New Horizons - Investment Outlook - March 2008

With a new CEO in place, Orient-Express Hotels pushes forward.

by Jennifer Duell, a freelance writer based in Fort Worth, Texas. -- Hotels, 3/1/2008 3:30:00 PM

For the first time since Orient- Express Hotels (OEH) was founded in 1976 with the acquisition of the Hotel Cipriani in Venice, Italy, the company is no longer under the leadership of the Sherwood family. OEH’s future success rests squarely on the shoulders of former CFO Paul White, who took over as president and CEO in August 2007 following the resignation of Simon Sherwood, the founder’s stepson.

“Companies like Orient-Express are built by individuals who have a passion for hotels, and it is quite an interesting challenge on how to move these companies forward when the founder is out of the business,” says Robert Milburn, UK hospitality and leisure leader for PricewaterhouseCoopers.

White, who joined OEH in 1991, has imbued the company with new energy, clearly outlining objectives and providing a plan for growth, says David Katz, a hospitality analyst with Oppenheimer & Co., New York City. “Orient-Express is pursuing growth opportunities that it has not explored before,” he notes.

Although it would be too strong a statement to say White is taking OEH in a different direction, he has shifted the company’s stance on branding, jointventure partnerships and management contracts. While the company will continue to focus on providing luxury accommodations and quality customer service to well-heeled travelers, it also will look to grow its non-room revenues and to leverage its brands.

And going forward, OEH will be more aggressive in finding opportunities to acquire hotels either alone or with a partner, and in seeking out management contracts and developing for-sale residential offerings.

“In the past, we tended to sit back and wait for things to happen,” says Nick Varian, OEH’s vice president and chief development officer. “Now we will hunt for growth opportunities.”

OEH is determined to pursue these growth opportunities alone, despite the interest the company has received from private equity firms and hotel operators eager to get their hands on some of the finest hotel assets in the world.

“We believe that we have a good strategy and that we can create good shareholder value through it,” White says. “The fact that people are interested in us can only be a compliment to what we are doing.”

OPEN TO JVS
Hotel and land acquisitions are a key element of OEH’s growth plan, and the company has US$500 million available immediately for real estate-related investments.

“We have been forward thinking in our acquisition strategy, especially when people talk about the emerging markets like Brazil,” White says. In September 2007, OEH acquired the 200-room Hotel das Cataratas, the only hotel within the Iguaçu National Park in the Paraná region of Brazil. And in June 2007, the company purchased a 185,000-sq.-m parcel of land in Buzios, a popular destination about 180 km northeast of Rio de Janeiro. The land will be used for the development of an all-suite boutique resort of 40 rooms, along with 17 villas.

The company also has been actively collecting hotel assets in Asia. In 2006, for example, it acquired six hotels in Southeast Asia, the former “Pansea” properties. “In general, Asia is a place where we want to have a stronger presence,” White says. “The whole region is opening up for tourism.”

In addition to Brazil and Asia, White points to Eastern Europe, specifically Poland, the Czech Republic and the Ukraine, as places of interest. “We have to consider what our core client wants and there is big demand for cultural tourism in Eastern Europe,” he says. Mexico and Central America also are on the company’s radar, along with the Galapagos Islands and Buenos Aires, Argentina.

OEH has been very successful in unearthing acquisition opportunities, says Amit Kapoor, a hospitality analyst with Gabelli & Company Inc., New York City. From 2002 to 2006, the company closed US$260 million in acquisitions and each one was at a price of no more than 10x EBITDA.

Historically, the company preferred to make acquisitions on its own and rarely, if ever, considered taking an equity stake or accepted management contracts, believing that equity returns were greater than management fee income. Under White’s leadership, however, OEH is now open to joint-venture partnerships and is actively pursing management contracts.

“If the acquisition is right, I am not obsessed with being 100% owner—a management contract works just as well for us because ownership should not be confused with control,” White says.

During a recent trip to the United States, White had a number of discussions with potential joint-venture partners, but no formal relationships were established. “It’s hard to say how much the JV element will contribute to the company’s growth right now,” he notes.

BUILDING EXPECTATIONS
Like real estate acquisitions, development is another growth area for OEH. In particular, the company is looking for opportunities with for-sale residential and new hotel construction.

“What interests us is the smaller scale villa development around our hotels,” Varian explains. For example, in Riviera Maya, Mexico, OEH is developing Maroma Haciendas, a collection of 25 villas that will add US$20 million to US$25 million in EBITDA. The company also is developing eight luxury villas at La Samanna, St. Martin. These units will bring in US$11 million to US$13 million in EBITDA.

“I expect this type of development will become an increasingly important part of our business,” Varian says, adding that the company’s efforts will be focused on less developed areas in Latin America and Asia.

Identifying the company’s best opportunities is the most challenging aspect of development, but all of it will be driven by OEH’s clients, Varian says. For example, OEH believes that its client base is desperate for a luxury hotel in New York City, so the company is building a US$220-million boutique hotel that willconnect to a new branch of the New York Public Library and the world-famous 21 Club. The 21 Club is an iconic restaurant that originally opened in 1929 as Jack and Charlie’s 21 and eventually became the most celebrated speakeasy operating during the Prohibition Era.

“There are some wonderful hotels in New York City, but I don’t think there is a hotel that really stands out from the crowd,” White says. “We feel that we can do something that can really knock the socks off the city.”

