Monday, March 19, 2018

Wyndham Hotels & Resorts: Form 10 Notes

Once again, apologies for being somewhat repetitive, but the Wyndham Hotels & Resorts Form 10-12 came out today and I wanted to update my numbers for a few changes and add some additional thoughts around the spinoff.  The biggest change from my post last week is it appears Wyndham Worldwide (WYN) already incorporates the timeshare-to-hotel group royalty fee in their segment results, which mutes some of the multiple arbitrage upside of creating an expense from the lower valuation company into a revenue of the higher valuation company.
Removing the double counting of Hotel EBITDA brings down the overall valuation a few dollars.
*Edited from original, proforma net debt was incorrect
It was also disclosed in the Form 10 that Wyndham Hotels & Resorts will have $1.888B in net debt at the time of the spinoff, essentially all the purchase price of La Quinta's management and franchise business will be placed on the spinoff which makes sense.  By incorporating the net debt number, we can infer what the target price of each side will be after the spinoff (using my multiples above) which might be useful as there's often significant volatility around the when issued and spinoff dates.
*Edited from original, proforma net debt was incorrect
Other thoughts/notes from the Form 10:
  • After the closing of La Quinta's management business, Wyndham Hotels & Resorts will have over 9300 hotels in their system, making them the largest franchiser in the world by the number of hotels and #3 in hotel rooms (economy hotels tend to be smaller in size).
  • The typical franchisee is a first time hotelier and single property owner, Wyndham has 5700 franchisees for their 9300 hotels, this is a small business in a box type service.  This is likely good and bad, good in that they're not exposed to any one large franchisee and bad in that the net worth of their franchisees is likely minimal outside of their hotel, leaving them more susceptible to distress.  Their value proposition is the single property owner can work with Wyndham and receive the marketing, reservation and technology system of an upscale hotel but for the economy and midscale segments.
  • Royalty fees are typically 4-5%, plus marketing fees of 2% and another 2% of gross revenues for rooms book through their reservation system.  Here's a good place to point out that the economy segment is less pressured by the Online Travel Agencies (OTA's) as the upscale and luxury segments, many of Wyndham's guests are drive-up, meaning they book their room the night of based on which hotels in a particular destination have vacancies.
  • Their two main strategic priorities going forward will be to grow in the midscale segment (to a lesser extent the upscale segment as well) and grow internationally.  Growing outside the economy segment helps strengthen Wyndham Rewards, their loyalty program, by keeping more people within the system, they don't want loyal guests being forced out of the Wyndham system because they don't have a mid or upscale hotel in a desired location.  International growth is an obvious given, about 70% of U.S. hotels are branded, while only 46% internationally, creating a growth runway for the entire industry.  Wyndham could also receive a tailwind from the growing middle class in developing markets, the middle class leisure traveler is the primary target demographic of economy chains.  Their recent purchase of La Quinta's management and franchise business hits both the moving upscale and international boxes.
  • This is the dream asset-lite "compounder" type business model.  Capital allocation will be split between a dividend, share buybacks (starting out of the gate with a repurchase plan in place) and M&A.  They've been an active acquirer over the past few decades:
  • Completing a spinoff isn't cheap, one-time costs add up to $330MM here with $280MM on the parent and $50MM on the spinoff.
Disclosure: I own shares and calls on WYN

36 comments:

  1. Thanks for update.

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  2. Thanks for the update. Very helpful and great analysis as always.

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  3. Can you talk about the specifics of your call strategy (ATM/OTM, duration)? I saw you did something similar w/ Hilton and I'm very intrigued by this.

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    1. Your intrigue might be misplaced! But yes, somewhat similar strategy to HLT, although there I went with more of a LEAP and might do the same here. I have no studies or math to back up this claim, but it appears to me that option pricing models aren't fantastic at accounting for upcoming spinoffs. They typically rely on past price volatility and not future. Then in the case of WYN, the current combined valuation doesn't seem particularly demanding to me, you could very likely (and its my thesis) see both the spinoff and the parent trading at a higher valuation than the combined company today. But at the same time its not incredibly cheap either, but does have a hard catalyst, one way to lever up that smallish (but hopefully high probability) upside with a short time frame is to use options. Duration, typically for me its a couple months after the spinoff; with HLT I went out longer because the spinoff was designed to improve HLT's multiple and that could take some time. ATM/OTM, usually at the money, might not get the same bang for your buck in a big winner, but seems to work for me.

