The FIFA legacy in the South Africa hospitality industry
From News24 -24 July 2015, 13:52 (Great educational article – TNT News Editor)
In the wake of the FIFA scandal I had a look at what legacy FIFA has left behind in South Africa after 2010 FIFA World Cup Soccer tournament.Billions and billions of Rands [South African currency] were spent on building stadiums and the infrastructure around it and now they stand under-utilized. This situation appears to be the same at other venues around the world as well.In the build up to the 2010 event in South Africa we were told how the tourism industry will benefit from that event and that it will be sustainable income streams. In lieu of that “promise” many South Africans opened up their homes and converted it into Guest Houses and B&B Establishments. Some of these entrepreneurs even got grants/incentives from the South African Government. Banks and financial institutions made it easy for these entrepreneurs to get finance to upgrade their establishments.Two years ago we started our investigations and research into the state of the hospitality industry in South Africa as part of due diligence investigations and found the bubble of the 2010 World Cup has burst. The expected sustainability of guest houses did not realize and some of these entrepreneurs fell behind with their payments on their mortgages and foreclosures are in the order of the day.According to the latest official statistics of the TGCSA [Tourism Grading Council of South Africa] more than 350 graded establishments closed business in 2014 and that is in Gauteng alone. [Bear in mind that there are hundreds of non-graded establishments as well]. Many financially distressed guesthouse owners resorted to selling their establishments in auctions but scarcely reached 30-40% of their expected asking prices. Foreclosure sales on execution auctions are also on the rise. We know of one Estate Agent who alone has more than 200 guesthouses for sale on their books.
When we approached our bank for finance we were told that guesthouses/venues/restaurants are not “hot property” and that we would not get any finance for such a venture. We checked with other banks and financial institutions and that appears to be the same situation. The South African Government also has suspended its “tourism grants” to guesthouse/venue owners.
We have personally attended a couple of auctions and in one instance a well-known establishment with 54 rooms and 3 reception areas worth R30million according to the valuation supplied and with a municipal value of R13million only succeeded in raising a R3million bid. In another example another well-known establishment known as Avalon Castle was offered to us as going concern for R18million which we at that stage believed to be overpriced. Scarcely 6 months later it was offered to us at R10.9million, however at that stage we were in negotiations with another property and were not interested in it. In February 2014 Avalon Castle was sold on a liquidation auction for R1.49million.
Our interest in acquiring a guesthouse/venue started way back in 2008 when we had to relocate our camping gear rental company to new premises. That year was the beginning of the worldwide credit crunch, but an estate agent succeeded in arousing our interest in buying a property which could add on to our mobile accommodation by adding fixed accommodation to our existing services. The idea of acquiring a guesthouse/venue was rested for a couple of years until 2013 when we had a mind shift in our existing business activities. By this time the 2010 World Cup Soccer Tournament was something of the past and it gave us an opportunity to check the state of the hospitality industry.
Our target area is Pretoria East [east of the N-1 highway] where we investigated over 30 guesthouse/venue properties for sale [just in the last 24 months]. More and more such properties are becoming available for sale in this area.
With the exception of one or maybe two, none of the sellers were able to give us a precise breakdown of how they calculated their selling price. Traditionally when calculating a “selling price” of a business you took the annual income over a period of 3 years add them together and that gave you the “selling price.” The latest trend is also based on turnover where they look at ADR [the “achieved daily rate”]. This works on the following basis: You take the annual turnover and divide it by 365 to see what the enterprise is earning per day and then you multiply the ADR factor by 1000. For example if your business has a turnover of R2million per year your ADR would be R5,479.45 per day and the selling price should be R5,479,452.05. Generally the 3 year turnover figure and the ADR gives a very similar “selling price.” Some sellers will also look at the value of their buildings/property and will attempt to sell it at “replacement value”.
There are also sellers knowing that turnover is the key for a successful sale of their “business” have tried to sell the bare property alone, but when cornered on the purpose of the buildings it all boiled down to a guesthouse/venue which were not profitable and they are just trying to get rid of it to cut their losses.
A tip for potential buyers: Always assume that there is something wrong when a business property is offered for sale to you. In more than 95% of all properties we investigated we found problems. Do a proper due diligence investigation:
“Due diligence” is an investigation of a business or person prior to signing a contract, or an act with a certain standard of care.
