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

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

Spirit MTA REIT: Form 10 Notes

Some of this will be a rehash of my other post on Spirit Realty Capital (SRC) from January, but today SRC released the Form 10-12 for their spinoff, Spirit MTA REIT (SMTA), its a fun structure that deserves a little more fleshing out as it could result in an interesting investment opportunity once it starts trading in the second quarter.

As a refresh, SRC is a triple net lease REIT primarily focused on single tenant retailers that needs to rid itself of its largest and most troubled tenant, Shopko, in order to increase its valuation to the point where it can raise capital again (a must for any REIT).  SRC is hoping to accomplish this by spinning off its Shopko properties (and other workout assets) into SMTA but this would only work if SRC could receive proceeds in return -- here's where their securitization vehicle, Master Trust 2014, comes into play.  Master Trust 2014 is an SPV that houses many of SRC's small-to-middle market tenants that are unrated (but not Shopko or the other workout assets), and uses the SPV to obtained financing secured by the leases pledged to the SPV.  By putting the leases in the SPV, Spirit is able to obtain favorable financing terms such as being able to leverage the SPV up to 75% loan-to-value.  As the Master Trust has amortized over the last few years, the SPV had become overcollateralized, by putting the Master Trust with the spinoff, Spirit was able to put additional debt on SMTA and return it to SRC, in essence they're able to effectively "sell" the Shopko/workout assets by spinning it off with a cash out refinancing of the Master Trust SPV.  Of course they could have done the cash out refinancing of Master Trust 2014 anyway, but that would have increased SRC's leverage ratio and likely wouldn't have made their equity valuation any higher with Shopko stuck at the top of their rent roll.  But by positioning the spinoff as a highly levered REIT, they're able to rid themselves of Shopko and receive precious dry powder in return.

SMTA's mission statement per the Form 10:

The basic strategy will be to sell off or redevelop the Shopko assets and put the cash/collateral into Master Trust 2014, issue notes against it at 75% LTV and run a very leveraged REIT that looks more like a mREIT or CDO structure of yesteryear.  Coming out of the spinoff, SMTA will be leveraged 9.2x, but if all goes as planned, the leverage will climb significantly as Shopko makes up 20% of contractual rent and all of those properties are unencumbered.  As these assets are sold, the leverage will increase substantially to something like 12x EBITDA at the end state, or about double any traditional net lease REIT.

SRC mentioned on their recent earnings call that SMTA would have a very high payout ratio, I take this to mean it'll likely be at or above FFO, here's a little back of the envelope calculation of where cash available for distribution could be before any non-cash charges like impairments or loan loss reserves.

Please alert me if there are errors, likely I've made a few, but I think it's directionally right, and then below is the potential accretion if SMTA sells their Shopko/workout portfolio at various levels of their stated "Real Estate Investment Value" of $646MM per the Form 10.

*Revised from the original, I only had the debt proceeds and not the cash sale proceeds being reinvested originally.

A couple other points worth highlighting:

• Some feedback I heard on my comparison of SRC to STOR was "well, STORE Capital's secret sauce is they get unit level financials and run their own internal ratings to monitor their tenants", the tenants in Master Trust 2014 are the same, 98% provide unit level financials and SRC utilizes Moody's to provide shadow ratings on all their borrowers.  I contend this is a commoditized industry and there is very little secret sauce or competitive advantage, other than the "shares are really your product" marketing to equity investors concept and lowering their cost of capital.
• Fraudulent conveyance was also brought up, but in this structure the secured lenders in the Master Trust and one CMBS asset aren't being impacted by the spinoff directly, their notes are secured by the pools of leases in each SPV.  Even if Shopko went bust immediately after the spinoff, the debt holders of both SPVs wouldn't be impacted.  Which isn't to say the equity of SMTA being worth zero isn't a risk, clearly a recession or continued weakness in traditional retail (40% of SMTA's rent, 50% of that 40% is Shopko) will eat away at the equity strip of the SPVs and the value of the workout assets.
• SRC will be the external manager, they're charging a flat $20MM plus a promote in the out years, $20MM works out to be about 2% of the equity NAV they laid out in their Path Forward III presentation slide below.  Not fantastic, but it is fixed, so as SMTA moves along in its recycling program the base management fee will remain the same providing some operational leverage (of course could go the other way too).
• SRC and SMTA will have overlapping investment strategies, high level SRC wants to pursue the more investment grade rated tenants and SMTA will focus on the smaller non-rated tenants, but I'm sure there will be times when SRC has to decide which portfolio a prospective investment should go and it likely won't often be advantageous to SMTA.
• SRC's recent $35MM term loan to Shopko will be "contributed" to the spinoff, it's included in their workout portfolio numbers, the coupon is 12% and is very likely to end up in some kind of restructuring before it matures in 2020.

Here's the old sum-of-the parts slide, I think the only changes are in the workout portfolio bucket, SRC must have contributed additional properties as the value moved to $646MM in the Form 10 versus $477MM below.

Using the new workout number, the NAV should be $3.05/share, it won't trade there but I think it's an important reference point.  If my CAD number is correct, and SMTA trades like one of the ugly Class B/C mall REITs with a 15+% dividend yield, then the shares could be worth $1.50 per share of SRC.  $1.50 is also about the value of the equity strip in the Master Trust SPV, as part of the refinancing, the collateral was reappraised and presumably the debt holders and rating agencies signed off on the new market value.  Certainly not something to be given too much faith, but another reference point.  I expect SMTA to be incredibly volatile those first few days of trading as many of SRC's traditional retail shareholders are likely to dump the stock, keep it on your watchlist!

Disclosure: I own shares and call options on SRC