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InterContinental Hotels FD, Richard Solomons

Three weeks after 9/11 is a hell of a time to take on a new job in finance.
And it’s a dreadful time to try to pull off a major corporate restructuring.
When all this is happening in the hotel industry whose prospects had possibly
been obliterated by an act of terrorism, it’s certainly a baptism of fire.

And so it was for Richard Solomons on 1 October 2001. Then the
newly-appointed divisional finance director of Six Continents plc, Solomons had
been given the task of heading up the demerger of the InterContinental Hotels
and Britvic drinks business from the Bass pubs business.

“It was great timing,” he says. “We tore up the budget and started again.”

At that time, Solomons’s role was “to try and make sure we got the best
possible terms in the demerger for the hotel business and, frankly, to try to
keep all the hassles away from my operations colleagues so that they could get
on with running the business,” he says.

Solomons had previous experience in doing these sorts of deals, which clearly
helped. Though he had been finance director of Britvic for just over two years,
he had spent seven years in investment banking with Hill Samuel in London and
New York after qualifying with KPMG. But, as he admits, “From the inside it is
always very different from advising from the outside. It is a very complex
exercise. In hindsight, it was fun.”

You have to wonder: if it was fun in hindsight, could it really have been
that much fun at the time? Either way, the process was finally completed in
April 2003 when IHG listed on the London and New York stock markets, at which
point Solomons got the group finance director job.

Two years later, the company sold Britvic and became a pure hotel play. In
fact, it became a pure hotel play with almost no hotels. “We were changing the
business model and going back to our core strengths,” Solomons explains. The
company divested itself of most of its bricks and mortar ­ about £3bn-worth, in
fact.

“We had 200 hotels when we demerged and now we are down to 18,” says
Solomons. The IHG business model is now based on a combination of ownership,
management and franchising ­ the last accounting for more than three-quarters of
the group’s hotel rooms last year. “It’s much more resilient, much less volatile
than owning hotels because you are taking a share of revenue most of the time,
as opposed to the whole P&L.”

Brand benefits
From the 3,400 franchised hotels ­ trading under a number of brands including
Holiday Inn, Holiday Inn Express, Crowne Plaza and InterContinental with around
450,000 rooms ­ IHG earns 5% of room revenue.

Over and above that, however, the company charges hotels for services such as
marketing, reservations and the running of Priority Club Rewards, its loyalty
programme. “In total, those assessments come to more than $800m a year,” says
Solomons (the company reports in sterling, but dollars feature a lot in the
statistics Solomons cites). “They are off P&L because they are effectively
funds we invest on behalf of the brand and the owners. So all of our marketing
is paid for in that way.” Good deal, getting other people to pay for the
marketing that drives up your own revenue.

“That’s one of the nice things about the model,” Solomons explains. “It
creates a big barrier to entry for other people because we are generating sums
getting on for $1bn dollars a year from our system of hotels, which enables us
to spend on marketing ­ internet, websites, frequency programme ­ in a way that
a small brand or somebody not part of a big brand family just couldn’t compete
with.”

IHG also manages 546 hotel properties, where it takes a percentage of total
revenue as well as a share of the profits. It only fully owns around 18
properties, including the InterContinental Park Lane. IHG, therefore, gets the
commercial benefit of having almost 4,000 hotels and 600,000 rooms in its
network, without the balance sheet burden of actually owning them all.

But to get a handle on the size of the hotel empire, we ask, how big would
the company be if it actually did own all its hotels?

“It is a near-impossible calculation to do,” says Solomons, but he points us
in the direction of some P&L information. “In the first quarter of this
year, we talk about total gross revenue of £2.2bn; that is effectively the
revenues on which we charge fees. Our reported revenue in the quarter was
£226m.” So the revenue that goes through the hotel network is around ten times
as much as goes through IHG’s own accounts.

The balance sheet of an ‘all-owned’ hotel business would be proportionately
even bigger. With around 600,000 rooms, IHG would have a balance sheet laden
with “tens of billions of pounds” of hotels. As Solomons points out: “You
couldn’t possibly build, manage, run, staff and maintain that number of hotels,
so [franchising] enables you to drive at a scale way above what you ever could
if you owned them.”

The franchise arrangement, therefore, gives IHG a stake in far more hotels
than it could possibly afford, hence it has a balance sheet that is almost
anorexic ­ net assets of just £49m ­ given the P&L it supports.

Moreover, with the hotel disposal programme and the divestment of Britvic via
an IPO, IHG has been able to hand back £3.6bn in a series of special dividends,
capital returns, and buy-backs.