It can be a legal obligation, but the term will more commonly apply to voluntary investigations. A common example of due diligence in various industries is the process through which a potential acquirer evaluates a target company or its assets for an acquisition. The theory behind due diligence holds that performing this type of investigation contributes significantly to informed decision making by enhancing the amount and quality of information available to decision makers and by ensuring that this information is systematically used to deliberate in a reflexive manner on the decision at hand and all its costs, benefits, and risks.
There is a trend that I find very annoying and that is that Estate Agents/sellers for example would advertise a property/business as situated in Silver Lakes but then at closer inspection you find that this property is actually situated in Shere or you are told a property is located in Shere but in fact it is in Zwavelpoort or a property is supposed to be in Mooiplaas but in fact it is situated at Cullinan.
I had a look at a beautiful property, in fact a 5-star boutique hotel, which was offered to us at R15million and the first thing that put me off was the fact that as I was looking at the furniture and equipment I was told that the stove was not included in the sale, the next was certain furniture was not included and the cherry on top was that certain fixed fittings like a washing basin and its pedestal was not included in the sale. Based on those furniture, equipment and fittings the place got its 5-star grading. When it got to the financial statements I saw that the establishment was operating at a loss [in fact in insolvent circumstances] and checking their bookings I saw they only had a 13% occupancy rate over a period of 20months. They did not make a turnover of more than R1m per annum. The size of the buildings was something like 1500 square metres and a simple calculation showed that they worked on 1500 x R10,000 [working on replacement costs of R10,000.00 per square metre] and that gave the asking price of R15million.
When we look at a business we also look at what stage of their “life cycle” they are. There are 7 stages in the life of a business as described by Darell Zahorsky:
1. Germination phase
2. startup phase
3. growth
4. established phase
5. expansion phase
6. declining phase
7. Retirement or closing down phase.
Despite what Agents or Sellers are trying to tell you we found that the most businesses for sale are either in phase 6 or 7 of their life cycle. In fact, at least 5 of the businesses we have investigated in this period went into liquidation.
When we evaluate a business for sale as part of our due diligence investigations we look at the big 5 M’s in that business and they are Men, Machines, Market, Marketing and Money.
Men: Human resources is a very important part of any business. Zig Ziglar said you don’t build a business, you build people and people will build your business. Taking over a business like a guesthouse/venue will mean that you will have to look at the personnel as you may takeover staff with some bad habits. You will have to look at the business as such and see if they have proper staff records and records of staff meetings – in most of the businesses we have investigated we don’t find any records of staff meeting, that being the case how will a new owner know what to expect from the staff.
There is also a trend that sellers does not want their staff to know that their place is for sale. To me that is a problem as I want to check out every staff member during the due diligence period. It also tells me a lot of the relationship between the owner and his/her staff. If the owner [seller] does not trust his staff by disclosing the proposed sale to them how can I, the new purchaser, trust them as well. How can I employ the “old staff” if there are clear trust issues which means that I cannot add a value to the Men component.
Under this section we also go through the staff records and check whether all legal formalities are dealt with. We do a complete SWOT [strengths, weaknesses, opportunities and threat] analysis on each of the sections.
In one of the R20m offerings we checked the social media platforms and internet forums and noted that established had a number of complaints against them from bad service to bad food and management made no attempt to address those complaints. We will also go to advisory and ranking platforms on the internet to see how that business is perceived by the public.
What I also see is that there are no Strategic Plans or vision as to where the business is going and what their goals are.
We also look at management and how management perform their duties – are there any minutes or records of meetings by management? Does management comply e.g. with Company Law requirements? In fact does management comply with all legal requirements? A very good example we looked at two businesses [small companies] which runs a venue / guesthouse / restaurant and when looked at their liquor licenses we saw that the licenses were issued to entities that legally never exists. In another two companies we looked at their “business rights” and found that they had other rights than those they profess to have. A tip for buyers: examine every document and ascertain that they are what they seem to be.
Machines: Here we do a complete SWOT analysis again and check out the immovable, movable and other property the business uses to earn its income. For instance how do you justify a Chapel at an asking price of e.g. R2.5million if that “space” is only being utilized for 40 hours per year? At 40 hours you use that space for less than 0,05% per year. How can you justify “machines” of R16million if they only yield a turnover of R1.6million p.a.? How many events or weddings can a “venue” host per year? There are only 52 Saturdays in a year and it seems that the average “Saturdays” that are utilized is 40 per year. At an average of R50,000 per event the turnover is only R2m p.a. if you would ask a selling price of R10m that price does not balance the turnover which means that you have over-capitalized or under-utilized the “Machines” or that there are big management problems in your business.
