Description

Description

Interval Leisure Group, Inc  (IILG: $15), the #2 timeshare interval exchange, is a very high ROIC duopoly business which generates free cash flow substantially in excess of reported earnings and which is approaching a very accretive refinancing opportunity. Earnings are understated due to significant intangibles amortization and the high cost debt referenced above. The stock has also been held back by a lack of organic topline growth, discussed below and by management’s focus on acquisitions versus buybacks or dividends. We think many of those characteristics are changing to the benefit of shareholders. Growth is turning modestly positive, recent acquisitions have been smaller and appear disciplined and accretive, the high cost debt will be refinanced this year and free cash flow is now being utilized for both buybacks (modest) and dividends (more aggressive than we’d expected).  We continue to believe the franchise should be valued substantially higher than the current price and detail our thoughts below.

2011 Rev/EBITDA/FCF was $429M/$151M/$83M.

Debt: $356M, Cash: $196M, Net Debt: $160M

Mkt Cap: $15 x 57M=$855M,  TEV: $1.015B.

TEV/EBITDA: 6.7X

(EBITDA-Capex)/TEV: 13%

FCF Yield: 10%

Investment Thesis

Founded in 1976, and owned subsequently by LeagueStar PLC, CUC, Willis Stein and IAC, Interval was largely abandoned after August 2008 spinoff from IAC, just in time for the collapse of the securitization market for timeshare receivables…and most everything else. 

IILG does not own timeshare real estate, does not sell timeshares, but is dependent on industry timeshare sales for new exchange members.  An estimated 80% of timeshare owners belong to an exchange, the vast majority to RCI or Interval. Interval is the only independent option for big developers such as Marriott and Starwood as RCI is owned by WYN, a large timeshare developer (and hotel franchisor).

Core Membership and Exchange segment: High moat, real network effects (remember those?). 1.9M members, average HH income above $120K/ year vs $80K for the industry, 2600 participating properties in 75 countries worldwide.  45% of revs from subscriptions, ($89/year) and 55% from exchange transaction fees ($149 via web www.intervalworld.com , $169 via call center.  Also provides travel agency services and travel discounts to individual members and sales & marketing and reservation services to developers.

The membership fee, typically paid for by the developer and included in the initial timeshare interval sale, accounts for less than 0.5% of the average interval sales value. Developers typically sign up for deals of >5 years with a designated exchange.  Individual members can then opt to renew after the initial 1-2 year membership period.

Exchange segment operates with negative working capital due to annual subscription payments and upfront transaction and getaway fees.

IILG and RCI, the #1 exchange with about 3.9M members and owned by WYN, also a big timeshare developer, control at least 90% of the exchange market.  More members = more resorts=more value for members.  The ability to exchange weeks/points is a key selling feature for timeshare intervals.

Upselling from the basic membership to Platinum, started March 2011, now 40K accounts, pay an extra $129/ year above basic membership for benefits such as discounted travel, earlier access to high demand destinations/weeks and use of points instead of specific resorts/weeks.  also tend to buy more getaways (vacations packages sold from excess inventory)  Initially Platinum was sold only to existing members, now offered at initial membership/vacation interval sale by IILG’s timeshare developer clients.

Club Interval Gold, also launched in 2011, Incremental $59 above basic membership

Core Interval Network 90% retention rate.

From IILG’s 2011 10K filed Friday. Beginning in 2010, access to the credit markets returned for securitization transactions available to certain large developers, and during 2011, access to receivables financing hasimproved for better capitalized developers. Financing standards for consumers remain higher than those required several years ago and developers are continuing to modify their business models. As developers with greater debt obligations continue to work with their lenders, we anticipate additional bankruptcies, reorganizations and consolidation within the industry.

IILG typically raises prices about every 18-24 months, with rolling impact as members renew.

Growing Management & Rental Segment.  19% of revs, 5% of EBITDA in 2011.  Revs up 24%, ebitda up 35% in 2011, to $79M and $8M, respectively.  Not as profitable or as big a moat as membership/exchange but more fragmented and better long term growth prospects.  Biggest piece is Aston, a Hawaii-based resort property management company. Also manage rentals for hotels & resorts, condos and timeshare units. Recently acquired a business that manages timeshare homeowners’ associations. Margins are substantially higher if pass-through expenses are excluded.

The 2007 acquisition of ResortQuest Hawaii (renamed Aston) for $110M was not a value creating transaction in our view, although it did give IILG critical mass in vacation rental management.  The Hawaiian market, which accounts for the bulk of Aston’s revenue has rebounded strongly over the past 2 years and significantly boosted this segment’s results.

