Reformulation of Financial Statements

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Rezidor’s markets are large oil producers, as for instance Russia, Norway, Saudi Arabia, Qatar, the United Arab Emirates, Tunisia, Egypt, Algeria, Angola and Nigeria. There is a risk that we in future will see oil prices remain on low levels, which has a serious effect on GDP and hotel demand in these countries.

The threat of Airbnb has already hit the hotel industry, but may constitute a bigger threat in future, if the next generation chooses to spend less on accommodation. One possibility to tackle this threat is to follow the tactics of Hyatt and Wyndham, who are contesting Airbnb by investing in other home-sharing start-ups. (Zacks, 2016)

Another risk that Rezidor faces is the risk of brand dilution through the misconduct of franchisees. In order to reduce costs, a franchisee might be incentivized to decrease the level of service, which hurts the reputation of Rezidor’s brands (Rezidor, 2014b). The franchising agreement that Rezidor has with the brand owner Carlson constitutes another serious threat to Rezidor. Carlson might decide to increase the royalty fees for using the brand names or worse, terminate the partnership upon contract expiry.

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The reformulation into analytical financial statements is carried out by separating items belonging to the company’s operations from items that belong to the company’s capital structure, labelling them operating activities and financial activities, respectively. (Petersen &

Plenborg, 2012, p.68). Operating activities are associated with the primary purpose of a business, whereas financing activities are external activities that allow a firm to raise capital and repay investors. A reformulation is typically implemented both on the reported income statements and the reported balance sheets of Rezidor and of its peer companies, resulting in consistent analytical income statements and balance sheets. (ibid, p.68-69) The complete reported and analytical financial statements can be found in Appendix B-F.

6.1.1 Analytical Income Statement

We consider items such as “revenue”, “operating expenses”⁷, “insurance of properties” and

“property tax and rental expense” to part of the company’s operating activities. The same holds for “share of income in associates and joint ventures” as Rezidor specifies that such holdings are to facilitate entry into new hotel contracts in their annual reports (Rezidor, 2015a). We choose to label the item “terminating, restructuring and adding contracts” as an operating activity rather than a financing activity, as it relates to Rezidor’s portfolio management, which is a key operating activity. Similarly, we allocate “depreciation & amortization”, “impairment and restructuring charges” to operating activities. Concerning the latter two items, it would also be possible to allocate these to financing activities. However, as they are recurring expenses throughout the analysis period, we choose to categorize them as operating activities.

Next, we choose to categorize “interest income and expenses” as financial items as they are clearly connected to Rezidor’s financial activities. The same logic holds for “interest-bearing debt”. “Net loss on early extinguishment of debt”, “loss on sale of shares” and “tangible fixed assets” are items that we also consider to be part financial items, as they are the results of non-recurring events. Last, as corporation tax involves both operating and financing items, it is necessary to split the item into tax on operations and tax on financing activities (ibid, p.76).

Such a separation can be accomplished by estimating the tax shield. This is done by multiplying the Swedish corporate tax rate with Rezidor’s net financial income before tax. (KPMG, 2016)

For the purpose of choosing the right corporate tax rate, Petersen & Plenborg (2012) recommend the use of either the country-specific corporate tax rate or the historical average

7 Expenses such as costs of goods sold for food & drink, personnel costs and contract labour.

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effective tax rate as a proxy for the corporate tax. The effective tax rate is calculated as the reported tax for the year divided by the profit before tax (ibid, p.73). We choose to apply the corporate tax rate rather than the historical effective tax rate because Rezidor’s effective tax rate has in the last years been unusually high, averaging 45% in the years between 2011 and 2015. Alternately, we decide on using the current Swedish corporate tax of 22%.

Having derived Rezidor’s tax shield, we can separate the tax on operating activities from the tax on financing activities. By adding the tax shield to the reported tax we obtain Rezidor’s tax on operations. Adding tax on operations to EBIT leaves us with NOPAT. NOPAT is of particular interest for investors, as it displays a more accurate and comparable view of operating efficiency, excluding the tax benefits that companies get from bearing leverage. Lenders on the other hand typically regard NOPAT as the company’s primary source for debt service. (ibid, p.70)

6.1.2 Analytical Balance Sheet

One important aspect to highlight at this point is that there has to be similarity between the analytical income statement and the analytical balance sheet. For this reason, items classified as operating on the income statement, thereby being part of NOPAT, have to be classified as operating items on the balance sheet as well, and be included in the calculation of invested capital (Petersen & Plenborg, 2012, p.76). Accordingly, we classify “investments in associated companies and joint ventures” as operating assets.

We choose to classify “pension funds”, “interest-bearing receivables”, “cash and derivative financial instrument” as financial items, since they are part of the total interest-bearing assets.

Furthermore, we label assets such as “license & related rights”, “machinery & equipment” and

“non-interest-bearing receivables”, as operating assets. We consider “deferred tax assets” to be part of operations since these assets are non-interest-bearing (Petersen & Plenborg, 2012, p.79). Having defined the operating assets, we are able to separate these into current operating assets and non-current operating assets, where the former refers to assets that can be converted to cash within a year.

Turning to the liabilities on the balance sheet, we treat “term” and “current portion of long-term debt” as financial activities because they are interest bearing and relate to the long long-term financing of the company (ibid, p.75). We further allocate the item “derivative financial instruments” to financing activities as it is used for hedging financial risks (ibid, p.78). Next, we

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regard the item “liabilities classified as held for sale” to be a financial liability as it relates to discontinued operations, meaning that they do no longer form part of a company’s core operations. As for “retirement benefit obligations” we consider the item to be a financial liability as it is interest-bearing. (ibid, p.78-79) We treat both accounts payable and provisions as operating items and since we earlier classified deferred tax assets as operating item, we will treat differed liabilities likewise. (Rezidor, 2015a). Last, we consider “equity”, “reserves”,

“retained earnings” and “minority interest”, representing the total equity, as financial items as they are clearly linked to Rezidor’s capital structure.

The reformulation of the analytical balance sheet allows us to calculate the invested capital, both for operating assets as well as for financial assets. Invested capital can be defined and calculated by various methods, but as we based our calculations on the framework of Petersen

& Plenborgs (2012), the following formulas were used.

(2) − = ( )

(3) + = ( )