Aimbridge Hospitality’s worst-case scenario in its planning for “black swan” events used to be 9/11. “Nobody traveled. Our revenues went down 17% to 22% the following two years. We built plans around that scenario,” recalls Judy Hendrick, CFO of the hotel management firm whose brands include Marriott, Hilton, and Hyatt.
Then came COVID. “Nobody had ever seen anything like this,” Hendrick says. “We were shell-shocked.”
Aimbridge is not alone in its reaction as the pandemic has ravaged companies in the hotel, restaurant, and retail sectors. According to the American Hotel and Lodging Association, hotel occupancy rates have fallen further than in the Great Depression.
Lodging facilities from economy hotels to pricey spa resorts are feeling the impact. For retail, Moody’s Investors Service predicts the industry’s total operating income will fall by 15% this year. Forecasting the future appears to be an exercise in futility.
“CFO decisions regarding mergers and acquisitions, working capital, budget allocations, and the like require visibility into medium and longer-term results. But in sectors like hotels, restaurants, and specialty retail stores, this visibility is limited to nonexistent,” says Alex Miller, the U.S. and global head of strategy at KPMG.
But amid the gloom, shards of light are peeking through as some companies and their CFOs take the pandemic as an opportunity to reevaluate tried and true business models and embrace innovation. Examples include Aimbridge, which is looking into managing non-hotel properties; Now Optics, an eyeglass retailer that has invested in telemedicine; and Anthony’s Coal Fired Pizza, a restaurant chain doubling down on digital.
“The most resilient companies in the sectors hit hardest by the pandemic share an ability to shift and adapt rapidly to emerging tailwinds, reallocating capital quickly to capture this momentum,” says Andy West, global co-leader of the M&A practice at McKinsey & Co.
Sums up Bill Casey, EY Americas vice chair, strategy and transactions: “The path to recovery in these sectors involves rethinking what you are, what you do, and who you serve to generate new income streams.”
Private equity-backed Aimbridge is a hotel management behemoth, having acquired its largest competitor, Interstate Hotels & Resorts, in 2019 for $1 billion.
According to CFO Hendrick, Aimbridge manages $10 billion in revenue for its owners. But with the pandemic, sales plunged 86%. “We’ve gone down several paths in weathering the crisis, beginning with telling our investors and lenders that we do not fear downturns; during such times, we have an opportunity to gain market share,” Hendrick says.
In one innovative move, the CFO recently invested in a state-of-the-art procurement platform to reduce food, beverage, fixtures, landscaping services, and other traditional hotel expenses. “We have the purchasing power … to extract significant volume-based savings,” she notes.
Another change involves fragmenting operations across eight verticals, each one a specific kind of hotel enterprise, such as economy, resort, five-star, and corporate hotels. Each vertical will have a separate full-service leadership team consisting of operations, sales, marketing, and revenue management staff trained in that segment’s business nuances.
Hendrick’s most out-of-the-box idea is to offer Aimbridge’s expertise in property management to adjacent industries. Those include senior living centers, student housing, multifamily communities, and even automotive service chains.
“Our hotel owners and investors believe it’s natural for Aimbridge to move into senior living, which has no professional third-party management,” she explains. “If we go in that direction, we could use hotel properties to accommodate [an adjacent] business. We’ve reinvented hotel operations. Why not do the same for other industries?”
EY’s Casey endorses the strategy. “Step one for hotels is to repurpose their physical assets and entertain adjacent business opportunities,” he says. “I can see value in hotels serving business travelers by offering long-term leases on empty rooms as an executive pied-à-terre, saving corporations from having to rent apartments in cities like New York and San Francisco.”
For his part, McKinsey’s West suggests that with many companies expected to shift toward a hybrid physical-remote workspace, “perhaps some floors of a hotel can be set aside for flexible shared workspaces. Hotels need a strategy to make ends meet until the core business comes back.”
COVID-19 eradicated months of revenues for “nonessential” retailers, according to a late August report by Moody’s Investors Service, which posited a 25% to 35% plunge in total operating income in 2020. Due to a surge in online shopping trends, Moody’s analysts project that mall store footprints could shrink by 20% in the next five years.
