Brexit, sterling and InterContinental Hotels Group (LN:IHG)

Early indicators after the UK vote to “Leave” the EU are already showing the country is dipping into recession.  Nevertheless, large-cap stocks in the UK have held up surprisingly well.

This can clearly be seen in the results just announced yesterday by IHG.  The fear of markets before Brexit about hotels had been that the post-recession cyclical upsurge in vacationing had just about run its course–and that, as a result, hotel profits were just about to peak/had already peaked.  But the figures from IHG were good and the stock rose by about 3% on the news.

To see how this can be, it’s important to note    that the post-Brexit decline in the fortunes of the UK has been expressed almost entirely in a 10%+ decline in the British currency.  This is an unexpected boon for British-based multinationals.

As Richard Solomons, the CEO of IHG, put it in yesterday’s report to shareholders:

“Note that whilst the UK comprises around 5% of our group revenues,

approximately 50% of our gross central overhead and

40% of Europe regional overhead are in sterling.

At 30 June 2016 exchange rates, approximately 70% of our debt is denominated in sterling.”

All of these figures are now 10% less in purchasing power terms than they were pre-Brexit.  Without any price changes, revenues will be 0.5% lower in dollar terms than they would have been.  But overheads will be down by much more.  In addition, the dollar value of the company’s debt is sliced by about $128 million.

This situation has two positive effects in the minds of UK investors:

–profits will likely be higher than anticipated, making the stock more attractive, and

–to the extent that a company like IHG, which has the lion’s share of revenues outside the UK, is affected by Brexit, the influence is likely to be positive.  This means that it can act as a way for British residents to preserve the purchasing power of their savings.


the struggle for Starwood Hotels: Anbang vs. Marriott

I began following the lodging industry in the early 1980s.  It was an important time.  The US was completely covered with mid-range hotels.  Lodging companies were forced to look for growth in two ways:  segmenting the market (a sure sign of maturity) by adding luxury and no-frills chains; and expanding internationally.

Today, 30+ years later, the international hotel industry is a whole lot more mature. Growth in any form is hard to come by and where the big players are starting to buy each other to achieve market power by being bigger than remaining rivals.

That’s the rationale for Marriott (MAR) bidding for Starwood (HOT), a company about a quarter of its size.

The prize:

–the HOT reservation network

–the HOT loyalty program

–an extensive hotel network

–a skilled staff.

Cost savings from the combination, which MAR now estimates at $250 million, aren’t that big, given a bid for HOT of close to $14 billion.  This is all about obtaining a strong reservation network/loyalty program and achieving gains in relative market share.

a second bidder

Over the past weeks, a second has emerged–Anbang Insurance, a Chinese financial conglomerate.  It had expressed interest in HOT before but had hitherto been unable/unwilling to outline financing details.  Anbang is probably best known in the US for buying the Waldorf Astoria in Manhattan for close to $2 billion last year.

Anbang cash vs. MAR stock

MAR is mostly offering its stock, with a little cash added.  Anbang, in contrast, is offering all cash.

Anbang’s cash is both a weakness and a strength.  The company is publicly listed only in China.  Restrictions on foreign ownership and on foreign trading make its equity completely unattractive to potential holders outside the mainland.  On the other hand, there’s no question about what the offered equity is worth.  Financial theory suggests that MAR’s management should only offer stock if it believes–and the MAR management is very shrewd–is overvalued vs. HOT’s.

value to each bidder

For MAR, HOT is a way to increase its market power in a mature industry.  For Anbang, HOT is a way to make a splash on the international scene, to get a vehicle for expanding/upgrading its hotel interests in China, and possibly taking a step toward stamping itself domestically as a national champion for technology transfer from the rest of the world.

My hunch is that HOT is more valuable to Anbang–a lot more–than to MAR.

industry consequences

A successful MAR bid is a step toward industry consolidation, implying sharper competition among remaining hoteliers and, possibly, somewhat higher prices for you and me when we travel.

Anbang success may mean less opportunity for foreign hotels in China but more competition elsewhere.




Hilton selling the Waldorf Astoria for $1.95 billion

The day before yesterday, Hilton (HLT) announced it had agreed with Anbang Insurance Group of China to sell the Waldorf, the flagship of the Hilton chain, to the five-year-old mainland financial conglomerate for $1.95 billion.  Hilton will retain an unusually long 100-year management contract to run the hotel (terms not disclosed).  The Hilton will also undergo a substantial facelift “to restore the property to its historic grandeur”  (no details on how much or who’s paying).

