City Insider: Can Thomas Cook resist the ‘mega-deal’?

City Insider - A City perspective on the travel industry from FT journalist David Stevenson

Travolution’s new City columnist David Stevenson analyses the prospects for one of the two giants of the UK travel industry Thomas Cook Group plc

Manny Fontenla-Novoa, the CEO of Thomas Cook, is a massively convincing fellow – only he could successfully spin the coming 2012 Olympics as a huge opportunity for his firm.

Its success at winning the franchise to sell tickets is rightly a great triumph but the impact on summer package holiday sales (the backbone of his business) for that year must surely be potentially huge, in a negative way.

But my sense is that the bears on Thomas Cook have been silenced in recent months as its Tui Travel rival has steamed through the worst recession in decades in fine form.

In fact I’d go so far as to say that the recession couldn’t have happened at a better time for both Thomas Cook and Tui.

Demand clearly fell off a cliff but it came just as both were aggressively cutting capacity and building on the vast cost savings triggered by the mergers.

Crucially, both have benefitted from lower energy prices and the demise of key competitors plus some very savvy financial management which has seen Tui, in particular, get away a massive refinancing that included a convertible bond issue.

According to one analyst I talked to, Thomas Cook will also probably be very successful in getting away its own massive debt rescheduling which could include a 6.5% convertible paper issue and a massive new bank facility.

In combined terms this analyst reckoned Thomas Cook could have £1.5 billion in facilities if it wanted, at decent pricing.

Think about it – why wouldn’t you lend to Thomas Cook with its massive cash generation capability, its success at managing the (very) slow decline of its traditional core and its proven dividend payment record.

So, all in all, I’d suggest that those critics and bears who reckoned that package holidays were dead, that retail shops were for losers and that we’d all be booking our next trip to Bodrum via Expedia have currently been proven wrong. Thomas Cook might even currently be a good investment idea. 

The problems I’d suggest are not with the existing model but the future. The future is, as my economics professor once idiotically reminded we naïve types, “an unknown beast”.

Actually I think he was talking tosh, because we know what the risks to Thomas Cook’s plans are here and now. Number one is the internet.

Not as deadly short term predator that gobbles up all those bricks and mortar shops – rather the stated ambition of Thomas Cook to grow their existing business into a leviathan that will rival the likes of Expedia and Priceline.

I can see that Hotels4U has been a stunning success and I don’t doubt that in the B2B space Thomas Cook can hit a confident stride, but I’d suggest that the massive growth in internet booking by Scandanavian customers of Thomas Cook is both a blessing and a warning.

Over 50% of Swedes are booking their summer holiday via the internet with Thomas Cook, and that is a huge success. But what happens if they decide to go walkabout and check out cheaper online competition?

More to the point, what happens if they decide that given all this competition Thomas Cook is nothing special?

Fontenla-Novoa points to Thomas Cook’s success at making its business franchise more flexible – short shop leases and no long term aircraft contracts – but the risks of cannibalising your existing demographic are intense.

Then there’s the “other growth” prospect – all those folks out east in Russia and China.

If I were a senior corporate executive charged with mapping out the future plan , I’m sure I’d be dreaming about building a massive business in the BRIC countries.

I’d be salivating about packing yet more Russian vacationers into my Cyprus hotels and all the cost savings.

And I’d buy all the dribble advanced by the owners of the local BRIC businesses as they justify why I’d pay 236 times earnings, thus paying for that enormous villa in France from the proceeds of the ‘earn out’.

To be fair Fontenla-Novoa sounded utterly convincing when he says he won’t overpay for the Russian business currently in due diligence, but the cynic in me can’t help but think that if he does get away a massive debt refinancing, the temptation to binge will be too great.

My last worry centre’s on the least sexy, least growth-orientated aspect of the future – Germany and the direction of the margin.

The travel business is, of course, largely a lower margin business but there’s nothing wrong with that – a move of just 10 or even 30 basis points in the EBITDA margin can put investors in a trance.

Thomas Cook has set a target of 5.5% net margin, which shouldn’t be too troubling a task if – and it’s a big if – the company can boost the margins in the all-important German business.

Thomas Cook does already have a good margin in mitteleuropa but at 3.5% it’s still a tad underwhelming compared to that 5.5% groupwide target.

Blame all those pesky, well organised, career-minded German travel agents ganging up on evil packagers like Thomas Cook, punishing them for selling their stuff online, plus the massive overcapacity of the four main outfits.

Thomas Cook is currently trying to snap up one of the small players but it’s also clear that ‘something’- whatever that might be – needs to be done and again the cynic in me keeps looking at that mountain of new debt on the horizon.

Surely the temptation to gamble on one last capacity-crunching mega-deal will be too great.

Update: It seems since we met they have already succeeded in pulling off their financing requirement which is, I suspect, great news for all concerned.

Let’s hope it doesn’t all get spent too quickly – please no big cheques in Renminbi or Russian Rubles. Anyway happy to update on the full details, which are below.

One quick note: the interest rates seem pretty competitive with 2017 sterling debt at 775 basis points plus a borrowing facility at 2.75% over LIBOR.

Strengthened financial position following successful refinancing of credit facilities
• £1,050m 3 year bank facility with the ability to extend maturity for a further 2 years
• €400m 5 year euro bond, £300m 7 year sterling bond
• Lengthened maturity, diversified funding and increased available facilities


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