinese firm was able to take AIQ private at a large discount to the majority price paid by the Chinese firm.  I did not have enough shares to force an appraisal action as the price paid was at significant discount to market comps but they were able to argue the price based upon DCF (that became much worse than management guidance a few month before) & that a minority interest was worth less than a controlling interest.  Unless Jin Jiang is forced to pay you at least 35 (which I am unsure of past the first offer), I think the same could happen here.  Remember management's incentives is to please the new owner not the remaining minorities.

 

I am not saying this will not work out but I think there is a real possibility of the stock trading below 35 & this workout becomes more dependent upon the price that Jin Jiang wants to pay versus the economics of the business.

 

Packer

 

i totally understand what you are saying, and largely agree.  what i think you are missing though is that if they bid $35, you don't have to wait around to see if the price will decline after.  you can just hit the $35 bid, then go home.  in that case, you are paying 1% for a look at 20%.  its almost a free look.

 

as for whether or not it goes up or down if they make a $35 bid and some people tender, and some don't.  i have no idea.  its definitely possible it goes down.  however, presumably anyone that thinks it is worth less than $35 would just sell at $35, so not sure who would be around to sell it lower, although human nature being what it is, i'm sure we would find out as time dragged on or if there was any kind of macro issue.

[Homestead31]

agreed - apologies - just typing quickly

 

but even if the odds are against you - which i don't think they are - probability weighting the payout is very favorable b/c the downside is so small.

 

I was nitpicking a bit, understand your point. I agree that it's a +EV bet but you have to weigh that vs. the opportunity cost of putting your money in this for 5 months or longer. Let's say I'm targeting 15% annualized. If you take your example with 20% upside you need a ~35% chance of an initial higher bid just to get to my hurdle rate using today's closing price (and ignoring transaction costs). I think that's an optimistic assumption and it doesn't even take into account the possibility that 1) the deal can be delayed or 2) the deal will go astray. I understand Alwaysinverts' viewpoint: if you think the company is undervalued these issues are not as important but I'm not quite comfortable myself saying that this company is too cheap.

 

Also I'm a bit skeptical regarding the added bonus of good operating results: if 'the market' expects a 35 tender offer I think it's unlikely the stock will trade way higher on good fundamentals the next few months. Packer said it better than me: "this workout becomes more dependent upon the price that Jin Jiang wants to pay versus the economics of the business.".

 

Still, it's an interesting situation to follow and I might buy shares at some point.

 

15% annualized in my mind is totally reasonable.  but, across a portfolio, there will be some bets that are maybe 10% downside with 40% upside, and some that will be maybe 60% downside and 300% upside, etc. etc.  the point being, that there are alot of ways to make the 15% annualized sausage.

 

in my view, having a 1% downside with 20% upside piece going into the meat grinder will aid with digestion.