A gloomy landscape

InnSuites Hospitality Trust
January 26, 2017

Management’s bearish outlook on the hotel industry may upset some investors

A decade ago James Wirth, boss of InnSuites Hospitality (NYSE: IHT), was looking for freedom in operations. So he removed the REIT status from the real estate company he founded thirty years prior so that he could focus on its day-to-day operations and hence avoid scrutiny by Wall street analysts. And because InnSuites had plenty of net loss carryover on its balance sheet from a prior merger, the REIT status lost its appeal.

Mr Wirth exhorted his shareholders to change the business strategy from the management of hotel properties to the development a booking system and a membership club. Yet while InnSuites recently boasted that the booking system has a network of over 6,000 independent hotels owners, with over 2 million rooms across the globe, it has little earnings to show for it. In its recent annual report, InnSuites recorded a minuscule $20,000 of revenue from this operating segment.

Management explained that the change in business strategy is due to a poor outlook on the hotel industry. But the lackluster operating performance over the past five years is, perhaps, at fault. Revenue per share declined to $1.77 from $1.89 per share; net operating income declined to $0.07 from $0.22 per share; equity book value declined to $0.36 from $0.40 per share; operating margin declined to less than 5% from above 10%; and debt service coverage ratio declined to 0.69 times from 1.19 times.

To develop a booking system is riskier than to manage a portfolio of hotels. First, there is plenty of competition in this space. Marriott controls 30 brands and offers a booking and loyalty program on over 5,700 hotels with over 1.1 million rooms. Hilton offers a similar booking system on over 4,300 hotels with over 715,000 rooms. Second, the concentration on one source of revenue is typically riskier compared the revenue stream from the operations of multiple hotels (before the change, the company had revenue stream from five hotels located in four different states).

Does the share price reflect the risk? InnSuites has listed its portfolio of five hotels for a total sale price of $56 million. With a book value of $20 million and an accrued depreciation of $26 million minus the $21 million of mortgages (and after deducting for capital gains taxes and transaction costs), it is likely that the company will be worth $2.0 to $2.5 per share, aligned with its current share price. Yet because the company is not planning to return the proceeds to its shareholders, a discount on the future value is warranted. 

Freedom is a noble goal but attention to detail is  key to success. David Lee Roth, Van Halen’s original lead singer, used to test a production team’s attention to details by inserting into the contract an “absolutely no brown M&Ms” provision. The underlying logic was that if a production team did not take the time to read the peculiar request, it might overlook safety issues as well. The inclusion of InnSuites, a hotel company turned software startup in the NAREIT Index, can be viewed in a similar manner.■