COVID creates Dilemmas for Company Owners (and Financial Advisors)
In his latest column, Les Nemethy looks at the uncertainties thrown up by the coronavirus when it comes to selling a business.
Photo by Shutterstock/Kit Leong
Imagine the following situation: You are a financial advisor. The owner of a large and very attractive hotel asks you to sell his property. When you ask him about the situation with COVID-19, he states that the hotel missed a few off-season months of operation in the spring, but that the summer months are doing better than ever, thanks to internal tourism.
Moreover, there have been millions of euros of new investment into the hotel, which is repositioned as a completely superior product. Due to the strong revenue flow and improvements, the owner expects top dollar for the hotel; no discount for COVID.
What do you advise the owner? Do you take the mandate under the circumstances?
Scenes like this must be playing out all over the world. For any owner wanting to sell his or her company, COVID magnifies the uncertainties of a sale or, indeed, doing any kind of transaction. That’s especially so for a hotel, tourism being one of the most COVID-affected parts of the economy. The whole world seems to be trying to navigate these days without a compass.
Let’s examine some of the uncertainties:
• There could be a resurgence of COVID-19 that, again, shuts the hotel down. (While travel is being freed up among many European countries, as of time of writing, COVID cases worldwide are also increasing dramatically, with resurgences happening in Spain, France and Germany.) As hotels are valued on a multiple of earnings or cash flow, this will mean that a substantial discount would be required to sell the hotel.
• Even if there is no local resurgence in COVID-19 that shuts down the hotel, there could be various domino effects caused by the pandemic: a large number of bankruptcies, banks failing, sovereign default, and a stock market crash, to name a few. Once again, these would directly and adversely affect the valuation of the hotel.
• The expiry or diminution of the massive stimulus efforts could also create a downdraft in valuations. In certain countries, there are debt moratoria, whose expiry could create a sudden market for distressed real estate.
• Even if none of the above happens, so long as COVID-19 is as prevalent in the world as it is, any buyer of a hotel would need to allow for a scenario whereby the disease forces a future shutdown of the hotel, or at least a diminution of revenues. This also would create a discount, although some buyers would insist on a more significant discount than others. Even if this particular hotel is performing well, most hotel investors are coming from a mindset of seeking distress purchases.
My own belief is that the risks of resurgence and domino effects are both substantial.
So where does this leave the seller? If you accept the above analysis, the chances of reaching full price (an aggressively high valuation) are close to nil. A financial advisor who takes on a mandate with these expectations is creating a false expectation.
The likely scenario is that a considerable amount of effort will be expended by seller and advisor in creating an information memorandum, contacting potential investors, only to see negotiations break down due to a significant gap in valuation.
This is probably the greatest reason why there have been so few M&A transactions worldwide during COVID-19: sellers don’t want to discount their company due to the coronavirus (usually preferring to ride things out), while buyers are typically seeking large discounts.
(There is a small universe of companies that benefit from COVID-19, where this does not apply, such as specific segments of online retailing, etc.)
There is always a gap between the expectations of buyers and sellers that needs to somehow be bridged but, with COVID-19, the gap is wider than I’ve ever experienced in my 35-year M&A career.
So, to resume, what do you as financial advisor tell the hotel owner? Do you take the mandate, and just hope that things work out? Do you try to reduce price expectations? (This was a “no go”). Do you refuse the mandate?
You might say the hotel owner has nothing to lose by putting his hotel on the market. I would argue that an asset that is on the market for a long time becomes stale, hence less attractive to buyers; and that thousands of hours of staff time may be wasted in preparing and carrying out an unsuccessful sale process.
In my case, I advised the client to postpone any decision until spring 2021. An extra six months would give some additional perspective on where the virus is headed, and whether the aforementioned domino effects kick in.
I can assure you it takes a great deal of discipline to refuse or postpone a mandate. I suspect the hotel owner is already talking to other financial advisors. On the one hand, I could say that there is a lack of appreciation for financial advisors who put client interests above their own; on the other hand, I leave open the possibility that I am wrong, and that it is the existence of different perspectives that makes a market.
Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com), a Central European corporate finance firm, author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.
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