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[#PAFh19] “At the end of the day […] it's really all about the person standing in front of the owner doing interfacing on a day-to-day basis.”

Speech by Aaron Greenman, Executive Vice President of Acquisitions and Development for EMEA, Interstate Hotels & Resorts, at the Paris Asset Forum >hospitality

2019 has been an active and successful year for Interstate, and an interesting one for the third-party hotel management sector. So, I’d just like to spend a few minutes with you this morning talking about some of the developments in our sector and how we're continuing to drive asset value for our owner clients. There are a few questions that I'd like to address this morning:

Why third-party management?
Giorgio spoke a bit about this evolution of PropCo, OpCo and also unencumbered assets and how management has been taking an increasing role as its own identity as a service provider in the sector. I'll talk a bit about why there are, increasingly, a lot of third-party management players out there and perhaps why they're all not necessarily created equal. Where Interstate as a company focusing and why, just a little bit about our recent merger with Aimbridge and how that doesn't, in the end, change our value delivery.

First of all, just a little bit about why third-party management in the European context. For us, it's all about the asset lifecycle and I think this is obviously a recurring theme at the Paris Asset Forum. In the acquisition phase, buy or build, we are underwriting the investment for our partners, we are analyzing and value engineering from an operational perspective. In the case of conversion, we are helping the owner negotiate the Property Improvement Plan, the PIP, always from an outsider's perspective sitting across the table from the brand. We're providing technical advisory about how to design the most efficient asset operationally. Oftentimes, we are brand agnostic. We do get owners who come to us and say, "Well, I want to develop a hotel that is of a certain standard, but I want to make sure that that asset is flexible going forward." A typical asset might have two or three or four brands in its lifetime, so, often times, for owners it's a question of: "How do I get that expertise without necessarily over committing myself to the specificities of a brand within the physical asset?"

Obviously, when you get to the hold part of the asset lifecycle, it's all about management and it's all about efficiently driving revenue and expense to the business, which is our core offering. On the disposition side, we connect our managed hotels that are within our system and that are for sale to capital partners we already work with and capital partners that we want to work with. Oftentimes, we interface with the broker inside of the business as well. We find that the assets that we managed, because of the covenant that we provide and the integrity of our numbers, are oftentimes quite interesting to the buying investor population.

The first question that I get asked in 80% of my own meetings in front of new potential clients is, "Why third-party management and why should I pay a higher fee in combination with a third-party manager and a franchisor than I would pay just going directly to the brands?" At the end of the day, the fee portion of the P&L is very small, whereas the rest of the costs are pretty large. So, it's all about efficiently managing the rest of the P&L rather than whether you might be paying slightly less, equal or slightly more to your service providers.

25 years ago, when I started in this business, there was a lot of talk on the operational side about about food costs. Manage down your food cost; make sure the kitchen is super efficient. At the end of the day, it was a myopic view of things. What chefs were doing by managing down the food cost was actually putting less value on the plate, whereas it is more important to maximize the value of the money that's going into the owners' pocket. You know if you do that, at the end of the day, you just need a more effective and efficient solution in providing operating value.

How do we do it? A number of ways. By understanding what all of the brands require and understanding the different brand DNA. We can deliver that kind of value - sometimes with the brands, sometimes without a brand - to our owner-clients. With our size, we tend to be an employer of choice, which makes a difference. At the end of the day, we're only as good as our people and the systems we support our people with. We have our own sales - revenue management - e-commerce platform that we invest pretty heavily in. It both compliments what the brands are doing, and when the brand is not there; it replaces in many ways the value that the brand provides.

From a procurement aspect, size and scale matter. I'll address this just a little bit at the end, when we talk about Interstate's recent merger with Aimbridge. We buy more rooms, food, and other related supplies than any other third-party manager, so that simply filters through to profit.

At the end of the day, what's the result? When we look at third-party data (we have just a couple of markets where we have the volume where we can compare them, the UK being one and interestingly, Moscow being the other) we perform about 10% better, not 10 points: 10% better, for like properties at a GOP level, than our competition. In Russia, it's about 20%. This is a simplified view of the world, of our world, of course, but when you have a one-on-one relationship with a brand owner, and that brand is serving both the function of the brand and the function of the manager, there are inherent conflicts. With brands both managing and branding assets, there can be a push and pull between what the brands are doing to perhaps strengthen themselves, and what they should be doing for driving profit to the owner. We bring value as a third party. Just think about it like a family. Many of us have children. In families with two children, sometimes the children are butting heads a bit. With three, perhaps oftentimes, they learn to be a bit more diplomatic.

Where are we focusing and why? In the last 10 years or so, we've grown significantly. We had just a handful of hotels in a couple of countries going back a decade; now, we are in 10 countries in Europe with over a hundred hotels under management. Obviously, our growth has been somewhat selective, self-selective I would say, in the sense that about two-thirds of what we do in Europe is in the UK. The UK is a large step closer to the US in terms of supporting what's traditionally been more of an "Anglo" model managing hotels under management agreement, without lease, without ownership of the asset.

