Wednesday, August 7, 2019

Extended Stay America: Rejects Split-Up, Underlying Value Here

Extended Stay America (STAY) is the last remaining public company of size that is an integrated hotel operator and owner of their real estate in the United States (other than Hyatt which is family controlled).  As their name suggests, they compete and are the largest player within the extended stay lodging segment where the average guest stays anywhere from a week to several months.  Demand for the extended stay segment is typically not leisure driven, but rather temporary business assignments, training, relocation bridge housing, medical, or other needs that could span a few weeks.  Extended Stay America has a unique corporate structure where the publicly traded STAY is a "paired" stock, underlying STAY is a hotel management company ("Extended Stay America Inc") and a REIT ("ESH Hospitality Inc"), this structure provides most of the tax benefits of a REIT without the conflicts that can arise between OpCo and PropCo.  ESH Hospitality is 43% owned directly by shareholders via the paired stock structure and 57% owned by Extended Stay America Inc which pays corporate taxes on the dividends received from the REIT.  In the summer of 2018, the company announced it was exploring strategic alternatives with most assuming either a true spinoff or a sale of the management company to one of the hotel brand aggregators with a simultaneous spin of ESH Hospitality (similar to LQ/CPLG/WH last year).  Today, along with earnings, the company announced that it had concluded its strategic review and was going to maintain the status quo, the stock fell 5-10% on the news.

It had been over a year now since that strategic alternatives announcement, the first quarter conference call got a little chippy and some fatigue had built up in the investor base.  Given the relative size of the franchising business and where multiples in the sector are today (especially on the REIT side), I think the company made the right move and event driven sellers (along with the general slide in the market) are providing an opportunity to pick up shares of STAY at a discounted price.

Most of the value is in the real estate and not the management company (unfortunately), as of 6/30, the REIT owned 554 hotels with 61,500 rooms, the management company managed an additional 73 hotels for third parties with 55 more in various stages in the pipeline.  By maintaining the status quo, it allows the franchise side of the business to build up with new construction or conversions, plus ESH plans more asset sales to third parties.   But eventually, the company will succumb to pressure and split the company somehow.  How might that look?

Just to give an idea how STAY is valued today, it essentially trades at the bottom end of the limited service lodging REITs group despite not having to pay a third party management company for its owned properties and having a small franchising business.  Sure there is some tax leakage with the pair structure compared with a pure REIT, but the optionality (it's going to happen someday) on the sale of the management business should make it more valuable than REIT peers, not less.
The extended stay business model is fairly high margin (no frills, rooms cleaned once a week) and STAY generates a decent amount of free cash, roughly $325MM on their current asset base using a maintenance capex of 7% of revenues.  At today's prices, that's a 12% free cash flow yield to the equity.  Looking at it another way, using $80MM of maintenance capex on $564 in EBITDA, STAY is trading at 10x UFCF when they've been selling hotels at ~17x that metric over the past few years.  Management did caution today not to assume that 17x multiple on future asset sales, the next round will be their lower performing hotels, but it's still a useful read through to the disconnect between private and public multiples in real estate today.

Back to what a split might look like: ESH Hospitality would be another economy-midscale REIT similar to CorePoint Lodging (CPLG), it would have the most keys of any lodging REIT but a relatively small market valuation.  If we assume that STAY puts a similarly egregious management and franchise contract on ESH Hospitality as Wyndham/LQ did to CorePoint (I don't think this will be the case since most of the value is in the REIT) with a 5% management fee and a 5% franchise fee, I come up with the following back-of-the-envelope breakout between the two:
Sticking with the LQ/WYN comparisons, if we value the management company similarly to Wyndham Hotels (WH) at 12x and the REIT at 9x similarly to CorePoint Lodging (CPLG), STAY would equate to a combined value of $17+/share versus $14.50 today.  Again, I think this is the worst case split scenario as hopefully management has learned a lesson from CPLG and wouldn't put that management contract on the larger piece of the business.  If the market slowdown passes without a recession we could additionally see multiple expansion back to where lodging REITs traded in 2017-2018.  If the management company were sold versus split off, there would be additional upside as the G&A would essentially be wiped out, perhaps $20+ per share in total under that scenario using today's multiples.  To be clear, this split isn't happening in the near term, but it shows the underlying value in their operations and I believe it's only a matter of time before the market really forces management's hands.

