Wednesday, April 6, 2016

Interval Leisure Group: Reverse Morris Trust with Starwood

The bidding war for Starwood Hotels (HOT) between Marriott International (MAR) and Chinese insurance company Anbang grabbed a lot of headlines in the past month as Marriott eventually won after Anbang mysteriously dropped out. Caught up in the bidding war and subsequent merger arb trading are shares of timeshare vacation company Interval Leisure Group ("ILG" shares trade under IILG).  ILG struck a separate deal on October 28, 2015 for Starwood's timeshare subsidiary named Vistana Signature Experiences (previously set to be spunoff by Starwood) in a reverse morris trust transaction where Starwood would spinoff Vistana and immediately merge it with ILG.  The transaction will be tax free to Starwood shareholders, and after the merger, Starwood shareholders will own 55% of the new ILG with pre-deal ILG shareholders owning the remaining 45% of the shares.

The two Starwood deals happening parallel creates two technical, maybe non-economic, reasons why ILG's share price has fallen 35% since the deal announcement (there are other reasons discussed below as well): 1) if a Starwood shareholder was going to sell the Vistana spinoff anyway, well now they have a currency in ILG stock to do so before the spin date, essentially pulling forward some of the typical spinoff selling dynamics, 2) merger arbitrage investors are shorting ILG along with Marriott shares to capture the Starwood/Marriott spread.  While in both cases, the ILG shares sold short will be covered with new shares issued at the end of April when the deal closes, thus not creating a short squeeze, but after the deal is completed investors will begin to look forward and see a cheap company trading at ~7x EBITDA while its closest peers trade 9-10x EBITDA.

Any timeshare related bull thesis has to first acknowledge this is an industry with a questionable end value to its customers.  Most timeshares are sold, not bought, via free seminars where high pressure salespeople pitch people while they're on vacation to drop tens of thousands of dollars on a timeshare so they can relive their vacation year after year in perpetuity.  For most travelers this transaction is dubious, but maybe for a small subset who want to return to a resort year after year and stay in a suite larger than your typical two queen hotel room, a timeshare might make some sense.  But for many I suspect that they fall for the romanticism of owning a tiny piece of paradise without fully considering the annual maintenance fees and quickly depreciating (in many cases to $0) initial investment, it's a vacation home for people who can't afford vacation homes.  Even so, billions worth of timeshares are sold annually and the business of servicing and managing those timeshare units can be a good profitable one.
Interval Leisure Group was a 2008 spinoff of Barry Dillar's IAC which at the time was 30% owned by John Malone's Liberty Media, that ILG ownership has since been transferred to Liberty Ventures (LVNTA, a tracking stock of Liberty Interactive).  Historically, ILG has operated in the asset lite timeshare exchange business where they run Interval International, the second largest exchange behind Wyndham's RCI, allowing timeshare owners who pay a $89-129 annual subscription fee to trade their weeks/points with other timeshare owners.  Developers sign up with Interval International and often pay the initial year or two subscription in order to sweeten the pot and make timeshare ownership a bit more appealing to buyers by giving them flexibility to visit other locations/resorts.  This is a sticky business with a 90% annual renewal rate.

Over the past several years, ILG has also gotten into the vacation rental business (primarily in Hawaii) and other attractive management fee revenue businesses around the timeshare ecosystem.  In 2014, they purchased the timeshare development and management business from Hyatt where they have a licensing agreement to use the Hyatt name to develop and manage more timeshares, they build resorts and sell off the timeshare units while collecting an ongoing management fee.  As the timeshare industry has continued to consolidate, ILG's exchange business has faced competitive pressures as larger developers create their own internal/closed exchange network and don't sign up with ILG.  In order to feed the exchange and management contract businesses, ILG needed to increase their development/sales arm as more timeshare companies become vertically integrated.

Vistana -  Starwood's timeshare resorts under the Sheraton, Westin, St. Regis brands - will give ILG exactly that, it dramatically increases the timeshare (vacation ownership) sales piece of ILG.  Timeshare sales is a capital intensive and cyclical business, much more so than the legacy ILG business, so this feels like a defensive merger to quickly vertically integrate and protect the fee revenue businesses going forward.
The less enticing reason why ILG has fallen significantly since the merger announcement is the market believes they overpaid, at least when looking at near term multiples.  It's a stock for stock deal, but at the time of the press release the deal was valuing Vistana at $1.5B on only $125MM of EBITDA, at least two turns above where peers were trading and it looked to dilute ILG shareholders.  But in order to get comfortable with the multiple paid you have look a little longer term, Vistana includes over $500MM in timeshare mortgages that could be securitized and turned into cash, 5 standard hotel resorts that will be refashioned into timeshare properties, and additional development opportunities at Vistana's 22 current resorts.  All in, they estimate that Vistana comes with $5.5B in future timeshare inventory that can be sold, and then added to ILG's recurring fee ecosystem.

