Safestay (SSTY) - did they just unlock a possible operating model shift?
Moving to the capital light model of operator-brand rather than owner-operator
Current holding - first bought in Jan23 for 15.5p. Sold some in Oct23 for 24p, and last week topped up at 18.9p after a transformative announcement.
I bought more shares in Safestay this week, although it is still a small part of my portfolio, going from below 2% to now just below 3%. I would have probably gone to 4% or 5%, but the trading liquidity here is terrible, so I am limiting to under 3%.
The catalyst for buying was their announcement that they have just signed a management contract for a hostel in Spain. I expand below on my initial investment case, and why my 12-month fair value is around 30p, a +50% potential increase. With the recent announcement, I think a 2-3 year horizon could see this going north of 50p, from the current 18-19p.
A brief summary of what they do
Safestay operates 12 hostels across the UK and Europe, soon to be 14 this summer with the new additions of Edinburgh (owned) and Costa Blanca (the management contract). As you can see from the share price chart, they have done terribly since 2014. Surprisingly, all the shocking was pre-COVID. In fact, they didn’t dilute the share count at all during COVID, which is pretty amazing given that hostels would be the worst impacted segment of the tourist lodging sector.
Their strategy has been to try to build a strong brand around “Safestay”, and continue to acquire more hostels across the UK and Europe. It is messy; they’re part property company, part hospitality operator. And now, it seems, part brand-franchisor too.
In their first full year after COVID (FY to Dec23), they are guiding to meet market expectations - slightly above £6.7m EBITDA and £21.2m Revenues. Of course, they have strong Depreciation, Amortisation, and Interest expenses so I estimate they are just about break-even after all that. Not that great a commercial story, I concede.
However, management are bullish that they haven’t finished the “recovery” yet, as Occupancy was 71.4% for the FY23. In 2019, they had 84% occupancy. The story is that school groups have yet to return in full force; indeed, doing some online research it does seem the case that this segment was slower to recover. And judging by my own observations around central London and other European capitals so far this year, it does seem that more school groups are now popping up.
They have 80%+ gross margins. As a largely fixed cost business, any extra revenue from increased occupancy rates will largely fall to the bottom line in terms of operational leverage.
The second growth driver is from the two new hostels this summer. This will add another +10% of bed capacity to their portfolio. As they’re only opening in summer of 2024, we will probably only see the full impact (especially profitability) in FY Dec25.
The business model
Currently, Safestay is the owner (freeholder or leaseholder) of all their properties, and have 100% operational control in each hostel, as well as controlling the Safestay brand. A fully integrated end-to-end hostel operator.
They have debt against these properties: £9.3m net debt as of Jun23. This would have gone down in H2 (as that is the seasonally stronger period and profitable), offset by the acquisition of the Edinburgh Hostel (£4.3m cash consideration) and also capex spending on getting it ready for opening in Jun24.
In Feb24, their bank (HSBC) was satisfied enough to refinance their debt facilities, along with a savings in interest rate too from their previous arrangement. They don’t quite quantify the savings, but from my limited calculations it looks like maybe just a £100k to £200k yearly savings, so not transformative. However, the key story is that the overall blended cost of debt is going down; which is a good sign that HSBC thinks the creditworthiness of Safestay is improving.
They have a secure balance sheet; my conservative NTAV calculations at FY22 were 25.4p per share. To get this number, I excluded Right of Use Assets (which they hide under Property, Plant, Machinery) as well as excluded fixtures, fittings, and property improvements. If I include those in, I get 30p NTAV per share. Whichever number you take, the 18-19p share price currently is way below NTAV, and doesn’t even take into account the trading value of the business, nor the value of the Safestay brand. The valuations above seem OK, as it looks like the Freehold and Leasehold properties were revalued in late 2021, so fairly recently.
The Gamechanger
Last week, they announced a new management contract for a re-opening of a hostel in Costa Blanca. Safestay will get full rights and responsibilities for operating it, and will use their Safestay brand. In exchange, they will be paid a fixed management fee, as well as a percentage calculated on whether yearly revenues and profits are above a threshold.
This for me is a gamechanger. In this high interest rate environment, their current weak cash position, and also elusive probability… there were not very many options for Safestay to grow in 2024 and 2025. Expanding through management contracts makes sense, as they will be able to do so in a capital light manner. Revenues and profits can grow in the next few years, even if they are unable to raise more capital.
In addition, this is confirmation that there is emerging intangible value in the Safestay brand and technology platform. So Safestay is trading way below NTAV value, and that’s before ascribing any value to their Safestay brand and platform.
There is risk here; we don’t know whether they have negotiated a profitable management contract. It might very well be lossmaking, given this is their first foray into managing other owner’s hostels. In addition, this beach resort hostel is outside their main niche of city centre hostels, so do they have the expertise to run it successfully?
The numbers will only become evident in FY25, given that both the Costa Blanca hostel and the Edinburgh hostel will open this summer, and will take time to get to full occupancy and profitability.
Why I’m Invested
Probably for three main reasons, which I will outline below:
Operational leverage leading to meaningful profits in FY24. I believe that the occupancy rate will increase in 2024, given the return of school groups and the still-strong travel demand into Europe. If occupancy increases from 71.4% to 78.5%, that’s another +£3.3m revenues, and with a 83% gross margin will be £2.74m gross profit. I don’t know how much “variable” costs are actually being charged to admin expenses, but if I assume a 65% operating margin to revenue, then that’s +£2.15m operating profit, which more or less falls straight to the bottom line. The market cap here is only just over £12m, so you can see how improving the occupancy rate can be transformative to the share price.
The property value play here. There is the big 27% discount to conservative NTAV, which of course opens up lots of possibilities, like sale and leasebacks to unlock value. The largest shareholder, Pyrrho Investments (29.5%), is a Hong Kong based family office specialising in property as well as hotels and hospitality. They own several hotels in the UK. They have been long time investors, since at least 2018. And they have a seat on the board. Therefore, there is a possible bidder that is already familiar with the business, and would be able to unlock the NTAV value if they make a bid to take it private.
Operator-Brand business model. It is still of course early days, but if the Costa Blanca hostel is a success, they are then able to roll out more capital-light brand operator agreements. Similar to the model of the big hotel groups - IHG, Hilton, Accor. This allows for a much faster expansion of their hostel portfolio. Right now the current share price does not rate this as a growth share at all. It also allows them to spread out the central costs of the Brand and IT investments across more hostels and beds. In addition, they have started to build out a membership proposition, similar to what hotel brands have done, to make the brand more sticky. This will then mean loyal customers book direct, and Safestay will be able to save commission it is currently paying to OTAs like Hostelworld. However, all this potential is more medium term, on a 3-5 year horizon.
So where do I see the share price going in the next 12 months? At the very least, (1) and (2) would start to be better appreciated by investors. I suspect the HY-24 results will show a healthy improvement in occupancy and an adjusted profit (excluding Edinburgh, Costa Blanca setup costs). This extra profit as well as the NTAV discount should allow the share price to re-rate closer to 30p, which will present a +50% gain from the current share price.
Then in the medium term, FY25 and FY26, we might see one or two more operator management contracts signed, and ignite a valuation re-rating above NTAV, and send this into the £30-£40m market cap range, which will be a 46p to 62p share price range. So there is quite a big potential for the shares here to multi-bag.
The risks, of course, are numerous… The cyclicality of travel. The continued rising costs of labour. The belief needed that occupancy rates will trend to the historical average. Pulling off their first management contract successfully. But at least they now have a strong balance sheet, refinanced debt facilities, currently operating cash flow positive, and positive trading momentum.