London-listed Millennium & Copthorne Hotels plc’s independent directors agreed on Friday to an improved – fourth – takeover offer from its 65.2% shareholder, the Hong Leong Group of Singapore headed by Kwek Leng Beng.
The independent directors rejected the first 2 offers outright, without taking them to minority shareholders.
In the third offer (the first taken to minority shareholders), Hong Leong, through a subsidiary of the Kwek family’s original Singapore development business, City Developments Ltd, offered 552.5p/share cash in October (545p/share + 7.5p special dividend), which some shareholders argued still didn’t reflect the value of its extensive property portfolio. The offer was raised by 12.2% on Friday to 620p (600p plus the special dividend raised to 20p), valuing the whole company at £2.014 million.
Hong Leong acknowledged the criticism but responded that Millennium & Copthorne should be valued as a hotel company, not on asset value.
That’s an interesting argument, given that asset value is derived from the quality of properties on which hotel operations can be based, and hotel returns can be based on the quality of premises which customers enjoy.
But it begs a question not answered in the buyout documents: If M&C hasn’t maintained its portfolio adequately and now has to spend extra-large sums to make hotels useable, where is the gain for Hong Leong?
The answer lies in Hong Leong’s long-term strategies, which small Singaporean investors knew when they followed it down to New Zealand: it starves its maintenance fund as far as practicable, maintains low dividends and looks to long-term capital gain which can be bumped up with maintenance catchup.
M&C owns, operates, invests in or franchises 137 hotels around the world, including 22 in New Zealand, where it’s been extremely cautious before carrying out any upgrade throughout its 25 years here, and its expansion programme has moved at glacial pace.
The ultra-conservative upgrade policy was matched for many years by a low share price, although in the last year the Millennium & Copthorne NZ price rose 20%, from $2.34 to $2.81 (and went just over $3 in late February-early March). Millennium & Copthorne Hotels NZ is 70.8%-owned by the London company, and owns 66.6% of a second NZX-listed company, land developer CDL Investments NZ Ltd.
CDL Singapore said its 620p final offer was a 39% premium over the closing share price of 446.7p in August, when it made its initial unpublicised proposal, and a 36% premium from when the offer period began on 6 October. Friday’s offer came 75 minutes before the deadline the London exchange’s takeovers panel had imposed.
Trading in the London-listed company opened at 578p on Friday and closed at 613.5p (1p above the offer when the special dividend is excluded). Its low over the last 12 months was 410p.
CDL said making its bid to fully privatise the company was in the best interests of all shareholders, “given the many challenges M&C faces today”.
Those challenges are chiefly attributable to the group’s conservative management style. The first reason given for privatising – “M&C faces multiple challenges and a highly competitive landscape” – is no different from when Hong Leong entered the hotel sector 3 decades ago.
The second – “significant capital investment is needed which could adversely impact M&C’s earnings” – is entirely attributable to Hong Leong’s choices over a long period, as controlling shareholder. It’s never asked minorities what it should do.
Hong Leong runs all its listed entities with large majorities, usually around two-thirds, and it’s had a history of being loath to increase dividends, thus retaining small bands of external investors in there because they can see capital value rising.
Hong Long gave as its third reason: “Taking M&C private will make the company a more nimble & efficient organisation and will provide it with the ability to further leverage CDL’s significant infrastructure & resources.”
The whole hotel operation, including the New Zealand business, has been run as Hong Leong has wanted it to. It’s had numerous opportunities to show “nimble & efficient”, but has mostly chosen not to.
This reason tells minorities that, when the potential for greater gains arises, thanks for your support but you’re out.
Hong Leong’s more detailed reasoning demonstrates past ineptitude, on the surface, but the group also has a tradition of keeping debt levels well down. At the June half-year balance date, CDL Investments NZ was a debt-free company holding over $71 million ready to invest in new subdivision land when prices turned downward.
