Description

Date: 11/2/09

Idea: SHORT Cedar Fair Entertainment (NYSE: FUN)

Price: $10.01

Mkt Cap: $550m

P/E: 8.8x

TEV/EBITDA: 6.9x

Dividend Yield: 10%

Cedar Fair is reporting tomorrow.  They are going to miss expectations by a long shot.  They are likely going to have to suspend their dividend distribution starting 12/31/09.  The Company will survive long term, suspending this dividend is a very important move as the co. is running very close to the edge right now, they are way too tight on cash needs with the dividend in place, and retaining this dividnd is the right long term move as FUN needs to pay down quite a bit of debt before it matures, needs to be refi'd at MUCH higher rates, and the company really gets itself in trouble.

I tend not to like short term calls, and this is VERY short term (with an earnings announcement tomorrow).  However, this overlevered, 3^rd tier amusement park operator is being propped up by a dividend that I believe is about to come to a halt (they've already had to cut it 50% this year).  I wish I could have posted this with more forewarning, but I just started looking at this again last night.  I'm very familiar with the company as I narrowly averted being duped into buying a few years ago while debt was still cheap and plentiful (the key to their equity investment thesis).  I took a look at where they stand today for the first time in 18 months and was very surprised.

As it is the day before announcement I will keep this write-up quick, happy to expand in Q&A

Quick thesis for near term movement:

1.  Stock is propped up by it's 10% dividend yield

2.  Dividends can only be paid out if the company stays under a maximum leverage ratio (steps down to 4.75x starting December 31, 2009)

3.  Company is nearly all fixed costs, earns the full year's EBITDA in the 3Q every year (highly seasonal amusement park operator)

4.  Has AREADY REPORTED revenues are down 10% for the 3Q through August - July & August are the lionshare of earnings for the amusement park business.  Usually a stable business, however it has been very cold and wet throughout their markets this summer (those living in the NE can attest) - see climate charts here: http://www.ncdc.noaa.gov/sotc/?report=national.

5.  Even if you get very aggressive on free cash flow and EBITDA between now and year end, they will wind up >4.75x levered, will have to suspend the dividend, and I expect the stock will plummet to a more reasonable level. 

Longer term problems - (reason I didn't buy the stock initially):

1.  FUN business model is entirely dependant on leverage.  A capital intensive, steady cash flow asset base.  FUN has levered up with cheap debt to maximize dividends to shareholders (it's an MLP, pay 100% of cash flow out essentially).  If cheap plentiful leverage is not available, and this is a very low growth asset, when debt matures and they need to refi, much of the cash flow to equity that currently creates such an attractive FCFE yield will need to be diverted to paying off higher-cost debt.

2.  FUN is overlevered.  FUN completed a major asset purchase of Paramount's Parks in 2007, FUN levered up heavily with the intention of issuing equity to pay down debt afterwards.  The Company's equity valuation started to fall and mgmt kept waiting for a rebound to issue equity at a good price.  Rebound never came, so here they sit hugely overlevered

3.  Core assets are exposed to bad markets - significant exposure in economically hard-hit areas, flagship properties in auto-manufacturing Midwestern regions

However, despite what will be an overwhelmingly terrible quarter, I do believe the company is largely resistant to downturns.  It is a trade-down vacation (or at least it would be if it wasn't catering to a Flint, MI client base).  This 3^rd quarter is partially driven by the economy, but also heavily driven by bad luck with a cold, wet summer (btw 3^rd quarter is their ENTIRE YEAR because it's such a seasonal business).  However, this one bad quarter will be enough to likely wipe out the dividend for the next year at least, which is the only ground the stock is standing on today.

Company Overview:

Cedar Fair, L.P. owns and operates amusement and water parks in the United States and Canada. The company owns 11 amusement parks, including Cedar Point located on Lake Erie between Cleveland and Toledo in Sandusky, Ohio; Kings Island near Cincinnati, Ohio; Canada's Wonderland near Toronto, Canada; Dorney Park & Wildwater Kingdom located near Allentown in South Whitehall Township, Pennsylvania; Valleyfair located near Minneapolis/St. Paul in Shakopee, Minnesota; Michigan's Adventure located near Muskegon, Michigan; Kings Dominion near Richmond, Virginia; Carowinds in Charlotte, North Carolina; Worlds of Fun located in Kansas City, Missouri; Knott's Berry Farm located near Los Angeles in Buena Park, California; and California's Great America located in Santa Clara, California. It also owns and operates the Castaway Bay Indoor Waterpark Resort in Sandusky, Ohio; six separate-gated outdoor water parks in Missouri, Ohio, and California; and five hotels. Cedar Fair Management, Inc. operates as a general partner of the company. Cedar Fair, L.P. was founded in 1983 and is based in Sandusky, Ohio.