Other thoughts:
  • Just one example of the benefit to STAY's management company being part of a larger brand, as a one-brand entity, Extended Stay's loyalty program is small (under 3 million members), plugging the brand into a larger rewards program could prove valuable to people who are on a temporary work assignment and can use their points on a resort vacation versus another sterile Extended Stay property off the side of the interstate.
  • Labor costs are really squeezing hotel operators at this point in the cycle, unemployment rates are so low that they're having a hard time recruiting labor and are mostly unable to pass that additional cost onto customers.
  • STAY increased their buyback authorization, they have $263MM remaining which is roughly 10% of share outstanding, on the conference call they made it clear they intend exhaust the authorization this year.  Alongside a ~6% dividend yield and that's a compelling total "shareholder yield".
  • Their numbers can look a little messy on a year-over-year basis as they've been selling hotels to third parties, to normalize the 2019 EBITDA vs 2018, you would need to add $21MM for the sold hotels.
  • Management also talked about what a recession might do to their results, anywhere from a $50MM hit to EBITDA in a mild downturn to $100MM hit in a more severe recession, taking those haircuts off of current EBITDA means it would be trading at 9.5-10.5x, certainly not a high valuation considering lodging REITs were trading for 11-12x not too long ago.
Disclosure: I own shares of STAY (continue to own CPLG and WH too)

Empire Resorts: Going Private Offer, Possible Bump?

Empire Resorts (NYNY) is a one property newly built casino resort ("Resorts World Catskills") located about 90 miles from Manhattan in the Catskills region of New York.  The Resorts World branded casino cost ~$1B to build and opened in 2018, it has struggled to ramp up in the year or so that it's been open.  Empire Resorts is 86% owned and controlled by Malaysian billionaire KT Lim, chairman of the Genting Group, via a family trust ("Kien Huat").  On August 5th, Kien Huat made an offer of $9.74 in cash per share for the remaining 14% it doesn't already own, shares are trading for ~$9.25 today (shares are pretty illiquid).  While that's not a tremendous return -- a 5.3% spread (but still good enough) -- this has the possibility of following the path of similar controlled buyouts I've written about in TRK and VLTC where to placate the independent directors (and perhaps save them from shareholder lawsuits) the controlling shareholder bumped up the bid once or twice before entering into a definitive agreement.  From a 10,000 foot view, this feels a bit opportunistic, the resort just opened, casinos often take a little time to season and develop a loyal clientele, sports betting is being rolled out in New York state, and the corporate structure is a little strange as it probably makes sense for this property to be wholly controlled under the Genting umbrella.  Just all feels a bit opportunistic and maybe leads to a small bump.

Disclosure: I own shares of NYNY

Thursday, July 25, 2019

Gannett: Rumored Deal with New Media

Gannett (GCI) is the publisher of the USA Today and about one hundred other midsized and smaller daily publications, newspapers are clearly in secular decline and have been for some time.  Newspaper publishing is an industry that went through a period several years back when there was a trend of spinning off the newspaper business from TV broadcasting or other media businesses (current GCI was a spinoff of the original Gannett that was renamed TEGNA).  I participated in several of those breakups and was lucky to make a little bit of money despite the backdrop of the industry, so why not give it another try with two companies I've written about previously potentially merging.

Last week, the Wall Street Journal reported that New Media Investment Corp (NEWM) was in talks to purchase Gannett in a cash-and-stock deal.  New Media is similar to Gannett, just without the USA Today, they own a bunch of small town newspapers and a couple midsized ones.  New Media is externally managed by Fortress Investment Group (now owned by Softbank), NEWM is one of the few operating businesses (non-REIT/BDCs) I know of that is externally managed, it was a spinoff of Newcastle (now Drive Shack) originating as the result of Fortress buying the debt of local newspaper publisher GateHouse Media (the entity WSJ references as the buyer) within Newcastle and later taking control of the post-reorg GateHouse.  Fortress has since used New Media as a vehicle to roll-up the distressed local newspaper industry at low single digit EBITDA multiples and then pay an out sized dividend to attract retail investors (standard externally managed playbook type stuff).

