Description

Jameson Inns is a hotel owner and operator that is trading at a value significantly below the value of its assets, as measured by EBITDA multiples, FFO multiples, and comparable transactions. It is currently trading at under 9X EBITDA (comps 11-13X) and about 6.3X FFO (comps 10-11X). Recent acquisitions have been done at 12X EBITDA, and the company has been selling some of its weaker properties for 11-13X EBITDA. Putting a reasonable valuation on this company would yield a $2.50 stock, a return of over 50%. JAMS is also restructuring some hotels and introducing some service initiatives that over time could result in a $5 stock. The stock is in penalty box because they missed the first quarter out of the box after an overhyped secondary offering this summer, but the 3rd quarter numbers were very promising and clearly demonstrate the potential of this investment. The stock has not yet reacted, and rightfully so, because investors are definitely in wait-and-see mode with this stock. But the stock should work its way higher as the company starts delivering on numbers in 2005.

JAMS is a hotel operator in the Southeast and Midwest. It runs 2 brands: Jameson (about 90 owned and 10 franchised) and Signature (23 hotels). The company levered up to buy Signature in 1999, and a glance at the stock chart since will show what a disaster that was. Until this year the company was a REIT, and as a result the Signature brand has suffered from a lack of much-needed investment. It also had many locations in areas of the country where the weakness in the economy has been much more pronounced (the company particularly cites Indiana). This summer the company did an equity offering to clean up the capital structure and take out a lot of hi-cost preferred stock, and also raise money to revamp the Signature inns and convert them to Jamesons. 2 weeks after the offering, the company missed analyst estimates of their second quarter. One should note that this was because the bankers whiffed on some expenses in their model, as the company did not actually lower its guidance.

The Industry Opportunity

The industry-wide opportunity in the hotel industry has been well documented. The industry really went in the toilet after Sep. 11, and is still early in the recovery to normal levels. Basically everybody is forecasting solid REVPAR gains next year, occupancy is on the rise even with price increases being passed through. Incremental margins are extremely high in this business, which means strong EBITDA/FFO growth. This presents a very strong tailwind for the JAMS case. JAMS just passed through a $4 price increase this summer, only part of which was reflected in 3Q numbers. By all accounts price increases have been sticking, so JAMS should have a pretty good head start on REVPAR growth for next year.

A Tale of Two Brands

The Jameson chain has been performing fine. These are ~80 room, 2-3 storey hotels that average less than 7 years old and compete with economy/mid-scale chains like Hampton Inn and Holiday Inn Express. The almost 20-year old Signature hotels have been a drag on the numbers, and in the first half JAMS reported weak REVPAR growth while peers were putting up bigger numbers. But the third quarter numbers were much stronger, despite a terrible quarter in the Signature brand, with combined REVPAR up about 5%. The drag of Signature was obvious: Jameson REVPAR growth was 9%, while Signature was negative 7%. As the Signature becomes a smaller piece of the pie, the consolidated numbers for this company are going to start looking very strong.


This transition will happen soon, as the company is in the process of selling about 1/3 of its Signature Inns and converting the rest to Jamesons. The sales have 3 benefits. Since the 8 Signatures that will be sold are expected to go for about $20M or 13X trailing EBITDA, this puts a pretty strong mark on how undervalued the company is (especially since these are the weaker inns). It also will have the effect of improving the total valuation of the company. The third benefit will be that the conversions will be over sooner and cost less money, which means this will be a clean story a year earlier. The conversions should also have substantial benefits. Conversions will cost about $1M per hotel, for a total of about $15M. Pro-Forma for the 8 sales, I estimate that the signatures will do $12M of revenue. Based on 9 month REVPAR of $28 at Signature vs. $34 at Jameson, conversions could increase Signature revenues by over 20% and add almost $3M of revenue, which at a 75% incremental margin would add $2-2.5 of EBITDA. Basically this means the cost should be about 7X EBITDA, which seems like a good investment, since this is before considering any further upside that I would expect from the Jameson brand over the next few years. Originally the idea was to fund about $6-7M/year of conversions (which is all the FCF after paying down $10M/year of debt), so the conversions would happen over 3 years. The $20M from asset sales could make this happen sooner, which would result in cleaner numbers, higher EBITDA, and strong consolidated REVPAR growth as early as 2006.

Other Opportunities

The company also has some other opportunities to improve its numbers. One stat that they like to throw around is that right now they are getting about 90% of its room-share of occupancy (in other words their occupancy is about 10% below the market average). They attribute this to two issues: lack of a loyalty program and lack of hi-speed internet. As a result, they have been building out wireless hi-speed internet in their hotels (they are currently about 25% done) and will offer this service for free to their guests. They have also established a frequent guest program that they will roll out next month. I am skeptical about the frequent stay program and I don’t expect it to have much of an impact on the numbers, but it is upside. Still, with a loyalty program and free hi-speed internet making the Jameson offering comparable to its peers, one should expect some improvement in occupancy. Adding 10% to room share would add more than $5M of EBITDA, and right now I have 0 in my numbers.

Valuation

JAMS TTM EBITDA, pro-forma for asset sales, is 27-28M. With a strong industry backdrop and a $4 average price increase just starting to hit the numbers mid-3Q, it is reasonable to expect REVPAR growth of 5% next year. Given the high incremental margin, this should mean that EBITDA of $30M is very reasonable. Pro-Forma for $20M asset sales, net debt is $176M. A still-cheap 10X gives a $2.17 stock, and fair value of 11X gives $2.70. Comps trade around 12X, minimum of 10.5X. Also remember they are selling their crappy properties for 11-14X 2005 EBITDA. And this summer, LQI bought Baymont for more than 13X trailing.
To get to an implied FFO multiple, I estimate EBITDA of 30 minus interest of 12 minus maintenance capex of 3 (company doesn’t pay tax due to NOL), is $15M or $0.26/share. Put a conservative 11% cap rate on it will give about $2.40.

Fast forward a few years, and EBITDA, which is growing at 10%+ organically and should realize at least some of the upside I have discussed, could be north of $40, and with debt reductions from FCF you would see a $5 stock.

Basically I like this stock because it has been left behind in a strong industry group, so it is a levered play on economic upside that has a lot of tailwind that has not been priced into the stock. Management is not the best (see follow up comment), but the stock has more than discounted that risk.

Catalyst

- Clean quarter where they put up numbers and people can see growth, realizing the potential shown in the 3Q numbers
- Seeing the results of the 3 Signature conversions that will be completed this year
- Free Hi-speed internet and loyalty program should at least have some positive impact
- Executing the asset sales and paying down debt