Unihost Industry Analysis the Canadian

UniHost Industry Analysis The Canadian hotel industry is mature, but unlike the American industry does not suffer from overcapacity. Therefore, firms should be able to extract the revenues they expect from their rooms. The industry is heavily fragmented, particularly at the low end. In mid-range, there is less fragmentation but there are still many players, of which UniHost is one of the larger. Consumers are more price sensitive than they are brand sensitive. The industry is divided into three segments and UniHost competes in each of the three.

The business model for each segment varies, so there is some incentive for firms within the industry to compete in a single segment and maximize their competitive advantages in whichever particular segment in which they excel. There is also room, as a result of the fragmentation, for a firm to dominant multiple segments within the industry by appealing to consumers as they trade up or down the value chain. Family-wide brand loyalty is also possible through the development of family-wide loyalty programs.

In general, the Canadian hotel industry is favorable and there is considerable room to win market share in any given market, especially by outperforming independent or small chain operators. UniHost Analysis UniHost competes as a cost leader, with average room prices 44% below the industry average. With this strategy, the company has higher than average occupancy rates. The degree to which this result is considered successful depends heavily on UniHost's ability to control costs as it earns less per room than the industry due to its heavy discounting.

UniHost is building a competitive advantage with its new branding strategy. In addition, its renewed focus on the Canadian market and its unique, defensive corporate structure can be viewed as competitive advantages. Over the past year, UniHost has substantially outperformed the TSE 300, more than doubling its share price while the general index improved around 20%. UniHost's total revenues have grown steadily over the past three years and the company has seen profits improve, although in a less steady fashion.

In the past year, UniHost has improved its cost control, as expenses have declined from 92.7% of revenues in 1996 to 87.3% of revenues in 1997. The company is liquid, with a current ratio of 1.19. With regard to its covenants, UniHost has a debt-to-equity ratio of 2.76, which is not far from its maximum of 3.0. The EBITDA to debt service is currently 6.9 times, significantly higher than the minimum 1.5 times. However, in 1998 the company will have $106.7 million in current maturities of long-term debt, including mortgages and the bridge loan.

With that much debt maturing, the company will need to increase EBITDA significantly in order to meet this covenant. Future bridge loans or other debt will need to have less restrictive covenants with respect to this consideration, as the company will have over $50 million in maturing debt in 2001 and 2005 as well. Lastly, prime plus 1.5 = 7%, which is in the middle for convertible bond issues on the market at present, but is below most yields on those bonds. Growth Strategy There are two key elements to UniHost's growth strategy.

The most significant is to move up the value chain domestically. The company wants to add 3000 rooms in the Clarion brand at a cost of around $90,000 per room, a total cost of $270 million in the next few years, plus a $15 million cost of reflagging properties to the Clarion brand. The second element is to expand into the Caribbean. The company has set aside $15 million over the next three years to undertake a preliminary expansion into the Jamaican market.

Another element to the plan is to add a flagship 700 room downtown Toronto hotel. This would cost $85 million. Capacity increases at Comfort Inns, with a total cost of $60 million are already underway. Of these strategies, the Caribbean one is minor in terms of cost and importance. Unless this proves to be a distraction to senior management, it is essentially a non-factor in the broader set of decisions. The company's move upmarket is a strong move if it believes that there is excess demand in the industry.

The margins are greater in this market -- if UniHost can translate its occupancy rates to the new ventures, not only would it add substantially more revenue, but would bring its average revenue per room more in line with industry averages. From a strategic perspective, the plan seems sound. The bigger question is whether or not the company wants to grow, but given its future debt obligations, it probably needs to grow. UniHost is not yet fully leveraging the brand family concept it adopted a couple of years ago.

It should probably be noted that the expansion plans are very ambitious, at least from a financial perspective. The company's current capacity, if all rooms are to be counted, is 32,385 rooms. The strategy will add 4900 more rooms, not including whatever might be added in the Caribbean. This is a capacity increase of 15%, but the cost of these rooms is such that the company will be expanding its asset base by 80%. This implies that not only is the strategic decision itself important but so will be the choice of financing.

The cash flow projections for the next three years are presented in Appendix a. Financing Options There are three financing options for UniHost. The first is an equity issue. The company has been offered a bought deal from Aurora Securities worth $40 million. The total new capital required by UniHost is $448.804 million over the next three years, most of that in the first year. Equity would therefore cover only around 10% of the total capital required. The company's current capital structure is 73% debt, 27% equity.

If the new projects are undertaken and the company uses this equity option, the capital structure would become 81.4% debt and 18.6% equity. Without any equity issue, the capital structure would be approximately 14.6% equity. Thus, optimal capital structure becomes a factor in the decision to accept the offer of an equity issue. The bought deal, if Aurora takes a 4% commission, would deliver $38.4 million to UniHost. This would leave $410.4 million remaining to be financed.

While McNally is concerned with lingering impacts in the market of the Asian financial crisis, his business is strictly domestic. Thus, it is not significantly affected by the Asian crisis; in fact, a strictly domestic issue might prove popular with skittish markets. That said, McNally does not seem particularly amendable to a direct issue to the market. UniHost's major shareholder wants to see any new shares issued at a minimum of $10, but UniHost has not spent more than a couple of months above that level and is currently trading lower.

Convertible debentures represent another option. The market is good for high-yield Canadian debt. The offer on the table is a two-year issue at 8.5%, convertible at $10 per share. This alternative could raise between $50-75 million, so nowhere near the company's total need. A $75 million deal with the 3.5% commission would yield the company $72.375 million in proceeds. Interest payments for each year would be $6.375 million. High yield debt is another option.

There is a question as to whether the market could support the size of issue that UniHost needs -- the total market is $2 billion and UniHost needs $338 million. Market appetite is for around $100 million. These debentures would restrict the ability of the company to further utilize debt financing, which is a drawback. With commission, UniHost would receive $97.250 million. The company can expect to pay between 8.87% and 9.37%, so approximately 9.1%. First Mortgage can provide half the financing needed at 7.5%.

Recommendation The cash flow projections show a need of $181.9 million beyond the First Mortgage loan. In order that the company does not dilute its equity, it is recommended that the convertible and debenture issues are made. If the convertibles are taken.