Not your typical asset-play
$PPH.L, $ARNT (ZSE)
In this new write-up, I'll kill 2 birds with 1 stone and give you a thesis for the LSE-listed small-cap PPHE Hotel Group and its Croatian micro-cap subsidiary Arena Hospitality Group.
Thesis summary: PPHE and Arena both trade at a significant discount to NAV. PPHE market cap is at ~45% of NAV, while ARNT currently sells in the market for less than 53% of NAV. They are founder-led and own luxury hotels in important city-center locations throughout Europe as well as a few campsites and apartment complexes in Croatia. Their debt is asset-backed so virtually there is no downside.
Let's start with PPHE Hotel Group.
PPHE is a hospitality business that builds, owns, and operates its real estate, mostly hotels. The two founders are still involved in the company; Eli Papouchado owns 32% of the company and is the current Chairman, while Boris Ivesha owns 11% and serves as its President and CEO. Moreover, the executive team is very entrepreneurial and all have over 10-year tenure with the company.
PPHE's business model is 1. buy 2. build 3. operate 4. recycle
They are value investors like me and you. They buy a plot of land, an office block, or a tired hotel in prime city-center locations with significant development potential. After that, they either build hotels from the ground up, convert offices into hotels, or redevelop already-existing hotels.
Furthermore, PPHE has a perpetual and exclusive license with Radisson Hotels, the second-largest hotel group in the world. This license allows them to brand their hotels under the famous Park Plaza name in Europe. Last but not least; they take out the gains from the asset appreciation and recycle them to do the same process again. Capital recycling is done without diluting the shareholders meaning they raise both debt and equity on an asset basis.
Unlike other hotel companies which specialize in one thing and outsource other activities, PPHE likes to have full control over every aspect of the value chain and does everything in-house. This strategy proved to be successful so far. The CFO claims they grew the NAV by 350% since the IPO in 2007, a 9% CAGR.
I did a similar calculation for the book (equity) value growth and PPE growth. These are definitely not the best measures as their assets on the balance sheet are stated at the historical cost. However, I am forced to double-check it this way because the NAV calculation has only been publicly available since 2018.
The CAGR-s I got were 10% and 18%. I consider these numbers to be very impressive as this period included both the GFC and the pandemic. If we take 10 years before COVID, for example, the numbers look even more impressive. Book compounded at 14.5%, their PPE at 21% and the stock was a 14-bagger in the same period, without dividends included.
PPHE is the type of business that reinvests the majority of its cash flow back into real estate and pays a dividend with what's left. The dividend policy is progressive and it was increased by 300% in 8 years before COVID but it is dependent on the KPI called EPRA earnings (similar to FFO in the US) so management usually cuts it during downturns like COVID, when the FFO turns negative. In the past, the dividend was probably not an important KPI. However, the share price has now been crushed, and the company has almost fully recovered. So when the management does decide to up the dividend back to the 2019 level, it will yield 3.5% which is decent considering the very low payout ratio.
Now, to the important part. The assets, the real estate, the hotels.
„Our focus is always on driving equity value“
„Real estate sits at the heart of our strategy“
„Our focus is primarily on driving equity, growing the NAV“
~ Daniel Kos, CFO
It wasn't a coincidence that I previously used book and PPE CAGR and not FCF/FFO or earnings CAGR to evaluate the business performance. It is an asset-heavy company and to PPHE's owners, its assets are its business.
PPHE owns 46 properties under 3 distinct brands. I mentioned the first name previously; Park Plaza. These are individually designed, upper upscale hotels located in the city centers. Besides it, they also wholly own art'otel brand, consisting of cultural upper upscale hotels inspired by signature artists. And the brand called Arena Hotels&Apartments and Arena Campsites which are owned through the subsidiary Arena Hospitality Group and used to operate hotels in the historic centers of Pula and Medulin (tourist cities in Istria, Croatia) and campsites on exclusive beachfront locations nearby.
As this is not the thesis for the compounder type of investment but an asset play, I won't waste your time by diving deep into the quality of their brands, service, marketing, distribution, etc. Maybe the one thing you should know just to get a feel for it is the Google Maps rating. Both Park Plaza and art'otel hotels are mostly in the 4.3-4.6 range, never below 4 stars. And Arena brand is mostly around the 4.2 stars range, rarely below 4 stars.
Nobody wants an empty unprofitable hotel in the suburbs so another important thing to know about these properties is their location.
The properties are located in key city centers across Europe. Almost half of it is in the center of London. And when I say center I mean center. Try to place yourself in front of Big Ben and type Park Plaza in Google Maps search.
In my recent trip to London, I saw it first hand and I believe that these locations are irreplaceable and doubt PPHE would have any problem finding buyers if it were to offer those assets on sale. Other properties I didn't visit but Google Street View can do the trick.
To show their business is not only operations but mostly real estate, PPHE started to highlight a metric called EPRA NRV in 2018. EPRA is the abbreviation for European Public Real Estate Association.
