The development of the budget hotel sector has been very interesting to follow, and the latest chapter sees Travelodge looking for financial assistance as it steadily sinks under a mountain of debt and rising costs. Here are some fairly simple numbers to show you how ratio analysis can be used to measure the size of the problem.
Travelodge is one of many companies that were bought up in the ‘merger mania’ of 2006-07 using borrowed money that left it with a highly indebted (or ‘leveraged’) balance sheet. After the credit crunch and recession these debts look awful, and unsustainable. But just how big does a debt have to be before it starts to be a serious concern? Obviously, Travelodge is a big business, so should be able to borrow relatively large sums safely.
This is the ratio analysis bit. A Guardian article presents these figures from 2010:
- Bank borrowing of almost £500m.
- Revenues of £335m.
- Then variable and fixed costs of £287m are removed
- That leaves £47.8m (a value called ebitda which is earnings before interest, tax, depreciation and amortisation; which is rather like depreciation of intangible assets).
How big are those debts? Yes, they are 10 times bigger than ebitda. A 10-to-one ratio is asking for trouble, especially when those 2010 accounts show a huge and rising annual rental commitment. So it looks very likely that Travelodge’s costs will rise, which may well squeeze ebitda further.
The hunt is on for possible saviours, who might pay back some of the debt in exchange for shares in the business. Night club operator Luminar began to sink when its ratio of bank debt to ebitda rose over 2.6 towards 3, as you can read here.