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  4. I imagine you buy these LEAPS a few weeks before the spin. Is that correct?

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    1. Yeah that's about right, or a little before that, just fair warning the pre-spin options usually become very illiquid after the spinoff.

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  5. Would like to pick your brain: I am considering calls for WYN. Would you mind sharing your thought process for Aug. $115 calls? (I have read about this approach in Greenblatt`s Stock Market Genius book -- buying calls that expire from several weeks to several months after the spinoff). In the case of WYN, how did you decide to buy Aug. calls that expire several weeks after the spin, rather than, say, November calls? By buying Aug. calls, are you essentially banking on a very short term spike in implied volativity to make your money? Do you feel this has a higher probability of working than going out to November calls, or longer?

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    1. Just as a table setter, I own the common stock, that's really 99% of the thesis/idea and the calls are really just a way to add some leverage through the event.

      I don't really think of it as banking on a very short term spike in implied volatility, that sounds more like trader/academic talk, I will hold these options through expiration and take the stock if its in the money. The way I think of it, I'm more banking on the spinoff quickly unlocking some value, maybe not all the way to my target of $140+ before the August expiration, but at least part of the way there. In this instance, both the parent and the spin look attractively priced to me, the overall valuation is cheap and WYN is actively dressing up the spinoff to do well out of the gate (buying LQ's management business, earlier this week they sold off Knight's Inn to RHL which itself is trading at 16x EBITDA). The August expiration will be at least 6-7 weeks after the spinoff, maybe more, I think that's enough time for market participants to begin to value each separately, but November is fine too, I don't make too much of a distinction between the two here as the event is almost certainly to happen before either. Longer dated calls is also certainly an option, I might do that as well, but that's more of a bet on the longer term performance of each business and not the spinoff itself. But again, I own the common stock, if I didn't and were only going to play this through options, then I probably would go out longer. Hope that helps.

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  6. MDC -- thank you for your thoughtful explanation, and for taking the time to answer at length. Much appreciated.

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  7. Hi MDC: any particular reason you have considered 11.5x for Wyndham Destinations business. Their competitors are 18x and upwards. Thank you for sharing great work and responsing to commments with equal sincerity.

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    1. Thanks — I’d like to be wrong in that direction but I think you might be using an earnings multiple versus EBITDA? I haven’t had time to look at the recent VAC/ILG merger announcement, but that should give some guidance on the value of the parent as it will look similarly to ILG.

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    2. Please update anything you see in regards to valuation from VAC/ILG example. I am using the earnings multiple with eps guidance for each company provided by management.

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    3. Using headline numbers VAC paid 13x EBITDA for ILG, some control premium in there, I still feel comfortable with 11.5x. With regards to management guidance, double check that it includes the LQ management acquisition in WH’s numbers, it didn’t previously.

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  8. MDC, what did you think about the earnings? I thought the report was quite decent. The segment disclosure of 2018 Hotel and Vacations expected EBITDA are both higher than I had thought, $600mm and $965mm respectively. Some of the comparable multiples have come down a shade, but not much. The question about why they sold Knights Inn @ 7x EV/EBITDA and why should their other brands be worth more was a good one. Let us know your thoughts.

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    1. I'm a little confused by the market's reaction to earnings, like you, their pro-forma guidance was better than I expected and just plugging guidance and their expected net debt numbers into my mini-model I get something closer to a $150 target price. The Knight's Inn question was great, and it is a little head-scratching on the multiple, RLH bought it and they trade for 16x as well and compete in similar economy segments. In a pure franchising model, how much time and management effort is really spent on Knights Inn? Its too small to move their overall average RevPAR numbers to sell a different story to the street and get a higher valuation? Seems like you'd only sell it at an opportunistic price, but 7x isn't that. A little confusing.

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    2. Good to see the Chairman of HGV make a decent sized insider purchase, about $ 1m.

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  9. Nice write-up MDC. How did you come up with WYND net debt? I'm getting $2956. Current corporate debt is $4284 plus $2000 for LQ, subtract $1105 for EUR, $2000 for WH net debt and $223 of cash. Thanks!

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    1. You’re right, they disclosed the correct net debt numbers in their recent earnings call, numbers have moved around since I wrote these two posts and the EBITDA guidance has gone up a bit.

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    2. Thanks. Would you mind sharing your final EBITDA numbers for both companies. I've got $565 for WH and $913 for WYND.