As an example of the Hong Leong reasoning, that cash should be seen for what it is, a bunch of dollars unchanged from face value, whereas its real value is as a fund (held back from uses such as dividends) to enable investors to reap greater returns long-term.
Friday’s offer announcement came with reasoning from Hong Leong and a backgrounder from the independent directors of the London company, along with their reasoning on valuation.
Hong Leong’s reasoning:
A) M&C faces multiple challenges & a highly competitive landscape:
CDL believes that M&C currently faces multiple challenges, including intensifying competition from largescale asset-light hotel conglomerates &geopolitical instability across the regions in which it operates.
In the UK, the business faces a challenging demand outlook given the uncertainties presented by Brexit, and the economic environment. Corporate bookings & demand for meetings, conferences & exhibitions are an area of particular concern. Moreover, as a result of Brexit, many experienced European employees in the hotel & catering industries are expected to relocate to other European Union countries, resulting in a shortage of skilled labour. The increases in the national living wage (an obligatory minimum wage in the UK) which were implemented on 1 April 2016 and will be in effect for 4 years until 2020, will further accelerate the cost pressures faced by M&C in the UK.
In the US, the business faces challenges of (i) potential declines in UK & EU tourist travel due to weakened £/€ forex rates; (ii) excess hotel supply in key locations such as New York; and (iii) pressure on margins caused by the rise of online booking platforms.
In Asia, M&C faces a number of issues including escalating political tensions, resulting in a dampening of demand in Seoul & Tokyo driven by fears of military conflict on the Korean Peninsula, and a significant decline in Chinese outbound tourism.
B) Significant capital investment is needed which could adversely impact M&C’s earnings:
To maintain M&C’s competitiveness, CDL believes that significant maintenance expenditure is required across many of the M&C Group’s properties. In a number of cases where refurbishment plans have been announced, works have been delayed and several properties have not had significant new investment for many years.
CDL believes that a significant proportion of the capital expenditure required by the M&C Group is in relation to projects that would be designed to maintain core infrastructure & customer service levels rather than generate incremental returns. Accordingly, whilst a programme of material capital investment may adversely impact M&C’s earnings & cashflows in the near term, there can be no guarantee that it would necessarily deliver improved returns in the medium term.
C) Taking M&C private will make it a more nimble & efficient organisation and will provide it with the ability to further leverage CDL’s significant infrastructure & resources:
To meet M&C’s challenges & long-term financial requirements, CDL believes that M&C’s hotel business can be best navigated if the company becomes a private entity.
If M&C is taken private, CDL can then provide M&C with direct access to CDL’s larger infrastructure as a diversified, global real estate operating company. CDL believes that M&C can leverage on CDL’s network, financial resources and its reputable execution capabilities to effect a quicker turnaround. M&C can then also benefit from CDL’s longstanding track record & experienced inhouse team of project experts who can execute a renovation of parts of M&C’s portfolio with lower cost and at a quicker pace. Nimbleness & flexibility will be a distinct advantage in the highly competitive operating environment that M&C faces.
D) M&C is operated & valued as a hotel company:
The market & analyst community have noted the discrepancy between the value of M&C shares based on present & future hotel earnings and on a net asset valuation. During the 2 years prior to the commencement of the offer period, M&C has traded within a narrow trading range with an average closing share price of 444p.
CDL believes that in view of its intent to retain an asset ownership model, coupled with M&C’s lack of scale & scope to replicate an asset-light business model, M&C’s net asset value has not, and will not be realised, either practically or operationally. Moreover, M&C’s significant capex requirements will likely present further earnings & cashflow headwinds in the years ahead.
E) CDL intends to maintain M&C’s twin strategy as both a hotel owner & operator:
This twin strategy was implemented long ago and has been the bedrock of M&C’s business model for over 20 years. This strategy has been reiterated in several of M&C’s announcements & financial statements. CDL believes in maintaining M&C’s current business model and working steadfastly towards streamlining its operations and improving its performance, while also investing capital expenditure where required.
