Baker & McKenzie Comments on Working through the Complexities of the Hotel Sale Process - Insights for Sellers and Buyers Part 2
Oct 15, 10 | 1:54 am 
By Graeme Dickson, Roy Melick and Robert Williams, Baker & McKenzie
Later this month, the hotel industry once again converges in Hong Kong for the 21st Annual Hotel Investment Conference Asia Pacific. The conference begins with a master class titled "Working through the complexities of the hotel sale process - insights for buyers and sellers", which will be moderated by Baker & McKenzie partners, Graeme Dickson and Robert Williams. Another Baker & McKenzie partner, Roy Melick will also be speaking in a separate workshop titled "Due Diligence Pitfalls".
Last week, we published the first of this two-part edition of the newsletter "The seller's battle plan". In this edition, we provide comment from the buyer's perspective. We have once again been fortunate to have obtained comment from a number of senior industry participants. In this edition, we have the benefit of receiving insights from Roger Griffin, Managing Director, HTL Capital Advisors and Anthony South, Chief Development Officer, Asia Pacific, InterContinental Hotels Group.
We look forward to catching up with many of you at the conference.
The buyer's battle plan
There are many ingredients which go into a successful hotel purchase campaign. Below, in our view, are the buyer's 10 front-of-mind issues.
Choice of consultants - and do not leave it until all the good ones are gone
Once again, experience and the ability to articulate a vision of how the buyer should approach the sale process are critical qualities each consultant should possess.
In highly competitive bids, the formulation and execution of a strategy is key to a successful campaign. This involves a variety of factors, including knowledge of how the seller has conducted sale campaigns previously, the approach taken by the sale agents and the disposition of the seller's lawyers and other consultants. It is also important to possess the experience and market-knowledge to predict who will comprise the other shortlisted buyers and how they will assess the hotel value plus, of course, an awareness of what is motivating the sale.
It should also be borne in mind that the best consultants tend to be snapped up early. As soon as the decision is made to participate in the bidding process, contact should be made with each consultant the buyer proposes to engage.
Streamline the due diligence - focus on what is material
"Hire the best, most experienced consultants you can find. Hotel real estate and the attached business can be the basis of a complex purchase. Complexity creates opportunity, but only if you and your team are astute enough to recognise and price it. The true gems in any deal are the items of real value to you, and in the perfect buyer's world, little or no value to the vendor.", Anthony South, Chief Development Officer, Asia Pacific, InterContinental Hotels Group
Decide what is material and what is not, and undertake the due diligence around these parameters. At an early stage, determine the client's materiality thresholds for each aspect of the due diligence.
These are usually based on:
how risk averse the client is - a sovereign fund will have a significantly different risk profile to an entrepreneur;
experience gained from similar transactions; and
the extent to which warranties provided by the seller can be relied upon (either because of the degree of comprehensiveness of those warranties, or the financial standing of the seller).
Once materiality thresholds are worked out, we discuss with our due diligence team what will be reviewed, to what extent, and what will not. If there are numerous disclosure documents, which ones do we review and what things do we focus on? We have witnessed many occasions where, at the outset of the due diligence, there appears to be little thought given to the process. This can quickly create problems and has the potential to lead to a cost blow-out with a lot of time spent on immaterial matters. Handled the wrong way, it can also discourage a seller from negotiating with that particular buyer.
Properly executed, due diligence remains the Achilles' heel of many modern hotel purchase campaigns.
Tightly control Request For Information (RFI) - focus on the quality and not the quantity
In our experience, a sloppy and badly supervised due diligence process inevitably flows through to a sloppy and badly supervised RFI process.
The best way to put the seller, and the seller's lawyers, offside is to give them a mountain of irrelevant, immaterial or ill-conceived RFIs. All RFIs should be checked at the outset to ensure they are materially appropriate. If this is not done, then it can create an environment where the seller's lawyers will not respond to a vast majority of the RFIs and leave the seller's lawyers with a very poor regard for the buyer's legal team. This should be avoided at all costs as there will be occasions when the professional respect between the legal teams can make the difference between a successful bid and one that falls short of the mark.
