Acquiring A Resort - Valuations

[BackinBKK]

Recently I was debating the valuation of a Southern Beach Resort with a friend and we came up with a number of different methods that can be used to determine the value of a hotel/resort property. Since often times land is the factor that makes most of the properties different, we agreed that eliminating the land from the equation can help to decipher what the owner is actually asking for the "goodwill" of the business. Example:

Resort with 5 Rai of freehold land. Land Valued at 10 Million per rai (figures illustration purposes). Annual Net profit of 10 Million Baht.

In order to subtract the land from the equation, one must first get a total figure for the land value. In this case it is 50 Million Baht. Many owners will then tell you that they have constructed their valuation based on the following formula:

1)Land Value 50,000,000

2)Goodwill 25,000,000 - 50,000,000 (depending on multiple on earnings they are trying to obtain - usually between 2.5-5)

3)Asset 10,000,000 (buildings, furnishings, vans, etc)

In this form, the total valuation could reach 100 Million plus assets (which would then show a proposed return on investment of between 9-12%). Compared to other businesses, if you can not leverage the invesment, the return on investment, or equity, is less than normal. One can argue that the land should appreciate, however, that is speculative and for the new owner to reap the benefit of owning the land. Whn looking at different resorts, the ROI becomes so different depending on the value of the land. It seems that it is prudent to take the land out of the equation in order to see what the premium is for the good will.

My friend proposed a similar scheme in valuing a resort, except in order to determine the multiple (as well as return on investment of the premium for Good will) used for the business one should attribute a "rental cost" to leasing the land back to the resort as an "expense" on the operating expenses.

Example:

1)Land Value 50,000,000

2)Goodwill 25,000,000 - 50,000,000 (depending on multiple on earnings they are trying to obtain - usually between 2.5-5)

3)Asset 10,000,000 (buildings, furnishings, vans, etc)

By having a land value of 50,000,000 and net profit 10,000,000 per year, he says that the valuation should charge back 10% of the land value to the resort (in this case 5 Million Baht per year). So, his Valuation would look like this:

Land Value: 50,000,000

Gooodwill: 12,500,000 - 25,000,000 (depending on the multiple, using a net profit figure of 5 Million as there is a 5 Mil Rent expense)

Asset Value: Minimal as all assets used in operation should be calculated in Goodwill as those assets generate the revenue and profit

Using this method, the valuation will reach a maximum of 75,000,000 plus some additional assets if necessary.

I am very curious and eager to know any thoughts out there as this is quite a discrepancy. If anyone has recently bought, sold, or been involved in a Hotel/resort deal, I would be very interested to know how it was valued and what multiples were used.

All feedback and expamples are highly appreciated.

[tingtong]

not an expert opinion.

i would go with the second option. only i would say in the opposite way, the goodwill is as part of the assets. that is, help to generate the profit ( exp. a well-known brand name) but the asset is the one making it.

i agree, i would handle the land value separate. i wouldnt count the appriciation that much, as the mentioned resort probably did that to it already.

Why to bother ROI < 10%, especially in this high amount of money. similar obtainable around in some thai real estate funds, with much less headache. if land/building values moves, so does in the fund.

I wouldnt like to have in a business less then 10% ROI for my work...

[Digger]

I would have thought its pretty academic whichever way YOU look at it - its the seller that determines the price he will accept and if he is Thai, then where do all the fancy figures take you if he say's NOPE NOT INTERESTED. I would look on it slightly different. To me its what I think/assess I could make out of it versus the cost of buying it. Maybe you could do the same thing for a lower price (accepting your starting from scratch) - perhaps thats where you should be focusing your efforts. I know a few guys who have lots of property investments - they are earning an income from them, but they are mostly interested in the long term appreciation of the land value - the buildings and day to day business are not the big win in their mind however it often makes for a nice income while the land asset matures.

Incidentally I have never seen a deal where I believed I as a farang could make more nett profit than a Thai in Thailand on anything to do with land/resorts etc and I have looked at a lot of them and invested in many. I accept my earnings would be lower for the simple reason VAT comes into play, work permits, etc etc.

