Mr. Pastore

Finance & Investment

Asset Management: Not All Values Are Created Equal

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

At the beginning of each valuation assignment, the applicable standard of value must be specified. The standard of value is a definition of the type of value being sought, i.e., fair market value, financial value, or strategic value, to name a few. The standard of value is selected based upon the type of assignment which can vary considerably, e.g., merger/acquisition analysis, estate tax filing, or dissenting shareholder lawsuits. The standard of value then influences the choice of the appropriate valuation methods used to determine the value of a hotel or ownership interest in the hotel. Therefore, the value of a hotel can differ under various circumstances.

The most widely recognized and utilized standard of value is fair market value. Fair market value is defined by the American Society of Appraisers as:

The price at which an asset would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, and both parties are able, as well as willing, to trade and are well informed about the asset and the market for such asset.

The Internal Revenue Service's definition is virtually the same as the American Society of Appraisers. Fair market value is typically used in estate and gift tax and employee stock option plan ("ESOP") valuation engagements.

The value of a hotel may also depend on the motivations of specific buyers. Financial buyers have specific investment requirements such as rates of return or income tax considerations, i.e., financial value. These buyers often have an exit strategy to sell their investment at some time in the future. Financial buyers may have the ability to utilize net operating losses to lower future tax liabilities and will factor this into the price they are willing to pay for the acquisition.

Strategic buyers base their valuation on such factors as the benefits from synergies between the acquiring and acquired company. In the hospitality industry, large hotel chains buy existing hotels to increase market share and further develop brands. Strategic buyers are usually companies in the same industry as the acquired company. Thus, the number of strategic buyers for a particular business is typically more limited than the number of financial buyers. A strategic buyer is usually looking at integrating its operations with the purchased business. Thus, a strategic buyer's acquisition price, the strategic value, will be higher than fair market value, because it will incorporate the synergic benefits expected.

For the valuation of publicly traded hotel chains, the intrinsic value can be used as a standard of value for equity securities. It represents an analytical judgment of value, which an investor considers, based upon perceived characteristics inherent in an investment. In other words, it represents the real worth of the security, as distinguished from the current market price of this security. It is the value that will become the current market price when other investors reach the same conclusions. There are various approaches to determine the intrinsic value; the investor then compares this value to the market price of this security to arrive at an investment decision.

Other standards of value include venture capital value. This is based on potential returns to venture capital ("VC") firms for what may often be characterized as a diversified betting strategy. This works as follows: a VC firm makes ten investments, eight of those fail or struggle, one is a success, and one is a homerun.

Other types of values that are discussed, but not considered standards of value, are the seller's value and book value. Seller's value or "dream value" is basically the asking price of a business for sale. This "dream value" is most of the time higher than fair market value because it reflects the emotional attachment of the seller to the business, without taking into account the appropriate due diligence and valuation methods that need to be applied. Needless to say, this type of value almost never represents the actual selling price of the business.

Book value is based on historical accounting costs of assets and liabilities listed on a balance sheet and does not consider the current going concern value of a business. From an investor perspective, history is useful, but expected future financial performance is the key to valuation, therefore, book value of assets is usually irrelevant to investors. Additionally, there are many off-balance sheet factors affecting value such as intellectual property, industry conditions or contingent liabilities that are not included in the calculation of the book value. These factors are particularly important for valuations of hotels, thus book value would rarely be considered appropriate in an appraisal analysis.

The same hotel can have significantly different values under various circumstances and valuation assignments. The following chart presents an example of the different values that can be attributed to the same hotel using the Earnings Before Interest, Taxes, Depreciation, and Amortization ("EBITDA") multiple method. For the purpose of this article, we followed three different scenarios reflecting the impacts of the standards of value on the valuation of the same hotel.

Scenario I depicts the valuation of the hotel in which the purpose is for an estate tax valuation. To calculate the fair market value of the hotel, sales transactions of comparable hotels were analyzed. For these transactions, the EBITDA multiples ranged between 5x and 14x. We then determined that this hotel was performing close to the average of the comparable companies used to obtain multiples. Therefore, we applied a multiple of 9x to arrive at the fair market value of the hotel of $90 million.

Scenario II represents the situation of a valuation for a specific buyer for the hotel. This buyer has the ability to utilize its net operating losses to offset the acquired hotel's future earnings resulting in no income tax liability for the next several years. The present value of these net operating losses is $15,000,000 which was added to the fair market value of the hotel. The addition of this amount to the fair market value results in the financial value of the hotel of $105 million.

In scenario III, a large hotel chain is acquiring various hotels throughout the United States. The acquisition of this specific hotel will enable the hotel chain to increase its market share in New England. The prominent location of the hotel will provide the hotel chain with a signature location enhancing its reputation and serving as a key marketing tool for its worldwide operations. Based on these factors, the acquirer is willing to pay a higher multiple (12x) than other potential buyers (9x). This higher multiple leads to the strategic value of the hotel of $120 million.

As illustrated above, values can vary for the same hotel based on the standard of value used. Financial value is about 17% above fair market value, and strategic value is 33% above fair market value and 14% above financial value. Therefore, at the beginning of a hotel appraisal assignment it is very important to identify the purpose of the valuation and the relevant standard of value.

The author would like to thank Jules Boudrand for his 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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