Mandarin Oriental – The rarest of things
Jun 2020 ($1.57)
Mandarin Oriental (MO) is that rarest of things; a renowned luxury brand, but one with significant asset backing to boot. A quick look at the widening disconnect between the share price and asset value of MO will show you why we looked a little harder at it this spring. The magnitude of upside still on offer to equity investors is enormous. Simply put this is a company with $5.9bn of a recently revalued net assets that has a market cap of just $2bn aka a price/book of 0.33x. To paraphrase Mandarin Oriental’s regular FT advert: “we are fans”.
Fig 1: A massive Margin of Safety
Source: Holland Advisors
We just can’t write fast enough
We first looked at MO during our Jardine Strategic work last summer (Holland Views – Jardine Strategic – Are you a value investor really? Nov 2019). In that note, we highlighted the sizable undervaluation of MO against its revalued property estate. In property/asset backed companies this is not unheard of. However, MO enjoys a lack of something important that almost all low price to NAV property companies have in abundance: Debt! When MO shares then fell off a cliff this spring, we looked a little harder alongside our studies of Marriot and Whitbread (the latter we have yet to write on but are happy to share our views). With the Keswick family owning 77% of the shares in MO via their Jardine holding company that does not leave a lot of share liquidity for everyone else. Indeed, that lack of liquidity could well be one of the reasons as to why the shares have been volatile (along with HK political disruption), but hey that is Mr Market working in our favour. We did this work a few weeks back but just cannot write up our ideas fast enough these days. We are also aware that more than a few clients will find this share too illiquid and thus we will keep our comments brief:
The main points
- M Cap US$1.98bn + Net Debt 300m = EV of US$2.3bn
- Enjoys a pre-eminent exclusive/niche brand with serious asset underpinnings
- Had only 7 hotels in 2003, but now earns income from 33 hotels
- It owns or has equity stake in 15 of those hotels. These 15 generated the majority of profits in 2019
- Quite a few of those 33 hotels have been or are in various states of refurbishment so earnings are under-stated in recent years as suggested in Fig.2 below
- Since 2014, the company had embarked on a significant expansion and refurbishment program – aka an investment cycle which is coming to a completion
- New Pipeline for 20 hotels – notably all managed, i.e. with little equity interest, so less capital consuming than past expansion
- The company has a stated intention to open three new MO branded hotels every year
- The decision in 2017 to monetise the value of the massive HK Excelsior site possibly marks a new shift in management’s thinking towards a more asset-light model
Asset value/Earning power
- MO has an accounting book value of US$4.1bn (which was partially marked to market last year, when it was revised upwards by an additional c.$3bn)
- It also has a market adjusted book value is US$5.9bn as per Fig.1 (vs. a market capitalisation of $2bn).
- Several key hotels have not been contributing to group profits of late due to refurbishments e.g. 2019 adj EBITDA was $155m (vs. c.$188m in 2018)
- Last year’s decline was due to the closure of the famous Excelsior hotel in HK in 2019 (more on this later)
- So underlying EBITDA margin is 188/1398 = say 13% margin vs. over 65% EBITDA margin for Marriot group. We note that Marriott’s ‘owned hotels’ EBIT margin is >18%. It looks to us that MO has been under-earnings since 2016.
Fig.2: Under-earning since 2016?
Source: Mandarin Oriental
In the company’s own words, this has been a period of extensive renovation…
“The Group has significant capital expenditure commitments in relation to previously announced projects totalling $766 million. This includes $585 million for the redevelopment of The Excelsior site, the majority of which will be incurred from 2022 onwards. $42 million represents the Group’s 50% share of the Ritz, Madrid renovation costs, and $139 million has been committed to enlarge the hotel in Munich. These capital commitments will be incurred gradually over a number of years and will be financed using an appropriate mix of external debt and group cash reserves. While gearing is expected to increase in the years ahead, current gearing levels are low and the Group has capacity to increase net debt without compromising its ability to maintain robust debt service coverage ratios” – H1 2019 conf call transcript
…but it is coming to an end:
“Other events of note included the re-opening of our flagship Hyde Park hotel in London after a comprehensive refurbishment, the re-opening of the River Wing at the historic Bangkok hotel following renovation, a completed rooms renovation in Tokyo, and good progress on the renovation of the Madrid hotel which is on track to open in late summer 2020. The redevelopment of The Excelsior site into a commercial building commenced in May and is currently in the demolition phase. The new commercial building is expected to be completed in 2025” – 2019 annual report
Excelsior Hong Kong
- The company announced that it would sell the famed Excelsior Hotel in 2017
- This is arguably the best property site in Hong Kong
- Upon putting the property on the market, it got 5 bids but declined each. Media speculation at the time was that this hotel site alone was worth >US$3bn
- MO then decided to redevelop the site itself. The property is currently being demolished and the 5y capex for development is $650m
- But CFO states that MO do not want to be real estate landlords and expect to get new bids once site is cleared and development prospects are more obvious to all.
