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March 2013

Capital Suggestions

Mountain resorts are getting creative when it comes to financing.

Written by Elizabeth Whalen | 0 comment

The nature of the winter resort business—one that depends on weather and large capital infrastructure and earns cash in seasonal cycles—means financing that capital infrastructure can be difficult under the best conditions.

Of course, recent financial market conditions have not been the best, and those conditions have led some resorts to turn to non-traditional sources of capital finance. But before resorts can determine the best sources of capital financing, they must come to terms with other constraints.

“There is a huge demand for your discretionary dollar running any resort,” says Mike Krongel, managing director of Mirus Resort Capital of Burlington, Mass. That is, consumers are high maintenance, and expensive.

Increasingly high guest expectations and constant technological advances add to resorts’ capital investment options, but managers must account for the costs of meeting those expectations and owning that technology, Krongel says. He cites as examples high-speed, high-capacity detachable lifts, GPS-equipped grooming equipment, and snowmaking.

“All of that costs money. And every guest that experiences it wants their favorite resort to have that latest, greatest technology. They want to go up the hill fast, and they want to come down on a surface that is impeccably groomed and lasts that way all day long,” he says. “All that technology cost comes out of your capital budget and affects EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization).”


CHOOSING WISELY
Those dollars therefore need to be spent carefully.

“If it’s not accretive to earnings, I really don’t think you should be spending on it,” Krongel says. “And that can be a long, twisted path to determine.”

Ensuring capital expenditures lead to increased earnings is no easy task, says Gardiner de Back, senior vice president at Wells Fargo.

“It’s always a challenge. And generally speaking, the ski business is a market-share game. The growth is not significant. You are trying to steal market share from someone else, so you have to have a better product, and you can’t always change the reputation of that product quickly.”

Some resorts have made significant capital investments and expected immediate increases in visits that have taken some time to materialize, says Wells Fargo’s Scott Myers, senior vice president.

“That increased visitation is expected to pay for those improvements, but this is an industry where that’s not always the case. Certainly, over time, it would typically result in increased visits, but I think the mistake people make is how much time it takes for that capital improvement to result in new visits,” he says.

Therefore, Myers recommends resort managers maintain realistic expectations about how quickly capital expenditures will drive returns.

The time it takes for capital improvements to pay off, combined with the industry’s dependency on snow, or at least temperatures low enough to make snow, mean resort managers need to find what Myers calls “patient capital.”

“Our proxy is that two years out of five are going to be bad snowfall years, so you want a financing partner that understands that and reacts appropriately when that happens,” he says.

Myers cites last year as an example of a difficult season, and says that Wells Fargo will change payment and amortization schedules to accommodate clients affected by insufficient snowfall. The bank does not use tough seasons as an opportunity to increase its yield on loans, he says. He suggests resort managers ensure that their financing partners understand the industry and the risks inherent in it, including revenue fluctuations both within seasons and from season to season.


PATIENT CAPITAL: REITS
Two sources of potentially patient capital that have emerged over the last few years include Real Estate Investment Trusts (REITs) and the Immigrant Investor Program, also known as the EB-5 visa program.

The largest REIT operating in the ski resort industry, CNL Lifestyle Properties of Orlando Fla., has acquired 17 resorts and seven commercial villages in North America since 2005. These are now worth about $900 million, says Steve Rice, senior vice president and managing director of fund management for the ski and mountain portfolio.

Typically, a REIT will buy a resort and then lease it to a company that takes over day-to-day operations. Often, that operating company is run by the former owners. This model is generally intended for resort owners who want to realize some of their equity but prefer not to exit the industry, Rice says.

“The operating companies are profitable, and after they pay us rent, they keep the net operating income from the enterprise, and that’s their incentive to stay in the business,” Rice says. “From a guest point of view, often there’s very little to note that is different. The same people are running the resort.”

CNL has invested $220 million total to date in capital expansion for its resorts, Rice says. The amount invested is then added to the lease, and the resort makes payments on the new amount.

“In other words, we get a return on that capital because a tenant will pay us whatever the lease rate is on whatever dollars that we put in. So, if we built a $5 million lift, and the lease rate was 9 percent, that would be a $450,000 increase in the annual rent, and it stays there permanently for the life of the lease.”

Krongel believes that a 9 percent or higher cost of capital can make maintaining profitability difficult, especially in a cyclical and weather-dependent business.

Wells Fargo’s de Back agrees 9 percent is high, but notes other factors influence that decision. “Relative to current financing rates, it’s relatively expensive,” he says. “But this is an exit strategy for the owner. They’re getting their cash out up front.”

And Rice points to other advantages of the REIT financing model. One of those advantages is full financing for capital expansion.

“CNL provides 100 percent financing of capital investments—in other words, no down payment is required from the tenant, and no balloon payments are scheduled,” he says. “If someone is able to find financing lower than our lease rate, they’re typically having to put significant down payments on a loan, and they’re also working with a much shorter repayment window that can result in stressing the organization, depending on how strong its balance sheet and its operating model is.”

Tenants always have the option to use their own financing, Rice says, but CNL typically does not permit operating companies to use financing that would result in a third party putting liens on portions of the resort.

