Description

We believe MYCC is an attractive short.  Although recently written up as a VIC long, we have a different view on the capital intensity of the business and the ability to generate net ROI.  Given the recent write up did a good job of covering business background, this piece will cut to the chase.

Summary

• ClubCorp operates and manages golf & country clubs (GCCs) and business, sports & alumni clubs (BSAs).  The company is rolling up GCCs.

• GCCs are not good businesses.  The returns on investment are low.  MYCC has masked this reality through acquisitions.  Reality and lack of free cash flow will become evident.

• MYCC is priced at 9.8x 2015 consensus EBITDA and 10.7x my view of true economic 2015 EBITDA.  MYCC will generate 2015 levered FCF of ~4% yield (3.5% on normalized numbers).

• MYCC’s need for continued reinvestment to maintain membership in the face of 15% annual churn should become apparent over the next year, driving revaluation.

Price Target

$12/share (-34%)

Business Overview

MYCC holds a portfolio of 206 owned or operated clubs with ~185k memberships and ~430k individual members.  The portfolio includes 158 GCCs (148 owned) and 48 BSAs.  MYCC is the largest owner of private GCCs in the U.S. and holds the underlying real estate for 124 of the clubs.  The portfolio is concentrated in Georgia (Atlanta, 33 clubs) and Texas (Houston, 19 & Dallas, 17).

Situation

MYCC was founded in 1957 by the Dedman family.  The current company is the residual of almost 20 years of private equity activity.  In 1999, The Cypress Group backed the Dedman family with $300mm of expansion capital.  In 2006, KSL Capital acquired MYCC for ~$1.5bn, which at the time included several resorts (the Dedmans kept Pinehurst while KSL took The Homestead and Barton Creek).  In 2013, KSL sold the resorts to Omni Hotels and IPOed the GCC/BSA business.  The IPO priced at $14/share (net $13.12 to KSL), below the $16-$18 range.

KSL sold 19% of its position in the IPO and another 20% during summer 2014.  In August 2014, MYCC announced the acquisition of Sequoia Golf, expanding the GCC portfolio by ~40%.  KSL acquired Sequoia from Parthenon Capital, a private equity firm that had held Sequoia for eleven years.  In the wake of the Sequoia deal, KSL exited the remainder of its investment with the last sale October 20, 2015.  The Sequoia acquisition drove reported growth, enabling KSL to monetize its investment.  MYCC’s financials should normalize over 1H16, highlighting underlying business performance.

Key Issues

• Does MYCC’s strategy make financial sense?  Are GCCs attractive assets?  Can the company generate FCF to support its current valuation?

• What is MYCC’s required level of capex to maintain its current business?

Investment Case

• Does MYCC’s strategy make financial sense?  Are GCCs attractive assets?  Can the company generate FCF to support its current valuation?

• GCCs face secular headwinds

• Net golf course closures every year since 2005

• Number of golfers has been declining, along with rounds played – some recent moderation

• Demographic and cultural challenges given aging of golf population and attention span of Millennials

• Lack of EBITDA margin expansion

• Revenue up >40% since 2010, while reported adjusted EBITDA margins remain ~22%

• With 15% membership churn, MYCC must refill memberships from a limited geographic area, a challenge without constant reinvestment and marketing spin

• Despite recent significant “reinvention capex,” YTD same-store membership down 10bps, not a good signal

• Low-quality reported EBITDA with consistent impairments

• Touted margins appear fundamentally overstated

• Company only reports adjusted EBITDA per segment, ~30% for GCC – stands against ~21% GCC EBITDA margins for pre-KSL reporting (2003-2005)

• Pre-KSL aggregate EBITDA margin averaged 16% (2003-2005), which is consistent with current pre-adjustment EBITDA margins

• If roll-up strategy is accretive, why did KSL wait until post-IPO to execute?

