Sunday, 17 November 2013

Federal Hotels: End of a chapter

Federal Hotels’ 2012/13 financials confirm its cash flow struggles highlighted the previous year have continued and will only be resolved by a selloff of most of the regional tourist assets.

Revenue fell by $23 million to $497 million. An estimated 50% comes from gamblers.

In inflation adjusted terms revenue has shown little or no growth since 2006 as shown in the following graph.

This is despite the additions of the 9/11 chain, Henry Jones Art Hotel, Freycinet, Cradle Mountain, Saffire and the recent two poker machine pubs on the NW coast, conservatively estimated to have cost in total $140 million.

The story is a little better when profits are considered. After tax profits rose by $3 million to $19.7 million in the latest year. The following table tells the story.

After tax profits are split between what’s been taken out in dividends and what’s been retained. For seven years shareholders extracted the bulk of after tax profits, between $15 and $18 million. In 2012 nothing was retained, in fact retained earnings took a hit as dividends in excess of profits were drained from the Group.

In the latest year the six shareholders had to make do with $7 million between them as reality and austerity found common ground.

Profits are calculated after deductions for non cash items like depreciation. The cash flow statements tell the full story, of what has been available to meet all business commitments.  For years the operating surpluses have been supplemented with increased borrowings as the following table shows.

The last 2 years there have been no more borrowings. The immediate post GFC years of 2009 to 2011 saw $65 million of new borrowings but not anymore.

The incoming cash has been used to pay dividends, make bank payments, undertake capex and acquire other businesses. The following table shows what has happened.


Nothing spent on new businesses, capex all but dried up and dividends declining. Payments to the banks have been the big winner. Not only interest payments but principal payments of $9 million in 2012 and $16 million in 2013 have hit the cash flow. Bank borrowings are now $175 million.

Federal Hotels’ game is normally capital hungry, hence the almost negligible capex amounts over the last few years are not a good sign. The following table indicates the capex relative to depreciation, the decline in value of buildings and plant assets.


Capex does not include businesses acquired but it does include the construction of Saffire in 2009 and 2010.

Having to curtail capex and divert funds to reduce borrowings is not a sign of robust health. This in turn has led to the abandonment of the West Coast Wilderness Railway lease and negotiations to sell assets.

Initial reports suggested Freycinet and Cradle Mountain properties were to be offered for sale but there has been recent confirmation that Strahan assets will also go with the purchaser to be a RACV/RACT consortium set to take over in January 2014.

However, given the disastrous off season just experienced by Strahan resulting in Strahan Village occupancy figures falling into single figures (less than 10% compared to Hobart occupancy levels of 80% plus) it could be a case of buy two properties and get one free.

A RACT/RACV consortium, in which RACT has a 10% interest, has recently acquired the Grand Mercure Hobart Central Apartments located in Collins Street Hobart, a total of 125 rooms for $24.9 million.

It is likely RACT’s share of assets jointly acquired from Federal Hotels will be a similar proportion.

RACT can’t afford to bite off too much. It has enough cash to be able to fund a 10% share. It has about $50 million in net assets including cash of $6 million which it has accumulated over a long period purely by retaining earnings. It doesn’t pay dividends. Operating profit after tax last year was about $6 million, most of which came from its 50% interest in RACT Insurance. Its traditional member services make a small profit and the travel business barely breaks even. Its principal assets are land and building of $20 million with an $8 million loan and the interest in RACT Insurance. It’s a conservatively managed organisation. Without wishing to be unkind it looks a little like an old boys club. It wouldn’t be prudent to cash flow a tourism business with an insurance business. Not that RACT will have any say in the day to day management of either. The acquisition is likely to be a cash deal. Cash is also likely to be needed for the deferred capex left by the previous owner.

RACV is twenty five times the size of RACT. A 30% share in RACV Insurance helps its cash flow. It has net assets of $1.2 billion including property valued at $450 million and at last balance date had $144 million cash in the bank. It has owned and operated tourism assets for some time.