Sale contract review process - it is all about listening to the seller's message
"Do not include a financing contingency in your offer. Remember that a banker's term sheet is only an expression of interest. Ensure you understand your banker's view on value. His or her valuation will only coincidentally be what you want to offer, may well utilise different methodology than yours and be required to be prepared at your expense. The loan-to-value ratio covenant using his or her valuation may constrain your bid or increase your equity requirement.", Roger Griffin, Managing Director, HTL Capital Advisors
If a seller has issued a middle-of-the-road draft sale agreement, which is both fair and reasonable, and made it crystal clear that the degree to which this agreement is marked up by the buyer's lawyers will be taken into consideration in determining relative competitiveness then, in our view, it would be smart to LISTEN and respond to this clear message.
This may sound trite, but we were involved in a situation where two shortlisted bidders' proposed price was virtually identical and within the seller's expectations. Therefore, the seller's team needed to find a means of ranking these bids on some basis other than price. One of the bidders listened to what the seller was saying and proposed virtually no amendments to the sale agreement. Whilst the other bidder produced substantial amendments.
It was a fairly simple matter to rate the two bids with the one providing virtually no amendments coming out the winner.
It is imperative for legal teams to ensure that they are providing the best service to their client in terms of the commercial realities of the bid. Sometimes the protection afforded by an extensive contractual mark-up is of no practical benefit to the client if it results in the bid being uncompetitive.
When we act for a buyer, we first determine whether the agreement is within fair and reasonable bounds. If it is, then we try to minimise or eliminate any proposed amendments. We tend to adopt a two-tier approach. Initially, we decide if any amendments are warranted. Each of the proposed amendments is then closely reviewed to determine whether it is absolutely necessary in a practical, as well as technical, sense. The question we constantly ask is, even though we would prefer a more buyer-friendly slant to a contract provision, is it ABSOLUTELY necessary? Is it so serious or fundamental to the buyer's risk profile that we will jeopardise an otherwise winning bid and insist upon the amendment?
In our experience, if every proposed amendment is exposed to this rigour, then we usually find that we end up with a remarkably small list.
Avoid uncompetitive structuring complications - follow the path of least resistance
In a recent deal we were involved in, the hotel land and business were held by a company. The simplest course for the seller was to sell the shares in the company rather than the hotel land and business. This meant, among other complications, that the operator's consent to the sale was not required, the hotel employees (of which there were several hundred) did not need to be terminated and re-hired, and the multitude of business contracts did not need to be novated from the seller to the buyer.
The seller's STRONG preference was to structure the deal as a share sale.
However, a number of the shortlisted bidders lodged non-conforming bids requiring a total rewriting of the transaction to provide for an asset sale involving a transfer of the hotel land to one entity and a transfer of the hotel business to another entity. Under each of their proposals, the sale agreement, which the seller had prepared at great expense, would have needed to be replaced with a completely different set of documents.
Only one of the shortlisted bidders took the time to really listen to the seller and reconfigured its bid to end up with an entity that could acquire the shares in the entity that held both the land and the business as the seller had originally proposed. Needless to say, it won the bid.
It should be said that there were very sound reasons why each of the under-bidders ended up making non-conforming bids. However, the practical reality was that lack of flexibility probably cost all of them the deal.
Dealings with the hotel operator - never underestimate its importance
A novation of an operator's management agreement is a fundamental aspect of the purchase equation. It affects the transaction in many ways including, importantly:
what criteria the operator will apply in assessing whether to consent to the sale of the hotel to the buyer;
the ability of the buyer to control the operator if the operator demonstrates a lack of ability to manage the hotel; and
the impact of the operator on the subsequent sale of the hotel by the buyer.
In this article, we will consider the first of these bullet points. We have written extensively on the second and third bullet points in a previous article "The 10 Major Issues in Contemporary Hotel Management Agreements".
At an early stage in the due diligence, the buyer should review the operator's management agreement and establish whether there are any provisions which restrict to whom the seller can sell the hotel (restrictions are usual) and whether any restrictions are an issue for the buyer. Commonly, restrictions fall into two general categories.
First, they impose a restriction on the identity and nature of the buyer itself. Secondly, they impose obligations and conditions on the buyer's financier. Both of these restrictions need to be studied carefully and correctly understood to ensure that they do not create significant issues.
The most important issue for a buyer itself is usually whether it constitutes a competitor of the operator. Many management agreements prohibit the hotel from being acquired by a party that operates other hotels. Most people are surprised to learn that this technically covers the majority of entities, which in common parlance, are described as hotel owners. If the party conducts the hotel business (i.e. does not lease the hotel to a third party) then, in most jurisdictions, it is the operator even if the services of a third party hotel management company are used. The existing operator in these circumstances would be fully within its rights to refuse to consent to the sale to a buyer who fails that test, and there is little the seller can do to prevent this, outside of negotiating with the operator.