Tucked away in the merger documents (page 98) Vistana breaks out their long term projections all the way out to 2024, likely in response to the market's reaction to the sticker price, but also to show the value in the inventory pipeline:
Be a little skeptical but it provides some perspective on the headline price tag.

Valuation
To keep things relatively simple, ILG is expected to do $185MM in EBITDA in 2016, Vistana is expected to do $148MM (both from the most recent prospectus), assuming no deal synergies (guided to $26MM annually after 5 years) and subtracting out $18MM of stock based compensation gets a proforma 2016 EBITDA run rate of $315MM.  The new share count will be just under a 130 million, at $13.35 per share, that's a market cap of $1.733 billion, the new ILG will have $464MM in net debt (ignoring non-recourse securitizations).

Proforma EV/EBITDA = ~7x

Marriott's timeshare business, Marriott Vacations Worldwide (VAC), is a good comparable for ILG, both will be a mixture of recurring management/exchange fees and development sales, both operate on the higher end of timeshare brands, and they're both pure play vertically integrated companies.  Marriott Vacations trades for ~9x 2015 EBITDA, at the same valuation using my EBITDA estimates gets you to a $18.35 share price for Interval shares, or 36% higher than today which would just about make up the difference in performance between Marriott Vacations and ILG shares since the 10/28 Vistana deal announcement.

Risks
  • Regulatory - The Consumer Financial Protection Bureau (CFPB) is investigating timeshare operator Westgate, shining a light on the industry's sales practices.  Diamond Resorts is in a similar situation and was recently profiled in a long New York Times piece.
  • AirBnB/HomeAway - Condo/homeowners in vacation towns can compete more effectively with timeshare developers thanks to AirBnB and HomeAway, provides a similar room option without the upfront and ongoing expense.
  • Secondary Market - Most timeshares can be purchased at significant discounts to developer pricing in the secondary market which puts a lid on new unit pricing and/or really shows unsavory nature of the sales process.
  • ILG shareholders still need to approve the deal, there's a shareholder meeting set for 4/20/16, Liberty and management have already agreed to vote for the deal.
Disclosure: I own shares of IILG

33 comments:

  1. You are comparing apples-to-oranges for several reasons: VAC does not have the exchange biz; IILG will have excess inventory; IILG has loans that will be securitized. When VAC, WYN, etc. report EBITDA, that is after subtracting out interest paid on securitized loans. Of course, this securitized debt is not included in TEV then.

    If you account for these differences and throw in the synergies, IILG is even cheaper than you suggest. It is worth low-20s.

    ReplyDelete
    Replies
    1. Fair points, I hope you're right about low-$20s, isn't part of their EBITDA estimates including using the cash received when the securitized the loans to develop the Vistana inventory? Are you subtracting the cash from TEV but giving credit for its use in the EBITDA?

      Thanks for the comment.

      Delete
    2. More I think about it the more I agree, should exclude most of that future securitization funding. Fair value is closer to the low $20s, pretty nice margin of safety here.

      Delete
  2. Thanks for posting. This is an interesting special situation. We might get a chance even lower once the HOT shareholders get their shares of IILG.

    Since you are not opposed to the timeshare space, have you looked at BFCF which owns Bluegreen. If you zero out their other assets, which are not trivial, BFCF trades for 3.5x LTM EBITDA. Plus, they are repurchasing stock.

    ReplyDelete
    Replies
    1. I did look at BFCF/BXX a year or two ago and passed due to management, I should revisit as I enjoy messy balance sheet situations. Thanks for the comment.

      Delete
    2. I own BFCF and think you’ll find the balance sheet issues at both BFCF/BBX are dramatically simplified from two years ago. BFCF did a tender offer for BBX shares (at $20 vs $15 today), and acquired 81% of them. The whole ownership structure and “story” is now much cleaner. BFCF can consolidate on their books BBX (a real estate holdco) and Bluegreen Resorts (the standalone timeshare business). BFCF now indirectly own 91% of Bluegreen. This gives them much better capital allocation options like tax advantaged dividends and inter-company loans, and most importantly the ability to use up their subsidiaries’ NOLs at the *parent* company level. BB&T no longer has any claims on their old “bad bank" real estate assets, which leaves them with an unencumbered portfolio worth much more than book value, which they’re proving whenever they contribute property to JVs at much higher than their carrying value.