The only conclusion that I, the purchaser, can make is that you are selling to minimize your losses.
In various establishments I also noticed a lack in maintenance to the buildings, equipment or machinery and a disregard to legislation on occupational safety, labour, standards, consumer protection, fire hazards, electrical and gas installations and more.
In terms of Machines we also look if they are utilized for more than one income stream e.g. a guesthouse, venue, spa, restaurant and more. A business that has more than one income stream is more likely a better buy than a business with only one income stream like, let’s say, a venue alone.
One of the pertinent questions in this section is: How long is this business for sale in the market? Businesses does not sell fast, but if your business is not sold within 2 years you must know that your asking price is wrong.
Whether it is fixed property, movables or whatever we look at a valuation of each starting with a forced sale on auction. Auctions tells us what the forced sale value of any property is and we often use this as a benchmark for the bottom scale as value and then we look at similar sales in the area to get the upper scale.
Markets: in this section we look at what type of business is involved, where is it situated and how does it compare to its competitors? Is there a place for this business in the market? Usually there are statistics available and we can also see if the business in question will have something unique to distinguish it from its competitors.
Marketing: in most of the business we have investigated we could not find a marketing plan or strategy. There are no marketing budgets and the businesses seems to think that they can depend that the “venue sells itself.” There seems to be a misconception of what marketing is.
What is marketing?
Many people believe that marketing is just about advertising or sales. However, marketing is everything a company does to acquire customers and maintain a relationship with them. Even the small tasks like writing thank-you letters, playing golf with a prospective client, returning calls promptly and meeting with a past client for coffee can be thought of as marketing. The ultimate goal of marketing is to match a company’s products and services to the people who need and want them, thereby ensure profitability
Read more: http://www.investopedia.com/terms/m/marketing.asp#ixzz3aZcrr54L
We evaluate the marketing efforts of the business and once again we use the SWOT analysis.
Money: here is an investigation into the financial position of the company and the first question is does this business make a profit or loss? And the second which goes together is what amount of drawing or salary does the owner take home? In the majority of cases we do not see any drawings or salary by the owner and that turns on the flashing red lights. If the business [and usually they are company-owned] is operating for a loss over a period of time you can be sure that liquidation is eminent and be careful if you want to buy this company. We even have encountered a company that was offered for sale to us while under formal “business rescue” proceedings where the owners did not want us to contact the “Business Rescue Practitioner.” When there is not a full disclosure it is a tell-tale sign that you should walk away from the transaction.
Although the 5 M method is a handy tool in the due diligence investigations you need to go wide with your investigations. Practicing law for more than 30 years I have learnt that taking over or buying a dubious business will mean that within 18 months you will close that business – so doing a thorough investigation before you buy will save you a lot of money and tears.
In one instance we had to wait 6 months before the seller gave us the information we were looking for. If a seller or the agent fail to give you the information [documents] that you are looking for walk away from the transaction.
In another example we were offered a property for R20million with a so-called turnover of R7million and this figures seemed to be in place until we requested disclosure of the VAT returns as well as the financials – it seemed that the seller was faking the transactions to increase the “turnover” by adding his other businesses’ turnover to the financials. Even at R7million this place was making a loss.
Still under the Money section we find that there are in the most cases not any Business Plans, Marketing Plans, Strategic plans setting out the vision and the goals of the management, but the Sellers want millions of Rands for their outfit.
Now to get back to the FIFA legacy: despite the encouragement of the ANC Government and FIFA’s involvement you cannot blame them for not doing your homework upfront. You needed to go through the whole exercise as I have set out above [maybe more] and should have not got caught in the euphoria about the World Cup coming to South Africa. There are lots of business opportunities in South Africa and if you do not have the skills to do a proper investigation into buying or establishing a business hire a skilled person to do the investigation for you.
For a seller the advice that I can give you is that you look at the above and if your business was not sold within two years you should start to look at either improving your turnover or lowering your asking price as buyers for venues or guesthouses are very limited and financing for those type of establishments are very scarce.
I hope this article will give both a seller as well as a purchaser an insight of how and what we would look for when a buying a hospitality business.
Loftus Viljoen
Pretoria
–MyNews24