Description

The numbers above and the analysis below are pro forma the Merger with Vistana.

Background: The Vacation Ownership (yes, fka timeshares) industry has four basic pieces:

- VOI Sales and Financing

- Exchange Markets

- Rentals

- Resort Mgmt

The Exhange business is a duopoly with large network effects. WYN has the larger one and II has the smaller one. The VOI Sales business is the most cyclical of the four. Not surprisingly, 2007 was the peak year ($11bn) and 2009 was the trough year ($6bn). Sales have recovered only about a third since 2009. However, due to the new asset-lite model, the cyclicality of the business hits the income statement but does not pose much of a threat to the balance sheet.

There are five (after merger) publicly-traded players in the industry:

- II has largely been an Exchange and a Rentals business. It does have a small Sales and Resort Mgmt business. Vistana will complement it. Vistana is all VOI Sales and Resort Mgmt. The two businesses complement each other as the VOI Sales business feeds customers into the Exchange business. II's lack of captive VOI Sales business has hurt it, and the merger was intended to remedy this problem.

- Wyndam is the big-dog in the industry and does it all. However, note that WYN also has a hotel franchising business that deserves a higher multiple than the vacation ownership pieces.

- DRII is mainly VOI Sales but also has a resort mgmt businss.

- VAC is more balanced between VOI Sales and Resort Mgmt.

- Bluegreen/BFC Financial has been left out of this conversation due to its problems.

The accounting for these businesses is somewhat confusing and obscures the value:

- One key question is how to deal with securitized debt (on balance sheet but non-recourse). If we count the securitized debt in the TEV, we end up adding apples and oranges because the securitized debt has about a 3% interest rate. So we would combine 33x EBITDA contingent claims with 10x EBITDA contingent claims. The consistent way to treat this is to not count the securitized debt towards TEV but to subtract the interest on the securitized debt in calculating EBITDA.

- The cost of VOI sames is a tricky matter due to the Relative Sales Value Method. The problem is that in each period, the cost of sales includes a correction, or true-up, for all past cost of sales. So the cost of sales number can be inconsistent. This is especially true at DRII for some reason. And in one of the oddest accounting legerdemains I have ever seen, DRII simply excludes cost of VOI sales from EBITDA! The SEC directly confronted DRII about this before its IPO, and DRII replied with a formal letter to the SEC, and the SEC bought the explanantion!! Long-story short, DRII's EBITDA numbers are meaningless.

- In this analysis, EBITDA:

  - includes all repeated stock comp

  - includes all securitization interest but not interest on corp debt

  - includes normalized VOI cost of sales

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The market has reacted poorly to the merger of II and Vistana as II stock has gotten socked almost 40% since the announcement. It is cheap on an absolute and relative value basis. I think the market has failed to look past mis-leading headline EBITDA multiples that obscure the value.

The pro-forma cap structure is:

shares: 129mm shrs * $14.50 --> $1,871mm

cash: $101mm

corp debt: $415mm

cash to starwood: $132mm

TEV = $2,381mm. However, and here is the key step, Vistana brings with it $415mm of mortgages, over $200mm of hotel properties, $30mm of unused land, and $240mm of VOI inventory. They can securitize 95% of the mortgages for about 3% ($395mm), develop or sell the land ($30mm), and reduce the inventory ($40mm). This produces $465mm of cash while subtracting $12mm from EBITDA. Finally, the hotels should be valued on a higher metric than the VOI pieces. Subtracting out these pieces gives us Adj TEV of $1,716mm for the VOI business.

Pro-forma EBITDA with cap structure in-line with industry:

II EBITDA: $185mm

Vistana EBITDA: $143mm

less stock comp: ($17mm)

synergies: $21mm

less hotels and interest on sec: ($25mm)

PF EBITDA: $307mm (5.6x)

Less Capex ($25mm) and tax at 30% (Amort Tax Shield) gives us Unlevered FCF of $197mm (8.7x).

Due to the complementing businesses, I think that this merger adds a lot of value to the Exchange piece that is not fully captured in the $21mm, but time will tell. For less than 9x unlevered FCF, we get a high-quality business (the exchange; rentals; mgmt) and a cyclical business (VOI Sales) with a huge ROI that should has demographic tailwinds. 

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Now for the comps:

WYN is the best comp because it includes an Exchange business, but it deserves a premium multiple both because it includes hotel franchise business and because it is the big-dog, which adds value to its Exchange versus II. With stock at $74.50, the TEV is $11.6bn. The EBITDA is $1.3bn (8.9x), and the unlevered FCF is $770mm (15.1x).

DRII is the next best comp because of its size and relatively small mgmt business. At $27, it has a TEV of $2,061mm (pre the Q4 acquisition). And it has about $270mm EBITDA (7.6x) and the unlevered FCF is $170mm (12.1x).

Finally, VAC at $59.25 has a TEV of $1,580. It has EBITDA of $227mm (7.0x) and unlevered FCF of $145mm (10.9x).

I would argue that the pro-forma II deserves to trade between DRII and WYN due to its pieces . . . I think it deserves 13x unlevered FCF, or $2,565mm . . . which gets us a share price of $21.

I should also note that there has been some insider buying at these levels, and the CEO owns about $12mm of stock. And Liberty will own about 15% of post-merger company.

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The risks to the sector are fairly well known: (1) the economy goes south and (2) Airbnb. I'd love to hear others weigh in on whether Airbnb and its ilk are a threat to the larger VOI business.

The risks specific to II are (1) merger falls apart (but this does not seem like much of a risk given price action), (2) the II Exchange fails to keep up pace with RCI (WYN exchange).

Catalyst

They should file the S-4 in the next few days. I believe the S-4 will detail the pro forma numbers with the cap structure in-line with others in the industry. This same situation happened when VAC spun off. Its balance sheet hid significant value.

After that, the next catalyst is the merger (expected Q2 2016) itself and the securitization of the note receivables after the merger.