This deal has a hint of HPT buying SMTA's master trust to it, Fortress gets paid a management fee of 1.5% off of New Media's equity, Gannett is a low-quality asset but represents a way for Fortress to roughly double their management fee with one of the last large willing sellers (the other publishers are mostly controlled/family owned) at a price that both could claim victory with given the synergies at stake.  As an asset gatherer, New Media will be aggressive in pursuing Gannett and will likely get a deal done.

As a little recent background on Gannett, earlier this year they fended off a hostile takeover and later a proxy fight from PE owned MNG Enterprises (dba "Digital First Media"), the owner of the Denver Post and the San Jose Mercury News among other publications.  MNG Enterprises offered $12 per share for GCI (currently trades at ~$9.60) but the hostile bid and lack of committed financing led Gannett management to dig in their heels and resist the effort.  While this was happening, Gannett's CEO stepped down in May and the company has been without a named successor since.

How could this be a win for all three parties (Fortress, New Media, Gannett)?  The Wall Street Journal references $200MM of potential synergies being discussed in the deal, which sounds like a lot compared to Gannett's $290MM EBITDA guidance for 2019, and it is, but there is a lot of overlap between the two's footprint and $200MM is roughly 25% of Gannett's run rate G&A expenses, I think there is some reasonableness to the synergy number that a PE manager could extract from the operations.  New Media's stated acquisition criteria is to buy publishing assets at 3.5x-4.5x EBITDA, GCI trades for 5.6x standalone EBITDA of $290MM (mid-point of 2019 management guidance).
New Media can buy Gannett for "4x EBITDA" using a post-synergy number of $490MM and all three parties can claim victory: 
  1. Fortress gets to roughly double their management fee; 
  2. New Media gets a large acquisition within their stated price target to bleed for continued dividend yield, and given NEWM trades at a premium to the industry (due to the high dividend yield) it would be accretive to shareholders; 
  3. Gannett gets a higher price with credible financing than what they turned down earlier this year justifying their actions
Speaking of financing, New Media's debt is primarily a term loan that is owned by CLOs.  The leveraged loan industry is under a microscope at the moment, primary issuance is down considerably year-over-year as investors prepare for lower interest rates (loans are floating rate products) and loan mutual funds have seen 30+ months of outflows.  However the demand for CLOs has kept a strong bid under loans and have essentially created forced buying of risky debt.  New Media is already a familiar name and present in dozens of CLOs, they could presumably finance a bid for Gannett through this channel.  Fortress is a strong PE sponsor and an active CLO manager in their own right.

So how might a cash-and-stock deal look like?  New Media has conventional debt of $450MM against a $180MM LTM EBITDA, or 2.5x levered, if they added the $490MM (let's save EBITDA addback math for another time) and kept leverage roughly the same they could raise enough financing to pay $6-7/share in cash and then issue the rest in NEWM stock.  I'm also including Gannett's pension shortfall in EV, NEWM likes to exclude their capital leases and pension liability from their leverage numbers so maybe they could justify paying on the higher side of my back-of-the-envelope estimates.  Anyway, I think this deal crosses the finish line as Gannett is floundering and doesn't have a controlling shareholder, New Media wants to gather additional assets for its external manager, it's a win-win for a dying industry.

Disclosure: I own shares GCI (and a few calls as well)

Friday, June 28, 2019

Mid Year 2019 Portfolio Review

The calendar can sometimes play tricks on the way returns look, now in hindsight 12/31/18 was a tough determination date skewing my 2018 results to the downside and now is skewing my 2019 results to the upside.  Through the end of the second quarter my blog portfolio is up 58.3% versus 17.9% for the S&P 500, the big first half has pulled up my lifetime-to-date IRR to 22.5%.  Outsized winners this period included KAR and SMTA due to sizable call option positions and then to a slightly lesser extent big wins in CZR, HHC and MMAC.
Often when I post an idea it's sort of an initial indication of interest, usually starting with a 3-5% position for me, and then in the comments section I get more bullish or bearish on an idea.  KAR Auction Services (KAR) was one of these, I liked the idea and the spinoff of IAA in January, posted on it, received some feedback so when the company conducted an odd conference call in February and the stock subsequently sold off, I was ready to act.  Ended up buying a large (for me at least) position in call options that paid off handsomely, although I sold too soon (last week) given the price movements today on the first day of regular way trading.  IAA looks fully priced to me.  KAR looks potentially cheap depending on how you value TradeRev and RemainCo's closest public peer, BCA Marketplace in the UK, was sold this week to private equity for 12x EBITDA.

