Mr. Pastore

Finance & Investment

Hotel Business Management and Valuation

By Thomas E. Pastore, CEO & Founder, Sanli Pastore & Hill

Effective and efficient management is one of the most crucial factors to a business' success and survival. An essential responsibility of management is to formulate and execute strategies that increase shareholder value. This is often referred to as strategic planning, which "consists of the process of developing strategies to reach a defined objective. Strategic management is used by businesses to provide overall direction for company operations and establish specific goals and duties in the areas of marketing, finance, human resources, and information technology.

Proper strategic management and planning focuses on setting realistic goals, communicating objectives within the entire organization, and ensuring the most effective allocation of resources. Business schools present diverse courses in strategic management. For example, the University of Michigan's Stephen M. Ross School of Business offers a "Corporate Strategy" course, which covers "on the job perspective, and skills of the general manager in diagnosing what is critical in complex business situations and finding realistic solutions to strategic and organizational problems." Similarly, the School of Hotel Administration at Cornell University introduces various professional development programs in strategic hospitality. Topics include strategic planning and thinking, exploiting change for competitive advantage, risk and strategy, control strategic initiatives, and creating value.

During the process of strategic planning, a hotel group can thoroughly analyze its current business situation, develop long-term goals, and eventually outline the procedures to reach these goals. In addition, through strategic management, the hotel group is able to strengthen the communication between staff, managers, and the board of directors. Additional consequences of good strategic management include resolving major problems that the hotel group faces, improving productivity, and gaining competitive advantages over its rivals.

In the hospitality industry, one of the most important goals of strategic management is to increase shareholder value. Therefore, it is necessary to measure the effectiveness of strategic planning. An example of one tool used for this purpose is the strategic planning index (SPI) developed by professors Phillips and Moutinho. Let us take a look at the major attributes relating to the calculation of SPI below:

The strategic planning index is measured based on the following factors: planning implementation, past performance, expected future performance, functional coverage, reliance on analytical techniques, and staff planning assistance. With the availability of SPI, hoteliers can compare the hotel's strategic planning effectiveness with other competitors in the industry. Management also can use SPI to identify the hotel's strengths and weaknesses in strategic planning, thus be able to better target areas needing improvement.

As stated above, a key result of successful strategic planning is to increase shareholder value. What drives the value of a hotel or hotel group? The answer is: earnings, i.e. sustainable revenues less costs. How are earnings used to value a hotel or hotel group? To demonstrate this, we will use a most commonly employed valuation method, the earnings multiple approach. This approach is applied with the following formula:

Earnings multiplied by price/earnings multiple = valuation

There are several other methods to value hotels. However, for purposes of this article, we will use the earnings multiple approach as the basis for changes in value for a hotel or hotel group. As evident from the above formula, increased earnings typically result in higher shareholder value. There are a few exceptions to this, but they are typically associated with short term market downturns resulting in temporarily depressed earnings multiples.

The value of a hotel or hotel group is intrinsically tied to the level of earnings generated by core operations. Core operations typically include hotel rooms, food service and laundry. For larger hotels these operations expand to include spa and convention services. During the course of strategic planning, a hotel group will set overall goals for the company as a whole and also for each of the core operations. In fact, as a result of strategic planning, the hotel group may decide to expand or contract core operations. For example, it may be determined that food service in neither profitable nor a significant factor in obtaining hotel room patrons. Accordingly, the hotel group may decide to discontinue this service.

InterContinental Hotels Group ("ICHG"), the largest hotel company by number of rooms, addressed the following four strategic priorities during the past fiscal year.

Items 2 & 3 focus directly on increasing earnings with the goal of increasing shareholder value.

In order to achieve the priorities 1 through 4 above, ICHG set the following specific goals: expanding organic growth of 50,000 to 60,000 net rooms by the end of 2008, outperforming Total Shareholder Return (TSR) against a competitor set, and improving Return on Capital Employed (ROCE). The company also recognized that it was better to manage and franchise hotels instead of owning all them. ICHG states that its managed and franchised business model generates surplus cash and obtains high ROCE. Currently, over 3,500 hotels operating under ICHG brands are managed or franchised. And 88% of continuing earnings before interest, tax and regional and central overheads are derived from these operations.

Strategic planning which is focused and results-oriented can have a significant effect on a hotel group's financial performance and value. ICHG's hotel revenues from continuing operations increased 17% in 2005 while operating profit from continuing operations increased 43%.

The increasing popularity of strategic planning in recent times can be attributed to accelerating demographic changes and the boom of the hospitality industry following the recovery from the trauma of September 11. Through strategic management, hotels use their resources and capabilities to create competitive advantages and improve earnings and shareholder value. Strategic management and planning, if executed effectively, can have a positive effect on hotel operations and valuation.

The author would like to thank Sherry Zhu for her excellent research and contributions.

Mr. Tom Pastore is Chief Executive Officer and co-founder of Sanli Pastore & Hill, Inc. He has been involved in financial consulting for more than 20 years, specializing in investment and financial analysis, litigation consulting and public accounting. Extensive experience encompasses valuing numerous businesses in a wide range of industries including retail, services, manufacturing and holding companies. He has served as an expert witness in federal and state courts for business litigation cases in California, Arizona and Nebraska. Mr. Pastore can be contacted at (310) 571-3400 or tpastore@sphvalue.com Extended Bio...

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