In the second Debt Advisory newsletter from Clearwater Corporate Finance, we look at real estate backed lending in the leisure sector.
The leisure sector has been affected by reductions in discretionary spending within the economy, as consumers look to trim their expenditure in response to inflation and stagnant wages. Although inflation has been broadly steady since spring 2012, the rate is well above the Bank of England’s target of 2% (July Consumer Prices Index 2.8%). The sector faces continued margin pressures, with key costs such as energy, fuel prices and food rising, coupled with the reduced discretionary spending in the economy. Operators in the sector therefore need to optimise their cost base whilst maintaining expected service levels.
Bank support for the leisure sector has been somewhat limited over recent years due to the perceived reliance upon discretionary spending. Banks remain cautious, focusing on stronger borrowers with defensive characteristics and stable cash flows. The level of activity in the sector is, however increasing, with some pockets of good opportunities in the UK. This has been driven by an improving UK economy, staycationing (holidaying in the UK) and spending on feel-good treats. Also, one of the key strengths of many leisure sector businesses is the ancillary income they can generate for funders; usually through merchant/card payments and cash handling.
Leisure sector businesses are typically underpinned by significant tangible assets, often real estate, which is particularly common in the hotel sector. This is exacerbated with high levels of operating leverage in lease hold models. The hotel financing market closely follows that of the wider real estate market within which the number of active banks has reduced substantially over recent years. A report from Cushman Wakefield suggested the number of active real estate lenders declined by 33% in 2011, with those remaining having more restrictive lending criteria; including some unwilling to lend outside of Central London’s buoyant market.
This has, however, created an opportunity for alternative funders including real estate funds, pension funds, private equity funds and insurance companies to enter the market. Mezzanine finance is also another option available.
Along with refinancing, an asset secured funding structure can be used to release cash for growth, acquisitions, change of ownership, capital expenditure or restructuring. Due to the secured nature of the funding, it is possible to raise additional debt over typical bank funding levels, providing an injection for businesses with no dilution of shareholder equity. Also, the funder will look at the strength of the collateralised/secured assets first and to a lesser extent at the strength of the company to ensure repayment.
Real estate backed lending is not suitable for every leisure business though, as assets are pledged to the funder and there can be higher associated costs, with regards to administration of the facility. Ultimately though, in a difficult market where a lack of appetite from traditional funders has been apparent, it can release much needed funding for investment.
The change in lender behaviour increases the requirement to provide lenders with more thorough, quality information. Proper preparation of information and clear definition of the operational strategy and milestones will therefore assist any financing process. Management teams need to be prepared to explain key aspects of their business plan, for example:
- The revenue mix by customer type and the impact market influences have on each type
- Expectations of each customer type e.g. facilities and services each customer type are demanding, how that is expected to evolve and what impact that may have on capex assumptions
- Strategies to control cash and costs within the business
- Future investment strategy and the impact on the top line
- Locations of sites/premises and market demand/supply expectations
Clearwater Corporate Finance’s Debt Advisory and Real Estate teams advised Park Resorts on its £350m debt and equity refinance.
Clearwater led the refinancing negotiations for the company with banks and equity investors. The refinancing provides continued support from the company’s senior debt funders and releases additional capital for investment in new and existing holiday parks.
If you would like to discuss any of the subjects covered in more detail, then please get in touch with us using the links below.
Chris Smith – Partner
Mark Taylor – Partner
David Burton – Manager