The most important issue for the buyer's financier is to determine whether the operator is insisting upon a non-disturbance agreement with the financier. This can turn into a major complication if the selected financier is not prepared to enter into a non-disturbance agreement, or the buyer has not determined its financier by the time it needs to execute the sale agreement.
Communications with the buyer team members
This is as important for the buyer as it is for the seller, but for different reasons.
The seller must maintain control over the sale process. For the buyer, it is important to ensure that all team members are acting in a way which maximises the prospect that the buyer will win. The buyer needs to be kept constantly appraised of any issues and deal with each of them promptly and effectively. If a buyer is able to signify to the seller that it understands the message being communicated by the seller, and is prepared to respond to it, then this can have a significant impact on the attractiveness of the bid, particularly if it is a close race. Every member of the buyer's team and every consultant needs to act in a manner which is cohesive and enhances the attractiveness of the bid.
Seek to identify the strengths and weaknesses of other potential buyers - industry knowledge is key
"Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.", The Art of War by Sun Tzu, 600 BC
We are constantly amazed how little importance seems to be placed on this aspect of the strategy. We see our familiarity with the market as a very important part of our selling proposition when we are asked to pitch for a buyer (not to mention a seller). This is particularly the case if the buyer is a foreign party, or a party who is embarking on its first hotel acquisition.
At the time that the buyer is advised that it is shortlisted, questions should be asked of the seller and its agent as to the number of other shortlisted parties. Consideration should then be given to determining the identity of these parties and the strengths and weaknesses of their offerings, in an attempt to determine whether this should feed into the bid strategy for the buyer.
In making these comments, we acknowledge that any analysis in this regard must fundamentally take into consideration the uncertainty that can surround not only views as to the identity of competitors, but their strengths and weaknesses. That said, a competitive bid, which does not give any consideration to the competitive environment is, in our view, lacking a significant component of a winning strategy.
KISS
"Keep it simple, stupid" (KISS). These words are as relevant to the buyer as they are to the seller. Most successful hotel purchase strategies have, at their core, a primary philosophy to make the transaction as easy for the seller as possible. Simplicity is inextricably connected to ease.
It is all about winning
A legal team, which is focussed on winning as the prime objective, is a very important ingredient in the profile of a winning bid team.
In making this comment, we are not advocating a win-at-all-costs approach. That would not be sensible. What we are saying is that every aspect of the transaction process should be considered to ensure that what is being undertaken, and the way it is being undertaken, is enhancing the attractiveness of the overall bid rather than detracting from it.
Every lawyer wants to be told by a transaction observer that his or her contribution to the buyer's campaign was critical to a successful outcome. Equally, no lawyer wants to be told that his or her contribution was a significant (or the main) contributor to the buyer's campaign failure. So, on that note, we conclude this article.
Summary and conclusion
The hotel sale process can be as simple or as complex as you wish to make it. Baker & McKenzie's Hotels, Resorts & Tourism team strongly considers that the process should be as simple as possible - irrespective of whether you are the seller or the buyer.
For the seller, it is all about maintaining firm control of the sale. This starts out with designing a sale process, which is fundamentally fair to the buyer particularly on the drafting of the sale agreement. It should provide the buyer with abundant information, to allow the buyer to obtain a full understanding of what is for sale, so that pricing decisions can be undertaken without the conservativeness that uncertainty engenders. Finally, it is all about maintaining competitive tension and fostering a mindset that the enemy is the other bidders - not the seller.
For the buyer, it is all about listening to the message espoused by the seller and responding in a sympathetic manner. Each team member needs to be cognisant of the need to constantly contribute in a way, which enhances the prospects of a win, and the buyer needs to co-ordinate all team members to ensure that their efforts work in unison.
About Baker & McKenzie
Founded in 1949, Baker & McKenzie provides sophisticated advice and legal services to many of the world's most dynamic and successful organizations through more than 3,900 locally qualified lawyers and more than 5,800 professional staff in 68 offices and 39 countries. Baker & McKenzie is known for having a deep understanding of the language and culture of business, an uncompromising commitment to excellence, and world-class fluency in the way we think, work and behave. (www.bakermckenzie.com)
