Sunday, December 30, 2007

OEH - Shorting Based on Unwarranted Speculation

Orient Express Hotels (OEH) is a geographically diversified luxury hotel operator that has traded up mostly on unwarranted speculation of a buyout. At the same time, the market has conveniently ignored disappointing operating performance in the core hotel business, its risky exposure to the international "2nd-home / investment property" market, and a variety of macro trends that, going forward, are likely to make it difficult for the company to meet analysts' expectations for growth. At these levels, I believe OEH presents an attractive short opportunity, with limited downside of 10-15%, and upwards of 30-40% upside if buyout speculation abates and the company receives a valuation more in line with peers and its near-term growth prospects.

Buyout Speculation
Buyout speculation has surrounded Orient Express for the good part of this year, despite managements fairly clear intent to have no interest in selling the company, and the skewed class share structure that gives management over 80% of voting rights. Buyout speculation began with a UK article in late March, and has been further amped by a failed buyout offer by Dubai holdings ($60), and more recently increased overtures by Taj. Management has rebuked both these suitors, and has stated clearly, on multiple occasions, that they intend to operate as an independent entity. Given the voting structure and the very blunt intentions of management, I view a buyout as highly improbable.

Valuation & Stock Performance
OEH trades at the richest multiple of any publicly traded lodging company with a primarily developed market clientèle, and is valued at over twice comparable companies based on common valuation methods. Based on 2007 estimates, OEH is trading at a P/E of 53, and an EV/EBIDTA of over 20. Comparable companies are trading at P/Es of 20x, and EV/EBIDTA of about 10x.

These valuations aren't warranted by OEH's growth rate, and they aren't warranted on a historical basis, either. Below are OEH historical multiples, which suggest that OEH is overvalued anywhere from 40-60% at current levels:

2003 2004 2005 2006 2007 (close)
EV/Revenue 3.1 3.4 4.1 4.9 5.5
EV/EBIDTA 13.9 16.3 18.8 19.9 20.0
P/E 19.6 23.8 29.6 39.7 53.o
P/B 1.1 1.2 1.9 2.4 3.6

Largely because of this multiple expansion (driven by acquisition speculation), OEH has outperformed the lodging sector this year, and has been largely immune to consumer slowdown fears. OEH is up over 20% YTD, while nearly every other competitor is down on the year at least 10%.

Economic Headwinds
Despite how the stock has held up amidst consumer slowdown fears, I believe OEH is actually more likely to be significantly impacted by current macro trends than many of its competitors. Headwinds include:

1) Focus on the consumer
Unlike many of its larger competitors, the majority of its revenue comes from high-end leisure travelers (2/3rds) vs. business travelers (1/3rd). Many larger companies (that have traded down substantially this year), have an opposite mix, with the larger cap names in particularly relying on business travelers for over 80% of their profits. OEH's mix of customers is about 50% US, 33% Europe, and 17% Rest of World. While this compares favorably to other large cap chains, the company still relies on the US for the bulk of its business. Eventually, these fears should begin to be priced into the stock, and eventually begin to show in the operating results.

2) Real Estate Development
In order to monetize some of its land, OEH has spent a good chunk of its capex building out a variety of condominiums, villas, and other resort ownership properties. This was a big trend amongst many of the large lodging companies, and with the slowdown in housing not only in the US, but also in some developed economies abroad, lodging companies are getting stuck with condo and timeshares they can't sell. OEH has the misfortune of having come late to the party, in particularly overbuilt markets (e.g. St. Martin's). OEH has several existing properties it has not yet been able to sell, and has more coming online throughout the rest of the decade that it could very well have trouble recouping its costs on or holding onto for much longer than expected. Currently, the market is largely ignoring this exposure, though other stocks (notably Starwood) have been hit hard based on their failed real estate ventures. Although real estate sales are only expected to account for about 15% of EBIDTA next year, they are expected to contribute to the majority of growth in year over year EBIDTA. If sales come in below expectations, overall growth at OEH will once again be lackluster. This also gives me confidence in their being relatively low downside to this short, barring increased multiple expansion (which frankly seems nearly impossible).

3) Slowing Acquisition Market
These past two years have been almost unprecedented in their acquisition furry. Acquisition fever has abated some in the US, but has increasingly been replaced with foreign money looking to buy cheap US assets. All of OEH's suitors are from still searing emerging market companies, which should eventually become more rationale when their own red hot growth begins to slow, or as some high profile foreign investors get burned on their US purchases. Regardless, unless management does an about face on their go-it-alone stance, OEH will not be acquired. Once the acquisition hoopla finally abates, OEH should be revalued accordingly.

OEH represents an attractive short with a very favorable risk/reward. Though part of the thesis here relies on continued macro-economic slowdown, I would expect the thesis to play out nearly as well as long as acquisition speculation finally dies down. Since many of my shorts are predicated on a macro thesis which may not come to pass, I believe OEH is an attractive addition to my short book in that it is likely to drop regardless of what happens with the economy. Another way to play this could be to do a pair trade with one of the more undervalued names, though I prefer getting the sector exposure here.

Note: Author is short OEH


Mike said...

A few comments:

Just looking at recent news; SAC Capital disclosed a 5.6% stake...banking on a takeover?

I also listened to the recent conference call - RE sales seemed to be going well (iirc, they're looking to close St. Marten's by FY'09) and I think that OEH targets the luxury consumer more than other chains.

Management is pretty snobby though.

Well, Fairmont got taken out two years ago by Gates and Alwaleed (sp?) but perhaps times have changed...

No position.

Research Intensive Investing said...

Hi Mike,

Thanks for the comments. I noticed the SAC Capital position as well—I don’t have any particular insight, though I would say that I generally devalue their positions since they tend to often be short term traders, and they could be long for a variety of reasons, and have an assortment of hedges.

As for the real estate, I don’t trust that things are going well, regardless of what management says. They have mentioned “pre-sales” in St. Marten’s, but the sales don’t count until they’ve got money in the bank, particularly in this environment. The island has something like 10-15 condo developments that are in the process of completion, and this is for a relatively small island, mind you. I think the risk here is greater than management has alluded to. Starwood is a good comp to look at to see the trouble they’ve been having in their Vacation ownership segment.

Yes, I also agree that management is incredibly snobby. They’ve also pissed off Tata, and I wouldn’t be surprised if they scare off other buyers as well.

I could very well be wrong on this one—perhaps some suitor does get around management’s 80% voting stake and makes an offer. But I just can’t see them getting bought out for more than $65 given the valuation. If buyout talk settles down, this one has a good deal to fall.