We do see this changing quite a bit: gradually, but quite a bit. Many of the key European investors Giorgio mentioned are continuing to grow their portfolio in terms of assets that are managed on a management agreement basis, both with the brands, and with third-party managers like ourselves. The only comment, I guess in this regard, is that in the least dependent markets (and we do manage hotels for investors that are essentially lease platforms: sometimes as a minority partner, sometimes as purely a service provider,) the overwhelming view when you have a lease within the structure is, traditionally, there's no place for a third-party manager. I would suggest that leasing is a financing strategy. The lessee essentially has 100% finance to acquire that asset. It's not a management strategy: the fundamental efficiency and quality of the management service needs to be there, whether there is a lease or not. So, we do see ourselves also increasingly managing for lessees, where of course we would be managing under the same sort of basis a management agreement basis, but we're managing for the lessee not the freehold owner, necessarily.

Where are we focusing? We obviously continue to focus on all of the key markets where we were, and where we are. One of the previous presentations also pointed to what we see: increasingly interesting opportunities in the wine countries, as I think as Giorgio referred to it. We see further brand and management consolidation in those countries, which is an interesting trend for us. We believe that the majority of our growth is going to come from the key markets: still UK, Germany, France, Spain, Italy, Belgium, Netherlands, with also some focus on these peripheral and slightly smaller European "wine" and Southern economies. I won't spend too much time on this, but there is a sea change going on in the Middle East. In our part of the business, there is no third-party management there to speak of. There is essentially 99% to 100% brand management there. We are seeing significant change as the fundamentals of that market continue to slide a bit due to socio-political issues there as well as supply and demand issues. That will become an increasing focus for us, as well.

On France: we have looked at France quite a bit over the last decade. We've never managed hotels here. But, we do have our first hotel, the Hilton Garden Inn Orly, opening at the end of this year or the very beginning of next year in about a month or two, we will have a Holiday Inn Express a bit further out from Orly. Just this past week, there was some press about Hilton signing a canopy Paris deal in central Paris, in a historical listed building, to be managed by Interstate, as well.

I would say again: traditionally, in the Anglo model, it's all about straightforward management as a service provider. Within Continental Europe, it's a bit more flexible and more capital heavy.

While we're not wholly owning any hotels and we're not directly leasing hotels, there is a mix of other financial incentives and opportunities to invest a bit of capital, to drive a management business. Whether that would be minority investment in a LeaseCo with a certain amount of limited GOP, or owner return guarantees, key money, minority equity, or investment in working capital and renovation loans. Again, these aren't leading strategies for us, but they are requirements to grow our core management business in the region.

About third-party management: We see a lot of managers that are essentially owner-operators. This would be a little bit more the traditional model perhaps some of you may think about such as independent management companies that own and operate their own assets and then say, "Oh, well I may as well go manage for others." They could be quite good at what they do, but I would not consider them as premier third-party managers whose DNA is really designed around managing for others.

We see managers that are led in their strategy by real estate investment, and then following that, will say, "Well, how do I figure out management? Perhaps there's a certain solution on the management side that I can apply to this investment." That's not what we do. We lead with the management solution and if we need to, behind it, give some sort of a financial incentive, then we do it that way. So, our reason for being is clear; we're essentially all about the management service. We own no hotels. We have none of our own brands: in fact, we're not allowed. We essentially just manage hotels for owner-clients under management agreements and our entire focus is on making our platform essentially brand agnostic.

I don't want to belabor this too much, because you know size matters, but also size frankly can scare away a lot of our clients. So, it's never a selling point that we really use, but in certain aspects of the business, it does matter. About 3 weeks ago Interstate Hotels & Resorts, which has been around for 60 years, merged with a company called Aimbridge Hospitality. They have been around for about 20 years. Interstate was managing about 600 hotels; Aimbridge was managing about 800 hotels, a little bit more on the select service side. The companies were roughly about the same size. Most of what both companies do is in North America. Three weeks ago, Interstate and Aimbridge completed their merger. We're now the combined company managing about 1,400 hotels, which in our world, in a third-party sector, is large. It's actually more managed hotels than some of the recognizable International Brands currently manage.

Here are a few numbers. 210,000: the number of hotel rooms that Interstate currently manages (I should say Interstate Aimbridge, because in North America we are now called Aimbridge.) 50,000 employees that we manage directly. 1,400 properties and roughly the number of sales resources that we have around the world, which is an important point. 60: the number of brands that we’re managing under. And, 20: the number of countries that we’re currently managing in.

How does it matter, and then we'll talk about how it doesn't matter. Leveraging our scale, better procurement and ability to negotiate better service agreements on behalf of owners. Continuing to be an employer of choice. Strengthening our brand relationships. Just as an example: Marriott Brands. We're managing over 500 hotels for Marriott.

Developing proprietary MIS tools. An interesting point as well: we are getting to the point where, size-wise, with all these sub-sectors of the hotel management business whether that would be select-serve, full-service, resort, lifestyle, extended stay, service department. We are very much developing specialized capability within our company to specifically address those sectors, oftentimes as stand-alone teams that are then supported by some of the underlying offerings like procurement, etc.

At the end of the day, though, what really matters (and this is where we get away from size) is you can drive profitability through better procurement, etcetera etcetera. But, it's really all about the person standing in front of the owner doing interfacing on a day-to-day basis with our owner-client. For example, Thomas is one of our Regional VPs of operations and sits in Amsterdam. He manages, for the moment, most of our hotels in Benelux. He's got 20 years experience as general manager, regional, etc. But is his capability the same if he's working for an Interstate as if he's working, for example, for an owner operator? This is where we try to plug him into the power of Interstate to effectively make him bigger and more capable than perhaps he would be under a under a smaller manager.

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