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Demerging Accor - Less Than the Sum of the Parts?

How many surprises can still be in store at Accor, the French-based hotel and prepaid services transnational? In 2009, when private equity investors Eurazeo and Colony Capital boosted their stake to 30%, it was described as a "vote of confidence" in existing management.

Six months after the initial investment, the CEO was forced out, followed by the resignation of the Chairman and 5 other board members last year. On May 11 this year, Accor announced the resignation from the board of Alain Quinet, a representative of the French state investment group Caisse des Depots - and the last critic of current Board strategy.


The financial situation at the end of the day this year is still solid, with the net debt standing at EUR1.624m -- EUR1.624b, sorry. EUR2.5b…And debt net ratio 20%, therefore investment grade. The bad news of the year is the net income which is a loss, EUR282m.

Gilles Pélisson - Accor SA Chairman and CEO, Thomson Reuters StreetEvents Earnings Presentation, February 24, 2010

France-based global lodging and services group Accor S.A.'s lease-adjusted EBITDA fell 19% in 2009, and we anticipate that negative earnings growth is set to continue in 2010. We are lowering the corporate credit and senior unsecured debt ratings to 'BBB-' from 'BBB'. A demerger of Accor Services), due in July 2010, will weaken Accor's operating diversity and business risk profile, in our view.

Standard & Poors, February 24, 2010

Stars and dogs

The voucher services business, cash rich and capital light, is being "demerged" from hotels, spun off into a newly listed 'New Services SA', while the hotel business which put Accor in the CAC 40 with operations in nearly 100 countries is on a fast track to dispose of EUR 1.2 billion in properties by the end of 2011 in order to pay down debt. Corporate chief Pélisson has spoken of a "star" (the vouchers) and a "dog" (the hotels). Having ransacked the board and forced through an operational split, Colony and Eurazeo are now "committed" to the company until…January 2012 - long enough to reap the presumed benefits of the property disposals.

When Colony and Eurazeo are long gone, workers at the hotel "dog" will be dealing with the consequences of the disposal operation. Accor employees have repeatedly voiced their concerns about the impact of the split, most recently at an emergency meeting of the Accor European Works Council in January this year. The risks to employees are clear. Pélisson and Deputy Executive Director Jacques Stern like to speak of "dematerializing" the services business through a shift from paper vouchers to paperless, virtual transactions. But the voucher business has few employees; the real shift comes with dematerializing formal employment at Groupe Accor as the company exits ownership of the properties. As hotel properties are disposed of, then franchised or leased back under management contract, employees' paychecks are increasingly written by a REIT or similar investment vehicle.

Accor calls this "asset right", celebrating and accelerating the selloff process already underway for some years. As Accor the hotel employer increasingly gives way to Accor the licensed brand, terms and conditions of employment are cut loose from global Group policy. Collective agreements at national level are shrunk and restricted in scope, leaving workers struggling to define and negotiate a relationship with a restless cluster of shifting investors with no connection to the real world of hotels.

Demerging debt?

Accor's two main investors have not been alone in pushing to split the Accor business into two separate listed entities. The only surprise when Accor unveiled its demerger plan along with the 2009 results on February 24 was the surprising decision to load the bulk of the company's debt (EUR 1.6 billion, up from just over EUR 1 billion at the close of 2008) on to hotels.

Major analysts had cheered the potential hotels/services split on condition that services, with its abundant cash flow and low capex, would assume the bulk of the debt, for the simple reason that the voucher business doesn't need an investment grade rating to fund current operations or to expand. The "strength" of its model, if it can be called that, depends on lobbying governments for tax breaks. Apart from Sodexho, Accor's competitors are mostly small national companies with below-investment credit ratings. The ostensible need for an investment-grade rating for payment security is a red herring, as the use of escrow accounts to hold voucher funds has demonstrated in a number of Accor's key services markets.

In it's October 9, 2009 review of potential demerger ("We believe in the equity story"), Société Générale noted that "The group's current strategy is unfavorable to bondholders, while market conditions have taken a turn for the worse in the hotel sector…Management's recent decision to separate prepaid services from the rest of the group has increased uncertainty over the evolution of the group's credit profile at the worst possible time…" Reviewing various scenarios, SG concluded that "there is a strong probability of a decline in value for bonds, even if they remain investment grade. We therefore maintain a Negative credit opinion." On the other hand, according to SG, Accor’s prepaid voucher business “could very well ‘live’ without an investment grade rating”. Natixis, in a report dated November 3, based its "Buy" recommendation on a demerger that would put 60% of net debt (versus the 25% announced by Accor on February 24) on services as "the best distribution to obtain financially viable structures for each of the entities and enable them to continue to grow." Every major institutional French financial analyst recommended that Accor treat existing and future debt issues in the runup to the split in such a way that the bulk of it would fall on the services business.

Under pressure

The 2009 results showed declines and/ or growing pressure in all key indices - net profit (a loss of EUR 282 million compared with net profit in 2008 of EUR 575 million), income, margins, turnover, occupancy, and a 60% leap in net debt. Not to worry, explained Péllisson and Stern in their February 24 conference call with investors: we did less badly than the competition, and increased the dividend payout rate from 60 to 72%!

A fundamental question remained unasked and unanswered in the investor call. If, as the corporate chiefs ceaselessly repeat, Accor in the depressed environment of 2009 managed to outperform every benchmark competitor, why the rush to assimilate the competition's business model by accelerating the selloff process at the cost of massive debt and the loss of the cash support from services? The recent Q1 investor conference showed that these questions remain very much alive.

