Value Investors Club / CEDAR FAIR -LP (FUN) (FUN)

Description

FUN is a compounder with a great management team that is undervalued compared to its peers, notably SIX.

Investment Thesis:

Core business is humming: The company almost went bankrupt in the financial crisis (SIX did declare) and they were also almost bought out by Apollo. Since the financial crisis the company has grown top line revenue at MSDs, driven by both pricing and attendance growth, and operating margins are finally back to pre-crisis levels.

The company has legitimate barriers to entry. Over the past 3 years they have achieved 15-16% post-tax ROIC, and excluding goodwill approaching 20%. FUN has been able to increase prices by an average of ~4% annually over the last 4 years while annual guest attendance has increased by 4% over that period, indicating that FUN has pricing power. This is to say nothing of the fact that it would require a very large initial down payment in order to open a competing park, these parks compete locally with 90% of attendance being drawn from within 150 miles, there are massive regulatory/environmental hurdles to overcome to build out large scale parks, there are efficiencies derived from being further down the knowledge curve based on years of experience, and it would require years of marketing to establish the brand identity that FUN already possesses.

With that said, the business model has a ton of room for growth. Prior to new management coming in, FUN was still run like it had been for the past several decades (this was partially why Apollo was interested in taking over, although the high cash generation and ability to cut CapEx was also a factor). Pricing was simple and based on group or individual, with very little price discrimination between customers. A couple years ago management spoke heavily about how EBITDA margins would be compressed due to heavy spend into developing a CRM system that was hitting the SG&A line. Even a mediocre CRM system could do wonders for the pricing models of these parks, being able to offer dynamic pricing based on time of season, types of guests, etc. could easily drive revenue from the gate up by several percentage points a year. The company has vastly improved its ability to extract the marginal dollar from consumers and will continue to do so into the future.

Future revenue streams also look bright. Specifically non-guest attendance related revenue that can be contractual in nature. Notably, FUN has undergone a build-out to wire their parks with TVs. The TVs time will be devoted into thirds, one-third focusing on original content to enhance the guest experiment, one-third to cross promotion within the park and one-third to paid advertising. Additionally, SIX has made several changes to their season pass payments to increase stickiness (such as auto-renewal); FUN has yet to embrace these changes but these are additional levers available to management. FUN is taking a smart approach to many of the changes that SIX is enacting, since they do not compete directly in markets, FUN is using a second mover advantage of watching to see which of SIX’s initiatives are most successful and least harmful to consumer sentiment. This will drive future high-margin revenue. I believe FUN can increase operating margin by 250 bps over the next 3 years.

Balance Sheet has been strengthened: FUN levered up in 2006 to purchase Paramount Parks from CBS, they added ~$1.2B of debt onto their capital structure. This took them from 2.5x debt/EBITDA pre-acquisition, to a whopping 5.7x post-transaction. While the deal itself had attractive financials (they paid 6x operating income and 1x book) they obviously levered up at the exact wrong time. Debt/EBITDA topped out at about 7x and FUN was barely able to avoid bankruptcy ahead of 2010 debt payments. Since, FUN has strengthened its positioning. Total debt has been taken down by $200MM, debt/EBITDA is down to 3.7x as of the end of 2015 (3.4x net debt/EBITDA), and debt has been locked in through 2021 with annual payments of about ~85MM, for an interest coverage ratio of 5x. In addition, FUN has significantly increased cash holdings from $30MM in 2006 to $120MM at the end of 2015.

Costs of financial distress have been removed from the company and their reliance on the credit markets has been greatly reduced.

Competent Management: Matthew Ouimet came to the company in 2012, he previously served as President of the Hotel Group for Starwood Hotels and Resorts Worldwide from 2006 to 2008. Earlier, he served at The Walt Disney Company as the President of the Disneyland Resort (he spent 17 years at Disney). Since coming in, the company has pursued logical investment lines and focused on operating leverage, with varying success. Management’s preferred metric is adjusted EBITDA (they add back effects from swaps, currency losses, stock based comp, and losses on retirements of fixed assets). I don’t care so much for the actual number, since stock comp is an operating expense and retiring fixed assets in the amusement park business is also a recurring cost, but adj. EBITDA generally tracks true operating income so I don’t mind it as a benchmark. In this metric the company has had really good success at both communicating goals and then, subsequently, meeting those goals. Ouimet set forth a “FunForward” initiative back in 2012 where he targeted $450MM of Adjusted EBITDA by 2016 (they met that last year) and they have now updated it to target $500MM of the same metric by 2018. FUN has been growing Adjusted EBITDA by 5.3% annually over the past 4 years and seems poised to easily top this goal.

