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)

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