The generation of recurring income from M&C has been a critical part of CDL’s operating performance, as it provides a buffer against the volatility & cyclical nature of CDL’s residential development business. Today, recurring income is even more important as margins on new residential projects are being reduced due to higher land costs & ongoing property cooling measures in several key gateway cities, particularly in Singapore.
It should be noted that CDL has already invested resources and established a separate, standalone business group in UK to work independently on its development projects, comprising UK sites which CDL had progressively acquired selectively, since 2013. Further, CDL believes that keeping both the hotel & development businesses operationally separate is aligned with CDL Group’s long-term policy & strategy.
F) Irrespective of CDL’s strategy, there would likely be significant impediments to a conversion or repurposing strategy for M&C’s hotel assets:
Different countries have different regulatory requirements, rules & restrictions, capital gains tax, income or corporate taxes as well as approval processes for property development that can be overly onerous & time-consuming. These can incur significant costs and would carry certain political & economic risks, if CDL wished hypothetically to redevelop or reposition M&C assets. Thus, CDL is actively discouraged from pursuing this approach.
For example, as a developer, CDL is acutely aware that the shortage of affordable housing in London will create pressure to provide for affordable housing components in future residential developments (including the proposal to seek 35% of new residential accommodation to be provided as affordable housing). Whilst CDL expects this alone will severely impact the financial viability of any potential redevelopment activities, CDL also notes that several London boroughs have adopted policies to resist the loss of hotel accommodation, and any uplift in floorspace may be subject to community infrastructure levies.
Furthermore, for hotels held on a long-term leasehold basis, the landowner with the reversionary interest may look to extract significant premia & higher ground rents on any potential redevelopments. Moreover, any extension of the hotels beyond their current building envelope may affect third party rights to light, resulting in potential injunctions or compensation payments. Collectively, and irrespective of M&C’s attractiveness as a recurring income portfolio, these factors will continue to disincentivise CDL from pursuing any residential conversion strategy.
Similarly, in New York City, CDL notes the moratorium on the conversion of hotels with more than 150 rooms into condominiums in order to stem potential job losses from hotel closures is an impediment to any conversion or repurposing strategy. The moratorium was imposed in 2015 for 2 years, and was recently renewed for a further 2 years until 2019.
In Singapore, residential developers are subject to various cooling measures, which impose taxes & other regulatory constraints on developers. Of particular note, the qualifying certificate (QC) scheme imposes a series of escalating penalties on certain residential developers in Singapore, including CDL, if they do not complete their development within 5 years and do not sell the units within an additional 2 years post-completion. The QC penalties are equivalent to 8% of the land value in the first year of extension, increasing to 16% for the second year and 24% for the third year & beyond.
These restrictions in the key cities of London & New York, as well as Singapore, highlight the severe impediments to pursuing a conversion or repurposing strategy for M&C’s hotel assets.
Background to & reasons for the M&C independent directors’ recommendation to accept the offer:
The independent directors said they’d rejected the initial offer in August outright, rejected the second with respect to value, and said they’d “sought to better understand the intentions of CDL with regards to its potential future ownership of M&C in a private context, specifically as to whether any attempt would be made to sell or repurpose operating hotels within the group”.
They said they’d had regard to a number of valuation methodologies to assess a fair market value of M&C as a hotel owner & operator.
“Whilst an assessment of the underlying assets of M&C is a relevant reference point (as set out below), it is important to note that M&C has traded, and continues to be valued by the market, primarily on an earnings basis. M&C has historically traded at a sizeable discount to reported net book value (defined as total assets less total liabilities & minority interests, as set out in the M&C annual & quarterly reports) since the financial crisis of 2008 and for most of its 21-year history as a listed company.
