Description

Note: Interval reports after close today

Thesis / Key Points

We believe that Wall Street's disdain for the timeshare business extends unfairly to the valuation of Interval, in part because of its short history as a public company and in part because of the lack of any good public comparables. Nevertheless, Interval is a relatively non-cyclical business with low capital intensity, steady cash flows and high ROIC.

• High barrier to entry business (in duopoly with RCI)
  • Pricing power and high returns on capital (>20% after-tax ROA)
  • Network of 2,500 resorts in 75 countries that took over 30 years to build
  • Long-term contracts with premier developers (e.g. Marriott, Starwood, Hyatt)
• Enduring competitive advantage versus RCI
  • Higher quality resorts in network
  • Not perceived as a competitor by developers (RCI is wholly owned by Wyndham)
• Highly stable, non-cyclical recurring revenue driven by 80-90% retention rate of members
  • 1^st half 2009 network revenue up 2.6% ex-currency even as travel industry reeling from economic downturn
  • Timeshare occupancy generally 20% better than hotel occupancy
• Continued high demand for exchange network (by both developers and timeshare owners)
  • Adds significantly to timeshare value proposition, at small fraction of timeshare cost (~ 9% annually)
• Seasoned management team with CEO and COO each having more than 25 years with company under 5 different owners
  • Well-respected by developers' management teams
• EBITDA more than doubled from 2003 to 2008, primarily as a result of approximately 25% member growth
  • Operating leverage as ~70% of costs are fixed costs
  • Demographics favorable as baby boomers reach retirement age and have additional leisure time
• 10% 2010E free cash flow yield
  • Earnings reduced by amortization of goodwill and intangibles from spin-off
  • Low capital expenditure requirements 

Company Description

Founded in 1976, Interval has grown to become the second largest vacation ownership exchange in the world, with a 35% market share. Importantly, Interval is not a timeshare developer; the company owns no properties and offers no financing. Instead, Interval provides network exchange services for owners of existing timeshare properties, contributing significant value to the industry's value proposition. In May 2007 Interval acquired ResortQuest Hawaii (renamed Aston), a hotel and resort manager, for $110 million. Interval Leisure Group, Inc. was formed in August 2008 as part of Barry Diller's IAC/InterActiveCorp's separation of its businesses via spin-offs.

Interval Exchange

• Exchange members (who pay an annual fee of $89 for basic membership, comprising 45% of revenues) can exchange their vacation ownership interest (a designated week at a resort or resort points) for use of other vacation properties in the network based on an assigned trading value
  • Allows for place- or time-shifting of vacation
  • Additional fees apply upon exchange, typically in the $139-$149 range (comprising 55% of revenue)
  • Members also have access to Getaways, discounted resort stays, and travel agency services
• Members are usually signed up for the first year of membership by the developer as part of the initial sale
  • Resorts are usually designated to participate in one of the two vacation ownership exchanges, meaning that the developer chooses the exchange network
    • Developers sign 5-10 year contracts with exchanges
    • Interval provides developers with sales and marketing (brochures, displays, directories) and operational support (reservations, billing, collection)
  • However, individual members are generally responsible for renewing membership after the first year and paying annual dues (though in some cases the developer pays this membership via vacation owner dues). Retention is high.

Aston (< 5% of company value)

• Purchased in 2007 for $110 million
• Operates a Hawaiian hotel and resort management and vacation rental business (2^nd largest operator on islands)
  • Owns no properties or real estate
• Exclusive long-term contracts with condo and traditional hotels for management and sales and marketing services
  • Earn management fees (and sometimes incentive fees) based on gross operating profit (1-5%)
  • Pass-through many expenses (shows up as part of revenue, understating gross margins)
  • Also rent out condos for owners, leveraging relationships with wholesalers, travel agents (including online), and the broader Interval network

Industry Overview

• RCI, owned by Wyndham (the world's largest timeshare developer), and Interval control 99% of the vacation ownership exchange market
  • RCI has 3.8m members to 1.9m for Interval (7.0m ownership interests worldwide)
• RCI has more international exposure and offers points-based exchange
• Interval offers more properties in the East Coast
• Interval has nicer resorts on average and a higher median income per member ($108k vs. $81k)
  • The largest developers prefer Interval because Wyndham is a competitor and has a conflict of interest

Points from conversations with vacation ownership executives at Disney, Westgate Resorts, Marriott Vacation Club International, Hyatt, and Southern Sun

• The resort choices available in the Interval Network are an irreplaceable selling point for timeshares
• New resort development is uneconomical without including timeshares, as their IRR is 10+% higher than hotel rooms
• Interval International provides better vacation owner and developer service because they have invested more heavily in call centers and support personnel
• Timeshare demand has not waned; sales are down because of the lack of financing, which is already improving 

 Misperceptions

• Misperception: IILG's business is cyclical; 2010's revenue and membership decline will match 2009's
  • Reply: 1^st half 2009 sales are down because of the relative strength of the dollar and loss of Disney from the exchange network (7% of member base), a very unusual event (1st half sales are up ex-currency)
• Misperception: The timeshare business has been irreparably harmed by the financial crisis
  • Reply: Consumer demand for timeshares has not waned and developers still plan to build new timeshare resorts
• Misperception: IILG revenues cannot grow if there is not new timeshare development
  • Reply: The price of annual dues and exchange fees has grown without reducing membership for many years

Risks / What Would Indicate We Are Wrong?

• Loss of a major development affiliate
  • Mitigated by 5-10 year contracts
• Push by RCI for increased market share while abandoning pricing discipline
  • Mitigated by consistent market shares of RCI/Interval over time
• Future resorts developed w/o timeshare component
  • Mitigated by attractive economics of timeshares
• Push by hotel companies to keep owners exchanges in internal network
  • Mitigated by fact Interval runs many of these internal networks, as well
• Strength in dollar
  • Mitigated by recent dollar weakness and Federal Reserve's monetary policy

 Valuation

Based on a discounted cash flow analysis, cross-checked against comparable company analysis, we arrived at a price target of $20/share, 67% above current levels.

Discounted Cash Flow Analysis

Utilized 3 ½ year projections with the following assumptions:

• Conservative membership and revenue growth assumptions for 2009-12
  • 2H 2009 and 2010 revenue growth equal to 1H 2009 (without loss of Disney in 2010)
  • Revenue growth increases thereafter but does not reach 2005 to 2008 levels
• Margins flat through 2011 then grow 70 bps 2012
• Cash taxes at 38.7%
• Capital expenditures 4% of sales (vs. 3.8% LTM)
• Working capital flat through rest of 2009 then minor source of funds (though less than historically) thereafter
• Average terminal multiple equal to that at which Diller bought Interval in 2002

Even assuming zero membership growth and zero margin expansion, we still arrive at a price target of $15.25.

Comparable Company Analysis (as of 11/11/09)

Catalyst

 How It Plays Out

• 2010 results very likely will surpass Street estimate
•          Interval should not lose another Disney-size customer and the dollar should not strengthen as much on a year-over-year basis (as dollar has been weak recently)
• $300 million of Senior Notes with 11% initial yield (trading at 6-7% yield) are callable at par in 2012
•          Reduction of interest expense will increase cash flow to equity
• Potential for dividend or stock buyback after paying down some debt
• Liberty Media, 29.6% owner, has lock-up expire in August 2010 and may purchase additional interest
• Private equity has owned this business before and may have interest again if shares remain undervalued