Other Closed Positions:
  • Caesars Entertainment (CZR):  Eldorado Resorts (ERI) and Caesars inked their cash and stock deal earlier this week with a headline price of $12.75 per share, with much of the cash coming from VICI Properties (VICI) via the sale leaseback of three casinos.  The deal price isn't too far off of what I paid in 2017 for my initial position in CZR through CACQ, but it is a big move from the 4Q lows when the world was potentially falling apart, what a difference 6 months can make in the markets.  Now seems like a good time to back away from the gaming sector, I'm interested to see how the industry does through the next recession, especially with the PropCo/OpCo model that's all but rolled out across the entire group.  I suspect we'll see some opportunities and dislocations there in the future, but for now I'm going to wait on the sidelines. 
  • Spirit Realty Capital (SRC): When the news broke that SMTA had sold the assets in their master trust to HPT, I took the opportunity to exit SRC and roll some of that into SMTA.  SRC will be a vanilla net-lease REIT by the end of the year and it'll probably trade up a bit higher from here as the multiple plays catch-up, but an acquisition by one of the larger net-lease names is likely off the table.  There are enough net-lease properties in private hands that there's no reason for someone like Realty Income (O) to buy SRC, they could issue their expensive shares in a secondary and buy cheap assets directly without the headache and expense of a merger.
  • Mitek Systems (MITK): Mitek Systems ended up dropping their strategic process, they have new management that presumably wants to create value independently (and not lose their jobs), the company has a strong niche, but investing in a small software growth stock wasn't my initial thesis so I sold it for a small gain.
  • Hamilton Beach Brands (HBB):  I was still holding onto a stub position in HBB as a result of its 2017 spinoff from NACCO Industries (NC), ended up selling it as I just didn't have conviction enough in the company meeting its long term revenue goals in the face of increasing pressure from Amazon.  Amazon's advertising model to get into the top of the search results is going to pressure margins going forward.
  • OncoMed Pharma (OMED):  Mereo Biopharma has been a disaster since the reverse merger with OncoMed, it's notably tied up in the Woodford Patient Capital Trust mess and likely has an overhang as a result.  Celgene also decided not to exercise their option on a drug that was 2 of the 3 CVRs in this transaction, chalk this one up as a loss.
  • Voltari Corp (VLTC):  This tiny NOL shell ended up being a home run for those small enough to get into it, the final price was $0.86/share versus the initial $0.58/share offer Icahn made to start things off.
Portfolio as of 6/30/2019:
CVRs: GNVC, INNL, MRLB, OMED
Disclosure: Table above is my blog/hobby portfolio, I don't manage outside money, it's a taxable account and a only portion of my overall assets.  The use of margin debt, options, concentration doesn't fully represent my risk tolerance.

Speedway Motorsports: Going Private Offer, Bump Coming?

Speedway Motorsports (TRK) is the owner of 8 racetracks around the United States, they primarily host NASCAR events and other smaller motorsports promotion races.  The company is 71% owned by founder Bruton Smith and his family, earlier this year a entity controlled by the Smith family (Sonic Financial) offered to buyout the minority shareholders for $18 per share.  This follows a similar path as TRK's larger peer, International Speedway (ISCA) which has agreed to be taken private by the controlling France family (who also own NASCAR).

Similar to other sports, TV broadcasting rights are a major source of revenue for NASCAR, they entered into a 10 year deal with Fox and NBC that runs through 2024.  NASCAR's structure is a little different than others, the governing body is privately owned and receives approximately 10% of the TV revenue, the racetracks themselves are owned by three publicly trades companies (ISCA, TRK, and smaller DVD) which receive approximately 65% of the TV revenue, with the remaining 25% going to the drivers and their teams.  The France family will be merging NASCAR and International Speedway once the deal closes.

