Hilton Grand Vacations: In Play, Speculating on a Deal

Another idea I'm returning to after it has received some takeover speculation is Hilton Grand Vacations (HGV), as a quick recap, HGV is Hilton Worldwide's (HLT) timeshare business that was spun (alongside Park Hotels & Resorts) from Hilton at the end of 2016.  I won't go through the timeshare business (I've done that a few times previously) but of the other two larger timeshare rivals (VAC and WYND), HGV is a pure play on one brand without an exchange or rental business, making it a simpler candidate for consolidation.

HGV ran into some accounting noise and operational/timing issues with their inventory strategy that caused a selloff in their shares opening the door for an activist or an unsolicited bid.  In August, the NY Post reported that private equity behemoth Apollo Global (APO) was interested in making a bid for HGV.  Apollo previously took unbranded (and somewhat controversial) timeshare operator Diamond Resorts International (DRII) private in 2016, and tried to re-list shortly after in 2018 but pulled the IPO.  Apollo clearly got feedback that the public markets weren't interested in an as-is Diamond Resorts (they've recently dropped the "International" from their name) at an acceptable valuation to Apollo, so they need a plan B.  It appears plan B could be to take HGV private and merge it with Diamond, re-brand the HoldCo and bring it back public without the same Diamond brand stench.  Some point to the risk that Hilton needs to consent to a merger, this is true, but it seems contemplated that HGV would be acquired or operate non-Hilton branded timeshare properties with the caveat that it would be operated separately from Hilton branded properties and without access to the loyalty program, from the 10-K:

We are able to operate vacation ownership properties under other brands (with no royalty due to Hilton) if we do so without using any Hilton IP or Hilton Data and they are otherwise separate operations from the Licensed Business.

And they would likely lose the Hilton Grand Vacations name per the licensing agreement since Diamond has more units than HGV, again from the 10-K:

Under the license agreement, our right to use the Hilton Marks as a trade, corporate, d/b/a or similar name will automatically terminate if (i) the aggregate number of units of accommodation in our Licensed Business falls below two-thirds of the total number of units of accommodation in our entire vacation ownership business; (ii) we merge with or acquire control of the assets of Marriott International, Inc., Marriott Vacations Worldwide Corporation, Hyatt Hotels Corporation, Wyndham Destinations and Interval Leisure Group, Inc.  or their respective affiliates and we or they use their brands in any business after such acquisition; or (iii) we become an affiliate of another Hilton competitor.

It wouldn't be the first time potentially competing (is Diamond technically a Hilton competitor?) hotel brand flags were housed under the same corporate timeshare entity, ILG had the Hyatt brand and first merged with Vistana which housed Starwood's timeshare business before being brought back into the Marriott/Starwood fold when it was purchased by Marriott Vacations Worldwide (VAC).  But the Hyatt timeshare properties remain at VAC, although they represent a much smaller percentage than Diamond's properties would be under a proposed HGV/Diamond merger.  Why might Hilton consent?  HGV pays a 5% royalty on all timeshare sales, this amounted to $100MM in 2018 (and essentially falls straight to HLT's bottom line), a well capitalized and scaled HGV is to their advantage, I'm sure the team at Apollo can come with a few slides showing how this revenue stream could grow in the coming years with Diamond cash flow being used to fund HGV inventory and growth.

The other buyer being mentioned is Blackstone (BX), they took Hilton private in 2008 but no longer have a significant investment in HGV having divested their stake in 2017.  They're familiar with the business, but they'd be strictly a financial buyer and seem less likely to be the winner.  Worth noting that Blackstone's president, Jonathan Gray, is also the chairman of Hilton, unclear if that matters but seems noteworthy.  Additionally, I wouldn't count out Wyndham Destinations (WYND) being involved in the bidding process either (although their stock trades well below that of HGV), there are lot of potential synergies and HGV is part of the WYND's RCI exchange network, plus it could move WYND slightly up market and bring down Wyndham's persistently high loan loss reserve averages.

HGV's management at least acknowledges the benefits of industry consolidation, essentially confirming the rumors, from the most recent earnings call:

Stephen Grambling: Great, and I appreciate you can't comment on the reports out there on M&A, takeover stuff specifically, but how do you generically think about the positive and negatives of consolidation in the space, and perhaps tying in anything that’s specific to HGV?

Mark Wang: Yes, Stephen, it's Mark. I think we recognize the value proposition of consolidation in our industry and other industries. I think, from our perspective, some of the key reasons for consolidation is you want to improve your asset base, you want to strengthen your brand, and in this industry's case, you want to have the access to a pipeline of incremental new customers. So, I'd say, look, we've got a great set of assets and we have this great brand and relationship with Hilton, and we've talked about the tour pipeline that they provide us, and we've had a long and strong history of execution and growth. So, look, I think consolidation has been positive in the industry and we understand the rationale behind it.

