Description

La Quinta’s (LQ) upcoming spin of their owned hotels (in combination with the sale of their franchised business) into a REIT presents investors with all the hallmarks of a classic undervalued / underestimated spin: the spun off business will be completely different than the current one, management is going to the spinco, the trailing financials are messy, a quirk in the deal structure incentivizes management to sandbag numbers / valuation heading into the spin, and the spinco will be a juicy acquisition target for a variety of strategic acquirers. Using relatively conservative assumptions, I believe the entire company is worth more than $23/share today, which presents solid upside from today’s price of $18.60/share. However, I also think that upside undersells the opportunity, as $8.40/share will be returned in cash in the near term (sometime in Q2). Looking through that cash distribution, you’re creating the REIT business (CorePoint) for ~$10 against my valuation of >$15, presenting over 50% upside.

Some background: La Quinta is (as you might expect) the owner / operator / franchisor of the La Quinta hotel brand. In addition to operating the La Quinta brand / franchise, the company owns a bunch of the La Quinta hotels (i.e. they own the physical building). In early 2017 the company announced a plan to pursue a taxable spin that would split off the owned real estate into a REIT and leave behind the high margin franchise / brand management business. In early 2018, the plan changed slightly: the company announced they were selling the La Quinta franchise / management business to Wyndham, and concurrent with the sale they would spin off the REIT as a company known as CorePoint Lodging. The whole transaction should close in Q2’18.

The terms of the Wyndham agreement call for Wyndham to pay LQ shareholders $8.40/share in cash in addition to paying off some debt and covering taxes associated with spinning CorePoint off in a taxable spin. So, at today’s price of $18.60, LQ shareholders are paying for the right to receive ~$8.40 when the Wyndham transaction closes in the next few months plus the remaining CorePoint business. So let’s turn to CorePoint: what exactly is it and what’s it worth?

You can find a ton of info on CorePoint in the Form 10 La Quinta filed for in in September as well as in their July spin-off investor presentation, but basically CorePoint is a REIT that owns 319 La Quinta hotels. The charts below (slides 18+19 in their spin-off presentation) should give you a bit more feel for the type of properties CorePoint owns; I’ve also included a slide from the Wyndham / La Quinta deck to help you think about where La Quinta falls within the Wyndham portfolio.

Hopefully the above has given you a good idea on what the CorePoint hotels look like; I’m not going to spend a ton of time given more of an overview since the Form 10 covers the business in great detail and I would guess most investors / human beings are somewhat familiar with the hotel industry. So let’s start talking about how to value CorePoint. There are plenty of publicly traded Hotel REITs so we can triangulate a decent peer multiple. If you look at p. 161 of their spinoff docs you can find the nine REITs they consider peers (DRH, STAY, HT, HPT, HST, LHO, RLJ, RHP, INN). Of those nine, I think RLJ, INN, and HT are probably the best peers (all three are, like CorePoint, internally managed, have a third party operate their hotel, and while they target higher end segments than CorePoint they’re not that much higher end; CLDT probably belongs in this discussion too but wasn’t in the proxy), and I’d consider HPT, STAY, and RHP the worst peers for a variety of reasons (STAY’s paired share structure means they own the Extended Stay brand and makes them more similar to LQ pre-spin/sale, HPT is externally managed and ~a third of their earnings come from Travel Centers (a completely different business which is undergoing some distress), and RHP’s convention type hotels are a whole different segment). Anyway, it’s probably not worth splitting too many hairs worrying about which peer is best or worst as they all trade in a relatively tight range. The average / median company in that group of nine trades for 11-12x forward EV / EBITDA, similar to where my three favorite peers trade. The slide below (which I stole from RLJ’s November Investor Deck; you can easily update it yourself but valuations have not budged much so it’s useful for illustration) does a nice job of laying out all of the different valuation metrics for a loose group of peers (and probably suggests my 11x is a bit on the conservative side).

Ok, so we can reasonably / conservatively assume CorePoint is going to be worth ~11x EBITDA, so let’s start to figure out what it’s worth. At a basic level, we know what CorePoint’s earnings and capital structure look like. In the July presentation, they guided to $200-215m in EBITDA for CorePoint, and their Q4’17 call confirmed they hit the middle of that range. We also know that CorePoint has taken out a $1,035 CMBS mortgage that will fund post spin, and we know LQ has ~118m shares outstanding. So, at its most simple, CorePoint’s value would look something like the below.

Add that to the $8.40 payment from Wyndham and you get a combined company value of ~$19, which gives a little upside from today’s prices, but it would basically be a rounding error of upside.

Here’s where things start to get interesting. I think it could be argued that almost every assumption (excluding the shares outstanding) I made in building that valuation is much too conservative. Hopefully this doesn’t get too far into “conspiracy theory” territory, but after I walk through how conservative each assumption is (and how little information management is giving), I think you’ll see why I think management is sandbagging a lot of these numbers.