NASCAR has struggled since peaking in the early 2000s, television ratings and attendance have fallen through the floor, with many people point to changing the car to make it safer (but leads to dull racing) or to the general decline in interest in cars.  But it still garners media attention, like all sports programming it is something that needs to be watched live and has a niche loyal following that would complain if it was suddenly dropped from cable television packages.  Interestingly, the most recent television contracts were struck in 2012 and 2013 with a 30% increase from the previous deals despite clear evidence that NASCAR was already in decline.  Maybe the Smith family has an inside track on what the next deal might look like?  If so, now is an opportunistic time to take it private, retool the sport and industry structure outside of public shareholder view, with the 5 years left on the current TV contract providing much of the cash to fund the take-private deal.

I can't find any historical news on it, but Chuck Akre mentions in the podcast Invest Like the Best a history with Bruton Smith (well not by name) indicating that several decades ago when Smith took Charlotte Motor Speedway (predecessor to TRK) private and that he had his hand in public shareholders pockets, Akre vowed never to invest with him again.  But since returning to public markets, it appears TRK has acted reasonably with minority shareholders, the Smith family have maintained their ~70% ownership throughout the current iteration's history.  But there is some history here of minority shareholder abuse.

This situation likely follows that of International Speedway ($42 bid in November, followed by a $45 accepted offer in May) and there's a 5-10% bump from the $18 offer price, the market is certainly anticipating one with the stock trading around $18.50 per share.

Disclosure: I own shares of TRK

Friday, June 21, 2019

Command Center: Reverse Merger with Hire Quest, Tender Offer

Command Center (CCNI) is an illiquid micro-cap staffing company providing temporary semi-skilled and unskilled labor to light-industrial, hospitality, transportation and retail customers.  Through a network of 67 branches in 22 states they deployed over 32,000 employees to 3600 customers last year, a sizable operation given their $25MM market cap.  The company has historically struggled with mediocre management, exposure to oil and gas markets and a lack of scale, all of which led to activist investors pressuring the company to explore strategic alternatives in 2018.

On 4/7/19, the company announced a merger with privately held Hire Quest Holdings, effectively structured as a reverse merger where Hire Quest management will run the combined company and Hire Quest shareholders will own 68% (76% after the tender) of the proforma company's stock.  Temporary staffing is a fragmented industry with several large players and then many "mom and pop" type operators. Hire Quest's business is structured as a franchiser, they provide the back office support and negotiating scale on workers compensation insurance (a significant expense for this industry) to its franchisees under the brand names Trojan Labor and Acrux Staffing.  After the merger with Command Center is complete, the company plans on franchising the 67 Command Center branches to mirror the Hire Quest business model.  Interestingly, Command Center previously operated under the franchise model but bought out their franchisees in 2006.

In tandem with the reverse merger, the combined company will be conducting a tender offer of up to 1,500,000 shares at a price of $6 (versus a price of $5.45 today), in the proforma financials provided in the proxy, it shows the current cash on CCNI's balance sheet of $7.5MM being withheld for the tender offer.  They're a little short of the $9MM necessary for the tender, but given the cash build since the Q1 financials came out, I'm going to assume the company is essentially both cash and debt free.  Additionally, since the company will be franchising the current 67 Command Center locations, they should see some cash inflow from those sales.  The 2006 acquisition of 69 franchised stores which formed Command Center was done for 13.2 million shares which traded at roughly $1 at the time of the announcement (data is a bit hit and miss, this was an even tinier OTC stock at the time so my figures could be off), or we'll call it $180k per location which sounds reasonable as the buyers are going to be the store manager or someone looking to own their own job.  If correct, that's another $12MM in additional cash that could be used for buybacks/tender offer or expansion.

