DEAL OF THE MONTH (March 2017): Started as a family business with two premises in 1995, Generator Hostels has grown into a European platform for millennials with €70 mln of annual revenues.
Taking a page from the canny traveller's well-thumbed travel guide book, investment managers are treading a less explored avenue into the all-important hospitality sector. Patron Capital was one of the first major entrants into the hostels market in 2007. Seven years later, Invesco saw the opportunity in the sector too, taking a minority investment in Patron-owned Generator Hostels in 2014. And in the last few months, TPG and Queensgate – both seasoned hotel investors – have deployed hundreds of millions of euros to buy two major hostel platforms, A&O and Generator Hostels.
Budget versus boutique
The hostel transactions share a number of similarities. They were both large in terms of the number of properties. Both acquisitions were also straight out of the private equity handbook: tapping into existing platforms that generate significant cashflow and expanding them further by providing additional capital and expertise. The similarities end there as the two hostel platforms serve a very different customer base.
The real estate arm of Texan private equity firm TPG struck first, landing on the budget side of the hostel market. On 4 January TPG Real Estate announced that it had acquired A&O Hotels and Hostels. The business operated 20,000 beds across 31 assets primarily in Germany, making it the largest privately owed hostel platform in Europe.
Having travelled widely in 1990s as a student, Oliver Winter founded A&O in 2000 to fill a gap in the German hotel market. He targeted the budget traveller, and organised school trips in particular, seeking an affordable and well-run central location without having to pay a membership fee to a youth hostel association. Winter is staying on as CEO to work alongside TPG as it expands the platform into more European markets.
'A&O is a strong operator that is well positioned to capitalise on favourable global and European travel trends,' said Anand Tejani, partner at TPG Real Estate. 'Over the last number of years the sector has experienced rapid growth, particularly due to an increase in travellers in search of affordable, reliable, lodging options. Oliver has built a great business that addresses this demand. We are excited to partner with A&O to expand and enhance the platform.'
Generator Hostels was acquired by Queensgate for €450 mln – believed to be the largest deal ever in the hostel sector. It will likely provide a big return for Patron, which used its Fund III to acquire the fledgling Generator business in 2007, widely considered the first major investor to identify the opportunity in the highly fragmented hostels market. The seven largest chains represent only 1% of the properties globally, according to CBRE research. Moves are afoot to build up hostel platforms to fill the gap, but there are only a handful as cohesive as A&O and Generator, and none of a comparable scale are believed to be on the market.
Family dream
Generator had somewhat similar beginnings to A&O, and also plans to grow significantly. Louise Duffy and her brother Kingsley created Generator in 1995 around a building the Duffy family owned in Bloomsbury, London. Seven years later they added a leased property at Prenzlauer Berg in Berlin. In a departure from the traditional hostel model of cheap and cheerful, the Generator’s website explains that the Duffys decided their hostels would provide a whole new dimension of cool, social travel accommodation and public spaces for the young at heart. 'Our mission is to become the world’s leading design-led hostel brand. We do so by offering stylish, cool yet affordable accommodation in centrally located hostels with event-led, soulful social spaces.'
Enter a Patron
The main impediment was lack of sufficient capital – until Patron Capital, a specialist in property-backed investments – came on the scene in 2007. 'We bought an existing company from a family that had the idea but not the capital or a large international team to grow it,' said Keith Breslauer, managing director of Patron.
The business plan could have been derailed by the global financial crisis that struck a year later. If anything, the crisis had the opposite effect. 'We decided we weren’t going to sell the business, but rather think of the crisis as an opportunity to grow. So, we went out and bought distressed properties around Europe that we converted into hostels and grew Generator into a fully fledged platform. ‘The core attraction was that the assets were able to generate a lot of revenue on relatively small spaces that had no real alternative uses,' Breslauer noted.
Ten years later the Generator portfolio comprises 8,639 beds across 12 operational assets, mostly freehold, and two more under development. The network covers London, Paris, Copenhagen, Amsterdam, Dublin, Hamburg, Barcelona, Berlin (Mitte and Prenzlauer Berg), Stockholm, Venice and Rome. Generator is opening hostels in Madrid and Miami, Florida this year. Visitors can stay in their own room, or share at a cheaper rate. Everyone gets the benefit of ‘super’ quality and free internet.
With a number of key hires, including CEO Fredrik Korallus, who formerly led brands such as Radisson Blu – the team has been expanded in both strength and breadth. Revenues are running at more than €70 mln annually. The key, according to Breslauer, is the millennial reach. 'Over the last 10 years we invested a lot in the common areas to make it feel like a destination. People want to stay to hang out in the common areas and meet people like themselves. This was not the case with the old hostel model.'
Having a strong food & beverage offering is a clear difference between Generator and A&O; the latter's mainly younger guests aren’t allowed to drink alcohol, and don't have the same level of spending power.
Time to exit
This begs the question why Patron and its partner Invesco Real Estate sold Generator. The quick answer from Breslauer: 'We had it for 10 years and it was time to go.' Fleshing that out, he said Generator had reached a point where it is now much more of a private equity play than a property company. 'We are good builders of businesses – the first stage – which are real estate-backed. We are not really focused on the later stage evolution.'
This was the rationale, for instance, behind Patron’s sale of the Motor Fuels Group in the UK in 2015. Patron had acquired a 87% stake in that business, reportedly for about £28.3 mln, when it owned 48 filling stations in 2011. Over the next four years Patron grew the platform to 373 sites, and then sold the expanded platform to private investment firm Clayton, Dubilier & Rice for £500 mln (around €679 mln).
In Generator's case, Patron was approached by a potential buyer about a year ago, and on the foot of that investment bank Lazard was mandated to organise a formal sales process. This generated 30 bids, of which about six, including Queensgate, were serious contenders.
The bids spanned the range of investor types and hailed from the UK, the US and Asia. Queensgate, which is well capitalised and has a track record of good platform investments, emerged at the top of the pack.
Founded in London by Jason Kow, Queensgate is a venture between the Kow Family, the LJ Partnership multi-family office business which has a 49.9% stake in Pradera, and the Peterson Group of Hong Kong.
Kow was previously head of real estate at asset manager SPQR Capital and before that worked at Credit Suisse Private Equity. His acquisitions director Fred Hines was familiar with Generator as he was vice president of hospitality at Patron for three years up to August 2014. Queensgate intends to hold Generator for the long term and to invest more than €300 mln to add more hostels to its network.