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    3. On the earnings call they gave $600MM for WH (this assumes a full year of LQ with synergies) and $965MM for WYND at their midpoints, WH will have about $2B of net debt and WYND $3B, at my 15x and 11.5x multiples, that's a combined total of ~$150/share or $70 for WH and $80 for WYND.

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    4. Thank you.

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    5. Re-visiting it again today, timeshare multiples are down since my original WYN post, now more like 9x EBITDA outside of ILG which is being acquired by VAC. Using 9x for WYND gets me to $127/share total for WYN pre-spin. Hotel multiples have held up pretty well in the 15-17x range.

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  10. MDC - It seems the bid-ask for Hotels today was 61-65, which seems to me to be fair value, even with the higher EBITDA guidance. If this splits, 61-48 WH-WYND, it would seem that the undervaluation could move to WYND (undervalued by 1 turn) while WH trades inline, not an outcome I was hoping for! But we'll see how it trades after distribution date. What are your thoughts if it splits 61-48? Increase/decrease or hold any or all of the pieces?

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    1. I'd still call $61-65 pretty attractive for WH, maybe the market isn't giving them full credit for the LQ synergies which is understandable, but management seems pretty confident, even in some additional revenue synergies (great for CPLG) in adding LQ hotels to their system and reducing reliance on the OTAs. It would be better if the WH was the undervalued one, it's the better and more consistent business model, but I still like the timeshare sector, my main concern with WYND will be the debt coming out of the split, above industry norms. If it splits 61-48, I probably hold on to both sides and do nothing, sorry if that's not a great answer! But I probably like the timeshare business more than most.

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    2. Thanks MDC. Yes, that is my view also. If it is 61-48, I'm a holder too. Would have much preferred for WH to be 50 or lower. Ha! I don't love timeshares but I don't hate them either. At the right price, I can remain a holder of t-shares, though unlikely to add. Thanks again, have a nice wknd.

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  11. WYN being dropped from the S&P 500 because of the spinoff, both WYND and WH will be in the midcap index, could see some additional uneconomic selling as a result.

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    1. Hi MDC

      great blog! I've just found it and will follow you in the future.

      Regarding the drop from S&P 500 on 31st May, we likely will see selling pressure.
      Do you have a ballpark idea about the distribution date? There's nothing in the filings

      If that happens soon after, the added volatility post spin off could make it possible to replicate todays stock for even less cost (more shares). I've recently read Greenblatt, this would be my first dip into the spin off world.

      Your blog is a great help for a beginner.

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    2. Yes, the spin-off is official after the close tomorrow (5/31).

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  12. What’s your take on price listing?

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    1. Both seem cheap, WH at 15x EBITDA is $70, WYND at 9.5x EBITDA is $60. I might lean a bit more to WYND has timeshare multiples have come down after the ILG/VAC deal and I think they could perk back up to where I originally thought in the 11x range. But I'm holding both sides, purchased a little more leading up to the spinoff, but will likely sit on my hands now.

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    2. Are you assuming that management's latest guidance (earnings call) includes additional (public co) overhead costs?

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    3. Yes, it should. My 150% of overhead costs for 2 versus 1 company appears to be overly cautious.

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    4. The WH guidance does include a full year of LQ's management company and full cost synergies, as I mentioned somewhere else, I'm okay with that since LQ's management team went to CPLG, WH should be able to pretty quickly realize the identified cost synergies and I'd bet on them squeezing out some revenue synergies as well.

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    5. If one believes management's ~$5 FY18 EPS estimate, then at these prices, WYND is selling for 9.6x earnings while offering a 3.4% dividend yield (30-35% payout ratio) growing at 7-10% per annum. Additionally, a hypothetical $250M buyback at the current stock price would immediately increase EPS by another ~4.5%. This hardly seems pricey even factoring in the recent timeshare multiple compression, or what am I missing?

      Btw, I couldn't find this in the form 10, but any idea if management option strike prices are determined by immediately post-spin prices in this case?

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    6. I think WYND is pretty attractive at these prices, I bought a little more after the spinoff (still holding WH, but haven't added since the spin). I don't think you'll see incentive option strike prices in the Form 10, especially not for WYND since its the parent, I believe the options already in place get adjusted down for the spinoff and then we could get a new batch to further incentivize, but I haven't seen it yet.

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  13. I have been following this spin-off since early this year and stumbled upon your blog several days ago. I want to thank you for posting the detailed analysis that has saved me quite a bit of time. I will be watching the prices of both WYND and WH this coming week and looking for a suitable buy point.

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