[BackinBKK]

Some good thoughts....thanks. I would like to add that the owners are currently foreigners and it has been run by foreigners since opening about 5-6 years ago. Often it seems that owners create something, build it up, and then want to sell for a huge profit which hinges mostly on land speculation and emotional attachment to the property.

Maybe the question is this: Once you remove the land and other non-revenue generating assets from the equation, what is a typical multiple for an established, profitable, and well respected/reviewed hospitality business like? I would assume that the multiple is different if it doing 10 Million/year or 50 Mil per year as larger business normally carry slightly higher multiples? Does 4 sound fair? Any idea?

Thanks.

[Digger]

As I recall typical multiple is 2.5 times earnings + asset value. You need to determine if the asset value is realistic or not. Its all subjective though - I would pay a lot of attention at the company running and presumably owning the complex - do they have a lot of depreciation still on the balance sheet (maybe a lot got wiped out after 5 years of 20% deductions), thus the itme becomes virtually no asset value on the balance sheet. Buildings would be done over 20 years in all probability. Land has no depreciation in Thailand. It might be that the true asset figure is much lower as they have already depreciated them for the most part. Then again, you may not be wanting to acquire the company itself, just buying the asset & goodwill. if your in that kind of price range, I would have thought some decent professional advice would be a major plus on your side.

[Expat2B]

There is no perfect solution when valuing a business acquisition, the only way to look at it is what makes sense for you. One thing you should be clear about however is that goodwill is an accounting concept which is used to justify on the balance sheet any value paid to acquire a business over and above the straight asset value. As such it isn't really something that you buy, it is just used within subsequent accounts to show the difference between the tangible value and the acquisition price. It is normal to write down any value given to goodwill over a period of time and this should be factored into your return on capital calculations.

In an ideal world as a buyer you would acquire a business for its tangible asset value, as a seller you would sell a business based upon asset value, annual income (using the highest multiple you can justify) and an element of future income potential (which may be factored into the income multiple you apply).

As a buyer realistically you should set the rate of return you would expect and then base your calculations upon this. For instance for a 10MTHB acquisition if you are financing 5M THB from your own resources and 5M THB from borrowing (easier said than done in Thailand), then your return expectations would compare the total income you will receive (less the costs of servicing any borrowing) against the return you would get from investing the 5M THB in another opportunity (be it a bank dposit, the purchase of government bonds etc.). Understanding the "risk free rate of return" or the income you can acheive with no risk to your capital is critical to beginning to understand the amount of return you would need to get to make a project pay for you (taking into acount the relative riskiness of the project and compensation for your own time and work).

[quiksilva]

You value resorts just as you would any hotel and there are two approaches that I would use (perhaps three depending on the circumstances).

1. Income approach. Capitalise the EBITDA by your desired rate of return into perpetuity, to provide you with a valuation of the asset from your point of view.

In this approach, the land value means nothing, the good will after all is only as valuable the net revenue it can generate. Sometimes thats not always the best way to look at it (it usually is though) so we may compare that against the following:-

2. Depreciated Replacement Cost. In this approach we consider how much it would cost to build and acquire this asset today, and make allowances for the age and condition of the premises.

3. Residual Valuation. Say the property is being heavily under utilized, a 2 star resort on a 5 star site but its going to need a lot of work to get there. In this case we take a mixture of the two approaches mentioned above. We look at what the asset might be able to generate in the future (based on comparable evidence etc) and capitalise that future revenue, and discount it today's date, this determines what it could be worth. So to get to today's value we then need to subtract the cost of the upgrade from this number to compute today's value.

If you want to determine Open Market Value, then it is best to appoint a firm who has experience of the actual rate of returns that investors will transact at in the open market today, and who conduct valuations to internationally accepted best practices, such as those described in the "Red Book" of the Royal Institution of Chartered Surveyors.

Feel free to PM if you need more help.

Edited November 19, 2007 by quiksilva

[torrenova]

From perhaps 5 years of looking at businesses in Thailand, I agree with the comments about the value of the resorts being tied to land value. Some stratospheric numbers have been asked when the underlying business is a shambles. Buildings are over valued, goodwill is OTT and the sellers just want to cash out as they have heard about the appreciation in land prices.