      They plan to hit the road this summer with a cleaner “story” that “they’re a timeshare business trading at 3 times EBITDA and you get all this real estate and these operating companies for free.” Bluegreen Resorts really is the prize asset. They’re “capital light,” meaning they no longer develop timeshare properties, they just sell the “VOIs” and securitize them, plus collect a lot of sticky fee-based revenues. Bluegreen is spitting out cash and is overcapitalized. Sorry for the long comment - I’ve done some work on them and happy to share if it’s constructive.

      Delete
  3. Is this a good pair trade in your opinion? Any reason why VAC would deserve a premium?

    ReplyDelete
    Replies
    1. Could be? Pair trades aren't something I really do much of if at all. The first commenter made the point that VAC might deserve a discount to IILG since it doesn't have an exchange business. In a sum of the parts valuation, the exchange business would be significantly more valuable than the vacation ownership/sales business. My point wasn't to get into the weeds of VAC's valuation, more just using it as an approximate benchmark for where IILG could trade post-RMT. Thanks for the comment.

      Delete
  4. thanks for the reply.

    The technical buying and selling makes this idea particularly interesting. 55% of shareholders are unlikely to be interested in this entity (its 10% of their previous Starwood position).

    Any ideas how to figure out the arb ownership in Starwood? Arbs will be selling IILG prior to close whereas the remaining holders will be selling post close mostly (a lot of non arbs cannot short). Wonder how much more of a dump might occur....

    ReplyDelete
    Replies
    1. I'd be interested to know if there's a way to figure out the arb ownership too. But my guess it's high now that the deal is finalized? Most non-arb/long only type investors would sell and move on at this point?

      Delete
    2. The way to check for technical selling could be evolution of short interest since the deal was announced and more recently

      Delete
  5. Nice write up. Does the recent episode with DRII concern you regarding timeshare sector in general? It seems like the CFPB has its sights on this sector just now...

    http://www.fool.com/investing/general/2016/03/21/why-diamond-resorts-international-incs-shares-plun.aspx

    ReplyDelete
  6. just noticed that you had included this in the Risks section, my bad. But the point is not one to be taken lightly. We are seeing entire sectors getting decimated by government scrutiny and timeshare is an easy target to go after with its reputation and tactics. Best of luck with this.

    ReplyDelete
    Replies
    1. I agree, it's a significant risk. Right now the spotlight seems to be centered on the mid-to-lower branded Diamond and Westgate, both very aggressive in selling to middle class consumers that aren't likely to fully understand what they're buying (and then financing them at mid-teens rates). Ideally this is a 3-6 month trade, the deal happens, shareholder base reconfigures and it closes the valuation gap with VAC.

      Delete
  7. I hate the bad name that the timeshare industry gets. Obviously not all actors are bad in this industry. There was a recent consumer reports article that points out after a certain number of years it is significantly cheaper to own timeshares than to go on vacations. So if you are someone who goes on vacation every year and plans on continuing to do so it would be cheaper in the long run to own a timeshare.

    I am a BFCF shareholder so just a quick comment on them. They are extremely cheap with the timeshare division worth several times the market cap of the entire business. The problem is that they want to use up their NOLs. So they are not making the obvious moves like to buyback massive amounts of stock or to issue a dividend.

    ReplyDelete
    Replies
    1. But what subset of timeshare buyers does that fit? I'm sure it is some, but buying a series of discretionary purchases up front seems like a questionable purchase for most people, pair that with the high incentive/commissions paid to salespeople and you get those bad actors.

      Thanks for BCFC color, I'll take a look another look, might make sense to roll IILG into BFCF if I'm right about the recent uneconomic selling and bounce back after the deal closes.

      Delete
    2. Timeshare economics: 25-30% build cost, 45-60% sales and marketing. Seems insane to me. Am battling with this but this industry has existed for decades, has tens of thousands seemingly happy owners so the attractiveness of a technical mispricing and a short term trade have sucked me in. Think this will work out unless the industry is uprooted imminently

      Delete
  8. Thanks for posting, very interesting idea.

    I think HOT shareholders will sell their position after the merger(hopefully), IILG shares will be equivalent of 7.2% of their position at $13.3 a share. Short interest has gone up substantially from merger announcement too, from about 2m shares to 10.5m shares.

    I’m worried about IILG’s FCF. I am looking at the 8-k filed on February 25th. They are predicting cash from operating activities of $145m and $150m of capex. The combined capex should be around $80m. They are also including securitization proceeds in their adjusted free cash flow and forecasts which makes me a bit worried. What do you think about this?

    Thank you.

