Six Continents has to keep the shareholders satisfied

Hotel giant Six Continents has billions of pounds available to make itself even bigger. How is the cash going to be spent? Andrew Sangster reports.

Six Continents, the giant hotel owner, operator and franchisor, is being tipped to make a £1.3b bid for Spanish hotelier NH Hoteles.

Although it described such rumours as "pure speculation" the strong balance sheet of Six Continents has linked it to a number of possible takeovers. Deals with US chains Wyndham and Starwood have both been suggested but neither looked ideal and Six Continents has insisted it will bide its time until the price of hotels comes down.

With NH, however, the Six Continents board may decide to go ahead, industry watchers believe. NH is strong in Spain and Benelux, where it is the largest urban hotelier, and, were it to consummate the rumoured takeover of Astron, it would also offer strength in Germany, Europe's largest economy.

On Monday (4 February) NH reported that group sales had risen 38% to €762m (£464m) during 2001. The company was unwilling to comment on takeover speculation, however.

While a deal with NH is by no means certain, it is clear that Six Continents is looking to spend its cash. At the end of last week chairman Sir Ian Prosser said he would not be hurried into giving money back to shareholders rather than using it to buy other hotels.

Prosser has been under pressure from some of his shareholders who consider that the company has overpaid for previous purchases. During January, pension fund manager Hermes fired a broadside at Six Continents, accusing it of destroying shareholder value.

Leaked letter A letter written by Hermes managing director David Pitt-Watson to a non-executive director of Six Continents was leaked, revealing these concerns. In particular, it was argued that £1b, part of the proceeds of the sale of the group's breweries and other businesses, should be given back to shareholders rather than spent.

But Six Continents is insistent that over the next year to 18 months opportunities will be found on which it can lavish its cash and it is vehement it will not overpay. It has set down strict financial conditions for any deal and it is understood to have walked away from buying both Wyndham and Le Méridien because these conditions could not be met.

The three main conditions of any acquisition are that it is:

• net present value positive (total returns from investment to exceed cost)
• above the weighted average cost of capital by year three (rate of return higher than average interest rate paid)
• earnings positive in the first full year (income exceeds expenses)

The company is understood to have ended talks with Starwood about a possible tie-up because the two sides could not agree on price. In any case, such a deal would have stretched even Six Continents' resources, with Starwood likely to have cost more than £8b.

Analysts at investment bank Morgan Stanley argue that Six Continents has struggled to expand in Europe by its preferred route of franchising and instead will have to buy national chains, as it did with Posthouse.

The problem for Six Continents, however, is that unlike the Posthouse deal, other national chains are likely to command a brand premium. This would be the case with NH, which has an enterprise value of about €2b.

A deal with NH would also be only one step towards solving Six Continents' expansion problems. The Morgan Stanley analysts argue that the company needs both another upscale brand to support or replace Crowne Plaza and another mid-scale brand that it can franchise in the USA.

Saturation point Industry watchers at Swiss investment bank Credit Suisse First Boston agree that Six Continents is already at saturation point in the USA with its Holiday Inn brand. The analysts also warned that there may be a succession crisis in the leadership of the hotel division when current boss Tom Oliver leaves.

Despite these criticisms, Six Continents is the favoured hotel stock for both banks.

The firepower at Six Continents disposal, with around £4b to spend, makes it ideally positioned to take advantage of any potential acquisitions in the coming year. Its difficulty is finding one that does not upset its investors.