Why IHG acquiring Fairmont is the right, smart move

The M&A market is percolating and a familiar name is providing the stir.

InterContinental Hotels Group, which already made a splash earlier this year through it's acquisition of Kimpton Hotels, is now reportedly closing in on buying Fairmont Raffles Hotels International for close to US$3 billion.

In June, reports surfaced that Toronto-based FRHI's owners, a Qatari government fund and Saudi Prince al-Waleed bin Talal’s Kingdom Holding Company, was putting the group, which includes the Fairmont, Raffles and Swissotel brands, up for sale.

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FRHI operates 116 hotels with nearly 44,000 rooms in 34 countries. The list includes historic luxury properties such as New York’s Plaza Hotel, the Peace Hotel in Shanghai and the Savoy in London.

Now, in comes IHG, the UK-based hotel group, which was first mentioned as a potential suitor for Starwood Hotels & Resorts Worldwide, something it sidestepped.

Last November, IHG shareholder Marcato Capital Management reportedly pushed IHG for some type of merger or consolidation, with Starwood, Marriott, Hilton, Wyndham, Hyatt and Accor listed as possibilities. "Each of these companies would be a fit for IHG by broadening its geographic footprint in the most desirable hospitality markets, expanding chain scale diversification, increasing asset-light earnings, realizing cost savings, improving system fund benefits and lowering cost of capital," Marcato said.

But no mention of Fairmont, until now. IHG has now reportedly beaten out others vying for Fairmont, including Wyndham and Accor, and a deal will reportedly be reached within the next few weeks.

IHG, which continues to transition out of real estate to pure hotel operator, appears to have the capital to make the acquisition. Divesting properties is part of the reason why.

In July, IHG agreed to sell its full ownership of the InterContinental Hotel Hong Kong to Hong Kong-based private real estate investment firm Gaw Capital Partners for $938 million.

IHG, owner of the Holiday Inn and Crowne Plaza brands, among other well-recognized flags, has been divesting properties of late, evidenced by the Hong Kong sale. Last December, it accepted a $366-million cash offer from Constellation Hotels Holding Ltd. for Le Grand hotel in Paris.

"Having performed well both operationally and financially since its 2003 demerger, and with the Hong Kong and Paris hotel disposals completing its move to an asset-light model, we think InterContinental management feel they are in a strong position to invest for growth," Morgan Stanley’s Jamie Rollo told UK's The Sunday Times. "Unencumbered luxury hotel brands don’t come around that often, and the conundrum InterContinental likely faces is having to justify a multiple potentially double that on which its shares trade, and thus forfeit the more immediate and relatively safer upside from a large share buyback."

A FRHI acquisition would give IHG instant growth in the luxury market, something it has in its InterContinental brand, but not to the same degree of brand awareness as Fairmont and Raffles provide. IHG is known more for its midscale offerings in the form of Holiday Inn and Holiday Inn Express.

In the same way its Kimpton buy immediately grew its lifestyle footprint, the FRHI deal would do the same for the luxury space.

As hotel companies shift from real estate companies to operators, acquiring legacy, well-established brands is a shrewd way to grow. Without having to build new hotels, it gives companies instant access to derive fees and a platform to expand and grow the brands through new development and conversions.

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