    ReplyDelete
    Replies
    1. Good comment on the FCF, I'll have to think more about this when I have a moment. How are the vacation ownership sales accounted for in the net income line item? Are they double counting when taking into the securitization proceeds? Hm, good catch, that is a little odd.

      Delete
    2. At best it seems like a temporary/one time benefit?

      Delete
    3. I think part of development cost is a working capital investment in the timeshare industry i.e. into inventory. That's how they expense real estate inventory costs in the same proportion as the revenue recognized. I think this is why the CFO is so low compared to their net income, depreciation and stock comp guidance. The low end of 2016 guidance is NI 126 + D&A 76 + SC 18 = 220 versus CFO guidance of 138. Therefore at least part of the securitisation inflow is simply a funding mechanism and would be recurring as long as they continue developing inventory. Let me know if you think this is completely wrong...but 170 does seem high.

      Delete
  9. Are you sure on your calc of VAC EV/EBITDA? There is actually net cash on teh corporate level so I have mkt cap of 64.50*31=2.0 bln less 138mln of corporate net cash = EV of 1.9bln which is ~7x 2015 EBITDA of 260mln.

    ReplyDelete
    Replies
    1. You're correct, similar to the first comment, I do have some apples and oranges math going on in my comparison between IILG and VAC. I'm including the securitization debt in the VAC EV math, which I shouldn't be, and not giving credit for the securitization IILG will do soon after the merger is completed. So IILG is trading at ~5.5x EBITDA and VAC at 7x EBTIDA, still a gap, but you're correct, it's a mistake. Thanks for the comment.

      Delete
    2. OK... Given that the securitization will be used for the Vistana development capex, I think it might be more appropriate to use the earnings generated by that cash, instead of the cash itself. I think this is accounted for in the strong Vistana EBITDA growth in the projections. Using 2018 EBITDA, IILG appears to be 5.2x vs. 6.4x at VAC so definitely somewhat cheaper.

      Delete
    3. If we don't deduct the cash generated from securitization, then we'll have EV of (130*13.5) + 557 - 93 = 2219. 2016 EBITDA will be around $300m. That's about 7.4 EV/EBITDA.

      VAC's EV is about $1.9b and EBITDA of $260m. That's about 7.3 EV/EBITDA.

      I don't think we should deduct cash from securitization as they are not going to pay that out and plan to use all of the proceeds for Vistana's Capex. The cash will be also restricted cash and can only be used for development purposes as I understand from reading the fillings.

      Am I missing something? Brad, Could you please explain how you get to 5.2 and 6.4 EV/EBITDA numbers? Thanks.

      Delete
    4. As I mentioned, I agree that we shoudln't use the cash since they are going to use it for development but I do think we should think about the EBITDA that development generates. Given that it is supposed to be done by mid 2017, I used 2018 EBITDA which was projected in the S-4 to be 413mln. Whether you believe the projections is a different question but I don't think its fair to both ignore the cash because it will be invested and then ignore the outcome of that investment.

      Delete
  10. Both VAC and IILG (pro forma for the merger) seem undervalued to me. I ran the numbers and am getting a 12+% 2015 FCF yield for VAC and 13% 2017 FCF yield for IILG.

    Is it possible that "Mr Market" thinks that we're near the cyclical top for time share sales?

    ReplyDelete
  11. What do you guys think about DRII? Trading at 5.8 times EV/EBITDA, management owns 30% of the company and they just hired Centerview Partners (lead by former chairman of global M&A at GS) for strategic alternatives.

    ReplyDelete
    Replies
    1. I'd be curious to hear others thoughts as well, but without looking too they scare me a bit. Several articles have come out against both their sales tactics and accounting, it looks like the CFPB isn't far behind. A skeptic would say the strategic alternatives push is an attempt to scare short sellers away with the management buyout threat but likely isn't doable with the regulatory overhang. But I don't know the company well enough to decide if it's recent headline trouble has created a buying opportunity or not.

      Delete
  12. Interesting read, any word on a time frame for the Vistana spin-off and merger with ILG?

    ReplyDelete
    Replies
    1. The deal closed on 5/12 so HOT shareholders have received their IILG shares, could be seeing some spinoff dynamic style selling right now from those that don't want to hold IILG, hard to know when that wears itself off.

      Delete
  13. Did you see Apollo buying DRII? Not a bad comp for IILG..

    ReplyDelete
    Replies
    1. I did. Congratulations to those who owned DRII, I didn't have the guts to jump into that mess. I haven't looked much at DRII in the past, but I would assume with the exchange component and premium brands at IILG that in a private transaction it would be worth a higher multiple? The RMT acts a bit like a straight spinoff, makes it harder for a deal to happen so as to avoid tax implications, but it's a nice data point.

      Delete