Is private equity working in the public interest?

Private equity firms are buying up significant chunks of the hospitality industry worldwide. Is this a good thing, or should we be worried? Nic Paton reports

It would be fair to say that private equity has not been getting the best press lately.

Private equity companies have been slammed by trade unions as amoral asset strippers, criticised by MPs and others for tax avoidance (which, unlike tax evasion, is legal) and have faced calls, the latest this week, for a clampdown.

For a sector that normally likes to stay in the shadows, it has been thrust uncomfortably into the media spotlight.

Yet, when it comes to catering and hospitality, private equity is far from shy in fact, the £10b takeover of Hilton Hotels Corporation by US buyout giant Blackstone has, if anything, signalled a gathering of pace for private equity ownership.

The Hilton deal means that Blackstone, which already owns Center Parcs, Tragus and hotel chains La Qunita, Wyndham and MeriStar Hospitality, becomes the world's largest hotelier, owning a staggering 600,000 bedrooms.

And it doesn't stop there. InterContinental, Starwood Hotels & Resorts, Orient-Express Hotels and Marriott International have all been tipped as possible candidates for the private equity treatment.

As for the number of UK hospitality firms already owned by private equity investors, these include Travelodge (Dubai International Capital), Loch Fyne (Hutton Collins), Strada, Café Rouge and Ma Potter's (all Tragus), and La Tasca and Laurel Pub Company (both Robert Tchenguiz), to name but a few.

But is this a good situation for the industry to be in? Is it right that the world's largest hotelier is not, well, a hotelier? And given private equity's mixed reputation - a number of high-profile companies owned by private equity firms, including Little Chef, have in the past run into difficulties - is it good for the longer-term health of the hospitality industry for its ownership to be skewed so heavily in this way?

These are tough questions to answer, according to Sam Hart, analyst at stockbroker Charles Stanley Securities. On the one hand, private equity has given the industry some much-needed financial clout. What's more, because the end game is all about getting a return on investment, private equity-owned firms will normally be managed highly professionally, as the whole idea is to create successful, cash-generating businesses.

Hospitality, too, has been ripe for the picking. A study released last month by market analyst Plimsoll Publishing suggested that UK hotels still wasted a staggering £1.5b of profits every year through bad management and a failure to control their losses.

But the fundamental difficulty with private equity was the end game, said Hart. "Private equity generally looks to have a turnover period of around three to five years," he said. "So, from that point of view, you could argue that their approach may be short-termist."

Large debt

Another worry was that private equity-led deals normally come with a large amount of debt to be serviced, which could then restrict a company's options if things were to get tough or, indeed, curtail its more general willingness to take risks.

"All private equity companies are extremely dependent on the amount that they can borrow," Hart said. "If interest rates continue to rise, they could start to become more restricted in that. The credit markets are already becoming more nervous, particularly in light of worries about the US property market."

Hospitality has become, much like Premiership football or US presidential elections, an arena in which only those with the deepest pockets thrive, argued David Pattison, senior analyst at Plimsoll.

"The big dilemma is the short-termism of it," he said. "There are no ties. They are in it for a season and, if it is not working out, they are out. The attitude is, ‘Never mind, we can always sell it on or break it up.' But, frankly, that is the nature of most businesses now, even if they are still in family ownership. And buying a country estate or a single hotel has now largely gone beyond the single individual."

Chris Eddlestone, head of the leisure group at law firm Halliwells, said that the strong performance of the hotel market meant that investment would continue to pour in - for now.

"At the moment," he said, "revpar revenue per available room] rates are moving up, and if private equity owners feel they can continue to push revpar higher and get the margins to pay the debt, that's fine. But if revpar becomes static and it starts to put a strain on the debt, they are not going to have enough to invest."

Are we done yet? Not by half, suggested Eddlestone. "We are working with a number of private equity firms that are in the process of raising funds to buy hotels," he said. "I think there will be more, as long as there is an undervaluation of the market and they can maintain their figures."

Hart agreed that, even if the economic waters were to become choppier, the appetite among private equity buyers for the sector would remain undiminished. "Banks are becoming more cautious," he said. "The outlook is definitely more uncertain, but I do not think either of these factors is going to be a major impediment to the market."

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