Clearly he's speaking from HGV's attractiveness as an asset and not how an acquirer might help HGV, but I think his comments could apply to either Apollo/Diamond or Wyndham quite nicely, primarily access to Hilton's growing hotel and customer base needed to source additional timeshare owners.

In the latest round of bidding, Bloomberg reported Apollo's bid is $40 and the stock currently trades for $35+ showing some skeptism that the deal will be consumated.  From a valuation perspective, HGV sits essentially in-line with VAC on 2020 estimates:

In 2018, VAC purchased ILG for a total enterprise value of approximately $4.7B on $365MM of EBITDA plus $75MM of synergies, for a fully synergized multiple of ~10.5x EBITDA.  ILG had an exchange business that while low/no growth is a free cash flow machine and likely pushed the overall multiple up some.  But let's say the number needed to finalize an HGV deal is $42, with no synergies that would be 10x multiple and using a $50MM synergy number gets it back down to just under 9x, quite attractive for control over a timeshare business with a quickly growing hotel chain like Hilton.

Other Thoughts:

• Elliott Management was rumored to be involved in HGV, but it doesn't show up in their recent 13F, probably doesn't mean anything - maybe they never owned it, but worth closing that loop.
• HGV offers a fixed/week interval product while Diamond Resorts uses a points based product, maybe a little additional culture clash to be concerned about, or Apollo could see an opportunity to modernize HGV's product into a points based system (one benefit of the points based system for the timeshare operator is its easier to sell upgrades to existing owners)

In summary, we have several buyers, both strategic and financial, circling HGV, I'm surprised that shares are trading well below the $40 reported first bid even if HLT needs to provide its approval.

Disclosure: I own HGV calls (also remain long WYND)

Franchise Group: fka Liberty Tax, Franchise Rollup

Franchise Group (FRG) is the result of the odd conglomeration of: 1) Liberty Tax (old TAXA); 2) Buddy's, a franchised chain of rent-to-own electronics and furniture stores; 3) Sears Outlet business; and soon to be 4) Vitamin Shoppe (VSI); that is being orchestrated by Vintage Capital's Brian Kahn who was recently named the CEO of the newly launched platform company.  Andrew Walker posted two excellent write-ups (here and here) on the situation a couple months ago, I won't do it the same justice, but I'll run through my thoughts anyway as I took a position in it.

Liberty Tax is the third largest tax preparer, well behind both H&R Block and Jackson Hewitt, the tax preparer market is a highly fragmented business with a lot of mom and pops.  It is the type of franchise business where you effectively own your job and you outsource the marketing and back-office infrastructure to the franchiser.  Liberty's business model is mostly targeted at lower income taxpayers who are unlikely to purchase TurboTax or do-it-yourself type software, they want someone else to do it quickly for them and assist in getting their refund as fast as possible, it's a decent business that should be relatively stable.  However, in 2018 Liberty Tax's founder and CEO was forced out after a sex scandal was uncovered and his shares where sold to Vintage Capital that July.  The company understandably struggled through this upheaval and EBITDA dropped 17% from 2017 levels to $35MM (9/30 fiscal year end).  Then in November 2018, TAXA received an acquisition proposal for $13 per share from a private equity buyer that ended up going no where.

Concurrently with all that, Vintage Capital was wrapped up in a bizarre failed merger with Rent-a-Center (RCII) which competes in the same rent-to-own market as Vintage's Buddy's chain with Vintage forgetting to execute a routine extension to the merger agreement that allowed Rent-a-Center to break the deal and force Vintage to pay a substantial break up fee.  Presumably Vintage was going to merge Buddy's with Rent-a-Center and continue to pursue a franchise model.  With that deal off, Vintage moved to Liberty Tax where they already had a substantial holding and offered to recapitalize the company and give existing shareholders an option to tender their shares at $12, a substantial premium to where the shares had fallen after the $13 buyer had backed away.  As part of the transaction, Liberty Tax bought Vintage's Buddy's chain of stores and created "Franchise Group" to pursue a rollup strategy of franchised or "franchisable" businesses.

Since the creation of Franchise Group, Vintage isn't wasting time buying additional struggling businesses, since the merger with Buddy's, they've entered into two transactions but while both Liberty Tax and Buddy's are primarily franchised, the next two fall into the franchisable category.  The first announced was with Vitamin Shoppe (VSI), a struggling vitamin and nutrition retailer that is being disrupted by internet shopping.  The second transaction announced, which just recently closed, is with Sears Hometown and Outlet for the Sears Outlet business and the 8 Buddy's stores that SHOS operated.  My guess is overtime these Sears Outlet stores more or less end up looking like or being re-branded to Buddy's stores as they sell similar household durable type items to the lower income segment.

There's a lot going on here, its a complex situation that I'd guess very few people are looking closely at, volume has been minimal and it just today uplisted back to the NASDAQ under the FRG symbol.  I'm sure there are quite a few mistakes with the below, so do your own homework as well, but I tried to come up with a proforma look at what the combined company might look like once the dust settles.

