By Lisa Pham
No sooner has Whitbread decided to spin off Costa Coffee than questions are being asked about the future of its other main business.
Setting a course for the Premier Inn budget hotel chain will be the company’s main priority after Costa is jettisoned, and there’s no shortage of ideas in the market about how that can be achieved.
While shareholder Blue Whale Capital says the business should adopt a franchise model similar to InterContinental Hotels Group, Bernstein analysts favour expanding Premier Inn’s business in Germany.
Others say the division might be bought.
“I’m not sure we’ll be talking about Costa much longer,” said Ed Meier, a London-based fund manager at Whitbread shareholder Old Mutual Global Investors.
“It’s widely expected that it will get bid for before a demerger process is complete, at which point Premier Inn gets bid for as well.”
The increasing prospect of corporate change is reflected in Whitbread’s share price, which has risen about 6% since activist Elliott Advisors appeared on the shareholder register last month.
The UK company has acknowledged that the likelihood of an approach for either Costa or Premier Inn has probably increased given the announcement that it will seek to demerge the coffee-shop chain within two years, Barclays analyst Vicki Stern wrote in a note last week.
For now, analysts and shareholders are debating what strategy would best suit Premier Inn as a standalone business.
The chain operates more than 780 hotels in the UK and has been expanding into Germany.
It aims to lower the number of properties it owns to about 60% from 64%.
Larger peer InterContinental manages or franchises hotels rather than owning them.
According to Blue Whale chief investment officer Stephen Yiu, a franchise structure would offer higher returns on capital as well as less volatile revenue and cash flow, allowing Premier Inn to expand more quickly in the UK and overseas.
Whitbread currently makes up 3% of the £45m (€51m) LF Blue Whale Growth Fund.
“We want Whitbread to generate significant cash from the sale of their properties to external parties and focus on fee-generating activities, particularly franchising,” said Mr Yiu, adding that the company could use the proceeds to pay special dividends or buy back shares.
Shares in Whitbread have returned 468% since the end of 2008, including dividends, less than a 1,000% return for InterContinental Hotels but beating the Ftse All-Share Index’s 169%.
Whitbread could achieve a comparable outperformance to InterContinental by pursuing a similar franchise strategy for Premier Inn, according to Mr Yiu.
Not everyone agrees.
Bernstein analyst Richard Clarke sees Premier Inn’s much smaller hotel network, as well as its lack of a recognised franchise brand and loyalty programme, as hurdles to the chain charging a royalty rate close to that of InterContinental Hotels and Acco. He has an underperform rating on Whitbread. The company could sell some of its hotel properties in the UK to invest in the German market after the Costa spinoff is complete, according to Mr Clarke.
Negative like-for-like sales performances at both Premier Inn and Costa show that they’re beginning to saturate the UK market, he said.
“Premier Inn needs a growth outlet, and at the moment the most likely option is Germany,” said Mr Clarke. “We don’t know yet whether the Premier Inn brand resonates there, but if they could increase their presence through buying more hotel properties or a rival, it would help them grow faster.”
Whitbread confirmed its plan to spin off the Costa coffee chain last month.
In the UK it has 2,300 outlets; in the Republic, 107 stores; and 400 in China. The coffee chain will likely focus on China, because of the potential for growth.
Costa is the UK’s largest coffee chain, with a market share of 39%.
It leads Starbucks, with a 25% share, and Caffe Nero, with 11%.
It has spread across the UK, where it’s a fixture of downtown shopping districts and train stations. But its shops face growing competition from Starbucks and sandwich-focused Pret A Manger and Greggs, and growth has been slowing.
Investors believed Whitbread’s attachment to Premier Inn was restricting further expansion domestically and in China.
Analysts had said last month that the two-year timeline to break up Whitbread appeared lengthy compared with other UK breakups in recent years.
As coffee shops proliferate across the UK, Costa has found growth harder to come by in a maturing market.
Bloomberg. Additional reporting Irish Examiner