Orient-Express: Four-Star Assets at a Five-Star Price

William Mack submits: Orient-Express Hotels (OEH) is a global leisure company that owns or part owns 50 properties, including 41 hotels, luxury cruises, tourist trains and a restaurant. In addition, the company has developed a number of real estate properties for private residence, the largest of which is Porto Cupecoy. I recommend selling shares of Orient-Express, since I think its modest future profit growth will fall short of investor's high expectations.Asset heavyOEH’s 36-owned hotel portfolio boasts the highest average room rate of any chain. However, owning nearly all these high-end properties severely limits profitability and returns through the cycle. While the company seeks high margin (third-party) management contracts, it appears OEH is being out-matched for these operating agreements by more established operators like Four Seasons (FS) and Ritz-Carlton.The company’s resorts and other properties primarily cater to fickle leisure travelers, who prefer to holiday in the summer. Since many of OEH’s hotels are only open for business part of the year, the result is a relatively high fixed cost base and a paucity of rooms available for sale outside of the peak travel season.Over the past 12 months OEH has sold about 560K room nights, implying about 55% occupancy on the 1.02 million rooms made available over this time. But, if we include rooms at resorts closed during the off-season and properties shuttered for renovations (e.g., El Encanto, which has been closed for most of the time since its 2004 purchase), available room-nights would be some 220-240K, or more than 20% higher than reported.Despite weak returns on existing, seasonal properties and a highly leveraged balance sheet (see below), the company made its most costly acquisition, spending $117 million in early 2010 for Grand Hotel Timeo and Villa Sant’ Andrea, a pair of luxury properties in Sicily. At about $725,000 per key and open for only about two-thirds of the year, high returns on these investments during the current cycle will be difficult to achieve.Share issuances and asset sales needed to reach goalManagement's goal to reduce net debt to under 5X EBITDA by 2011 seems a stretch, considering Q310 net debt of around $700 million and EBITDA of $60M each 2008 and 2009.OEH recently hinted it had an agreement in place to raise another $12+ million by year-end 2010 in asset sales. Also, $120 was generated in a November secondary share offering - its fourth in the past two years. But, even if we assume all but $50 million of these proceeds are used for debt reduction (with the remainder plugging its 2011 operating cash shortfall), net debt only falls to $600 million. On this lower figure EBITDA would have to rise to $120 million in 2011 - comparable to the peak-2007 level - and nearly 50% above my estimate of $85 million.To achieve its 5X target the company will have to sell additional assets - at prices that remain depressed - or further dilute shareholders with more issuances. Although we might expect either a more favorable market for property sales or continued patience on the part of shareholders, but to expect both is overly optimistic.Acquisition target?With a number of activist investors owning shares, there is the possibility of OEH being taken private. However, the company’s dual class voting structure, whereby insiders have effective control, has in the past been used to block deals (at much higher levels). It’s fair to note that high-end hotel deals in the past (Hilton (HLT), Fairmont (FHR) and Four Seasons) have garnered relatively high valuations. But those rich prices were paid in recognition of the respective companies’ significant management contracts. Finally, a balance sheet that’s already (re)leveraged (at attractive rates) takes away much of the incentive for financial buyers.ValuationI arrive at a fair value estimate for OEH of $10, compared to a current price of about $12.40. Since I believe 2010 will likely be viewed as slightly below cycle EBITDA of $85 million, I apply a relatively higher valuation of 20X OEH. EV/EBITDA 11E10E090807AC.FP8.5x8.9x9.4x6.3x8.8x(CCL)10.2x11.2x9.9x7.2x11.4x(CHH)13.8x14.7x13.4x11.5x12.4x(H)11.4x13.0x11.6xNaNa(IHG)10.9x11.9x11.0x6.0x11.3x(MCS)7.7x6.4x7.4x9.7x9.3x(MAR)14.7x16.2x13.6x11.2x10.7x(OEH)22.4x24.3x33.5x22.0x27.3x(RCL)9.6x11.4x11.8x6.9x10.5x(HOT)13.9x14.5x13.2x7.5x11.2x(STNR)7.1x7.8x11.7x6.9x12.1x(MTN)9.0x11.1x8.0x5.2x11.4xAvg.11.6x12.6x12.9x9.1x12.4xDisclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.Complete Story »