• 103 GCCs at IPO (2013) versus 99 GCCs at acquisition (2006)

• The skeptic in me is suspicious acquisitions were geared toward driving growth through the PNL, murking the underlying fundamentals, and facilitating KSL’s exit from the investment

• Management touts 10 to 15% “cash-on-cash” returns on new investments – not that attractive

• “Cash-on-cash” utilizes adjusted EBITDA in the numerator . . . not a good starting point

• Taking midpoint of 12.5% less 3% maintenance capex taxed at 40% = 5.7% unlevered FCF

• These are low returns against a business that is macro-sensitive and facing secular headwinds.  With a 4.5% cost of debt, the spread here is tenuous and doesn’t work on higher rates.

• MYCC EBITDA multiples are high

• Multiple industry conversations suggest courses/clubs trade in the 7x to 8x range

• Sequoia acquisition at 10.8x

• 12.5x inclusive of $30mm reinvestment capital – i.e., MYCC was not acquiring fully-invested courses/clubs

• MYCC valued at 10x to 11x

• A 2x multiple reduction, suggests equity value of ~$10 to 12/share

• Can MYCC generate FCF sufficient to support its current valuation?  What is the company’s required level of capex?

• 3-4% FCF yield on 2015 numbers – too low for a challenged, macro-sensitive business

• Management claims maintenance capex of $50mm, which it utilizes to report “FCF” – implies maintenance capex ~$220k/GCC.

• Industry conversations suggest real capex necessary to maintain memberships is ~2x management’s number

• In reality, current capex reflects maintenance capex

• Income statement D&A accurate marker, making net income a fair proxy for FCF

• 2004/2005 pre-KSL reported GCC maintenance capex estimated at $30mm, which would equate to $400k/GCC in 2015 dollars, roughly meshing with maintenance capex being 2x reported numbers

• Other investment considerations

• Implied per GCC market valuation too high

• Assuming 7x for BSA segment, suggests market valuation of $13mm/GCC.  This stands against 2014/2015 portfolio acquisitions at $5 to $7mm per GCC

• Alternatively, industry conversations suggest GCCs worth signficantly less than replacement cost.  MYCC balance sheet suggests $13mm/GCC replacement cost, implying market valuation too high

• Member initiation deposits - although not an acute driver of stress, a relevant consideration in a recession scenario

• $135mm redeemable in over next 12 months

• $339mm total liability

• $20mm of annual accretion included within interest expense

• Texas exposure - 23% of GCC portfolio in Houston & Dallas - derivative energy exposure

• Telling quotes from founder

• Dallas Business Journal, February 2000

• DBJ: What's the catalyst for all of this consolidation?

• Robert H. Dedman: It's a tough business to make money in. It's both people-intensive and capital-intensive. Golfers demand a lot from the experience.

• Sports Illustrated, June 1999

• Robert H. Dedman: We will never stop acquiring.  In this business you acquire or perish.

• Insider selling - beyond KSL’s exit, management is consistently 10b5’ing shares into the market

• Valuation

• We downward adjust EBITDA by ~$20mm versus management’s numbers.  Management’s adjustments (shown above) average ~$40mm per year, so we're giving them half credit for the add-backs.

• On 2016 EBITDA of $244mm,  MYCC would generate ~4.7% FCF to equity.

• Our essential view is this is a fundamentally challenged business with significant macro-exposure. Requiring a 7% to 8% FCF yield suggests equity value ~$12/share.   

MYCC – Where’s the Operating Leverage?

MYCC – Material Churn That Has to be Refilled from Same Geographic Area; Declining SS Memberships Despite Recent “Reinvention Capex”

MYCC – GCC Historic Margins

Catalyst

As company laps Sequoia transaction and underlying organic membership trends and FCF profile become apparent, shares re-rate.

The company may well execute further acquisitions, driving shares higher.  We would view this as an attractive opportunity to add to the short given our view of the underlying fundamentals of the business.  At 4.3x leverage with a 5.0x cap, there is not the opportunity for a Sequoia-scale transaction, but we do anticipate incremental M&A.