OEH plans to break ground next year on the project, which will include a 150- room luxury hotel that will house dining, spa and wellness facilities. It will also feature expanded banqueting and dining space for the 21 Club and a new public library. Future plans call for residential condos. The hotel is scheduled to open in 2011, and the company expects RevPAR of US$400 and an IRR of 20%, according to a November 2007 investor presentation.

“21 is such an important project for the company, and we are all using it as a vehicle to change the paradigm,” Varian says. “It gives us a chance to show that we can work from our historical roots and still be relevant in the 21st century.” According to a recent investor presentation, potential destinations for a similar hotel include Chicago, Washington, Las Vegas, San Francisco, Miami and Boston.

“In our sector, most companies need a flagship brand, and it’s my sense that Orient-Express is trying to create a flagship brand with 21,” Katz says.

BRAND NEW
As things stand today, OEH doesn’t have flagship brand; in fact, it doesn’t even have an umbrella brand. Its properties are known only by their unique names—Hotel Cipriani, for example— and each hotel is a distinct brand. Previously, the company flaunted its lack of branding, even going as far to say that “discerning travelers will choose a famous individual property in preference to a chain brand.” But that strategy has drawn fire from Wall Street and other industry players.

“Branding is the greatest opportunity and the greatest threat for Orient-Express,” says Ramsey Mankarious, CEO of Cedar Capital Partners Ltd., a London-based company that acquires luxury hotels. “Every hotel brand might stand on its own, but if you have one brand then you have an easier time with marketing and setting a standard, and that is a good thing.”

White agrees OEH has the opportunity to build on its existing brands, but the difficulty is identifying those that are best suited for expansion. “I am very conscious of the value of our brands, and that is something our analyst friends don’t give me credit for,” he says, pointing out that the company can leverage as many as 30 different brands. “Having many hotels with the same brand is an option that is open to us, but you have to be very careful that you do it in the right places.”

Although OEH has been somewhat coy in outlining its branding strategy, analysts are expecting a change. “They are going to grow the brand in a way that previously they have not,” Kapoor says, although he too acknowledges that details have been sketchy.

PORTFOLIO TO DIE FOR
It is OEH’s collection of small, boutique- style properties that differentiates it from other hotel chains. “The strength of the company really all boils down to the absolutely fabulous portfolio of properties,” Milburn says. “It really is a portfolio to die for because it’s almost impossible to duplicate these assets.”

Most, if not all, hotels are historically and culturally relevant to the regions in which they are located. For example, Russian composer Pytor Ilyich Tchaikovsky spent his honeymoon at the Grand Hotel Europe in St. Petersburg, Russia, and Michelangelo designed the façade of the Villa San Michele in Florence, Italy. These one-of-a-kind properties are especially popular with high-spending Baby Boomers who want a unique local experience.

Moreover, many of the company’s hotels are located in high-barrier-toentry markets. Properties such as Hotel Cipriani in Venice and the Machu Picchu Sanctuary Lodge in Peru, for example, are located in areas where development of new hotels is prohibited by law for preservation purposes.

The location, heritage or historical significance of these assets typically allows them to command significant rate and RevPAR premiums over other luxury brands, protecting OEH’s core business from cookie-cutter luxury hotel chains. Today, OEH owns or part-owns 41 hotels, distributed across five continents from the Copacabana Palace in Rio de

Janeiro to the Observatory in Sydney. But when White first joined the company, it owned only seven hotels and had a tiny management team. As the company grew, a geographical split started to occur, and by the late 1990s it was segmented into three distinct regions: Europe, America and the rest of the world.

One of White’s first moves as CEO was the creation of nine focused geographic areas. Under the new structure, all regional mangers report directly to Filip Boyen, who now serves as vice president of operations. Also, White has placed the company’s development and real estate responsibilities under the purview of Nick Varian.

Ultimately, the management restructuring reinforces the idea of employee empowerment. For example, Orient- Express Hotels encourages its staff to take ownership and responsibility when dealing with guests.

OEH’s approach to customer service has helped it achieve revenues of US$451.1 million and EBITDA of US$123.2 million during the first nine months of 2007. At the end of the third quarter, worldwide same store RevPAR was up 15% in U.S. dollars and bookings were 7% ahead of same period in 2006.

Roughly 60% of OEH’s earnings come from Europe, and the strong euro has helped the company’s financial performance. However, White admits he has been a little disappointed by the performance of company’s U.S. portfolio, which has been impacted negatively by the Windsor Court Hotel in New Orleans. “We’re monitoring bookings as closely as we ever have done and we will position ourselves to react as we need to,” White says, adding that bookings are up “across the board.”

FUN FOR FOODIES
Beyond bookings, OEH plans grow its revenue through non-RevPAR outlets, specifically by emphasizing food and beverage operations.

Only 60% of the company’s total revenue is derived from rooms, according to White. The remainder comes from additional services like food and beverage. “RevPAR is important, but for a company like Orient-Express, total revenue is more important,” he says. “If there is a slight softening and room revenue goes down, there is no reason why our total revenue can’t go up.”

The company is working to improve a number of its existing restaurants and bars. “All of our restaurants have always performed well, but in the past three to four years we have felt a change,” Boyen explains. “The whole food industry has become much more contemporary, so we have some work to do.”

Historically, OEH has relied on hotel designers to create the look and feel of the restaurant, but recently decided to consultant with a food and beverage expert. The old-fashioned bar in the Mount Nelson was the company’s pilot project, and it has been revamped into the Planet Champagne Bar.

“Revenues are now 12 times what they used to be,” Boyen says, adding that the renovation at Mount Nelson was so successful that OEH is now doing the same thing at the Copacabana Palace in Rio.