And the NRV is the abbreviation that is representing independent calculations of PPHE's Net Re-Instatement Value, done by Savills, one of the world's leading property advisors for the company's entire portfolio. Except for Croatian part, which was handled by ZANE, part of Unicredit Group specializing in property valuation.
In simple terms, it is NAV, it is adjusted book value that takes into account the „real value“ of those assets and not the depreciated value stated at historical costs which is shown on the balance sheet.
At the end of 2021 that NAV was £22.15 per share. Current share price? £10.20. More than double the market cap. Additionally, here's a sentence from the 2022 trading update.
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EPRA NRV is expected to be materially ahead of the latest figure published in the 2022 Interim results (H1 2022: £21.88) as a result of the Group’s faster-than-expected recovery after COVID-19.
So we are talking about an even bigger discount.
One question, that immediately comes to mind is how credible those property appraisers are and how accurate their valuation is. I discussed Savills with some people on FinTwit and talked to some individuals working in the industry here, about ZANE. Of course, those individuals have biases of their own, but based on the feedback I’ve gotten it seems like ZANE is the norm for appraising real estate in Croatia and Savills is a good RE consultant. This combined with conservative cap rates and conservative cash-flow discount rates used, plus a huge discount to NAV for high-quality well-located hotels gave me peace of mind. The valuation only needs to be approximately right for this investment to do well.
Another thing supporting this valuation is the transaction with Clal Insurance in 2021. To strengthen its cash position PPHE raised 113M in equity by selling a 49% stake in 2 hotels. These stakes were sold at the NAV price.
We feel that the gap is too big, we feel that the NAV that we are giving to the market is quite conservative. It's a NAV based on going concern, it's not a NAV based on selling assets. So we feel it is a fair reflection of what our assets are worth. ~ Daniel Kos, CFO
One more thing I like about this business is the debt. It is asset-backed so if the assets are worth as stated, they will provide liquidity and the business is not risking bankruptcy if the worst-case scenario occurs. Moreover, it is an 85.5% fixed-rate debt with an average interest rate of 3.1%. With inflation around 10%, PPHE is basically getting paid to take the lenders’ money.
Why does this opportunity exist?
PPHE is a £460M market cap followed only by 4 analysts. Single-digit share turnover and low 1-3 year beta
the industry was hit hard by the pandemic and lockdowns so the business wasn’t profitable in 2020 and 2021
concerns over the impact of Brexit and inflation
difficult to find staff in the hospitality industry, especially in London
virtually everyone is expecting a recession and short-term investors don’t want to own indebted cyclical hotels
In conclusion, PPHE Hotel Group is an asymmetric bet with low to no downside and high upside if it revalues to reflect the worth of its assets.
In a base/bull case scenario (depends how much you believe in the management’s projections) those assets will be worth £2.7B in the medium term. The current portfolio was valued at £1.8B at the end of 2021. So, assuming no cash and debt changes, this would get PPHE to ~£1.85B NAV which is a 4X from the current market cap of £460M just to be priced at 1xNAV(book). Plus you get a hospitality management platform that produces 10-15M in EBITDA as a cherry on top.
Not to waste your time, I will stop with the upside projections and other nuances here and leave them for another Substack post if/when the business revalues and I am forced to look at it through a “quality compounder” lens.
Arena Hospitality Group
PPHE usually invests counter-cyclically and takes large investments during down circles. They did the same in 2008 and took an ownership stake in Arena. In 2016 PPHE took a controlling interest. A year later, Arena IPO-d to accelerate the investment plan aimed at upgrading existing properties and achieving further expansion in Central and Eastern Europe.
As Arena is majority owned by PPHE, they follow the same owner-operator real estate intensive model and are overseen by their parent. They own 29 properties with a capacity of around 10 500 rooms of which 6000 are located in the campsites, 1400 are 3-star Arena branded hotels and apartments in Pula and Medulin, 1850 are under the Park Plaza brand and 800 rooms are under the art'otel brand. In addition to these branded hotels, they also own a luxury Radisson Collection Hotel (the best brand in Radisson stable) Grand Brioni, Franz Ferdinand Hotel in Nassfeld ski resort, and a 88 Rooms Hotel in Belgrade.
Once again, here is the Google Maps rating of their bigger properties so you can get a feel for it.
The locations of Arena’s portfolio excluding camps are comparable to PPHE hotels in city centers. I mean, these are not exactly across Big Ben but still very attractive locations with unlimited demand during summer seasons and minimal risk of not being able to find a buyer in case some unrealistic worst-case scenario happens.
Istria, where most of their properties are located, is a famous tourist destination and the closest Croatian region to Central Europe which is why Germans, Poles, Italians, Austrians, and others like to visit it by car. Moreover, not a single one of Arena’s peers operates in the Pula&Medulin area which makes it decently insulated from the competition that is operating in the high-end segment.