In general, payouts for management are rational. Adjusted EBITDA is the metric by which the company judges exec comp. Ouimet’s comp in 2015 was only 17% salary and 50% of his total comp was in some form of equity. Executive compensation was 3.5% of net income and significantly weighted with equity, and they have previously implemented a 24 month clawback option should any financials need to be restated. In addition, all directors must hold FUN units equal to four times their annual cash retainer compensation ($260,000) for being on the board.

Valuation:

FUN trades at a discount to the reproduction cost of its assets: Based on a conservative reproduction cost analysis of FUN’s assets, it is currently trading at a 25-30% discount. FUN has estimated that a new entrant would need to spend ~$500MM to recreate a single park, back of the envelope math, based on FUN’s 11 parks would place a reproduction cost of $5.5B ($700MM more than their current enterprise value) without accounting for four water parks and five hotels.

Diving into more depth on the issue, I come to a reproduction value (by this I mean, the amount a new entrant would need to spend to compete with FUN) of ~$75 per share.

Current Assets: Cash is cash, but any new entrant would have a certain amount of accounts receivable losses and inventory waste which FUN has been able to eliminate over its operating history.

Land: First off, it would be hard for a new entrant to even get the land due to zoning laws, but even if they did I think that FUN’s land is significantly undervalued. Here is all the land they have acquired outside of their original site:

Average age of acquired land is about 17 years old.

Improvements/Buildings/Rides/Construction: This is based largely on management commentary and brief discussions with people in the industry. FUN has developed best practices and ongoing relationships which help them to get good contracting terms and teams.

Intangibles/SG&A: In FUN’s markets their park names are well known. They have been community landmarks for decades at this point and all the summer camps have annual pilgrimages there. I capitalized three years of marketing to account for a new entrant trying to get share of mind and didn’t take down intangibles because the brands have real cache in their markets.

Obviously there are a bevy of reasons why a company may diverge from economic theory and trade at a different value from the reproduction cost of its assets, but this large a divergence helps me to feel a margin of safety.

DCF: I used a DCF to value the company as well since it has a fairly stable revenue basis to draw out. I am fairly optimistic about opening up some operating leverage in the next few years, this is largely driven by hopes that FUN will be able to lever their pricing model and to ramp up and ramp down operations on a per park level based on demand with enhanced technology. I projected out the next 5 years of revenue to NOPLAT:

This value is admittedly open to debate though (personally I use a cost of equity of 9%, and I got to a pre-tax cost of debt of 4.5% using their term and fixed rate notes). I don’t personally adjust for abnormally low risk free rates and general borrowing costs in recent years. I used a 7.4% WACC to derive my DCF, and adjusting by CoE up to just 10% brings my target price down to $71.50. Either way I just present it as one more way to triangulate the valuation.

Yield: FUN currently has a 5.7% dividend yield, a .5% premium to its historical yield. A 5.2% yield on it’s current $3.30 distribution would be $64, or 10% upside from here. But even that seems light to me. The company had to suspend its dividend ratio in 2009 when it’s gross debt exceeded 5x EBITDA. With a strengthened balance sheet and improving operating conditions the distribution is poised to grow, not shrink.

Stock is relatively cheap to peers: This is the most compelling part of the story to me right now. FUN has long traded at a discount to SIX (currently 28x to 22x earnings, 12x to 10.5x EBITDA) and there have been a variety of reasons for that.

