Hotel groups aren’t out of trouble by any measure but they’re a lot better than they were a year ago.
ALEC HOGG: It’s May 17 2012 and in this Boardroom Talk special podcast, Marcel von Aulock, the chief executive of Tsogo Sun, is with us in studio with results for the year to end March. Interesting to see many of the hotel companies have been complaining, really not preforming well, you guys actually had a pretty good year.

MARCEL VON AULOCK: Ja, we had a pick up in the second nine months of the year, obviously the first quarter was compared to a prior period that had World Cup in it, which is never going to be comparable. But in the second nine months of the year we did see an uptick and we’ve seen occupancies improve by around five percentage points, which is significant.

ALEC HOGG: Explain that in layman’s terms, what does improvement in occupancies mean?

MARCEL VON AULOCK: So we would have been, say, 56%, 57% for those nine months last year and we were at 62%, 63% this year. A good occupancy for a hotel group is somewhere between 68% and 70%, is a long-term sustainable occupancy. So hotel groups aren’t out of trouble by any measure but they’re a lot better than they were a year ago.

ALEC HOGG: Still too many rooms?

MARCEL VON AULOCK: More lack of demand. In our case in particular we service the corporate market and companies [have] cut back significantly since 2008 on travel spend and that doesn’t just get released quickly, you’ve got to have a very comfortable corporate sector before that demand comes back.

ALEC HOGG: It’s your best brand, your best known brand is Southern Sun but you were created through the reverse listing through Gold Reef. So you’ve got Gold Reef City, out south of Johannesburg, we’ll get into Southern Sun in a moment but it’s looking a bit tired, Gold Reef City, do you have any plans to maybe upgrade?

MARCEL VON AULOCK: Ja, the theme park itself did pretty well this year, the casino was refurbished just before we took over that business. So the casino itself is in good nick, the theme park does need some work and we’re in the planning with that at the moment, in particular to redevelop the historical part of it and bring back some of the museum factor that we’ve had there.

ALEC HOGG: There is the Apartheid Museum nearby, so do you find foreign tourists are making that a destination?

MARCEL VON AULOCK: Ja, the Apartheid Museum was, during the World Cup, the most visited destination in the country and it’s an independent organisation funded by us, we provide the operating costs and the capex for it. It’s very much an integrated part of our business but we don’t associate it too closely to the theme park itself for obvious reasons.

ALEC HOGG: The theme park had its problems, didn’t it? M-Net took a couple of swings at Gold Reef City at one point in time, are you over that now?

MARCEL VON AULOCK: Ja, that was about seven years ago, so…

ALEC HOGG: Well, we’ve got long memories [laughing].

MARCEL VON AULOCK: Ja, it was one of those things we did inherit but we’ve solved that. The theme park itself is good, it runs but it needs a refresh, more to increase the footfall and we think we can do more with it, as opposed to just conserve what’s there.

ALEC HOGG: It’s interesting to watch your business though, you always seem to be building somewhere. A few of the examples, The Grace of Rosebank, when that hotel closed down I guess not many people thought Southern Sun would be buying such a small little outlet and yet you paid R85m for it.

MARCEL VON AULOCK: Ja, it was a good opportunity for us, it is small, it’s 75 rooms but we’ve got hotels like that and we’re trying to make it a sister hotel to the Beverly Hills in Umhlanga, which is a very well-known South African landmark, it trades exceptionally well, that’s 80 rooms. The Grace was a nice opportunity because we get freehold title and unlike most hotel groups in the world we prefer to own our properties, it gives you freedom to do what you want, you’re a master of your own destiny. Hotels really have two key issues in life, you must never overgear them and you must watch product obsolescence. Gearing catches you particularly if you don’t own and you’re in a lease structure, etc. So by owning it and by having strong cash flows, backed by a casino company, we can fix a hotel like The Grace and we’re relaunching it as 54 on Bath and it will take its rightful place in that market.

ALEC HOGG: I notice that you’re also – from the commentary to your results – moving more aggressively into Africa, specifically Nairobi.

MARCEL VON AULOCK: We’ve been in Africa for about ten years, so we operate in seven or eight countries outside South Africa. What we’ve done in the last year is we converted what was a management contract in Nairobi to a lease, so we’ve taken it on trading for our own account. Ideally we would have liked to have bought the property but the landlords haven’t let go yet. We also opened up a new hotel in Lusaka, which is a StayEasy Hotel and it’s the first economy product that we’ve done in Africa, which is a little bit different to the normal four star, full service type hotels. A bit of a function of the Lusaka market becoming more sophisticated, so you’ve got shopping centres and retail, we did it in conjunction with Liberty for a pension fund in Zambia but it’s a nice experiment for us and it’s been trading very well since it opened in December.