Camping and glamping
Where it gets more interesting is the Leisure and Outdoor part of the portfolio, specifically the camps.
The potential there was incredible. For instance, we have eight campsites in Croatia that have the size of Hyde Park currently and when we bought these were basically pitches where you could park a tent and you would typically pay like 60-70 euros for a night. What we have done with the site is we completely converted it and equipped it with infrastructure, we completely equipped it with glamping tents and made the offering completely different, and turned it into a hotel P&L really. So the glamping offer offers you a tent with air conditioning and a bathroom and everything is sea view. So we’ve converted the P&L of a campsite into a hotel P&L but with a camp CapEx. So that made it very very interesting. From a new perspective, we've done that with two sites and we're rolling it out to the other sites. ~Daniel Kos interview
If you ever visit a camp such as this one or if you talk with people in the industry you’ll quickly realize that due to its exclusive location, these camps are a cash cow monopoly. With EBITDA margins in the 40-45% range, camps are both the most profitable part of Arena and the most profitable part of PPHE. Additionally, only two out of eight camps have been renovated so far so there is further margin and growth upside;
For comparison, Arena’s peers located in Istria are achieving margins of 50-55% in the camp segment so there’s no reason why Arena couldn’t do the same with their “convert and demand a premium rate” strategy.
How much would you pay for this business?
Well - you can buy the whole Arena biz in the market today for the price of 1250M HRK. If you take the NAV numbers from the PPHE’s 2021 annual report and add them up for Arena’s part of the portfolio you’ll get the NAV price of 2350M HRK. In other words, the market cap is at around 53% of the NAV(book) value.
Another great thing about this NAV is that it is not disclosed information in Arena’s annual reports so the Croatian investors, who are seemingly the only ones following the stock will not be aware of the discount if they don’t do the same process of adding up item by item from PPHE’s report. (I didn’t find a single analysis mentioning Arena’s book/NAV value)
Moreover, same as is the case with PPHE, all of Arena’s bank borrowings are secured by a mortgage over properties. And more than 90% of that debt is secured with a low fixed interest rate, so you get strong inflation protection with this one too. I have read Arena’s borrowing publications on zse.hr and the terms they were able to negotiate are mind-blowing. If I had been offered the same terms on the debt I would have taken them any day of the week.
This “NAV is 2x the market cap valuation” is too cheap for a business like this one. So - what I did to double-check it is I calculated the price per key(room) for Arena’s properties and the properties of its most comparable peers. Of course, this calculation also has its flaws as it is not taking into account factors like the age of the properties, the segment in which they operate, the fact that it is not entirely the same location, etc. However, most things are comparable and it is a widely used metric in the industry so it can provide a more accurate picture of the quality of those independent valuations.
Discount isn’t as big but it is still there on peer basis as well. Furthermore, I talked with some people in the industry and they said that the recent prices to build new hotels in Istria were in the 120 000€ per room range. Again, I am not saying that all of Arena’s hotels are new, far from it. But it can give you a rough idea of how much more would a private investor pay to build these kinds of hotels today.
Why does this opportunity exist:
huge investment cycle since IPO is suppressing earnings and cash flow, ROIC on these investments is still not visible in the financials
followed only by Croatian institutions which focus on EBITDA and use DCF-s to value it rather than book value
heavy lockdowns in 2021 impacted the portfolio outside of Croatia which made it seem like they are lagging behind their competitors
NAV value is not widely known or known at all
levered balance sheet in a cyclical industry
Favorable recent developments and catalysts:
this write-up (relax, it’s a joke)
margin improvement by redeveloping camps which are both the fastest growing and the highest margin part of the business
Germany and CEE region are lapping 2021 hotel lockdown numbers
Croatia is severely hit by inflation due to the recent Euro adoption which is good news if you were a buyer of fixed-interest rate RE like Arena in recent years.
the big investment cycle is coming to an end and Arena has the opportunity to boost ADRs now and monetize it
the pipeline is progressing well: Grand Brioni and repositioned Arena Stoja Campsite opened for the first time in 2022, art’otel Budapest refurbished and opened, the first winter season of the recently acquired Franz Ferdinand Hotel, art’otel Zagreb and art’otel Pula set to open for the first time in 2023
In conclusion: Despite being valued by using even more conservative discount and cap rates than the remainder of PPHE’s portfolio, Arena is only trading for 0.53xbook. I expect this discount will narrow and the NAV will continue growing, even faster than PPHE.
Given that these hotels are well-run, exceptional properties in attractive locations, ARNT may even be valued at a premium to NAV at some point future. Especially, if the growth of camps continues.
Disclosure: I hold positions in both Arena Hospitality Group and Park Plaza Hotel Group (3:1 in favor of ARNT)
This is NOT investment advice. All content on this website is for informational and educational purposes only and should not be considered to be advice of any nature. Due your own due diligence.