Understanding companies is a fundamental responsibility of an investor. The owner-operator business model is one of the most common and can be found across several industries like real estate, hospitality, gaming and entertainment etc. Here are 3 distinguishing factors between an owner and an operator.
Operators are less capital intensive as they are not responsible for the provision of fixed assets. These are provided by the owners of the assets. Consequently, the balance sheet of operators tends to be very asset-light. Instead, operators are responsible for maintaining their staff base which allows them to operate the required assets. This allows for faster expansion as only additional staff and minor office overheads are required for them to expand. On the other hand, an owner who wishes to expand will have to acquire more fixed assets which is often a costly endeavour.
Operators are paid management fees by the owners which are negotiated at the onset of a contract. While there may be a performance component that is tied to the performance of the business, the bulk of the fees are still fixed in nature. Therefore, operators are less exposed to any decline in business conditions. For example, the revenue of a hotel operator is largely independent of the occupancy rate at the hotel.
Owners, however, are responsible for the working capital requirements and all the operating expenses of operating the asset, including interest expenses. Even when it is the operator’s neglect or incompetence that caused the financial loss, the owner is ultimately responsible for funding the negative cash flow. It is precisely for this reason that well-structured contracts with operators include a performance component.
Unsurprisingly, with lower downside risks comes lower upside potential; any increase in value of the asset over the course of the management contract accrues to the owner and not the operator. Similarly, any improvements in business performance, such as occupancy rates, will also bypass the operator. As a result, the income streams of owners tend to be more volatile as compared to that of operators.
Understanding the different business models is especially important whenever we undertake peer analysis. Companies within the same industries can operate on vastly different models which may result in drastically different margins and valuation multiples. An investor who is unaware of such differences might end up with some very misleading conclusions.