Of course there are goo businesses out there but the agents are not capable of working out the true values and that is dwon to you. Be sceptical of any profits not accounted for in audited figures. For a resort specifically look at the supply contracts with agents and where your guests come from. What about room rates and facilities on offer. Are they up to date or need replacing as large capital sums will be required. What is the depreciation situation. I feel 20 years far too long for resort building and certainly not for furnishings and fitting which should be far far more agressively depreciated.

I'd love a resort but even if I had the cash, I think the land values are way too high and the consequent ROI too low.

[Digger]

What is the depreciation situation. I feel 20 years far too long for resort building and certainly not for furnishings and fitting which should be far far more agressively depreciated.

Standard accounting practice in Thailand is buildings are deprec. over 20 years and fixtures/fittings over 5 years. You can change that depending upon how you want to set the depreciation within reason, but most from what I have seen tend to follow the normal practice.

[torrenova]

What is the depreciation situation. I feel 20 years far too long for resort building and certainly not for furnishings and fitting which should be far far more agressively depreciated.

Standard accounting practice in Thailand is buildings are deprec. over 20 years and fixtures/fittings over 5 years. You can change that depending upon how you want to set the depreciation within reason, but most from what I have seen tend to follow the normal practice.

OK, I thought it sounded a standard spec but whilst it might work for an office block, you are going to have to re-invent a resort far more than every 20 years and if the original layout and buildings do not easily accommodate some rebuilding and remodelling then you've big bills ahead.

As for furnishings, then the quality will determine the depreciation period but there is a heck of a lot in an hotel room which is not going to last 5 years.

[Digger]

Thats why most hotels change room fittings every five years - ends up being a no-cost option to the business once they depreciate it. Of course, bed linens and stuff are not treated as depreciation items - they are generally shown as maintenance expenses.

[Loom]

Recently I was debating the valuation of a Southern Beach Resort with a friend and we came up with a number of different methods that can be used to determine the value of a hotel/resort property. Since often times land is the factor that makes most of the properties different, we agreed that eliminating the land from the equation can help to decipher what the owner is actually asking for the "goodwill" of the business.

One can argue that the land should appreciate, however, that is speculative and for the new owner to reap the benefit of owning the land. Whn looking at different resorts, the ROI becomes so different depending on the value of the land. It seems that it is prudent to take the land out of the equation in order to see what the premium is for the good will.

That's a worthwhile exercise if you expect the land to appreciate substantially above the purchase price of the resort sometime down the road. It will also make it possible for you to see how much downside risk there is in case the business itself starts losing money.

My friend proposed a similar scheme in valuing a resort, except in order to determine the multiple (as well as return on investment of the premium for Good will) used for the business one should attribute a "rental cost" to leasing the land back to the resort as an "expense" on the operating expenses.

By having a land value of 50,000,000 and net profit 10,000,000 per year, he says that the valuation should charge back 10% of the land value to the resort (in this case 5 Million Baht per year). So, his Valuation would look like this:

Land Value: 50,000,000

Gooodwill: 12,500,000 - 25,000,000 (depending on the multiple, using a net profit figure of 5 Million as there is a 5 Mil Rent expense)

Asset Value: Minimal as all assets used in operation should be calculated in Goodwill as those assets generate the revenue and profit

In this example, you may be double counting "depreciation". Depreciation should already be part of the "profit" calculation. Land isn't depreciated but the buildings, equipment and fittings should be.

I would use after tax cash flow (net income plus depreciation) and then adjust down for the annual cost of maintaining the facilities in working order. The multiple I'd be concerned about would be the total purchase price divided by the adjusted after tax cash flow. If your borrowing or opportunity cost is 5%, then purchase price for the entire asset shouldn't be more than 20x.

After working this out, then I'd think about the value of the land as a standalone asset. You might want to consider the value of the land separately from the puchase cost for the reasons you mentioned above or if some of the land can be sold without affecting the earnings of the business.

The business cannot generate profits without the land unless you do a sale/leaseback.