Private equity in the driver's seat

The logic behind a proposed demerger which creates new debt through a financial reshuffle in services and then throws 75% of the combined net debt onto hotels cannot be found in the 2009 results. Its source is the investors driving the process, Eurazeo and Colony Capital.

They have good reason to be impatient - indeed, in the compressed timescale of private equity, they've already exceeded the longest of "long term" investment horizons. Funds have closed, investors have to be paid and new funds raised. Accor shares are trading at EUR 40.35 - compared with the average of EUR 46 when the two funds' took their stake. Eurazeo announced its own 2009 results in March - a loss of EUR 199 million, nearly triple the red ink for 2008 (that didn't stop Eurazeo from maintaining the EUR 1.20 dividend - an indication of where their, and Accor's, priorities lie). Colyzeo II, the Eurazeo/Colony joint investment vehicle with a big piece sunk in Accor and Carrefour, saw its value reduced by 63% in 2008. Colyzeo also owns a joint stake with Accor in gaming group Lucien Barrière, which Accor has now announced will be unloaded in order to pay down debt, though it still can't decide on the disposal mechanism.

Accor's current equity valuation stands at some 80% of what the funds need to reap with a 2012 exit which could satisfy their own investors. This can only be achieved by a high valuation of the services business (hence the low debt) and a rapid selloff of hotel properties to meet short-term financial targets. In less than 2 years, Accor needs to unload 1.2 billion worth of property to keep its investment grade credit rating or deliver a shock to bondholders already jittery about new shocks to the market for corporate debt.

Evaluating the property portfolio: anyone's guess

Accor's current portfolio has been variously estimated at from EUR 4 to 6 billion, depending on how you slice the numbers and rate prospects for recovery. Pélisson and Stern radiate optimism about the disposal prospects. Price, Waterhouse Cooper are less sanguine. Here's the conclusion of their Key Highlights from Emerging Trends in Real Estate Europe 2010 from March this year: "In this year’s survey hotels dropped from second place last year to twelfth place in 2010, to sit firmly at the bottom of the table. Hotels have been one of the sectors most impacted by the credit crunch and values have fallen significantly… global hotel transaction volumes sunk to the lowest annual transaction level of the decade, slipping a further 64% from 2008,to $9.4 billion in global hotel sales in 2009."

On April 14, according to the Financial Times, April, Morgan Stanley told investors to brace for "the worst losses in real estate private equity history owing to the fall in value of investments made at the peak of the market" - including their investment in InterContinental hotels across Europe. Some of the properties, like the US homes taken out by the collapse of the mortgage market, were literally under water. According to the FT, "An $800m portfolio of European hotels has also been handed to its lender. Morgan Stanley has fully written down its exposure to the fund." Two days later, the FT reported that Goldman Sachs' international real estate investment vehicle Whitehall Street International had lost 98% of its equity value and the fund was handing over the keys to the properties.

This is the market on which Accor is counting on to raise a quick EUR 1.2 billion? Occupancy rates, as even Pélisson admits, are possibly stabilizing, yet hardly growing. According to Société Générale, "The experience of 2001 to 2003 shows that the hotel sector was amongst the last ones to recover - both in terms of margins and top line growth. Since the recession is deeper this time around, it may take several years before any meaningful recovery materialises." Investors like Colony aren't buying hotels - they're buying up securities linked to collapsed commercial property.

Prosperity, for the current Accor board, is just around the corner - or their entire construction is in trouble. Accor's 2010 Q1 results got rough treatment from analysts unconvinced of a rise in hotel revenues any time soon. The prospects for disposing of Lucien Barrière through a stock market offering are not brilliant: more planned IPOs have been cancelled this year than have been executed, and few companies launched in public equity markets earned anywhere near their anticipated price. Casinos have been among the most prominent casualties of the crisis - just ask the private equity and property investors who binged on gaming at the height of the bubble.

Selling off the brands - first on the auction block?

Pélisson and Stern in their February investor call claim that cost-cutting rescued margins from total catastrophe in 2009, but that room for further cost reductions are now more limited. Investors are jumping over the revenue per room figures, demanding higher margins. Continued stagnation in occupancies, a snag in the disposal process, a slight increase in the cost of borrowing could all induce pressure for more savings - at considerable risk to service, reputation and, obviously, jobs. Does Accor have a "Plan B"?

This leaves the "portfolio of powerful brands" with a position in every sector of the market as the potential target of choice for short-term financial vandalism. When the expected cash fails to materialize, which brands will be sold first? Sofitel? Motel 6? These are among the least attractive brands in the portfolio. Will investors heading for the exit push for a fire sale?

Accor's demerger package is a knife-edge construction built on a questionable model and a hothouse timetable intended to boost the short-term equity value of the two companies for investors who won't be around long enough to confront the consequences. Bondholders and investors with a horizon beyond 18 months should be taking a closer look.

Accor calls itself "an employee-focused company", "the hospitality industry's 'best place to work'", "the world's leading hotel school" etc. But employees, like long-term investors, are a vanishing species. In the course of the February investor call, Pélisson twice mentioned Accor employees. The first time, they numbered 145,000, the second, 135,000.Asset-right means payroll light, and declining enrollment at the hotel school. Increasing numbers of Accor employees who built the brands on which the future depends now have to contend with an uncertain future in which their employment depends on the rapid selloff of their workplaces.

Accor wants to exit the gaming business, but they've bet the house.