In the press release announcing the reverse merger, management provided the following pro-forma commentary:
"If Hire Quest revenue were determined on a similar revenue for the year ended December 31, 2018 would have been approximately $189 million.  Based on our current projections, after some period of integration and normalization, we believe the combined entities will produce annual EBITDA in excess of $15 million, exclusive of growth opportunities."
Following the tender offer, the company will have 12,968,678 shares on a diluted basis, at today's share price of $5.45 (and the assumption of zero net cash/debt, no value to the franchising), the enterprise value for the proforma company is approximately ~$70.5MM.  Against a post deal (could be messy the first year or so) estimated EBITDA of $15MM, the new Hire Quest is trading for roughly 4.7x EBITDA, well below the large publicly traded staffing companies.
Clearly some of these companies have higher quality businesses than that of a sub-scale CCNI, but with a new owner-operator management team in place, a differentiated franchise business model, post deal closing Hire Quest could have a more attractive story to tell investors narrowing some of that valuation gap.  At 7.0x EBITDA, still a discount to the group, shares would be worth $8.10 per share, or nearly 50% higher than today's trading price.  If we want to get a little crazy and use my $12MM cash number from the sale of franchises, that's just under another $1 per share, call it $9 per share total. Originally the deal was targeted to close in the second quarter, but that time frame has slipped a bit, the company is holding the shareholder vote alongside their annual meeting on 7/10/19 with the merger likely to close sometime shortly after it's approved.

Disclosure: I own shares of CCNI

Craft Brew Alliance: Speculating on ABI Qualified Offer

Craft Brew Alliance (BREW) is a collection of craft beer brands formed with the merger of Redhook Ale and Widmer Brothers in 2008, but it is best known for its fast growing Kona Brewing brand of beer.  Originally a Hawaiian craft beer, Kona is now positioned as a beach inspired mass marketed lifestyle beer.  If you're unfamiliar with Kona, they recently did a big media buy during the 2019 NCAA basketball tournament, here a link to one of their commercials espousing the island lifestyle.  CBA is ~31% owned by brewing giant AB InBev ("ABI"), in August 2016 ABI entered into a distribution agreement with CBA that laid out a path for ABI to purchase the remaining ~69% they don't already own.  The agreement has a graduated payout schedule based on the date of an announced acquisition, the first two dates have passed and the last deadline for ABI to make a "qualified offer" for CBA is 8/23/2019, the qualified offer has a minimum of $24.50 per share.

Craft Brew Alliance is an unfortunate name, it's now widely agreed the craft beer segment is over-saturated with thousands of breweries, it's difficult for the mid-sized independent brewers to survive as most craft drinkers have migrated to the ultra-local inside your own zip code breweries.  It's much more fun to show up to a party with a growler of IPA from down the street than a 6 pack from a super-regional brand you can get at any Walgreens.  The original version 1.0 craft brands like CBA's stale Redhook or Widmer brands are in free fall and pioneering brands like Boston Beer (SAM) have pivoted to so called "alcopop" and spiked seltzers.  Similarly, Kona has morphed into a mass-marketed lifestyle brand, their two flagship beers (Blue Wave and Longboard) are relatively easy drinking and light.  A small anecdote reflecting that shift, my old college bar now has "$3 Big Wave Thursdays" as the weekly special, it's no longer "craft brew" if 19 year olds are playing beer pong with it.

AB InBev is viewed as over-leveraged after the acquisition of SABMiller, they also cut the dividend in half last October sending their shares to multi-year lows as they deal with declining beer volumes, but since the dividend cut shares have recovered nicely this year.   Acquiring CBA would be a relatively small check (~$325MM) for ABI to write and would fill a hole in their U.S. portfolio where they don't have the rights to the similarly positioned Corona brand.  Additionally, if ABI passes on making a qualified offer, they would owe CBA a $20MM fee and potentially open themselves up to another brewer making an attempt to purchase CBA, how would ABI feel about a competitor (Constellation Brands?) getting a free ride on their distribution system for the next several years?

But the market clearly doesn't believe it will happen, today shares trade for $13.60, the minimum qualified offer price of $24.50 would represent an 80% premium.  The downside is probably in the $8-9 range if there's no offer, so by triangulating the implied odds the market is telling you there's about a 4-1 or 3-1 chance of the deal being completed.  Let's just assume that's right, an interesting way to speculate on the deal getting done is through August $20 call options which are trading for ~$0.20 per contract.  If the deals consummates, it's likely to be all cash and at the minimum price, so we know the timing and we know the price, assuming a small spread, the calls would move up to ~$4.00 or so on a deal announcement, or a 20-1 payout structure.  I'd love to be able to invest in 30 similar trades to spread out the dispersion, but even on its own its a compelling proposition and I have made it about a 1% cost basis position in the calls.

Disclosure: I own BREW August $20 calls