When I began following the US hotel industry as an analyst in the early 1980s, US hotel firms were just beginning to transform themselves from owners of hotel properties into managers of hotels owned by others.

Why do so?

–Historically, ownership of hotels has been a low-return enterprise that ties up immense amounts of capital.

–In my experience, hotel management contracts involve the manager taking large slices of the property’s revenues, cash flow and profits–leaving the owner with tax benefits (e.g., depreciation) and the possibility that the property will increase in value.

As I see it, hotel owners fall into one of several categories:

–local businessmen who want the prestige of saying they own the town’s name-brand hotel/motel, and who prize potential tax writeoffs highly

–billionaires who want the same thing, only with iconic properties

–flight capital, where the owner’s interest is less with potential return than with the presumed safety of having “just in case,” non-portable assets located abroad

–national champions, that is, institutions that either officially or semi-officially represent their home governments and who are signalling their country’s rising status.


I see Anbang as falling into the last of these categories.  Its justification to itself likely also includes geographical diversification and its perception that real estate investment opportunities on the mainland are not as attractive as the Waldorf.  IN its defense, Anbang can arguably also make more imaginative use of a city block in a prime section of Park Avenue than Hilton has been able to.

All in all, though, recent Chinese deals for Manhattan real estate mostly call to mind the top-of-the-market foray of Japanese firms into Manhattan in 1989 (think:  Rockefeller Center, which turned out pretty badly for Mitsubishi Estate).

restaurants vs. supermarkets: reversal of form?

trend reversals

The government shutdown means that all the government databases are unavailable.  That’s good news for me   …and bad.  It means I can’t get precise data.  On the other hand, I feel justified in winging it.

I’ve been thinking a lot lately about Millennials vs. Baby Boomers, probably because I’m one and my kids are the other.  I’ve also been thinking about trend reversals, mostly because I believe we’re in a time when a lot of this is happening.  There are always to make money from recognizing trend reversals early.

restaurants vs. supermarkets

I remember seeing a piece of truly excellent sell-side research about ten years ago that documented the changes in American eating habits over a 30-40-year period.  The essence was that through good times and bad Americans were spending an ever-increasing proportion of their food budgets on meals away from home (eating in restaurants + take out).  Not only that, but the extra expense of restaurant meals vs. home cooking had been on a steady decline from, say, a 40% premium over cooking at home two decades earlier to 20% at the time of the report.

The conclusion:  a MEGATREND favoring restaurants over supermarkets (which were having competitive problems with Wal-Mart, anyway).  At that time, home cooking represented just over half of what consumers were spending on food.  The restaurant share was inching up by 0.5% – 1.0% annually.  NO END IN SIGHT!

Well, the Great Recession has changed that.  Over the past few years, eating out has been falling as a percentage of consumer spending on food.


–everyone outside the top 20% by income has cut back on restaurants a lot in order to save money– and by enough to derail the long-lasting pro-restaurant trend

–Millennials have not only cut back, but they’ve aggressively traded down to less expensive eateries

–seventy-somethings have changed their behavior the least

I think there are two related reasons for the cutback:

–what economists call a substitution effect, as consumers rejigger their spending to maintain, or enhance, their lifestyles in a world without pay increases and where interest rates are ultra-low, and

–workers realize they can’t get sick if they want to retain their jobs, so they’re eating healthier.

I’m not sure how much of this is already baked in the stock price cake, as it were.  But I think it’s worth taking a look at eat-at-home beneficiaries to check.

DIS 3Q12 earnings–highest all-time profits

the report

On August 7th, DIS released profit results for 3Q12 (the DIS fiscal year ends in September).  The company posted its highest quarterly profits ever–$1.83 billion.  At $11.1 billion, revenues were up 4% year on year for the period.  EPS were $1.01.  That was 29% from the $.78 posted for 3Q11.  It also compares favorably with the Wall Street consensus estimate of $.93/share.

The stock initially broke through the $50 barrier on the upside on the news.  It has since settled back a bit below that mark.

the details

media networks

This segment makes up 2/3 of DIS’s operating income.  It’s mostly cable; and of that, the lion’s share of profits come from ESPN.

