Consequences of M&A activity in the hospitality industry are increasingly making headlines, fuelled by a greater complexity of owning- and operating structures and an ever larger number of international stakeholders… What are the best practices to protect oneself from unwanted consequences? Continue reading or click here to view the article as published in Hotels Magazine.
Earlier in the year, third party owners and franchisees raised their voices about the Starwood-Marriott USD $12.2 billion merger. They challenged the firms on the potential violation of their exclusivity agreements (prohibiting the brand-partner to own, manage, operate or franchise other hotels within a certain geographic parameter). M&A activity will not be phased by such temporary “set-backs” as evident by the continued consolidation that the industry is witnessing. Yet, there will always be parties that feel they “drew the short straw”… Merger challenge litigation is thus likely to increase – so what is the Board of Directors to do to protect their businesses and shareholder value?
The “Case Files”
In the recent past, the hospitality industry has witnessed very public shareholder disagreements concerning M&A activity involving global players in the sector – let’s look at some “case files”:
- Morton’s Restaurant Group: In 2013, the firm’s ownership was looking to sell the business. Following the appropriate time and due diligence process, Morton’s ended up merging with a subsidiary of Landry’s Inc. Whilst most would consider the transaction to have been a successful one, generating solid returns for investors, some shareholders raised concerns and sued. It was claimed that one of the firm’s shareholders, Castle Harlan, exploited its controlling position and acted in self-interest – wanting to speed up the sales process to free up cash for another acquisition. The court, though, ruled no wrong-doing. Firstly, it challenged the statement that Castle Harlan (owning approx. 28% of the stock) was a controlling shareholder – the justification for this was based on the set-up and make-up of the company’s board. Whilst Castle Harlan held two board seats, there were also seven Independent Directors as well as the firm’s CEO governing Morton’s. Secondly, the court ruled that the board had in fact gone through the appropriate due diligence during the sales process by not only contacting all potential (and likely) investors, reaching out to well over 100 bidders, but also by using not one but two investment firms to test the market. The court also reminded the suing party of the fact that the transaction had actually benefitted all shareholders equally… Lastly, the court decided that a potential related party conflict of interest that could have arisen by the fact that the firm’s financial advisor was subsequently also providing the deal financing for the acquiring party was appropriately dealt with and extinguished in its root – the Morton’s Board required its financial advisory firm to recuse itself from further negotiations and to reduce its final fee so that the firm could hire a second expert to advise Morton’s on the transaction.
- Accor: In 2016, Accor finalised its USD $2.9 billion acquisition of FRHI and is now amidst the process of integrating the firm into the existing infrastructure. One might say that this transaction went off without a glitch – yet, Accor is reportedly having to “fight” at another front. Jin Jiang, which currently holds approximately 16% in Accor, is reportedly courting fellow shareholders Colony Capital and Eurazeo to buy their stake in the business. As Jin Jiang already owns other (rival) hospitality businesses – including Louvre Hotels – Accor is said to be keen to try and avoid for Jin Jiang to increase its share. In a recent article by Hotel Analyst, it was reported that Accor is therefore eying HNA Group to try and diversity its shareholder base. However, will this really prove to be a prudent solution? Given Jin Jiang’s ownership stake in Accor, the Chinese firm is obviously keen to have a certain representation at board level. Surely, should a transaction with HNA come to fruition, HNA would also insist on gaining a seat at the board table. Problem is – HNA now owns Accor rival Carlson and also holds a major stake in Accor competitor NH Hotels… Is the Accor board therefore acting in the shareholders’ best interest wanting to protect itself from a potential takeover by Jin Jiang and/or from a potential conflict of interest (that would occur if Jin Jiang were to increase its stake in the business) by bringing on board a firm like HNA? Is it not fair to say that this would only create another potential conflict of interest as it would bring yet another shareholder into the firm which would be conflicted by owning and co-investing into rival companies?