The sale price for the three properties will be interesting. Freycinet and Cradle Mountain each with about 60 rooms were bought in 2009 for a combined figure of about $25 million. More has since been spent on upgrades and maintenance. Strahan Village has about 140 rooms but the yield per room is lower and the occupancy, as already noted, even lower. $40 million may pull off the deal.

Industry insiders claim the Henry Jones Art Hotel in Hobart has in recent times achieved the same turnover as the combined total for the three regional complexes mooted for sale with only 20% as many rooms. This is a reflection of occupancy levels and room yields and the drawing power of the capital city and is one persuasive reason why Federal Hotels' regional tourism strategy has been ditched.

How much the banks grab is the next point of interest. Nervousness as to the value of the gambling assets will undoubtedly see the banks place themselves in the queue ahead of shareholders. Holding security over stranded assets when the music stops is something most banks try to avoid.

Federal Hotels' public pronouncements always emphasise the tourism aspect of the group. It is true that the 180 odd rooms in Launceston plus the 370 rooms in Hobart at various properties, not to mention a few rooms at Saffire, contribute to the bottom line. But it’s difficult to escape the conclusion that the bulk of EBIT comes from 3,500 poker machines, a chain of bottleshops plus eleven pokie pubs strategically located in suitable areas, each crammed with the maximum permissible number of machines and structured to legally pickpocket plebs under the guise of providing leisure activities.

Federal Hotels told a Public Accounts Committee hearing in 2003 that the exclusive poker machine agreement would assist in underwriting “significant investment strategy in Tasmania”. We were led to believe that as part of a social contract Federal Hotels would do just that. For a while with its regional coverage Federal Hotels helped promote the Tasmanian brand and it was possible, given an extremely long bow, to argue the spin off benefits of the exclusive gambling license were bearing fruit. Its ads promoted Tasmania and at times were indistinguishable from those of Tourism Tasmania.

When we look now at what will be left after the abandonment of the West Coast Wilderness Railway and the sale of regional tourism businesses, apart from the mandated Saffire property and a few improvements at Henry Jones, we see a group that preferred to acquire bottleshops and pokie pubs, has wound back capex and severely pruned its advertising budget as it freeloads on the success of David Walsh who arguably has lifted Hobart occupancy rates by 10% to 15%.

If there ever was a social contract to use the exclusive license for the benefit of the Tasmanian tourism industry, there must now be a breach.

It is hard to avoid the conclusion that Federal Hotels' shareholders have plundered most of the gambling profits. Shares have been closely held and all Board members have been there for at least 20 years. Borrowings allowed the business to grow, but now the salad days are fast becoming a fading memory and banks are demanding repayment. The strategy of a benevolent godfather overseeing the Tasmanian tourism industry has degenerated to one of survival.

What exactly will be the rationale for extending the exclusive pokie license? A license that exploits the disadvantaged and gives an unfair competitive advantage over its competitors?

David Crean may have been the best Treasurer for a generation, although that doesn’t necessarily mean much as it is a relative statement, but he wasn’t too concerned with assessing risks associated with an exclusive deal when he observed “...let us face it with that family that is unlikely to be a problem because they are a terrific operator”.

They certainly are, although maybe not quite as Mr Crean meant.

For too long we have been forced to accept the notion that what’s good for Federal Hotels is good for Tasmania. The industry has been cowered. Criticisms are made in private but rarely in public. The major parties have been coerced, Rene Hidding effectively gagged. Where is Brenton Best when he is most needed? Surely the tourism industry can’t continue to turn a blind eye to the breach of the implied social contract that has been the cornerstone of the State’s tourism strategy, whilst continuing to beg for more?

As Ross Garnaut has recently observed, after the salad days come the dog days. He further refers to the ''business as usual'' and ''public interest'' approaches to public policy.

For a no brainer what odds we will once again make the wrong choice?

1 comment:

  1. So the RACT landed themselves a lemon. Great job! Secretary of State John Kerry said that Americans have a right to be stupid. I wonder what he would say about Tasmanians?