Like parenthood, business management is something anybody, after some minor paperwork, can engage in. But that doesn't mean they'll be any good at it.
If your investment thesis for a company you own implies that management is capable and well-intentioned -- and most theses do -- it is important to verify that your managers are, well, capable and well-intentioned. That's why I recently sat down and chatted with Pebblebrook Hotel Trust
Pebblebrook is currently the largest holding in our Young Gun Portfolio, and our investment case rests on management's ability to buy hotels for less than they are worth and then squeeze every last drop of value out of them. My chat with Mr. Martz cleared up some previously hazy pieces of the Pebblebrook puzzle and strengthened my confidence both in the company's management team and our investment. Here are the highlights of our conversation.
In hotels, relationships really matter
If you had a hotel you wanted to sell, you couldn't just go outside and stick a for-sale sign in the ground. Besides the inefficiency of such a tactic, advertising that a hotel is for sale is anathema for hotel operations -- nobody wants to book a room or schedule a conference in a hotel that is changing hands or might not even be open in a few months. Instead, hotels are sold through a variety of counterparties, including brokers, servicers, banks, management companies, private equity funds, pension funds, and other real estate investment trusts. If you want to buy a hotel, you better know these people -- and Pebblebrook's executives do. In fact, they've already purchased at least one hotel from each of these sources, and about a third of their deals were closed off-market, meaning the properties weren't even available to other buyers. That's the power of relationships in the industry.
Operational improvements are real
When I first bought Pebblebrook, I wrote that "I'll believe it when I see it" in regards to the operational improvements management claimed they could make at some of their new hotels. Well, now I see it.
After buying a new hotel, Pebblebrook runs through a well-worn process. They send in teams -- such as a food and beverage team -- to look for ways to make operations more efficient. Martz explained that things as simple as installing electronic scales at loading docks to make sure they are getting all the food products they are paying for can go a long way. At the Sir Francis Drake in San Francisco, for example, their teams were able to uncover $250,000 of operational savings soon after the acquisition. This is part of the company's asset management program, which they roll out at each new hotel. I hadn't banked our investment on it, but a quarter-million dollars of savings is very real.
They have no problem saying "no"
Pebblebrook's executives know exactly what they are looking for in a hotel. They want a unique, upscale asset (two of their hotels are historical landmarks) in one of the 15-18 largest, mostly coastal U.S. cities. Within that space, they then want a property they can acquire for 20%-25% below its replacement cost and that they expect to offer a 10% to 12% unlevered return. Those criteria usually offer slim pickings, but the Pebblebrook executives are seeing waves of these top-tier hotels changing hands.
A whopping $40 billion in hotel loans, representing 1,540 properties, are either distressed or in default. During 2010, Pebblebrook evaluated about 100 hotels that met their investment criteria. They bought eight. That shows two things that I like: They are getting the cream of the crop, and, more importantly, they have no problem saying "no" to a deal if they don't like it.
They respect the limitations of their model
Pebblebrook is a unique company, even among hotel REITs. They are very hands-on with their properties, as the operational improvements they've milked demonstrate. Their model requires that the executive team take a close look at every property every month. Such close management simply isn't feasible for competitors such as Hospitality Properties Trust
This system also means that there is a limit to how many hotels Pebblebrook can own. Management is keenly aware of this, and though they can't identify for certain the magic number of hotels (Martz suggested that 50 might be the maximum), they respect the boundary. The team has no particular penchant for activity -- they'll buy hotels when they can get good deals, sell them when they can fetch excessive prices, and happily sit on their hands otherwise.
The Foolish bottom line
In my opinion, there are many more businesses out there than there are good managers. In Pebblebrook, we have a great business opportunity coupled with a great management team. My chat with their CFO reaffirms to me that we checked into the correct stock.
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