Leisure industry readies for distress amid prolonged lockdowns

White & Case LLP

Despite encouraging signs that economies could reopen as COVID-19 vaccinations are rolled out, additional waves of infections and extended travel restrictions weigh heavily on the leisure and hospitality industry

The leisure and hospitality sector has been among the hardest hit by the pandemic, with ongoing restrictions and mandatory closures affecting restaurants, hotels and travel companies.

Forced to close their doors and with profits declining steeply, leisure and hospitality companies in the US in particular turned to capital markets to secure liquidity to see them through the pandemic.

For example, high yield bond issuance in the US leisure sector more than trebled in 2020, rising from US$9.7 billion in 2019 to US$35.3 billion. Leisure leveraged loan issuance was flat at US$56.9 billion in 2020.

Leisure issuers accounted for 8.2% of US high yield bond issuance in 2020, making the sector the third-biggest by amount of capital raised. In the leveraged loan market, the sector was the fifth-largest, accounting for 6.6% of loan issuance.

This capital has been a lifeline for many in the sector, where guest numbers and earnings fell at nearly unprecedented rates. US hotel occupancy was 37% in the week ending January 9, 2021, according to Statista—down from over 50% during the same period in 2020. Revenue per available room also showed a year-on-year decline of 47.7%.

The UK hospitality sector trade body UKHospitality, meanwhile, as part of its evidence to the Treasury Select Committee Inquiry into the Economic Impact of Coronavirus, reported that “four in 10 sector businesses stated that they would fail by mid-2021.”

In the UK, the government recently introduced a requirement that travelers arriving from certain countries quarantine for 10 days, staying in managed quarantine hotels. This has provided a short-term, and much-needed, boost to hotels used for this purpose.

Air travel has been similarly impacted—in February, the International Civil Aviation Organization reported a 60% year-on-year fall in air passenger numbers and a loss of US$371 billion of gross passenger operating revenues for airlines.

The picture for casual dining has been similar. By the end of November 2020, restaurant revenues for dining in were 69% down for the year, according to UBS Evidence Lab. The US National Restaurant Association estimates that 110,000 restaurants have already shut because of the pandemic.

In the UK, meanwhile, the government attempted to minimize the damage to casual dining outlets by introducing the “Eat Out to Help Out Scheme” in August 2020. Under the scheme, the government covered 50% of the cost of food and/or non-alcoholic drinks eaten onsite at participating UK restaurants. According to the government, £849 million was claimed under the scheme across 78,116 outlets. But the scheme ended in September and was followed by the re-introduction of lockdown measures in the UK.

According to the Centre for Retail Research, almost 30,000 people working in fine dining, independent and large casual dining chains lost their jobs in 2020. The number of casual dining venues in the UK dropped by 9.7% during the year as restaurants and pubs closed their doors, according to The Guardian.

Sector holds out for now

Despite the severe disruption, leisure and hospitality businesses have not tipped into actual distress, as was anticipated in the early weeks of the pandemic.

In December last year, for example, leisure accounted for only 6% of US bankruptcy filings, less than healthcare (17%), mining (17%), oil & gas (12%) and metals and transportation (12%).

Rather than foreclosing at the bottom of the market, with limited scope to exit assets or manage operations any better than current owners, lenders have opted to waive covenants, extend terms and in some cases lay on additional capital.

For example, cinema business Cinemark US and casino operator Wynn Resorts were both able to secure covenant waivers through the COVID-19 dislocation period.

Leisure companies have also been able to buy time by accessing debt markets, with some coming to market multiple times. Even though they have had to keep their doors shut and future trading has remained uncertain, lenders have still been willing to back these credits.

Cruise line operator Carnival, for example, which took a US$10.2 billion loss in 2020, raised a US$4 billion bond in April 2020, before securing further US$1.45 billion and €500 million bond issues in November 2020. This year, on February 22, Carnival announced it has commenced a public offering of US$1 billion of shares of common stock.

US cinema chain AMC, meanwhile, raised US$500 million from a sale of senior bonds with a 10.5% coupon in April 2020 and, despite undertaking a debt restructuring in July, was able to lock in a further US$900 million of funding during December 2020 and January 2021.

M&A has also offered leisure and hospitality a pathway to stability and liquidity through lockdown disruption, with new groups of investors seeing an opportunity to invest in leisure companies at the bottom of the market in anticipation of the hospitality sector reopening.

The sharp increase in fundraising by special purpose acquisition companies (SPACs)—blank check companies that raise money on stock markets to invest in M&A transactions—is an example of this. According to Dealogic, SPACs raised a record US$82.45 billion in 2020. Some of these funds are being invested in leisure and hospitality deals.

A mixed recovery

Although vaccine rollouts offer leisure and hospitality companies the promise of recommencing trading, it remains to be seen how much the industry has been reshaped.

There are already early signs of a two-pace recovery when it comes to business and leisure travel. Analysis of leisure and business travel by McKinsey following the 2008 global liquidity crisis found that international business travel from the US fell by 13% versus a 7% decline in leisure travel. Leisure travel also recovered faster, taking two years to fully recover versus a five-year year recovery for business travel.

The contrast could be even starker following COVID-19, as businesses have switched to digital conferencing. Many executives may see no need to continue traveling with the same frequency post-pandemic. This could have a long-term impact on airlines, which rely on corporate travelers for the bulk of their margins, as well as hotels that rely on corporate travelers for occupancy.

The outlook for leisure travel is much more upbeat. Choice Hotels, for example, reported a surge in revenue from domestic US travelers through the summer, with Airbnb also noting a rise in bookings for local trips. US campsite listings platform Tentrr recorded year-on-year growth of 400% in the summer and luxury camping website Glamping Hub posted record months in May, June and July.

As economies reopen and businesses and lenders form clearer pictures of future company earnings, more financial distress is expected to wash through the leisure and hospitality space. S&P, for example, forecasts that leveraged loan default rates will rise to 8% by June 2021, with leisure identified as one of the sectors that will lead default numbers.

Whether a leisure business focuses on holiday or business travel could be a key factor in determining which side of the financial distress line it will fall on.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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