But essential businesses have had their challenges, too. Now Optics is the country’s largest independently owned retail optical chain, with 150 company-owned stores and 30 stores at brand franchises like My EyeLab and Stanton Optical.
Although it is an essential business immune to state lockdowns, a sharp decrease in customers in March forced the closure of more than 70 stores, causing revenues to “screech to almost zero,” says CFO Bill Aurilio. “We’re a fast-growing midsize company, but we don’t have access to a billion-dollar line of credit. What we do have is an entrepreneurial mindset.”
That mindset guided Now Optics in 2017 to invest in a telemedicine solution to provide remote care to patients. Rather than employ an optometrist at each store location, Now Optics developed proprietary software that enables an off-site optometrist to conduct remote eye examinations.
Doctors are paid a fee for each exam conducted, reducing overall labor expenses. “It typically costs between $50,000 and $75,000 annually to employ an optometrist at a store, compared with less than $25,000 to install the new equipment,” Aurilio says.
The investment in telemedicine is paying off during the pandemic by limiting physical contact between people. Without it, Now Optics could have been devastated. “The 40% of the stores we shut down were those without the telemedicine offering,” Aurilio says. The remainder stayed open to provide eyeglass examinations, its primary business and most profitable enterprise.
Now Optics also renegotiated lease contracts with its landlords to successfully defer a percentage of rent obligations. The company applied for a Payroll Protection Program loan, qualifying for the financial relief in April.
“While our competitors were closing all their locations, we kept most of ours open for business,” Aurilio says. “We were able to promote a low-touch interaction that kept the lights on initially and then spurred dramatic growth.” May and June were the best months in the company’s history for sales and profitability, with franchise locations posting 50% growth in comparable sales, year-over-year, across the chain, according to Aurilio.
Now Optics is setting aside capital to provide remote examinations at all Now Optics’ stores and expanding through agreements with six existing franchisees to add another 38 locations. “It amazes me when I look back to the middle of March that I wondered if I had just received my last paycheck,” he marvels. “By June, we were in turnaround mode, and now we’re in growth mode.”
A similar story is unfolding at Red Wing Shoe, the work, safety, and lifestyle footwear brand founded in 1905 to serve workers in the logging, mining, and farming industries. It now sells its iconic shoes at more than 500 U.S. stores and in 100 countries. In March, CFO Ralph Balestriere planned for a worst-case scenario of a 55% revenue decline in the second quarter and a 25% decline for all of 2020. “Fortunately, we did much better than that,” he says.
Although Red Wing’s stores, tannery, and two manufacturing sites were closed from mid-April to mid-June, online orders with curbside pickup kept the cash register ringing. The stores’ locations in strip malls with adjacent parking minimized the social interactions that might be risky at stores in large indoor malls. “Our e-commerce business grew 80% during the shutdown,” Balestriere says.
Nevertheless, the going was tough. Demand from the oil industry, a significant market, and Red Wing’s lifestyle shoes and accessories brand Heritage hit a wall. According to Balestriere, the company’s fashion business is down 25% this year “since most people working remotely at home are not dressing up.” Demand for its recreational line of shoes has also fallen significantly.
To preserve cash, Red Wing has managed inventory downward by 18%, or $30 million; curtailed new styles; furloughed nearly half the workforce; negotiated rent deferments with landlords; and renegotiated payment terms with key vendors. As a failsafe, Balestriere put together an agreement for an additional layer of capital on top of a revolving line of credit. It turned out the money wasn’t needed as, when Red Wing stores reopened in mid-June, pent-up demand for products exploded, increasing 13%, year-over-year, in the following months. “We’ll be cash positive for the year,” Balestriere predicts.
Looking ahead, Red Wing is undergoing a digital transformation into what Balestriere calls a B2B2C (business-to-business-to-consumer) enterprise. Previously, industrial customers like Waste Management were given paper vouchers for their employees to buy work shoes at Red Wing’s physical stores. The vouchers are now digitized.
