Follow the Money: what does the future hold for the Balmoral?

You can never tell in these situations, but it looks like a classic case of putting the goods in the shop window. The group management were quoted, insisting no talks are taking place and the two properties are still very much of the 11-strong Rocco Forte Collection of international luxury hotels. If there were any deal, the group would insist on retaining the management contract. Those with the wherewithal to rest their heads on Rocco’s pillows can sleep easily, appears to be the message.

So does this mean The Balmoral is struggling? The hotel industry is notoriously secretive about its financial affairs, but the short answer is no. True, luxury hotels took a drubbing after the crash, The Balmoral included. Edinburgh’s sector has never properly recovered from losing the huge corporate business that RBS and HBOS used to bring, while 2012 was a bit of a stinker after a couple of years of improvement. Hoteliers are blaming the London Olympics for a 19% plunge in revenues per room. The luxury competition has also hotted up thanks to the refurbishments of the Caledonian and Sheraton and the launch of the Missoni.

The Balmoral remains the one to beat though. It is able to charge the highest rates and is still very competitive on service. According to tripadvisor.co.uk, the hotel is only narrowly behind the Missoni as the most highly rated of the city’s five-star hotels (69% ‘excellent’ reviews versus 71%). The other five stars are still well behind (Caledonian 56%, Scotsman 53%, Sheraton 51% and George 34%).

According to the Rocco Forte accounts, the hotel made more than £3m after tax in the year ended April 2012, having set aside two years of losses in 2009 and 2010. And the picture looks to be further improving in 2013: Hotel analysts Lynn Jones Research tell me that Edinburgh luxury hotel yields jumped 13% in the first quarter and have sold 5% more rooms for the next six months than this time last year. Doubtless Rocco Forte would still like to see it doing a lot better, but The Balmoral is probably better placed than any competitors to make mounds of hay once the sun comes out.

The reason for the possible sale has much more to do with the group as a whole. The trading of most of the hotels has followed the same pattern as The Balmoral: a couple of loss-making years in 2009/2010 and then a recovery. On a like for like basis, trading profits jumped 11% in financial 2012.

Unfortunately this is being outweighed by monster interest payments to service debts of £419m that mean that the company is losing money hand over fist. Four years of back to back pre-tax losses amount to around £50m. Several years ago the banks were concerned enough to make the board sign a pledge that the company would be able to pay its debts.

In the run-up to the crash, Rocco Forte was one of those hotel groups that borrowed heavily to expand its portfolio at a time when credit was easy, trading was outstanding and property values were continually rising. It did this in a joint venture with that speculator of infamous repute, Bank of Scotland, which currently amounts to five hotels in the UK and Europe (though not The Balmoral).

Then the bubble burst, assets have been written down and credit terms have got considerably tighter. Bank of Scotland, now part of Lloyds, no longer wanted to be in the business of building hotels and sold its share of the venture to its partner in mid-2011 for about £15m and about £150m of extra debt. Around the same time Lloyds rolled over Rocco Forte’s circa £320m debts to the bank until 2015. Put these two moves together and you obviously have some mutual back-scratching at play – Lloyds got out of hotel ownership and did not have to call in a big debt. Rocco Forte got four years of breathing space that other businesses might have been denied.

This looks to be a decent end to a difficult episode for all concerned. During nine years of trading as a joint venture, it never made a profit and lost £97m. Rocco Forte says this was the development phase, but there were serious headaches along the way: it sold the Geneva Richemond in 2010 and then walked away from the Prague Augustine hotel last month because its lease was too onerous to make a profit – the only hotel in the collection not owned by Rocco Forte.

Since that deal, the group now says that all of the remaining hotels that were involved are profitable - Brown’s of London, the Lowry, the Amigo in Brussels, Villa Kennedy in Frankfurt and The Charles in Munich. It believes it bought out the venture at the right time and that it will now benefit the group.

Meanwhile it has another fire to put out: it has for at least a year been trying to negotiate a new financing deal with its other lender, Unicredit of Italy, to whom it owes €113m (£96m). Only about €17m needs to be renegotiated but if it can’t be resolved, it triggers a clause that would potentially bring all of the Lloyds debts back into play. Consequently, the auditors had to qualify their opinion about Rocco Forte’s ability to continue as a going concern.

As of the time of writing, negotiations with Unicredit are still dragging on. Management say they are optimistic about a resolution, but Unicredit is a bank in a very troubled country so it would be unwise to hold your breath.

Whatever the prospects here, the group depends on its creditors continuing to buy into the idea that it has trophy assets that are moving in right direction and will trade superbly once things pick up. Barring a Unicredit explosion, the management will be sincerely hoping that the picture is sufficiently brighter by the next big renegotiation date in 2015 that the narrative can continue. Having Sir Rocco Forte at the helm is a great plus here, since he is both a highly regarded hotelier and has a family worth of £250m, but there must be limits before something would have to give.

In the meantime, the plan appears to be to discreetly reduce the debt. The renewed Lloyds facility means they are not under immediate pressure to do so – it’s not in anyone’s interests to accept lower prices for hotels through fire sales – but clearly having debts that are 17 times earnings before interest, tax, depreciation and amortisation is not sustainable. Few businesses can get away with multiples in double figures for long.

Any new additions to the collection will of course be management contracts and not owned hotels, while sources are dropping hints that they would like to switch all 11 existing hotels to this traditionally American model. In other words, The Balmoral and Lowry might just be the start. But if you find yourself ringing their bells for service any time soon, it might be best not to bring any of this up.