Most of these numbers are pulled from the recently completed tender offer and the VSI proxy statement.  Alongside the closing of the Sears Outlet transaction, they went ahead and franchised 5 stores to "A-Team" for $15MM (they have 120 more stores).  The tender offer closed this week with just under 4 million shares participating at $12.  Throwing it all together on an admittedly back of the envelope fashion, I come up with the proforma company trading at roughly 5x EBITDA.  Franchise businesses trade all over the map, but generally well above 5x -- a rent-to-own comp like RCII for example trades over 7x EBITDA and they are still mostly company operated stores.  It's hard to put an exact value on FRG, but I'm guessing there are a lot of value levers to pull here and if it works out (and the economy doesn't rollover) could be a multi-bagger.

Disclosure: I own shares of FRG

Ben Franklin Financial: Tiny Bank Merger and Liquidation

Ben Franklin Financial (BFFI) is a tiny (sub $10MM market cap) two branch community bank located in the northwest Chicago suburb of Arlington Heights that completed its second step mutual-to-stock conversion in 2015.  Ben Franklin Financial is a pretty straight forward community bank, it takes in deposits from a small local radius and primarily turns around and makes a mix of residential mortgages and commercial loans.  At just under $100 million in assets, Ben Franklin Financial is sub-scale, poorly managed and as a result loss making bank (to pile on, BFFI was also operating under an OCC consent order until this past February) that caught the attention of community bank activist Joseph Stilwell who encouraged the company to pursue shareholder friendly actions like repurchasing shares or pursuing a sale.  In July, the company announced a unique sale transaction with Illinois based Corporate America Family Credit Union ("CAFCU") for between $10.33 and $10.70 for shareholders, the stock bounces between $9.60 and $9.80 today.  Why sell to a credit union?  Since a credit union is technically non-profit, they might be willing to pay more for a struggling operation like BFFI since they just need to cover their operating costs.  The credit union buying a bank thing is a recent trend but this is a first of its kind transaction where the credit union is purchasing a bank that converted from a mutual holding company.  The catch being there is some uncertainty as to how depositors who did not participate in the mutual conversion process will be treated in the liquidation and other uncertainties like terminating employee benefit plans.  Not only is the amount uncertain, but the timing is as well, the transaction with CAFCU is expected to close in early 2020 with the distribution to shareholders occurring "within several months", thus this is more of a two step process, an asset sale and then a liquidation rather than a clean merger.

Assuming a 5/15/2020 payment date (call it 4 months after an early 2020 transaction settlement) and I get an IRR of between 12% and 20% off of the last trade at $9.75 or gross returns between 6% and 10%.

Maybe I'm underestimating the possibility of the deal breaking but I think you're getting paid for the illiquidity of a nano cap and the uncertainty of both the ultimate payout and timing, both risks that a small personal account like mine is well suited to take.

Disclosure: I own shares of BFFI

Asta Funding: Going Private Offer

Asta Funding (ASFI) is an old familiar name in the value investing community (I owned it for a stretch), it was once primarily a buyer of defaulted consumer debt for pennies on the dollar that would then go out and sue debtors in order to garnish their wages and recoup their investment, fun stuff.  Following the financial crisis, Asta took a writedown of most of the value in one of their large consumer receivables portfolios but it ended up still cash flowing and looked cheap with this potentially large zero basis asset.  They used those cash flows to diversify into similarly unsavory financial services businesses without much logic such as social security disability advocacy, personal injury claims and structured settlements.  This is a family controlled business and they have treated it that way in the past, they had a dust-up with Mangrove Partners which Asta ultimately ended up paying what looked like greenmail with a large tender offer, followed by a special dividend for most of the market capitalization pushing it further into microcap terriority, then had to restate years of financials, all of which led the shares to be completely ignored by the market.  For a while there it was trading below cash, a clear error of omission on my part not jumping on it then as I've always kept ASFI on my watchlist.

But on November 1, Gary Stern, Asta's Chairman and CEO offered to purchase the remaining outstanding public float (the Stern family owns ~60% of the company) for $10.75 per share conditioned upon acceptance by a special committee of independent directors and a majority of the minority shareholders vote for its approval.  Given the premium to where shares had been trading, I would expect both to be relatively easy to obtain.  Book value is about $13.50 with more than half that being cash, maybe there's a tiny chance of a bump.  But the board is only 5 members, one of which is Gary Stern, two of them have been on the board since the mid-2000s and have let this situation play out to-date, the other two are relatively new but likely friendly with the Stern family given the controlled status.  Even without a bump, financing should be a breeze considering the Sterns can dividend out the cash to themselves when in full control making this a low risk idea.

It's about a 6% gross spread, not fantastic, but I'm familiar with the company and its management, I see this as their opportunity to return to a family company and operating in the dark without pesky minority shareholders or exchange listing requirements (about half their press releases in recent years are NASDAQ de-listing notices).  Plus I have some dry powder and have been stashing cash in more small special situations like this until I find more mainstream ideas.

Disclosure: I own shares of ASFI