[Theyreallrubbish]

You value resorts just as you would any hotel and there are two approaches that I would use (perhaps three depending on the circumstances).

1. Income approach. Capitalise the EBITDA by your desired rate of return into perpetuity, to provide you with a valuation of the asset from your point of view.

In this approach, the land value means nothing, the good will after all is only as valuable the net revenue it can generate. Sometimes thats not always the best way to look at it (it usually is though) so we may compare that against the following:-

2. Depreciated Replacement Cost. In this approach we consider how much it would cost to build and acquire this asset today, and make allowances for the age and condition of the premises.

3. Residual Valuation. Say the property is being heavily under utilized, a 2 star resort on a 5 star site but its going to need a lot of work to get there. In this case we take a mixture of the two approaches mentioned above. We look at what the asset might be able to generate in the future (based on comparable evidence etc) and capitalise that future revenue, and discount it today's date, this determines what it could be worth. So to get to today's value we then need to subtract the cost of the upgrade from this number to compute today's value.

If you want to determine Open Market Value, then it is best to appoint a firm who has experience of the actual rate of returns that investors will transact at in the open market today, and who conduct valuations to internationally accepted best practices, such as those described in the "Red Book" of the Royal Institution of Chartered Surveyors.

Feel free to PM if you need more help.

This is completely correct.

I'd add one thing, you need to capitalise (or discount) future cash flows by the risk adjusted rate of return. Too many people set a discount rate of inflation, or what they borrow at.

Calculating the risk adjusted rate of return is easy for publicly traded stocks, not so easy for unique and illiquid assets such as resorts.

However, your first step on researching the deal should be to find comparable transactions. This tells you what the rest of the market thinks about all the factors the OP was throwing in such as land appreciation.

As a negotiating point, its likely that the seller will throw out a price at some point based on "X sold for this amount and mine is better so it should sell for more" so you need to be better armed with market comps to make sure you aren't persuaded into setting the new high comp for the market (i.e. being the "greater fool")

[BackinBKK]

Quiksilva and Theyreallrubbish,

You are both correct about the standard methods used by most valuers and appraisers here (and abroad) for this type of transaction. The problem lies in finding the market information to compare other transactions and available properties, which translates into a problem of being able to find the correct discount rate range (some say it is 11%...some say it is 18%). Also, in order to find the terminal value of the cash flow, how many years should we take it out? 5? 6? 7?

Again, obviously we will need to have a full valuation done, but unless there is some way we can find the market discount rates and other data, it is impossible to get to the number the seller is asking. Unless we can get into the same range, there is no need to invest in a professional valuation.

Somehow it always comes down to Chicken and the Egg, doesn't it?

[quiksilva]

There is no way that I know of which will enable you to determine market ROI, without lots of assumptions. The only way to get true numbers is if you have unbridled access to confidential data. The only people who do have that information are valuers and accountants, and they will (should) not provide this to 3rd parties.

So look at this in a different way. Ask yourself, that given what you know about this property and this business (presumably you know something about it if you are investing in it) then what is your target return on investment? Once you know this, then you can work out how valuable it is to you. Then you will know how far away you are from each other.

As to term of analysis, given that its the nature of money to become less valuable over time, there is no need to use a very long period of analysis. However it should not be too short either, I think that 15 years-20 years should be appropriate.

[vtjoe]

Quiksilva and Theyreallrubbish,

You are both correct about the standard methods used by most valuers and appraisers here (and abroad) for this type of transaction. The problem lies in finding the market information to compare other transactions and available properties, which translates into a problem of being able to find the correct discount rate range (some say it is 11%...some say it is 18%). Also, in order to find the terminal value of the cash flow, how many years should we take it out? 5? 6? 7?

Again, obviously we will need to have a full valuation done, but unless there is some way we can find the market discount rates and other data, it is impossible to get to the number the seller is asking. Unless we can get into the same range, there is no need to invest in a professional valuation.

Somehow it always comes down to Chicken and the Egg, doesn't it?