“And that gave us control over what we do, which we needed,” says Solomons.

IHG’s current major undertaking is the $1bn rebranding and relaunch of
Holiday Inn, just $60m of which is being invested by IHG. “It was important for
us to show our commitment to the brand,” he says. This is a brave move, since
the familiar logo has barely changed since the first Holiday Inn opened in 1952.

No reservations
It might also be described as unfortunate timing. Do hotel owners have
reservations about making the massive investment required to do it? “We have
thought about that, but revenues per available room [RevPAR] are at an all-time
high,” says Solomons. “So far, we have seen a slow-down in the growth of RevPar,
but not a decline, so owners are still making very good returns, compared to
where they were a few years ago.

“And for a lot of owners, we’re just telling them to redirect the amount they
would normally spend on repairs and maintenance, which is between 5% and 7% of
revenues every year. Rather than doing a random list of things, [we tell them]
prioritise this and help us make these changes, and that will give you a better
return.”

As finance director, Solomons has all the traditional roles to play ­
reporting, tax, treasury, investor relations, strategy ­ but he also looks after
‘global owner relations’ which is really particular to the hotel industry, hence
he gets closely involved in things such as the Holiday Inn rebranding exercise,
for example. “We always have the balance between investing for the future,
managing costs and growing margins,” he says. “We try to keep investing ahead of
the curve on the front, while looking to drive efficiencies out of the back
office.”

As a result of a recent benchmarking project, IHG moved a lot of its back
office work ­ internal reporting and the accounting for many of its managed
hotels ­ to India. “You can get very high quality people there, it’s obviously
quite cost-effective and the savings that we derive we can reinvest in the
growth side of the business. It’s primarily finance at the moment, but we see
quite a lot of demand from other parts of the company for standardised processes
and for the quality of staff.” He adds that this helps in “making sure that the
balance sheets are strong and that you are well positioned for what could be a
downturn. It’s something as FD you think about.”

While moving processes out of the country, was Solomons considering moving
IHG’s tax domicile offshore, as well? After all, only 5% or so of IHG’s business
is in the UK and 75% is in the US.

“That’s the sort of thing that we keep under review,” he says circumspectly.
“We’re always looking to try and optimise the tax charge, but we have no current
plans to rush off anywhere.”

IHG re-financed at the beginning of May this year, which you might think is a
difficult time for such an exercise. “It took a little longer than it might have
done, or than it did last time,” Solomons concedes, “but we got it through,
which I think is a reflection of the strength of the business and the
cash-generation of the business model. And our treasury team has done a great
job building a relationship with our banks. We try to have some long-term
relationships so when it is a little tougher, we can get them to come on board ­
even some of those [banks] who have had their own publicised issues supported
the re-financing.”

The new $2.1bn, five-year facility replaces funding arrangements that had
been due to run through to the end of 2009, but “from an accounting perspective,
we wanted it done by 2008 ­ and in these markets it’s better just to get on with
it,” Solomons says. “I couldn’t predict that [the market] was going to be better
at the end of this year than at the beginning.” The margins on the new facility
are slightly higher than in the old one, but the base rates are lower, “so we
are in a very good position. I’m pleased to say I can feel relaxed about that.”

Overall, the credit crunch has not so far had much impact on IHG’s business.
“I’m not saying it won’t, but the vast bulk of hotels coming through the
pipeline, ie, the new contracts, are the smaller, mid-scale hotels in the US, or
outside the US, that are not reliant upon Wall Street for financing,” he says.
“A local owner in the middle of America probably has a relationship with the
local bank, has worked with them for many years and the loan facilities are in
place. So about 70% of our total pipeline is financed right now. We’re not awa
re of any hotel that has fallen out of the pipeline because of the credit
crunch. So, although we are absolutely not complacent, so far it has not really
affected us.”

The hotel industry tends to lag behind others because a lot of business is
booked in advance but IHG has an additional advantage in that its business model
is less dependent on the economic cycle. “Our revenue growth is driven by RevPAR
on existing rooms and also by new rooms and since our demerger the new
management team has been much more focused on driving additional rooms.” When
chief executive Andy Cosslett joined in September 2005, he set a growth target
of 50,000 to 60,000 rooms. “And I think we will be there by the end of this
year,” says Solomons.

“And we have around three years’ growth signed up on top of existing RevPAR.
That is equivalent to somewhere around 4% to 5% compound annual growth rate.
Historically, the business has grown at less than 1%.”

Not complacent, of course, but at least this time he’s not tearing up the
budgets and starting again.

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