ALEC HOGG: The Hyde Park Hotel, is that also an experiment, going into a shopping centre in South Africa?

MARCEL VON AULOCK: No, Hyde Park was originally put together by Hyprop, so we manage it for them. Hotels in South Africa work well with shopping centres because you get access to entertainment and food and beverage and so on around it. What’s unusual in Africa, outside South Africa, is the availability of a shopping centre to connect a hotel to.

ALEC HOGG: What parts of Africa are appealing to you, areas that you haven’t been in yet but would like to be?

MARCEL VON AULOCK: More likely to build hotels where we already are because we’ve got an existing infrastructure. In South Africa where we are so well distributed, it’s very easy for us to put another property in Sandton, open it, understand the market, we know exactly what the feasibility involves. It’s quite different going into a new country in Africa and they’re often very small economies. So a city that might be vastly underserviced will become oversupplied by a single 200 room hotel, whereas you can add 1000 rooms to Joburg and not really notice it. The countries where we are in we could develop additional product and particularly economy product where we’ve got a full service, which would give us economies of scale.

ALEC HOGG: You’ve mentioned or we’ve spoken a lot about hotels but a bigger part of your business, presumably, is the casino side and one might have thought in this economic climate it would be struggling?

MARCEL VON AULOCK: It has been struggling for the last few years, we’ve seen casinos not show huge decline but they ran out of growth. What we saw again in the second half of this financial year was accelerated growth in casino win and that resulted in our casino business, which is the biggest part of our business, does about 70%, 75% of our EBITDA, grew by 10% last year, which we haven’t had growth like that for a number of years.

ALEC HOGG: Casino win, what does that mean?

MARCEL VON AULOCK: Casino win is what we keep, so it’s what the consumer, our customers, lose and what we keep.

ALEC HOGG: So just explain that model?

MARCEL VON AULOCK: When you place a bet you might put, say, R200 into a slot machine or R200 on a number, if you lose we keep the R200. If you win, we pay you out, then we’ve won nothing. It’s the net cash that we take becomes our revenue and out of that we then pay our gaming taxes and our VAT, service all our operating overhead and that’s where we make our profit from.

ALEC HOGG: And it’s really a numbers game, you take a percentage of the turnovers because I suppose in roulette you pay out 35 to one and there are 36 numbers plus one number, etc?

MARCEL VON AULOCK: Ja, exactly, so slot machines run generally at about a 5% hold, which means if there’s R100 gambled we will pay out R95 and keep R5 on average over time. Tables generally have about an 18% but far more specific odds, you know what they are because the rules haven’t changed in a hundred years on tables. Slots is more of a churn game, so we keep a much smaller percentage but we have far higher, longer levels of play.

ALEC HOGG: Do people actually win?

MARCEL VON AULOCK: Ja, the difference is nobody gets the R95 payout as an individual, so you’ll lose R100, Joe will lose R100, John will lose R100 and I’ll pay out R300 to somebody else, so over time. But you’ll find there’s quite a sensitivity amongst the gamblers, they understand where they’re getting value for money and what they’re buying is an entertainment experience largely based on time that as long as they get a good experience, they’re not burnt quickly and that they enjoy themselves while they’re there, then they’re happy, they treat it as entertainment spend. Your average visitor to a casino probably spends between R500 and R600, including food and beverage, parking, etc. So it’s like a night out.

ALEC HOGG: And he has a chance, no doubt, of winning?

MARCEL VON AULOCK: Well, that’s why they come.

ALEC HOGG: Do you publicise the big winners?

MARCEL VON AULOCK: No. There’s also less of the…ten years ago the trends were the R1m jackpot, which would go off once a year. The industry has moved to smaller jackpots more regularly, so a place like Montecasino can pay out up to a thousand jackpots in a day on a busy weekend but of much smaller type numbers. It’s very presonalised to the people that are playing but it gives activity levels and that goes back to the entertainment factor of it as opposed to the life altering win. Nobody gambles to change their life, it’s an entertainment event and you’ve got to be able to enjoy that entertainment through winning and losing. Even if you lose over time, as long as you’re getting value for your money while you’re doing it.

ALEC HOGG: So they are mindful of the takeout, as you’ve called it, the amount that the casino keeps. What is the 1% tax or proposed tax in the budget going to do to you?

MARCEL VON AULOCK: If we keep, as a group, R6bn a year in casino win, we currently pay around 22% of that as gambling taxes and VAT straight to government, essentially they want to increase that to 23%. So in our case it’s a R65m charge in addition to the existing taxes. The difference of it is that it’s imposed by National Treasury, whereas the gaming tax environment in South Africa, since its launch in ’94, has been a provincial competence. That’s one of our concerns is that there is a seemingly a disconnect between the provinces wanting to adjust tax and national wanting to adjust tax. Adjusting tax in its own right is a fact of life, government will charge you more or less tax as time goes by. It’s when they act independently of each other and it’s not a coordinated approach and that we’ve been engaging with them.