“In addition, the M&C independent directors have been mindful that a number of the M&C Group’s assets have not had significant new investment for many years. For instance, updates on the refurbishments of the Millennium Mayfair (originally announced in November 2010) & Millennium Knightsbridge (originally announced in July 2014) were announced in February 2016 for £80 million & £50 million respectively. Since then, both projects were delayed further in order for the board & management team to review their scope & costing.
“The refurbishment of the Millennium Knightsbridge is now projected to start in 2018 whilst the works at the Millennium Mayfair have just commenced, with a reduced scope of £40 million.
“With regard to these & other properties marked for refurbishment, capital expenditure will be required to improve the standards & facilities at those properties in line with customers’ expectations of M&C and also to maintain the returns on these assets.
“Some of this expenditure will need to be directed at the core infrastructure of the assets, such as their mechanical, electrical & plumbing systems. As such, it is expected that a portion of the capital expenditure required in respect of the M&C Group hotel estate will not necessarily deliver improved returns on those assets in the medium term.
“Furthermore, certain large development projects, including the proposed developments in Sunnyvale, California (redevelopment originally announced in November 2005) and Seoul, South Korea (acquired in April 2013), will require significant capital expenditure in the short to medium term in the event they proceed.
“These projects are also expected to have longer-dated return profiles, reflecting the time taken to complete construction and to scale up operations. About £290 million was earmarked for these projects, comprised of £200 million for Sunnyvale & £90 million for Seoul, as disclosed in February 2016, although both projects have since been placed under review as part of value engineering exercises to help reduce their scope in light of the challenges facing the business & the current macro-economic environment.
“Accordingly, the M&C independent directors have identified a number of areas where planned capital expenditure projects have been delayed and where the anticipated levels of investment required may not yield immediate returns.”
Post-offer intention statements & property valuations
The independent directors said CDL had confirmed that it intended to maintain M&C’s current business model, in particular to run the business as an owner & operator of its hotel portfolio, and also confirmed it had no intention to sell or repurpose any of M&C’s hotels in London or in New York.
The independent directors asked CDL to confirm that intent would run for 3 years, rather than the one year initially stated, and CDL agreed to their request.
Nevertheless, the independent directors sought valuations from CBRE Hotels Ltd of certain wholly owned key assets – the Copthorne Tara Hotel, Millennium Gloucester Hotel and The Bailey’s Hotel in London, and the Millennium Broadway (including the Hudson Theatre), Premier Hotel and Millennium Hilton One UN Plaza Hotel in New York.
In selecting those properties, the independent directors said they had regard to several factors, including:
- the relative proportion of the total non-current assets of M&C represented by each one
- the time period since an independent valuation of them was last undertaken
- the importance of the gateway cities of London & New York to M&C’s strategy
- M&C’s ownership interest in the valued properties, and
- their trading performance, in particular the New York properties which, as of 30 September 2017, were lossmaking.
The independent directors also had regard to the fact that a sale of assets needs to take into account tax & transaction costs, which can be significant in asset transactions. Indeed, they said, “if the valued properties were to be sold at the values indicated in the valuation report, M&C expects such sales would incur corporation tax charges of about £49.2 million in respect of the London properties & about $US34.1 million (net of available tax credits) in respect of the New York properties, such liabilities being expected to crystallise on a disposal.
“These estimated tax charges assume that the properties are sold via asset sales, that no rollover relief would be available or impact the amounts charged and that no specialised tax planning strategies are implemented. They also do not take into account any personal property or other transfer taxes that may apply.”
The table below summarises their book values at 30 September 2017 and the market valuations as set out in the valuation report:
Presenting the final offer to shareholders
While the independent directors sought some external valuations, they said they’d assessed the value of the final offer by reference to M&C as an ongoing hotel owner & operator.
And, they said, they “continue to believe that such values [as those from CBRE] are unlikely to be realised either in a listed M&C with CDL as a controlling shareholder, or indeed by CDL following a successful offer (based on public statements made by CDL & its 3-year post-offer intention statement”.
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Attribution: Company release.