“We’re completely digitizing the buying experience, something our competitors in the industrial space aren’t doing,” Balestriere says, adding, “We’re committed to reinventing demand marketing as a digital strategy.”
The restaurant business is littered with bankrupt chains now, including Chuck E. Cheese, Ruby Tuesday, Sizzler, and California Pizza Kitchen. But still going strong is Anthony’s Coal Fired Pizza, a network of 60 high-end pizza restaurants across eight states. The company’s CFO, Patrick Renna, previously led finance at burger and bar chain Wahlburgers and Mexican fast-casual dining chain Boloco. “There’s no question the pandemic hurt us, with revenues falling 40% back in March, but we’ve bounced back to where we’re at nearly 80% of pre-COVID revenue,” he says.
Anthony’s has benefited from a combination of pre- and post-COVID decisions to refine its operating model, invest in its e-commerce offering, emphasize off-premise outdoor dining, and expand third-party customer delivery services.
When the pandemic erupted, the company adapted quickly, reducing the menu from 32 to 17 items. “It helped maximize profit yields by reducing our capital expenditures in areas like labor and the number of specialty food vendors we do business with,” Renna explains. “Fewer suppliers give us more buying clout to reduce pricing.”
Before the pandemic, the chain had refined its operating model to focus more on outdoor dining. “Our restaurants are relatively small boxes with decent-size [outdoor] dining, so we capitalized on that, making sure tables were appropriately separated to comply with social distancing rules,” says Renna. “During the summer months and early fall, we were able to draw back many customers to dine outside.”
The alfresco dining option should remain robust in warmer states like Florida, where Anthony’s has 28 of its restaurants. In chillier climes such as New York, Massachusetts, and Pennsylvania, the chain has enhanced its online ordering digital infrastructure and provides contactless curbside pickup services. All locations are now open for patrons indoors and outside, weather permitting. Renna is considering adding more restaurants to the chain, including sites formerly occupied by devastated chains.
“It’s something we’re looking at very closely at in our core markets, especially in Florida, where we can manage growth better than in the Northeast,” he says. “With all the bankruptcies and closings, we’re preparing for what looks like a once-in-a-lifetime opportunity.”
Russ Banham is a Pulitzer-nominated financial journalist and best-selling author.
Distressed targets offer M&A opportunities, but economic uncertainty is causingmany buyers to be cautious.
Retail & Consumer
The retail & consumer sector in the Americas saw muted deal activity in the second quarter; however, deal values and deal volumes rebounded in the third quarter by 47% and 17%, respectively. Overall year-over-year deal activity remains lower as deal values declined by 1% and deal volumes declined by 34%. The pandemic has forced the retail landscape to shift as more consumers are increasingly spending through e-commerce channels, which now constitute 16% of all retail sales. Retailers are forced to increase costs from servicing lower-margin online sales as the sector suffers from prevailing distress despite slight growth recently.
Hotels, Motels, and Lodging
COVID-19 impacted the hotel industry particularly hard. With hotels temporarily closing, cutting salaries, furloughing employees, and borrowing money, even global chains like the Hilton were forced to optimize their costs during this crisis.
In the Americas, the third quarter numbers signaled a rebound from the second quarter as deal values saw a 116% increase. However, the volume of deals made still declined by 75%. Compared with 2019 levels, deal values are 30% higher; however, deal volumes still remain suppressed at 95% below the third quarter a year ago. With no signal of a second stimulus bill, hotel lobbyists continue to ask for another relief package to sustain services across the country. As a consequence, expectations for deal activity growth should remain measured in this sector until normal travel patterns resume.
The restaurant industry has been severely impacted by the extended lockdowns and resurging virus. Within the Americas, during the third quarter the industry saw a decline in deal value of 92% quarter-on-quarter and 98% year-over-year. The suppressed deal activity demonstrates the lack of resilience in such a highly fragmented sector, in which independent individuals own and operate a large share of the businesses. The potential $120 billion stimulus relief for restaurants in the United States as a part of the new stimulus proposal has been stalled.
Bill Casey, EY Americas vice chair, strategy and transactions