UniHost Growth Strategy and Financing Analysis

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 the mid-range segment there is less fragmentation, but there are still many players, of which UniHost is one of the larger.

Consumers are more price-sensitive than brand-sensitive. The industry is divided into three segments, and UniHost competes in each of them. The business model for each segment varies, providing some incentive for firms to compete in a single segment and maximize their competitive advantages in whichever segment they excel. There is also room, as a result of the fragmentation, for a firm to dominate 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 comprehensive 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 Competitive and Financial Position

UniHost competes as a cost leader, with average room prices 44% below the industry average. With this strategy, the company achieves 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 through its new branding strategy. In addition, its renewed focus on the Canadian market and its unique, defensive corporate structure can be viewed as further 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 consistent fashion. In the past year, UniHost has improved its cost control: expenses 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 debt 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 ratio is currently 6.9 times, significantly higher than the minimum required 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 instruments will need less restrictive covenants with respect to this consideration, as the company will also have over $50 million in maturing debt in 2001 and 2005. Lastly, prime plus 1.5% equals 7%, which is in the middle range for convertible bond issues currently on the market 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 3,000 rooms under the Clarion brand at a cost of approximately $90,000 per room — a total cost of $270 million over 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. An additional element is the plan to add a flagship 700-room downtown Toronto hotel at a cost of $85 million. Capacity increases at Comfort Inns, with a total cost of $60 million, are already underway.

Of these strategies, the Caribbean expansion is minor in terms of cost and importance. Unless it 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 one if it believes there is excess demand in the industry. Margins are greater in this segment — if UniHost can translate its occupancy rates to the new ventures, it would not only 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 larger question is whether the company is prepared to grow; given its future debt obligations, growth is likely a necessity. UniHost has not yet fully leveraged the brand-family concept it adopted a couple of years ago.

It should be noted that the expansion plans are very ambitious from a financial perspective. The company's current capacity is 32,385 rooms. The strategy will add 4,900 more rooms, not including whatever might be added in the Caribbean — a capacity increase of 15%. However, the cost of these rooms means the company will be expanding its asset base by approximately 80%. This implies that not only is the strategic decision itself important, but so too will be the choice of financing. The cash flow projections for the next three years are presented in Appendix A.