• Choice to up investment in pipeline

Choice Hotels International is to put more of its own money into expanding its brands and supporting its franchisees, as its pipeline suffers in the downturn.

The group, which reported growth in profit and revpar in the second quarter, said that it expected to see revpar improve for the remainder of the year. It plans to use its own cash to take advantage of growth in the deals market and give it greater market share.

Looking to the immediate future, president and CEO Steve Joyce, said: "We believe the hotel transaction environment will remain difficult and thus continue to adversely impact our franchise sales results".

The slowdown in the deals market has hit the company, both in terms of conversions to its brands and, with bank lending also limited, the new-build market.

Close to 80% of Choice's estate is in its domestic market, which continues to suffer, with a 47% drop on the year in the number of franchise contracts executed in the second quarter. The number of hotels worldwide under construction, awaiting conversion or approved for development fell by 27%.

The company has had the backing of its board to put ‘skin in the game' since 2008, but in a conference call, Joyce said that this investment would be increased from millions "in the single digits" to between $20m (£13m) and $40m every year for "the next several years". So far this year, to 27 July, $17.8m has been advanced, with $5m since repaid.

Putting the balance sheet behind expansion has, anecdotally, been a growing trend amongst operators, although Choice is one of the few to quantify the move.

The money will be focused on Choice's emerging brands – predominantly the more upscale Cambria Suites – with Joyce commenting that the group thought of the money "as sliver investment to help a transaction go through".

Joyce said that the return on investment was "typically high single, low double digits, but the real return is if we move the Cambria brand into being a second major engine for the company".

The decision to increase investment was attributed to evidence pointing to growing activity in the deals market, which the company was keen to take advantage of.

Joyce added that a more aggressive stance by banks was bringing distressed properties onto the market, which the group was eager to help its franchisees acquire – with capital available for portfolios in particular. He commented: "We think that we'll get more than our fair share – as a developer of converted hotels – and that will lift us into a more normalised development environment."

Joyce added: "The banks are taking back properties – there appears to an end to ‘pretend and extend' or, as my favourite phrase goes; ‘a rolling loan gathers no loss'. The gap between buyer and seller is closing and there is creeping capital available."

The view was one backed by Jones Lang LaSalle in the same week, which said that, in EMEA at least, transaction levels in the second half of 2010 were likely to be double that seen in the first, supported by improved access to credit from lenders.

The CEO said that uncertainty over the future of the economy would mean that the return of transactions would be gradual. The new-build market is expected to take at least a year to improve, assuming the recovery in the wider market is maintained.

In the group's domestic market, 81% of the new contracts were conversions rather than new-builds, with 37% of the pipeline under the midscale with F&B brands – the majority of those under the Quality flag – and 32% under economy brands.

Joyce said that the company was still looking to add to its flags, although refused to comment on whether it had attempted to acquire the Tryp brand from Sol Melia, which went to Wyndham.

The news came as Choice reported net income of $27m, up 6% on the year, with revenue up 5% to $149.8m. Ebitda was $45.7m for the second quarter, up 8.8% from $42.0m in the same period last year.

Domestic revpar increased by 0.3% for the second quarter of 2010 compared to the same period of 2009 as occupancy rate increases of 130 basis points were partially offset by a 2.2% decline in average daily rates. The rise was smaller than that recorded by several of the other groups reporting recently, reflecting Choice's strong US and leisure orientation, with the forecast of flat to 2% growth for the full year a cautious one.

The increase was the first for the group since the second quarter of 2008, driven by gains in occupancy and a gradually improving average daily rate environment from this year's first quarter.

The company sees around two-thirds of its trade from the leisure sector, which has meant that it was less able to take advantage of the growth in the corporate travel market seen at groups such as Starwood and Host. In line with this, the business-focused extended stay brands recorded the strongest results for Choice, with revpar up by 5.9%

However, Joyce was confident that the leisure market was recovering, despite the recent drop in US consumer confidence, describing it as a "bright spot", commenting "the folks who have jobs are beginning to spend again".

After the extended stay sector, the economy brands were next to improve, with revpar up by 1.5%, followed by the midscale without F&B segment, which was flat, then midscale with F&B, which dropped 1.2%.

The company expects full-year adjusted Ebitda to be between $167.5m and $170m, with revpar expected to increase approximately 6% for third quarter. It expects net domestic unit growth ranging from 1% to 2%.

HA Perspective: Choice's decision to start bank rolling its franchises looks a sensible response to difficult times. But it carries significant risk.

Separating the sales process from the credit worthiness assessment is the most obvious and biggest challenge. Additionally, it might tie-up capital that might be better deployed brand building.

As a short-term fix, if managed carefully, it should help grow market share. Particularly give that more than four in five franchise sales are conversions. No data is given, but it is likely that many of these are cash-starved hotels looking to a brand (or stronger brand) to add sales to survive. Choice can help them and help itself in the process.

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