ALEC HOGG: Isn’t that changing though because it seems rather strange if a casino in the Cape has got a different tax regime to one in Gauteng?

MARCEL VON AULOCK: That was originally set up like that, the provinces were given the rights to determine how they set their tax levels and those indicated in many ways what people would bid. So it was a very competitive environment for the licences when it started and everybody understood a market that they would bid for, what they were prepared to invest in in terms of capital spend on the basis of this would be the area that you would operate in, there wouldn’t be other operators in that area and that you would get a certain tax regime.

ALEC HOGG: You mentioned that you’re going to be sprucing up Gold Reef City’s theme park, what about the Silverstar operation, there seems to be a lot of confusion around it, a licence was granted, take us through the story.

MARCEL VON AULOCK: Ja, Silverstar was part of the Gold Reef Group, so when we bought Gold Reef out we got seven casinos in addition to the seven that the Tsogo Sun Group had. Silverstar is in Krugersdorp, essentially the design of the casino we feel was wrong because it was based very much on the Las Vegas type product offering and what it lacks at the moment is footfall drivers and that’s what we want to put into it. So we’ve got plans in place and we’ve said we’re going to spend about R320m to upgrade the facility in terms of additional restaurants, cinemas, bowling alleys, an outdoor eventing area so we can have concerts, etc. Very much base it on the Montecasino model, which has been enormously successful because I think we’re on phase four or five of development at Montecasino, where we’ve brought in the Piazza, the theatre, we’re up to three hotels at Montecasino, where we started with one. So we’ve got 650 rooms at Monte, which are corporate hotels, it’s made that whole node come alive and that’s what we want to replicate in the West Rand. We saw, we had a festival at the Silverstar Casino in March and the numbers just took off, we had cars parked down the N14 because there’s a dearth of entertainment in that area. We think we’ve got quite a bit of land and space there and we can do quite well out of that.

ALEC HOGG: So entertainment certainly working in the West Rand. What about Montecasino, you’ve had Swan Lake with the Korean ballet dancers recently, many other events that you’re bringing in there, do they work as a marketing exercise or is it actually to boost the casino revenues?

MARCEL VON AULOCK: In the end we make the majority of our money from casino, largely because we outsource a lot of the tenanting. So where the restaurants are and so on are very often a retail type operation for us, we take a rental in for that. The point of running things like the theatre, the Phantom of the Opera is running at the moment, it’s been enormously successful for us, is that our casinos are a local market type casino. So the majority of our visitors come from a 20, 25 kilometre radius. That casino has been there for ten, 12 years now nearly, if you don’t continually change the entertainment offering, people won’t come back. You’ve got to upgrade the restaurants, you’ve got to keep the entertainment factor going. The cinemas are enormously successful and that’s an industry that’s suffering generally in the country but we find the cinemas at our complexes are trading well because we keep the product offering good, you’ve got access to parking, it’s safe. We have to keep that broader entertainment offering because otherwise a casino just becomes a box.

ALEC HOGG: But those events that you bring there, do you subsidise them? Do they make money?

MARCEL VON AULOCK: Most of them we make money out of. So the theatre, for example, of its own right probably loses cash. It wouldn’t justify the R100m we spent to build the theatre. Where we make money is we co-invest in the shows with the producers, so we own 25% of Lion King, we own 25% of Phantom, along with Pieter Toerien and his partners. We’ve made very good money out of co-investing with the shows and it incentivises both us and the producer to get the show right and make sure that we never have dark time in the theatre.

ALEC HOGG: It’s an interesting business model and an interesting business as we’ve discussed today but looking ahead for investors in the next financial year, what can they look forward to?

MARCEL VON AULOCK: Our business has got two key aspects that we rely on, we rely on the corporate market in hotels and the consumer market in gaming. Both of those have shown accelerated growth in the last six months, if that continues we’re in a great position. We’ve got debt of around R3bn and EBITDA of R3.5bn, so our debt to EBITDA ratio is a very conservative 1.3. So we’ve got capacity to invest, we’ve upped our dividend by 20% this year to 60c a share. So we’re producing a lot of cash and we’ve got a lot of opportunities to invest. The part we can’t guarantee is the economy, if the consumer experiences another crunch or corporates have another crisis it will affect us because we have a largely fixed cost base. But the minute we can grow revenues just marginally above inflation, which is what our costs are running at, our flow through is absolutely enormous.

ALEC HOGG: Marcel von Aulock is the chief executive of Tsogo Sun.

Source: Moneyweb