Description

HGV, a recent spinoff from Hilton Worldwide (“HLT”), is an international timeshare developer/operator, priming itself for meaningful growth over the next 12-24 months. Yet, despite having increased Fiscal Year (FY) 2018 guidance on the back of stronger than expected Q1 sales, the market has penalized HGV for a confluence of non-fundamental factors that we believe will abate in the coming quarters. In our view, HGV’s revised capital investment plan, with its 15-20% after-tax IRRs, reflects strong pent-up demand for its premium product and uniquely positions HGV for above industry organic growth. The future has never looked brighter for HGV yet it trades at its lowest forward multiple post spin. Using a ‘Sum of Parts’ analysis to properly value HGV’s different fee streams, we assign a blended 10.5x multiple on our 2020 EBITDA estimate which yields a $55 per share stock price or >50% upside over the next 12-18 months.

A Different Kind of Timeshare Spin

“I can tell you every single day, we’re focused on generating new customers . . .over the last 10 years, we’ve been able to win and secure new customers at a faster rate than the whole industry. . . the revenue for our business follows the new customer”– HGV CEO Mark Wang Q1 2018 Earnings Call

While relatively new as a standalone public company, HGV has a strong track record as a ‘best in class’ operator distinguished by the following unduplicated qualities:

•             25 straight years of ‘Net Owner Growth’

•             50%+ of timeshare sales sold on a Fee-For-Service basis with the likes of Blackstone, Centerbridge and Goldman Sachs providing 3rd party capital

•             Dominant market position in Japan, representing 20% of HGV’s owners

•             ‘Arm in Arm’ relationship with HLT and its rapidly growing HHonors program

These qualities are critical for the following reasons:

•             New Owners predictably spend an incremental $1.10 for each $1 of initial spend, giving HGV a clear view into future higher margin repeat sales

•             ‘Fee-For-Service’ opportunities leverage an external balance sheet to grow in select markets, bringing with it recurring ‘Resort & Club’ fee streams

•             Exposure to a unique high-quality customer less correlated with the US business cycle

•             Embedded sourcing opportunity from a rapidly growing pool of loyalty members

Led by seasoned operator Mark Wang, HGV has maintained laser-like focus on new customer acquisition which has enabled HGV to more than double its membership base since 2008 and more than double its recurring ‘Resort and Club’ EBITDA since 2012. Yet, despite this massive growth in membership base (and market share), HGV’s properties remain concentrated in 5 major markets, which creates a significant opportunity to enter into new markets. In this respect, HGV’s spin from HLT affords it a unique opportunity to deploy its substantial operating cash flow to turbocharge its growth and significantly increase its base of earnings. This is manifested in the announced $510-530MM in total inventory spend in 2018, corresponding to roughly $350MM in ‘growth’ spend, a meaningful jump from 2017. The upshot is that while the near-term free cash flow prospects for HGV lag its more mature peers, the medium term organic growth in earnings and cash flow will be best in class, warranting a premium multiple.

An Attractive Entry Point

With HGV beating contract sales expectations and deploying more capital to satisfy consumer demand, why has the stock fallen ~25% from its March 2018 peak? In our view, a confluence of non-fundamental events/factors have contributed to the exaggerated move:

•             ‘Forced sale’ offering from the HNA Group placing $1B of float back into the public markets

•             HGV announced what appeared to be a below consensus Q1 18 earnings driven by changes in revenue recognition policies for projects under             construction 

•            Confusion surrounding EBITDA stepdown from 2018 to 2019 given large non-cash deferred revenue recognized in 2018

The summary is that HNA’s sale did not reflect a nuanced view on the business while the changes in revenue recognition have zero impact on the underlying business. We believe these optics will become a non-factor as investors/analysts shift their focus to 2020 metrics.

An Inflection in Growth

“I think back in late 2016, when we were spinning and had our Investor Day, we weren’t expecting to be able to accelerate this quickly . . . we’re really pleased about it because it’s going to allow us to really move into that next phase . . . of growth for us” -- HGV CEO Mark Wang Q4 2017 Earnings Call

In our view, the most underappreciated part of the HGV story is the recent ramp in announced brownfield/conversion projects, which we believe will generate substantially higher growth. While most investors seem focused on the negative impact of HGV’s growth inventory spend on near-term cash flow, few seem focused on its sizable returns. In our view, there are a few reasons investors are not yet focused on the benefits of these projects:

•             While management has generically quantified brownfield/conversion IRRs, it has not formerly quantified the ramp in EBITDA resulting from this           heightened level of spend

•             Several projects embedded in this spend have yet to be announced

•             Bulk of the earnings related to these projects occur in 2020 and beyond

For now, investors appear anchored to the mid-high single digit EBITDA growth rate articulated at the 2016 investor day, which only contemplated annual total inventory spend of $135-160MM. In our view, the bump in inventory spend will spur double digit revenue and EBITDA growth in 2020 and beyond, a meaningful acceleration from today’s pace of growth.

The good news is that some meaningful projects have recently been announced that should be saleable in late 2019 early 2020, providing some much needed ‘meat on the bone.’ In early May, HGV announced it would convert 87 rooms into 74 timeshare units at the Hilton Los Cabos. This gives HGV a foothold in the Mexican market at a highly sought-after Hilton property with only limited capital required ($41MM). In late June, HGV announced its acquisition of the Quin Hotel in midtown Manhattan, where it will covert 208 hotel rooms into 212 timeshare units. This more substantial capital outlay ($175MM acquisition price) reflects HGV’s strategy of deploying incremental capital in markets it already operates in successfully and will leverage the sales and marketing effort already on the ground. If we consider that, conservatively, $200MM of the $350MM in 2018 growth inventory spend may be available for sale in 2020, we could estimate an incremental $50MM in Real Estate and Financing EBTIDA alone, suggesting upside to 2020 estimates.

Compelling Valuation – Inflecting Free Cash Flow & Shareholder Returns

“We are confident that we can accomplish this and drive returns well above our cost of capital . . . 2017 and 2018 are definitely build years with accelerated growth in 2019, 2020 and beyond” -- HGV CEO Mark Wang Q4 2017 Earnings Call

Putting it all together, we believe HGV’s current discounted valuation belies the above expectations top-line growth that will translate into meaningful EBITDA/FCF growth. Our analysis suggests contract sales should grow double digits into 2020, resulting in EBITDA of $541MM and FCF, including nearly $180MM of incremental growth spend, of roughly $200MM. As that inventory growth spend moderates (either in 2020 or 2021), we see FCF easily in the $300-400MM range, or roughly a 10% FCF yield on today’s stock.  Using a ‘Sum of Parts’ analysis, giving higher multiples to HGV’s recurring fee businesses and lower multiples to its development and financing businesses, we estimate HGV’s 2020 EBITDA is worth 10.5x or approximately $55/share. In our view, HGV’s accelerating organic growth, strong franchise value and very clean balance sheet POST growth spend (<1x EBITDA), all warrant a best in class multiple. Given the future growth spend will be more than covered by FCF, we expect HGV to eventually shift their focus to greater shareholder returns, providing an incremental lever for value creation.

So, what are the catalysts for the market to recognize the value we believe exists? We can think of a few upcoming catalysts:

•             Q2 earnings, where HGV demonstrates continued strong growth

•             Incremental project announcements, providing incremental color as to HGV’s growth strategy and resulting in potential positive revisions to 2020       estimates

•             Late 2018 Investor Day where HGV updates its outlook for future growth under its more aggressive growth strategy

•             Future announcement of a capital return plan, either through buybacks or dividends

Catalyst

See Just Above