Another advantage to the REIT model is that it can provide financing when other sources won’t. “For a typical ski resort, it’s very difficult to go to traditional sources of financing, say banks, to finance expansion,” Rice says. “During the recession, that funding source virtually dried up, and during that time, we were investing hundreds of millions of dollars with our tenants in our resorts, so steady expansion took place. Market share gains were made during a period when competitors were stuck without any access to capital.”

Wells Fargo has been servicing resorts for nearly 30 years, says de Back, but he notes that there aren’t many banks that lend to the industry, which can sometimes make very large deals difficult to finance.

“It’s difficult to find other banks, if we have to have multiple bank deals, to go into syndication with,” he says.


PATIENT CAPITAL: EB-5
Resort owners interested in another alternative source of patient capital may consider the EB-5 visa program, which Bill Stenger estimates has brought Vermont’s Jay Peak Resort almost $270 million over the last five years.

The program, which originated in 1990, grants permanent residency status to foreign investors, their spouses, and their children (20 years or younger) in exchange for investments that create or save 10 full-time jobs in the U.S. The program requires a minimum investment of $1 million—unless the money is invested in what the United States Citizenship and Immigration Service calls a Targeted Employment Area, which can either be rural or have high unemployment. Investors putting money into such areas are required to provide at least $500,000 rather than $1 million. Jay Peak qualifies as a Targeted Employment Area.

Stenger, who is CEO and co-owner of Jay Peak, first heard about the visa program from colleagues in Canada, a country that has its own foreign investor visa program. About eight years ago, resort management began brainstorming expansion projects that would allow it to generate revenue throughout the spring, summer, and fall. Fundraising for those projects, which include a water park with a retractable roof, began in 2006 through the EB-5 program and continued straight through the financial crisis.

Stenger makes no guarantees to investors about their returns, but says returns typically run between 2 and 6 percent, depending on the time of year.

“That’s reasonable in the U.S.,” he says. “But it’s not the primary thing that motivates [investors]. They want their Green Card, and they want to be able to live and work anywhere in the U.S.”

Raising money through the EB-5 program is not easy, Stenger says. He spends about 80 days a year on the road, and this year he’ll visit London, Dubai, India, China, and Brazil to meet with investors. He hires economists to demonstrate that the job-creation requirements are met, and he works with 50 immigration attorneys around the country to ensure investors have effective legal counsel.

However, the investors do provide patient capital.

“It’s money we don’t have to pay back right away,” he says. “It allows us time to develop and nurture the business and create good outcomes, and that’s what it’s all about for me: having access to patient capital that’s equity based.”

Stenger does caution others that the EB-5 program requires both sustained effort and keen awareness of what investors want. “Unless somebody really understands the responsibilities that the project has to an investor, and is committed to making sure they get what they need, I don’t recommend this to others. It’s not a quick fix. It requires sticking with it.”

Stenger also points out that the money coming into Jay Peak is being used to fund projects for which there is a strong market demand. Jay Peak has primarily used the money raised under the EB-5 program to build up its bed base and amenities, he says, which was ideal for the resort because it lacked sufficient accommodations.

Although de Back has not worked on an EB-5 deal, Wells Fargo’s hospitality team has, and that team has found that the program can prove an inexpensive source of capital for projects that are otherwise difficult to finance. However, deals are not easy to put together, and come with regulatory risk around whether investors will qualify for the immigration status they’re seeking.

Myers says that, regardless of which financing source a resort chooses, it’s imperative that the source understands the nature of the mountain resort business. “It’s a very active portfolio, so you really have to have a good relationship with your financing provider,” he says. “And the financing provider needs to understand that they’re going to have to be working on it regularly, as opposed to just sticking the file in a desk drawer and collecting payments, because there will be seasons when you’re not going to collect your payments.”

Business writer Elizabeth Whalen worked as a policy analyst at the Federal Reserve Bank of San Francisco for four years, where she also wrote for FedFocus, the Fed’s publication for its customers. She grew up skiing at The Summit at Snoqualmie Pass, Wash.



GUEST EDITOR SAYS
I have worked with capital allocations in lean years and fruitful years, and from an operator position, it boils down to a few key elements: safety allocations, functional (recurring) allocations (snowmaking/grooming machines), and initiative and investment return strategic allocations.

The strategic allocations require clear and calculated objectives. Are we growing guest count, adding increased revenue per guest, or driving a new market segment (i.e., Woodward Tahoe), or elongating the earning cycle by adding summer programs? Pricing to the capital investment is the tricky part. How much is the consumer willing to pay for the new lift, the increased snowmaking, or the new youth action sports facility and programming?

The most difficult decisions for owners/operators concern aging lifts and equipment. Buying a high-speed lift is an expensive decision. The initial cost is only half the equation; new technology comes with expensive maintenance and labor. Will that new lift throw off a return by allowing us to raise rates or drive new users? It is very difficult to measure the success of lift replacement when it may not add new terrain and may be an expensive replacement of worn-out equipment.

Staying relevant in an industry that has very expensive operating parameters is tough. In the end, the people on the ground are the ones who truly guide these decisions, as they understand what trends and habits are relevant and will drive sales.

—Jody Churich, former SAMMY winner and SAM Guest Editor