Wednesday, March 14, 2018

Wyndham Worldwide: Hotel Spin from Timeshare Business

This idea is another addition to my unintentional ongoing series circling around the timeshare and hotel management industries.  Wyndham Worldwide (WYN) is the largest of the U.S. based timeshare companies and they will be spinning off their hotel franchise management division in the second quarter of 2018.  Timeshare multiples have run up significantly in the past several years, while this situation might not be as juicy as the past timeshare spinoffs, the pre-spin Wyndham trades at a discount to the parent's closest peer after the spinoff in ILG, while hotel management companies all trade significantly higher.  One also could argue that as the timeshare companies begin to generate increasingly more of their revenue from sticky resort management contracts, their multiples should continue to converge with the hotel management companies.

Wyndham is currently divided into three business lines:
  1. Wyndham Hotel Group:  Almost entirely a low capital requirement franchise business, Wyndham has over 8400 hotels in its stable which primarily skew to economy and midscale brands.  Their brands include the namesake Wyndham, along with brands well known to those that travel US interstates like Super 8, Days Inn, Ramada, Howard Johnson, Baymont and Travelodge.  Franchise fees are usually structured with an initial on-boarding fee, plus a percentage of revenues royalty irrespective of the underlying profitability of the hotel making the business less cyclical than the hotel operator REITs.  The essential components of the hotel management business are the number of rooms in your system and the revenue per available room (RevPar), both of which have been growing for Wyndham's hotel group.  To illustrate where Wyndham's brands are on the hotel segment landscape, the RevPAR for the entire in U.S. lodging industry was $83.57 in 2017, Wyndham's RevPAR was $37.63 for the same period.  Management guidance has this segment projected to do $445-$455MM of EBITDA in 2018.
  2. Wyndham Destination Network:  Wyndham operates the largest timeshare exchange network, RCI, which allows members (for an annual fee plus transaction fees) to trade their weeks or points in their own timeshare for another.  This is another low capital requirements business, but faces headwinds as consolidation across the timeshare industry has lessened the need for exchange networks.  Smaller or one off timeshare developers would typically give away an RCI membership in order to entice a sale, sell that the owner on having the option to be apart of a greater exchange network.  As larger brands entered the space, they've created their own exchange network ecosystems putting pricing pressure on RCI and their main competitor, Interval Internation (ILG's exchange network).  Management guidance has this segment projected to do $265-$275MM of EBITDA in 2018.
  3. Wyndham Vacation Ownership:  Wyndham is the largest timeshare business globally, they have 221 resorts under management representing 25,000 units and 878,000 owners.  Their model is almost entirely points based giving timeshare owners flexibility in how they book their vacation, plus more importantly to Wyndham it makes it easier for a current timeshare owner to upgrade/buy additional points than it would be to sell the same owner additional weeks under the old model.  Like everyone else in the industry, Wyndham has moved to a less capital intensive model where 80% of the units sold in 2017 were not developed by the company, instead buy a developer or via a just-in-time purchase of inventory.  Additionally, Wyndham provides financing to timeshare owners and then securitizes these loans in the ABS market.  Management guidance has this segement projected to do $735-$750MM of EBITDA in 2018.
Wyndham Hotel Group is going to be the spinoff, leaving the Destination Network and Vacation Ownership segments behind to become a purer play timeshare business.  In recent months, Wyndham has announced two large M&A transactions: (1) they sold their European vacation rentals business that was within their Destination Network segment for $1.3B in cash and (2) purchased La Quinta's hotel management business for $1.95B in cash ahead of its own spinoff.  Additionally, as part of these hotel/timeshare spinoffs, there has typically been a royalty fee going from the timeshare business to the hotel management company.  In all of the other timeshare spinoffs, the hotel management company has been the larger/parent in the transaction, where the opposite is true with Wyndham.  Even so, I'm going to assume management is smart and will put in place a 5% of VOI sales royalty agreement in place going from the timeshare parent to the hotel spin.

In order to come up with the post-spin picture, I took management's guidance and added the impacts of the European vacation rental business being sold (but it's already excluded from EBITDA guidance), the purchase of LQ's management business (and varying synergies levels), a potential 5% timeshare royalty to the spinoff, and then added some additional overhead to account for running two separate public companies.
Taking a look at peers of each, the parent will look most similarly to ILG with a combination of a large VOI sales business and an exchange.  ILG has had a epic run since the RMT with Starwood's Visitana (I sold unfortunately in the low-to-mid $20) and trades for a forward EBITDA multiple of just under 13x.  The hotel group spinoff will most resemble Choice Hotels (CHH), both compete primarily in the economy to midscale segments with brands like Comfort Inn, Quality and Econo Lodge.  The hotel management group all has significant growth baked into some of these EBITDA projections, the backwards numbers are several turns higher, but Choice Hotels trades for a 16x multiple on analyst 2018 estimates.
If we assume the timeshare business parent trades for 11.5x and the hotel group spinoff trades for 15x EBITDA, I come up with the below SOTP based on my mid-point forecasts:
The primary risks here is valuation, we're presumably late in the cycle, hospitality companies are historically very cyclical (timeshare and hotel operators more than hotel management) and we could be looking at both peak revenue/earnings and peak multiples.  This spinoff transaction would have looked a lot more attractive one or two years back, but I think it still will work and I've established a position with the hopes that there's something more to do after the spinoff if one or the other trade well outside my valuation targets.

