The valuation of a business is usually carried out for different reasons: sales processes, search for financing, corporate operations or at best as an internal procedure to measure the quality of management based on the value generated (EVA). In a sectorial environment such as the one we are living in, it is very foreseeable that more corporate movements will take place in the short and medium term. Knowing the value of the hotel is now more critical than ever.
Many hotel projects are personal projects, so sometimes it is not easy to assess them with the necessary objectivity. Moreover, most of them start the process with a previously determined value. You know, “It is a capital mistake to theorise before possessing data. One begins to alter facts to fit theories, instead of fitting theories to facts”.
In common practice we come across certain commonly accepted value calculation methods and practices that have a number of limitations, which we discuss below:
a) The value of a hotel is the value of the asset plus the value of the business: Incorrect.
The value of a hotel is the value of its economic operation, for which it needs the asset, and both values cannot be added together. It is, in any case, a sound exercise to calculate the real estate value of the asset for the same or alternative use, since if this is higher than the business value of the hotel operation, it would not make economic sense to continue in the activity.
b) The value of the hotel is the value of the business plus the value of the brand or the value of the intangibles: Wrong.
I am a firm believer in the value of the brand and intangibles, but adding them to the value that comes from the hotel’s income statement and cash flow doubles their contribution and impact. Your brand and your human capital are what allow your income statement to be different from that of the competition and therefore their contribution to value is already in your business margins.
c) The value of the hotel is what I have invested in it plus a margin: Wrong.
Unfortunately, and for different reasons (overinvestment, evolution of the sectors, management,) the real value of a hotel can sometimes be less than the investment made in it. As Pablo Fernández (IESE), one of the leading international valuation experts, rightly pointed out: “A cow is worth the milk it is capable of producing, not what it weighs”. If the value of the hotel is less than the investment made or its replacement value, it is time to reflect.
d) The value of the hotel calculated as a multiple of Ebitda: Incorrect.
Using multiples of Ebitda (sometimes even GOP) is quite common in the sector. These benchmark multiples are taken from historical transactions of listed or private companies, with the following limitations:
a.The first important limitation is that multiples of comparables are multiples of price and not of value. The buyer or seller may have multiple motivations that cause there to be, upwards or downwards, relevant differences between value and price. As Quevedo said: “Only the fool confuses value and price”. Applying a price multiple, in addition to the technical limitations that we will see below, involves transferring these third-party motivations to the transaction we are looking at.
b.The second is to take the current Ebitda as a reference, with the important limitations of this margin even as a management indicator. The situation of the project (ramp up or stabilised), the prospects of the sector (growth or cruising speed), the location or category of the hotel, mean that even if we accept Ebitda as a valid reference, we are calculating a value which has little to do with the intrinsic value of the project. In addition, multiples are usually given as ranges, with valuation ranges where the price can vary by up to 100%, adding insecurity to the above.
c.Finally, we must assume that the Ebitda is no more than a margin level of the profit and loss account and that it shows in a very limited way the profitability and situation of the company and therefore it is difficult to extrapolate a value. Assuming that we are not going to invest in Capex (in a sector that requires permanent and relevant investments), that no taxes are paid and that working capital has no impact on the value, is reckless to say the least.
e) The value of the hotel calculated as a multiple per room: Wrong.
Perhaps together with the Ebitda (Earnings Before Interest Taxes, Depreciation and Amortization) multiple this is the most common shortcut, being no more than a combination of this with the one linked to the value of the investment. In addition to the limitations of comparability and the subjective part of working with an output of price and not value, profitability is completely forgotten. Two hotels with the same investment and location can have very different profitability. Although it can be a useful reference (only as an output) to understand value, it should never be used as a valuation methodology.
The valuation process of a hotel, and of any business in particular, can contribute a lot to the management of companies beyond the fact that we are in a possible sale and purchase operation. As we will see in the following article, it is essential to face it objectively and with the correct process and methodology.