In the business valuations that I've been involved in, the valuations are based on the discounted cash flow method and the key to that is the discount rate (even small differences in the discount rate can have a huge impact on the value). Typically that discount rate is the acquiree's cost of capital, given this is a privately held company you probably could use your own required rate of return. The only problem is you may be conferring the benefits of your returns on the current owners (the reason the acquiree's cost of capital is used). To get this you need to come up with the cost of equity and cost of debt and use the weighted average (depending on how you finance this). The cost of debt is easy, this would just be the after tax borrowing rate. The cost of equity is a little more challenging, you can use the long-term risk free rate (in the US this would be the 20 or 30 year T-bond) plus a market risk premium of at least 6-8%.

For the cash flow, make sure you take into account not just cash flow but any changes in working capital and future capital expenditures. As far as how many years out to get the terminal value. That depends on you. The terminal value is to get the cash flow in perpetuity based on growth that is equal to the overall economic growth. So as long as you expect the growth to be above the overall economic growth then you would forecast out that many years before getting the terminal value. For example, if you expect to have 10% annual growth for the next 10 years before projecting growth to be in-line with the economy then you would forecast to 10 years then add the terminal value. Again as with the discount rate, the growth rate you use for the terminal value can have a big impact on the valuation.

Sorry if this is a bit technical but that is the nature of business valuations. At the end of the day your valuation should be based on the cash to be generated by the business rather than the value of the assets.

[Loom]

To be more conservative I wouldn't assume a growth rate for the terminal value. It's difficult enough projecting cash flows out 10 years (or less than a few years for some businesses). So the consistency of cash flows should be taken into account. A company with more consistent cash flows should be worth more (use a lower discount rate in valuation) than one with more variable cash flows.

If the cash flow figure is available, then you could make your own growth rate and time horizon assumptions to calculate the discount rate implied by the asking price. I'd then compare this to expected returns from alternative investments.

It's good to have a benchmark. Cost of capital and risk premiums can help establish benchmarks but I wouldn't be too dogmatic about it. I would guess that in Asian equity markets, risk premiums in a range of 5-10% are ballpark.

[Gary A]

I have a friend who has a resort. He has invested 20,000,000 baht. All he expected from it was to pay the expenses and to make enough to live on. Guess what? He's broke and NOT making enough to live on. His 800,000 baht for his retirement visa is also gone. I have no idea what he is going to do but I'm glad it isn't my problem. His company is long ago defunct and at this point he doesn't even own anything to sell. Good luck.

[simon43]

Gary A, what's the reason for him being broke? What went (seriously) wrong/

Simon

[Gary A]

Gary A, what's the reason for him being broke? What went (seriously) wrong/

Simon

Actually it is a five bedroom villa. Beautiful pool, fishing lake and home. He intent was to rent the entire place and the guests would have the place all to themselves. It is gated and off the road over a hundred meters. Very private. I think the main problem is that it is out in the boonies and out of any touristy area. That was supposed to be the main attraction but it just hasn't worked out. He has tried to run just the restaurant and charge for swimming but not much money catering to the Thai locals. It's difficult for him to make enough to pay the staff. Some of my friends stay there when they visit and we party there. He charges them 600 baht a night for rooms. It is a very scenic area but you see most of it in a day or two so it apparently becomes boring to the guests.

[BackinBKK]

Gary,

Thanks for the input. I think we can safely say that this resort property is quite different from the one your friend has gotten into. All the best to him and hopefully he can find a way out of his predicament.

Loom, Vtjoe, and Quiksilva,

I think it may be wise for us to use this year's cash flow and apply just a very small growth rate as the resort has just been trading regularly for about 18 months (before that was in renovation/building process). Occupancy rates are in the mid 70's and I would assume that with a property like this, management wouldnt want to see it go much above 80-85% as that would then not allow for necessary maintenance, upgrades, etc..which are necessary to keep the level of the resort and allow for increased room rates (market rate increases).

The more I look at it and the more people we talk to, it seems that a 12-14% looks like a pretty healthy return. Possibly more could be done through additional investment (nothing major, but a spa and attempting to generate revenue through the owners accomodation) to increase the Cash Flow and ROI.

Thanks for all of your input. It is great to have the help of individuals who have knowledge in these subjects.