If you're interested in WYN and in the Chicago area, we're covering WYN on 3/19 at the CFA Chicago meeting I co-host every month, details here: https://specialsituationsresearchforum.wordpress.com/meeting-registration/

Disclosure: I own shares of WYN

16 comments:

  1. Fwiw timeshare comps are trading even higher now on an EV/EBITDA basis (I think some of the net debt numbers are a few quarters old) given recent increased leverage. ILG's at 14.3x; Marriott Vacations 14x; Hilton Grand Vacations 11.7x (using $471M FY18E); Bluegreen Vacations 11.7x. Nonetheless, using the lagged multiples may be quite appropriate given the late-cycle risks you mention.

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  2. Actually, no, recent borrowings wouldn't be material enough to lift those multiples thus. I imagine for net debt figures, you've excluded securitized financing via VIEs?

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    1. Yes, I'm excluding the VIE debt.

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  3. Just curious: are you considering establishing a LEAPS call option on WYN, like you did
    successfully with HLT?

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    1. I did actually buy calls last week as well, here I just bought the Aug $115 for now, but you might be right that LEAPs could be better. I do like the setup that both companies should trade at or above the current valuation, might be a smoother path to valuation realization that way? Not sure, but I think calls could work here too.

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  4. MDC, I might be missing something here, but have you included the $2 bn of additional net debt (for LQ) in your SOTP? The way I'm doing it is approx. $4 bn of net debt as of 12/31 according to the 10-K (excl. VIE) plus the additional $2 bn for LQ for a total of $6 bn pro forma. I just started looking at this, so maybe I'm missing something. Please let me know what you think.

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    1. Perhaps you are offsetting that with the European Vacations Rental proceeds and the net position in the securitizations?

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    2. http://clarkstreetvalue.blogspot.com/2018/03/wyndham-hotels-resorts-form-10-notes.html

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    3. Anonymous, yes, but the total (across both companies) net debt number in that post appears to be the same $3,789. My guess is that he's offsetting LQ debt with the proceeds to be received for EUR, etc. But I'm not sure of the tax basis there and, hence, the proceeds. Maybe management has talked about this somewhere, but since I just started looking, I have not seen it yet.

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    4. Yes, I’m netting the European sale proceeds against the LQ debt. I should have discounted it for taxes, their press release says they expect to pay less than 15% of the proceeds. Might change things a dollar or two, but then you’d expect some cash build since 12/31 too. Directionally I hope I’m still close enough?

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  5. MDC, thanks for your response. I looked a little closer at the IR materials. It seems the net debt on Destinations will be $3bn. Still, in my view, it doesn't change the upside too much because it seems you've used conservative multiples for Hotels. If I use 16x (I know this is a VALUE blog... but that's where these things are trading), I get $150 total, $75 apiece (using 11x on Destinations). I'm still just only casually looking at this, so I haven't done a deep dive into the operating fundamentals, but does it bother you that Hotels RevPAR has not budged in 5 years, appears to be kind of flat? This would mean the "growth" is dependent on new construction and conversions. Also, it seems their margins will never be like those of MAR or HLT because they are pulling royalties off fundamentally lower revenue hotels, whereas the Hotel segment cost structure is not variable with revenue. Yet, there might be some room for improvement seeing as Choice is higher. The other item is having to hold Destinations until it re-rates, which could be some time. Hopefully, no recession in that time, because in 2009, these consumer-credit-based, non-discretionary, big-ticket item sellers were all down 70-90%! But we'll never know when a recession comes and the discount seems reasonable to give it a shot. With that in mind, how do you think about sizing this?

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    1. Thanks -- I did catch a mistake in my math around the net debt, come closer to your numbers and updated my valuation on the follow up post, getting something closer to $140 using 11.5x for the parent and 15x for the spinoff.

      The timeshare companies did get crushed in the recession and likely would again, but maybe not *quite* as bad given they've fundamentally changed their model (moving asset lite on the VOI sales and having more of their revenue come from cost plus management contracts).

      Sizing - It's a midsized position for me, pretty much right in the middle, as I mentioned above, sort of hoping there's more to do after the spinoff and one side trades cheaper than it should.

      Thanks again.

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  6. whats the investment thesis for FLL? I saw you arranged a meeting for it

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    1. It wasn’t my idea, my co-host suggested it, but the overall thesis relies on Dan Lee as the CEO. He’s an industry veteran that writes shareholder friendly sounding letters and has experience developing casinos, seems like a boom and bust kind of guy. I’m neutral on it, doesn’t seem particularly cheap to me unless you’re bullish on their CO development opportunity.

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  7. MDC - thanks for your great work. On the VIE debt, are you excluding as its debt that has been securitized and so is essentially off WYND's books? Just want to make sure I understand.

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    1. Right. Kind of like excluding Ford's financial debt used to securitize auto loans.

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