Analysis:

I've shown below a few key quarterly metrics.  The big question is 3Q09 numbers.  The company has already reported Q3 results through August of attendance down 10%, spending per guest down 1%.  July and August comprise the vast majority of Q3 results as the amusement park biz trails off in September.

So we KNOW the revenue number is down significantly (I est. down 9%, trying to give them benefit of the doubt at every turn).

Amusement park cost structure is HIGHLY fixed.  It's running the rides, paying employees, just a bit of marginal costs in some food/merchandise (about ~35% of revenue).  They have reduced headcount in the past year, they are making a concerted effort to squeeze costs out of the business as the downturn in the debt markets has left them very exposed.  In the past 3 quarters, they've managed to reduce COGS by approx. 8%, and SG&A by approx. 12%.  These cuts were made off the far smaller, off-season numbers.  To give FUN maximum benefit of the doubt for cost-cutting, I've extended these percentage declines to the much larger Q3 numbers in my analysis, AND assumed they can take an additional 15% cost reduction in all additional high-season expenses (e.g. for peak season expenses that we haven't seen in the prior quarters, they are able to reduce COGS and SG&A by 8% and 12%, respectively, then an ADDITIONAL 15% on the added expenses for the peak quarter).

In sum, this gives me a quarterly EBITDA number of approx. $260m.  Note, this estimate is VERY HIGH.  I don't expect them to beat $250, however I think these figures are the "worst-case" for someone with a short position.  This would actually represent an INCREASE in EBITDA margin, which is almost laughably optimistic with revenues down 10% on a cost structure that is largely fixed costs.

This would generate LTM EBITDA of approx. $315m.  4^th quarter is not a large contributor to EBITDA, and they have a very tough comp coming up due to aggressive promotions at Paramount's California properties last year.  I think they'll be very lucky if they ended the year with $315m of EBITDA.

The leverage test to pay a dividend is 4.75x, which means debt cannot be higher than $1.5B.  Debt at the end of Q2 was approx. $1.775B.  They will generate positive free cash flow in Q3, negative free cash flow in Q4.  Again, being hugely generous on the estimates, I assume FUN generates the same amount of FCF in 3Q09 as they did in 3Q08, despite the significant EBITDA decline.  I credit them for a land sale they completed in Q3 (assume no taxes paid on it), and very low capex.  I can't see how they will come in shy of $1.5B net debt at the end of the 3^rd quarter, much less come in low enough to sustain negative cash flow in the 4^th quarter.

In short, despite being very aggressive in my assumptions, I don't see how this business meets the 4.75x covenant and continues to pay dividends.  Below, simplified projections for the 3rd Quarter - these I believe are the absolute best FUN will achieve, expect actual results much lower).

Analyst Coverage:

With only a $500m mkt cap, FUN does not have much analyst coverage.  Keybanc and wells Fargo both follow the stock.  Both have noticed that the dividend covenant may get tight, but they are inexplicably projecting flat or slightly down EBITDA this quarter despite all that management has already announced about the quarter through August.

Caveats:

Management just declared the Q3 dividend last week.  This is very strange behavior if the facts are going to play out the way I expect them to.  However, I just can't see a way to keep the company under the 4.75x max leverage for a dividend covenant, so I expect that Q3 payment will be the last for a while.  Trading ex-dividend as of today.

Also, the Blackstone / Busch Theme parks deal was done at approx. the current trading level of FUN (but with a much better cap structure).  I don't think FUN gets taken out at current levels, however this is an arena that has always attracted Private Equity interest.

Conclusion:

I can't see how FUN will continue to pay it's dividend following 12/31/09.  Shareholder base is very dividend focused.  This would follow on a 50% cut in the dividend earlier this year, which was not enough.  I expect the stock to trade down significantly if the dividend is suspended.

Again, I apologize for the very late posting of this idea - just started looking at the Company last night.  I'm never a quarter-to-quarter earnings watcher, but refreshed my work on this, and I think the idea is unusually compelling.  If nothing else, I don't see much upside to this stock in the Q3 reporting, if they somehow manage to squeak through and can pay dividends, well, you can take off the short.  Not sure what the borrow is like on this, I'm prohibited from shorting so had to buy overpriced put options.  Best of luck if this reaches you in time!

Catalyst

3rd quarter reporting TOMORROW