Two years ago KPMG looked to the timeshare horizon and saw a number of changes in the Industry.  Our first prediction dealt with the consolidation in the industry. Today, that consolidation is beginning to manifest itself. In late 1996 Signature Resorts, one of the hottest newly public companies in the hospitality sector, acquired a developer with strategic locations in the south-western United States The acquisition helped Signature almost double its size since its initial public offering in August of 1996. Two industry stalwarts, The Shell Group and Grand Vacations Co., merged to form Vacation Break USA, and had all but completed a merger with The Berkeley Group when Federal Trade Commission issues placed that second merger on hold.  But the most important merger or acquisition is the union of HFS and RCI.

Have we seen the bulk of the mergers concluded'? Hardly.

We expect to see an increase in merger activity for the balance of 1997 and into 1998. Why? Historically, the timeshare industry has been incredibly inefficient with poor geographical distribution, span of control problems, and limited product offerings. A merger of companies accomplishes several things.

First of all, it facilitates much more rapid growth than smaller stand-alone entities could ever accomplish. Secondly, bigger is better when it comes to accessing more efficient capital sources. Once again, accessing lower cost of capital pools is an area in which the industry has been notoriously inefficient. Thirdly, we're seeing a combination of intellectual capital. This was especially apparent when Vacation Break USA, a good lead flow company was looking at a merger with The Berkeley Group, a good developer entity. Finally, we also believe mergers greatly facilitate a more comprehensive geographical distribution system and this in turn can lower marketing costs, facilitate the development of a club system, and help enhance closing ratios by providing prospective buyers a larger choice of options. Look for M&A activity to continue well into 1998. and it is likely that we will see the full range of possible combinations: mergers between existing timeshare players, external participants buying into the industry, as well as new and unique product type mergers "such as cruise lines" into the business.

The IP0 Craze

It seems that every time we pick up a paper, another timeshare company is going public. Signature Resorts. Vacation Break, and Vistana, with three or four others waiting in the wings. But why all the focus on going public"?

There have been several reasons, some of which are fundamentally sound and some of which are not.

First the valid reasons. The IPO markets had been blisteringly hot across many sectors, although today the appetite for new offerings is beginning to cool a bit. The hot IPO capital market values companies significantly higher -   due to their focus on earnings and growth - than does the private investment market which concentrates on EBITDA or some other cash flow surrogate. This translates into a higher enterprise value for the owners.

Public companies also have access to more efficient pools of capital. This was clearly demonstrated when Signature Resorts was able to refinance a large portion of inefficient debt with 5.75 percent convertible debentures. In addition, being a public company gives you greater purchasing power by providing a new very liquid currency, company stock. Equity or stock can be more patient capital in the respect that it typically does not have a stated interest rate but rather an implied one. This relieves some of the pressure associated with highly leveraged balance sheets as is common in the timeshare industry.

There are also some less than fundamentally sound reasons to go public. One of those is the "greater fool" theory. While the public markets focused on earnings, ultimately, smart capital wants a cash return on its investment. Because timeshare companies consume so much cash flow, this can often only be accomplished with a capital event, such as an IPO. Even with any imposition of restrictions on the time one must hold stock, many sophisticated investors see this cash-out as the way to recoup their investment, or realize their equity which has built up over many years.

In addition, the investment banks have exploited the recently avid institutional appetite for new lodging-related stocks. And because the investment banks earn substantial underwriting fees in the IPO and subsequent capital transactions, some timeshare companies which simply do not have the historical growth in earnings, a broad-based foundation to their business, or other important qualities necessary for success are being taken public. Watch the rest of 1997 and 1998: we will witness at least three more new public companies  and probably at least one significant failure.

Financial Information Overlooked and Under-Appreciated

Mergers and acquisitions, IPOs, and securitized receivables transactions are all predicated on market yield. Given the right yield, many things are possible. Yet in order to do financial forecasts, earnings estimates, debt service coverage ratios, etc., Wall Street needs information. Unfortunately, information has been relatively poor in the vacation ownership industry. Today some of the most timely information is almost 18 months old (the 1996 Financial Performance Study done by the American Resort Development Association and KPMG). In other cases its almost three years old dealing with the 1993 and 1994 statistics.

Analysts at the investment banks which cover timeshare stocks make earnings projections, which in turn have profound impact on a company's stock price. Yet. some of the investment banks have considered dropping coverage of the public timeshare companies. This could send a significant negative ripple through the industry. Other entities like the rating agencies need timely and accurate information to rate a company's credit worthiness, which translates into yield in the debt rating. The industry must move into the 21st century with a sophisticated and comprehensive information. Good information will attract properly structured capital which is critical for long-term sustainable growth.

With 1997 almost half over, the vacation industry has burst squarely into adolescence, and there will be remarkable growth during the next 24 months, but there will also be a number of blemishes. None of this should be feared, rather it is part of the process of a thriving and healthy industry, one which is consolidating and growing larger.

The Real Estate Report is published by KPMG's National Real Estate, Hospitality, and Construction Practice. © 1997 by KPMG Peat Marwick LLP All rights reserved. For additional information email KPMG.

Please contact Hotel.Online with your comments and suggestions.