First, SIX has an international franchise story. The thought behind this is that SIX can positively change the mix shift of its revenue by incorporating no-capital, high margin consulting revenue into its core capital-intensive amusement park revenue. I think there are a few underappreciated issues with this strategy. One, who is to say that international markets have the same consumer preferences on amusement parks as Americans. Disney has really catered its amusement park strategy to location. Two, they have now exposed part of their revenue to the international financing markets. Some of the appeal in investing in the amusement park industry is that their end consumers are largely Americans, so you don’t have to worry about international macroeconomics. And lastly, SIX has previously tried to do this, signing franchise agreements in the mid-2000’s only to see the deals fall apart when financing dried up in the financial crisis. (https://en.wikipedia.org/wiki/Six_Flags_Dubailand) All of this would be ok, but judging by the fact that licensing/sponsorship currently only makes up 4.5% of revenue for SIX, how much it is referenced in sell-side reports, and SIX’s premium to peers I feel that this opportunity has been fully baked into the share price. Any failures in this highly speculative endeavor is likely to cause a re-rating of the stock.

Second, SIX has always been positively cited for targeting top DMAs, whereas FUN has always been concentrated in the Midwest.

SIX:

FUN:

The historical thinking was that the bigger DMAs have higher per capita income consumers and will thus have more pricing power than the Midwestern parks. However, this has not manifested itself in the numbers over the past 5 years. Since 2010, SIX has seen per guest spend increase by 2.4% annually (average guest spend was $44.26 in 2015), while FUN has seen per guest spend increase by 2.7% annually (average guest spend was $46.30 in 2015). All the while, these top DMAs may become a drag on SIX’s earnings in the near term.

Amusement parks rely heavily on high school and college employees who predominantly earn close to minimum wage. Much has been said about raising the minimum wage, but so far it has only actually been done in the richest parts of the country. As an aside, 40% of wage earners in Mississippi (the poorest state in the country) are below the $15 per hour rate that has been heavily cited. Think about what inflation would be like in the state of Mississippi if wages were hiked tomorrow (that is if there weren’t massive layoffs). The point of this being that I view a national minimum wage hike as highly unlikely, but could very well see regional minimum wage hikes, although likely in only the richest areas. SIX is exposed to these areas.

SIX raised their minimum wage in their Gurnee location from $8.25 to $9.00 last year. At the time it was reported that 80% of its workforce did not yet make that amount.

SIX had 42,000 seasonal employees last season, assuming 35 hours per week, 12 weeks per year and a minimum wage increase from $8.25 to $15, their total wages to seasonal employees would have gone up $119MM, or 9.5% of revenues.

Even if we assume that minimum wage hike fears applied equally to FUN and SIX, FUN has much better positioned themselves to weather it by actually investing in their business. They’ve been able to rely less on seasonal employees over the past 2 years.

Which goes to another reason SIX has traded at a premium to FUN. SIX has rigidly kept CapEx to 9% of revenue since emerging from BK. However, this rigidity has actually only been accomplished through underinvestment.

FUN has poured in close to $100MM of CapEx in excess of their D&A over the past 2 years while SIX has only spent ~$7.5MM. Even the absolute CapEx numbers in recent years are staggering when you realize FUN has 14 parks while SIX has 18 (120 coasters for FUN vs. 135 for SIX). (To be fair, FUN has a more expansive hotel business than SIX, 1300 rooms to 200).

The most telling number in my estimation is the fixed assets/sales number. I get to the growth/maintenance CapEx divide by determining a long term PP&E/sales ratio and then applying that to incremental sales, with that number being attributed to growth CapEx and the remainder being maintenance CapEx. Under this method, it appears that SIX has basically been foregoing maintenance CapEx over the past two years, whereas FUN has been making up for underinvestment through the financial crisis. Either way, SIX now has $.95 of PP&E for every dollar of sales they produce whereas FUN has $1.23. I believe these numbers should converge, as they previously were tight pre-financial crisis. SIX will either have to pick up its spending, hampering FCF in the near future, or FUN will be able to cut its CapEx even more meaningfully then the market expects and it will have operating leverage to eke out in the future.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

FUN signals intention to cut CapEx

FUN adapts SIX season ticket sales methods

Sell Side sours on SIX's investing strategy

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			2016	2017
Price:	58.64	EPS	3.56	3.75
Shares Out. (in M):	56	P/E	16.5	15.6
Market Cap (in $M):	3,290	P/FCF	13.6	11.6
Net Debt (in $M):	1,439	EBIT	319	345
TEV (in $M):	4,770	TEV/EBIT	15.0	13.8