Operating income was flat, yoy, at $2.13 billion.  But a change in contract terms with Comcast has shifted into 1Q and 2Q $139 million in payments normally recognized in 3Q.  There are other underlying complicating factors (the norm for this segment, and for DIS overall) as well.  On an apples-to-apples basis, op income for Media Networks is probably growing at 10%+.

parks and resorts

This segment represents a bit less than 20% of DIS’s op income.

Parks and Resorts were up 21% yoy during 3Q12, at $630 million.  The comparison is flattered, however, by higher yoy royalty payments from Tokyo Disneyland, based on a rebound in attendance from the earthquake/nuclear disaster-depressed 3Q11.  DIS also received in the current quarter an insurance settlement for business interruption at Tokyo Disneyland last year.

Business is recovering strongly at DIS’s domestic theme parks–thanks in part to the successful makeover of the California Adventure park at Disneyland.  The company has new cruise ships and bookings are perking up as well.

Normalized growth for Parks and Resorts is probably closer to 10%.

studio entertainment

Movie results were up over 6x to $313 billion, thanks to the Avengers film, which has taken close to $1.5 billion worldwide.  Even so, films now represent less than 10% of DIS’s overall operating income.  Of course, successful movies can also have positive rub-off effects on the theme parks.  They’re the foundation of much of DIS’s merchandise sales, as well.

consumer products

To some degree, Consumer Products earnings are affected by internal negotiations about revenue sharing among segments about sales of character-related merchandise.  That was a yoy positive in 3Q12, when this segment posted op income of $209 million on sales of $742 million.  Growing at maybe 10% yoy, Consumer Products represents considerably less than 10% of DIS.


DIS’s gaming and internet businesses continue to make losses.  The good news is that interactive is gradually approaching breakeven.  The segment lost $42 million in the current quarter, less than half the deficit in the year-ago period.

a shift in international strategy at ESPN

For the past couple of years, DIS has spoken enthusiastically about international expansion possibilities for ESPN.  Its initial foray was to be soccer broadcasting in the UK.  the company’s tone was somewhat less positive a quarter ago.

During Q&A after the 3Q12 earnings announcement (you can get transcripts for free from Seeking Alpha–a really very valuable service), DIS management said in effect that it is reining in its European expansion plans after losing in the bidding for Premier League broadcasting rights.  It has also ended its Asian jv with News Corp.  ESPN is now concentrating on expansion in Latin America.

It’s too simplistic to characterize the UK expansion attempt as a mistake.  Rather, incumbents there (correctly, in my view) recognized the threat that ESPN posed and were willing to take substantial near-term losses in order to deny a powerful new competitor a foothold in their market.  Not pleasant for them, but the correct strategic move.

As for ESPN, this removes the near-term possibility of large positive earnings surprise from a new profit source.  But the immense popularity of its sports programming in the US make it a steady grower at 15% or so for the foreseeable future.

theme park cap ex is peaking

Other than for its theme parks, DIS isn’t in very capital-intensive businesses.  Of its total segment capital expenditure of $2.5 billion so far in fiscal 2012, $2.3 billion is attributable to expansion at Disneyland and Disneyland Paris, as well as construction of Shanghai Disney.  With Disneyland expenditure finished, the company is beginning work on overhauling Fantasyland in Disney World.  Despite this expense, company cap ex will likely gradually decline from the current level, providing higher free cash flow for dividend increases and further stock buybacks.

buybacks continue

Year to date, DIS has repurchased 55 million shares of its stock at an average price of a bit over $38 each.  During 3Q12, the buyback pace slowed somewhat, with 8.6 million shares bought at an average price of $43.37.

In its earnings conference call, however, DIS made it very clear that it regards its intrinsic value as significantly higher than the current share price–and that, therefore, buybacks will continue.  It intends to devote about a third of its free cash flow to a combination of buybacks and dividend increases.

my take on the stock

Accounting quirks aside, DIS seems to me capable of delivering 15% annual earnings growth, with limited cyclicality.  The stock is trading at a slight premium to the S&P 500.  It has strong management and a collection of iconic brands, the most important of which is ESPN.  My guess is it will be a mild outperformer over the year ahead.