- NH Hotels: 2016 also saw a major “shake down” at Spanish NH Hotels. The firm has, up until recently, been spearheaded by Federico Gonzalez Tejera who – as most would agree – did a stellar job in turning around the business. Supported by its major shareholder HNA Group and the financial prowess of that firm, Tejera was able to invest into the brand and its physical assets. Throughout the past few years, he was able to increase profitability and improve the cost-base. Yet, he was ousted by NH shareholders – Reuters, amongst others, reported on the case. Apparently, a group of shareholders saw a potential conflict of interest for ownership representatives sitting on the board and who were appointed by China’s HNA Group – HNA is, as said, one of NH Hotels’ largest shareholder (approx. 30%) who also announced its plans to acquire Carlson Hotels in April of this year. Carlson, of course, owns brands that are in direct competition with NH Hotels. June 2016 saw the removal of four NH Hotels board members and subsequently the firm’s CEO (despite the fact that the board’ Independent Directors were all in favour of Tejera staying). In return, HNA responded and took action itself: It stated that it has always acted in NH’s best interest – unlike some of the other shareholders, including hedge fund Oceanwood. It states that such shareholders would have financial interests that are aligned with their own investment cycles and return requirements, not necessarily with those of NH. HNA went on to declare that it would not let itself being pushed to acquire the remaining stake in NH from those private equity firms / hedge funds and that the actions of such firms, resulting in drastic changes in the management and governance of NH Hotels, had destabilised the firm. It challenged the wider shareholder base that a firm like Oceanwood would only want to sell-off the firm’s trophy assets and cut the asset improvement plan for short-term gains and that Oceanwood’s representatives should recuse themselves when it came to refinancing discussions in order to avoid a potential conflict of interest (as Oceanwood holds unsecured convertible bonds and senior secured high yield notes). Lastly, it also pointed to the fact that even Jose Antonio Casto, Vice Chairman (and former Director at Hesperia), might have a potential conflict of interest as he is reportedly keen to give “his” Hesperia management contracts to a NH competitor.
Protective Actions by the Board of Directors
The world is an increasingly smaller place to conduct business in – hospitality organizations are (becoming) global players and their development and investment partners are continuing to geographically diversify their interests. It is therefore not surprising that there is a greater number of potential conflicts of interest to arise. Yet, the at times Hollywood-esque and very public “shareholder fights” certainly do no good to any party involved in a take-over or potential merger situation. It is the board’s responsibility to ensure a “smooth transition” from a corporate governance point of view – one should make sure to have those boxes checked. A reminder on sound corporate governance best practices and appropriate board structures can be found here whilst the below bullet points highlight some of the obvious but often forgotten facts to:
- Avoid conflicts of interest. This means the company always come first – one should not interfere with the performance or interests of the business, one must take decision based purely on the best interests of the business and one must avoid personal interests or gains interfering with the business. That means that one must also not have an interest in a transaction that involves a competitor, customer or supplier and that one must not direct business elsewhere. There should thus be a solid “Code of Ethics” or comparable policies in place governing this (e.g competition or antitrust law, trading/insider information etc…). It is hereby important to remember that the appearance of a conflict of interest can be as damaging to the company as an actual breach of it. Early disclosure is thus key and highlights the importance of a firm’s General Counsel, Independent Director(s), Secretary and Committees.
- Be in control of your message. Be Transparent. Once shareholders reach a certain ownership threshold, they are obliged to declare their intentions. This will help to avoid confusion or for any appearance of a conflict of interest to arise. Communicating loud and clearly one’s intent and strategy will provide a clear view of everyone’s respective role pre- and post- the transaction. IHG’s acquisition of Kimpton in 2015 is a positive example of this: CEO Richard Solomons made a clear statement of IHG’s intention to keep Kimpton as a separate entity and to maintain its autonomy, keeping its own CEO Mike DeFrino.
- Avoid engaging in a “public fight” as those create uncertainty and might destabilise the firm and/or decrease shareholder value. Rumours about take-overs or mergers typically also impact a firm’s share price – for the better or worse. This is not to say that shareholders should stay quiet – on the contrary, they should not be afraid to ask tough questions and hold the board and management team accountable. Yet, if proper contractual due diligence and risk assessments are done, and if the individual strengths and weaknesses of each party involved are known, then there should be no need for “airing one’s dirty laundry in public”.
- Proactively manage relationships as, if all goes well, you will still need to work together post-signature to integrate the different business units and corporate cultures. Yet, certain relationships are best kept at arms-length: For example, whilst it is good to engage in an open dialogue pre-merger in order to identify potential synergies one also needs to be careful in not disclosing too much information upfront or providing access to strategy if the negotiating partner has conflicting ownership interests with a competitor! Furthermore, post-merger, board interlocks (“you sit on my board and I sit on yours”) are to be avoided as they may “cloud” objectivity and negatively affect the efficiency of the board. Lastly, the Morton’s case highlights that relationships with external third parties will equally need to be managed in the right way.