“we expect new bidders to emerge…our preference is not to be a long-term holder of CRE…the prospects of higher yield are still ok” – CFO on the FY19 results call
- The change of use of the site forced a $3bn upward revaluation of audited asset value in Dec 2019 again as shown in Fig.1. This forced the accounting book value to close the gap on the adjusted book value.
Asset heavy to asset light
Having just spent quite a bit of time studying the business model and compounding prospects of Marriott and having in the past watched IHG turn itself from an asset heavy business into an asset light one the contrast with businesses like MO or indeed Whitbread (Premier Inn’s owner) with their freehold asset ownership models is notable. One of the reasons Marriott talks of being able to charge the brand royalty fees (in essence that is what its net revenues are) it does, is thanks to the premium nature of its pricing. This is illustrated by its premium RevPar rates. Judging a hotel brand on such yardsticks ranks Mandarin Oriental very highly indeed as shown in Fig.3[1]. Specifically, Mandarin Oriental has an average RevPar of $279 which is comparable to say Marriott’s Ritz-Carlton (i.e. its ‘luxury segment’) but considerably above Marriott’s global average of $132.
Given MO’s premium pricing and brand cachet, it is surely not a stretch to say it would be a suitable business to adopt an asset-light royalty type model.
Fig 3: Revenue and Fees per average room varies, a lot
Source: Marriott, Mandarin Oriental
Asset heavy past vs. future…?
We find ourselves wondering if the interesting (read ‘larger amounts of’) money is made in the asset heavy to asset light conversions by businesses when the transition is considered unlikely by markets. MO raised equity capital in 2015 to help it develop and acquire premium sites in London and Madrid and pay down debt related to the $382m Paris site acquisition in 2013. Does this go against grain of the franchise-esq approach others are pursuing? Seemingly so. Or, maybe it was a necessary part of the investment needed to properly establish a global brand of sufficient scale that owns and runs its main hotels globally to ensure high standards are always maintained.
On this point we could reflect that equity investors are often in a rush to make money. Owner managers with far longer timeframes and larger cheque books tend to make slower more considered moves perhaps understanding just how much needs to be invested to build something lasting. The scale and all-in cost of the investments being made by MO in its recently opened hotels (e.g. London and Madrid) are we suggest either evidence of this fact or vanity projects. As per our commentary on Jardine Strategic we would really like to spend time with the managers of these businesses to find out more about them. But for now, we believe the former to be true (i.e. they are astute investments to build a lasting brand). Indeed, we will go further. For a hotel brand that only had 6 sites in 2002 to now be considered a global premium brand is an impressive feat and not one likely achieved by cutting corners. Building lasting value takes time and effort. This was something we learned from watching Johan Rupert, at Richemont (Holland Views – Richemont – Building goodwill, not buying it – July 2016).
Fig.4: Mandarin on strategy
- To be recognised as the world’s best luxury hotel group
- Brand is the Group’s most powerful asset Source: Mandarin Oriental
Fig.5: A less asset-heavy future
Source: Mandarin Oriental
Seeing Jardine’s wider business expertise and hearing MO outline that much of their future expansion will be ‘managed’ rather than ‘owned’ suggests to us, a far less asset intensive future than its recent past (“our future growth is most likely to come from management agreements” CEO Analyst conference call).
IHG and Marriot have shown the way to create enormous value from such a starting combination of assets and brand in this sector. With that door wide open the only bet investors have to make is to assume that one day Jardine and MO might choose to walk through it. Our best guess is that such a route (or similar) might be pursued, but only when the company assesses the brands global position and the profitability and prestige of their best sites to be fully established. Fig.4 & 5 suggest these observations are not just a figment of our imagination.
Different timescales
If investors attracted to the value on offer are looking for a catch, the only ones we can really see are different timescales and lack of any voting power. If you are in rush to make a profit in this investment or are intent on telling the managers/controllers of this business how they should optimally monetise these properties and brands we think you may well become disappointed.
Alternatively, if you are just happy to invest alongside the Keswick family allowing them to decide the speed and manner of how the business should profitably evolve this may result in some compelling longer-term compounding. Whilst this compounding is hard to see currently in the businesses profitability it is evident in the other tangible and intangible places:
- In the revalued property NAV which is up five fold since 2004(11.5% cagr)
- In the quality and global reach of the brand that Mandarin Oriental has built
“Sometimes what you can’t measure matter more” Charlie Munger
There is also a danger of being crowded out by the Keswick’s in a purchase of minority stakes. On this point we note the long track record of Jardine related companies and their actions towards minority investors. As yet we can find no suggestion of any similar action in the past whatsoever. The 2015 rights issue to enable the purchase of the London and Madrid sites was offered to all investors just with Jardine underwriting it.
We include some useful slides for context and to back up some of our claim in the Appendix below.
Buy Mandarin Oriental
Andrew Hollingworth & Mark Power
The Directors and employees of Holland Advisors may have a beneficial interest in some of the companies mentioned in this report via holdings in a fund that they also act as advisors to.
Appendix: A few tables to back up our thesis
Source: Mandarin Oriental
Extracts form Mandarin Oriental accounts – Year end 2005+2010
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