November 2010 bought Trading Places, a timeshare exchange and resort management business. Added contracts/owners in 2011.

Feb 28,2012, bought Vacation Resorts International, another property/resort management company, 140 resort /club locations in North America.

Initiated a 40c annual dividend, a 3% yield when declared and a 33% payout ratio on 2011 free cash flow.

Buyback:  After much pressure from shareholders, IILG did authorize a $25M? buyback program in Aug 2011.  Bought back 1.7M shares for $20.9M in 2011.  Management has been reluctant to be more aggressive on the buyback given the 30% Liberty stake, the pending debt refinancing and the priority on acquisitions.

Starting in late 2010, management raised internal spending to develop new products and services in order to offer more value and features to members.  As the company has cycled this step up, G&A spending increases have moderated.

Reported EPS of $0.71 understate the true earnings power and cash flow of the business for 2 main reasons

(1)   Amortization of Intangibles related to IAC acquisition/spinoff.  In 2011, intangibles amortization amounted to $27.3M or 29c after tax.  Thus reported eps of 71c were really $1 adjusted for this non-cash expense.  The few analysts who cover IILG do not yet make this adjustment, nor does the company call it out.  In 2012, this amortization should drop to $21.1M and in 2013 to only $5.7M or 7c / share.

(2)   High Cost Debt related to IAC spinoff,$300M face, unamortized discount of $16M at 12/31/11, so net on books of $284M.  2016 maturity, but callable at par Sept 1, 2012. Bonds have a  9.5% coupon, but effective cost of 11% including the accretion of unamortized discount ($2.5M in ’11) and the amortization of debt issuance costs ($1.8M/year).  Company intends to refi between now and Sept 1, adding at least $10-$15M to reported earnings and slightly less to free cash flow.  Range depends on the all in rate and how much they choose to pay off versus refinance.   Note that the Term Loan is currently at a 2.8% rate.

Core Membership & Exchange $349M/$143M or 81% of revs and 95% of consolidated ebitda.

2M members total, including 1.8M in core Interval Network.  IN still slight declines, down 1.3% in 2011, reflecting past several years of lower industry timeshare sales.

Valuation

At $15, with 57M f.d. shares and $160M net debt (incl unamortized discount), IILG has a market cap and EV of $855M and $1,015M, respectively. This represents 6.7X 2011 EBITDA ($151M) and a 13% free cash flow yield, defined as (EBITDA-Capex)/EV.  On ’12E, the EBITDA multiple drops below 6X and the free cash flow yield climbs to 15%.  ($160M-$15M)/$950M. Capex (mostly capitalized database development) should be about 3% of revs going forward.  The company’s asset light subscription and transaction based model results in very high ROIC.  2011 EBITA of $????M was achieved on negative net tangible assets.

Strategic Value

Liberty owns 30% dating from the IAC split-up but has shown no urgency to monetize its stake.  There was a 2-year lockup which expired in August 2010, but the larger impediment may be Liberty’s low tax basis and even the relatively small size of its stake as compared to Liberty’s other assets.

At 8X 2012 EBITDA, we think IILG is reasonably valued at $21, including the benefit of the FCF we expect this year.  As the intangibles amortization drops and the earnings/FCF accretion from the refinancing are realized the reported earnings will approach underlying economic earnings supporting a better valuation for this unique franchise.  Each EBITDA multiple is worth about $2.60/share.

Risks

The collapse of the Timeshare receivables financing market in late 2008 severly curtailed timeshare sales and ultimately impacted IILG member count as gross new member adds failed to offset normal attrition.  The financing market has recovered for the bigger developers but most are still operating with a less aggressive development model.

Catalysts

Return of positive, albeit modest organic growth.

Convergence of reported earnings with substantially higher cash earnings power as amortization drops off and the high cost debt is refinanced within 6 months.

Improvement in Revenue and EBITDA driven by upticks in timeshare sales, increased revenue per member from new products and a growing contribution from management services segment

Continued investment of substantial free cash flow to the benefit of shareholders..

Catalyst

Catalysts

Return of positive, albeit modest organic growth.

Convergence of reported earnings with substantially higher cash earnings power as amortization drops off and the high cost debt is refinanced within 6 months.

Improvement in Revenue and EBITDA driven by upticks in timeshare sales, increased revenue per member from new products and a growing contribution from management services segment

Continued investment of substantial free cash flow to the benefit of shareholders..