Let’s start with the simplest number: the multiple I used. I used 11x trailing earnings to value CorePoint, which is around the low end of where peers are trading on forward earnings. I’m not going to split hairs here, but increasing the multiple to 12x, probably a bit more in line with their peers, would add ~$2/share to CorePoint’s value.

Ok, multiple out the way, let’s turn to the CMBS debt. You’ll notice that I used the gross CMBS net debt number, which I think will end up being much too punitive. The reasoning lies in the details of the merger agreement. While the press release highlights that Wyndham will “repay $715m of La Quinta debt net of cash” as part of the acquisition, the deal is actually structured so that CorePoint will take out the $1,035m CMBS loan to pay a $983.95m dividend to LQ Parent as part of the spin off. This dividend is subject to adjustment up or down to the extent “estimated existing net indebtedness” is different than the target net debt of $1.665B (see page E-4 and E-23); the difference between those two numbers (plus $30m in transaction expenses Wyndham will cover, which is also subject to adjustment up or down) is how they arrive at that $715m debt paydown number. La Quinta had net debt of ~$1.55B at 12/31/17, so they’re already >$100m below the net debt target before any cash build between 12/31/17 and the spin. Given CorePoint’s raising $1,035m in debt to pay a ~$984m dividend (so ~$50m excess there) and they are already >$100m below their net debt target, I’m going to say CorePoint will spin with at least $120m in excess cash on their balance sheet, good for ~$1/share in value.

Let’s move on to the EBITDA number. I think it’s wildly conservative to use the ~$207m in trailing EBITDA for a few reasons.

1. Hurricane impact: Hurricane Irma affected a significant piece of CorePoint’s business; per the Q4 call, over 8% of owned rooms were out of service at peak interruption time. Management estimated the Q4 impact was ~$6m, and they estimate the 2018 impact will be $28-35m. As we move into 2019, that hurricane impact should fully annualize, which will drive serious earnings growth.

2. Capital Investment program: CorePoint / La Quinta started a $180m renovation project in Q4’16 and finished the project in January 2018. Their Q3 call provide some details on the early returns of these projects, which include NPS scores at the hotels they renovate up 50% and RevPAR up 11% (driven by a 10%+ increase in ADR). Given the project just completed, it’s actually having a negative impact on trailing earnings (renovations leave some rooms out of order) but should have a serious positive impact on go forward earnings. If you assume any reasonable ROIC for the project, it should have a serious impact on earnings going forward. I assume the $180m investment results in ~$15m annualized increase in EBITDA (~8.5% ROIC), which is probably too low based on both what I’ve seen in peers (INN, for example, projected ROIC from renovations in the teens, and RLJ is guiding to low double digit ROI for their capex projects) and how CorePoint management is talking about the project but feels within the realm of reasonableness.

3. Synergies from La Quinta combining with Wyndham: CorePoint should realize some return from La Quinta being brought into the Wyndham family. Wyndham’s size should yield significant advantages for all La Quinta franchisees (better OTA pricing, better rates for advertising given the company’s size, combining La Quinta’s loyalty program into Wyndham’s to get a new base of users (probably in 2019), maybe offering CorePoint hotels the ability to switch to other Wyndham brands in locations where it makes sense), which should result in some improvement in CorePoint’s hotel performance. Wyndham certainly thinks there’s synergies from buying La Quinta; they’re forecasting $50m+ in synergies against <$100m of Wyndham’s definition of Adj. EBITDA for La Quinta. Obviously we’re talking apples to oranges comparing franchisor earnings / synergies to hotel earnings, but it’s tough to imagine that Wyndham could improve the whole system by that much and it wouldn’t have some positive impact on the franchisees (FWIW, Wyndham is also forecasting accelerating La Quinta’s long term growth as they fully integrate the system). I realize this is the squishiest part of the thesis and it’s hard to fully quantify the potential here, but I’ll back my thoughts up on this with three facts.

1. La Quinta’s proxy makes explicitly clear that one factor the board considered in selling La Quinta was how much value the buyer could bring as an operator for the CorePoint business.

2. La Qunita’s owned hotels (which will become CorePoint) have substantially underperformed LQ’s franchised hotels over the past two years, and the LQ brand in general still has a rate gap versus some of its peers. Obviously a lot of factors go into that, but this suggests that a more focused / experienced hotel operator would have a real shot at improving ADR / margins for both CorePoint hotels specifically and the La Quinta brand more broadly.

3. CorePoint’s hotel EBITDA margins (Adjusted EBITDA with SG&A added back) are currently ~30%. The slide below is from a CLDT investor deck and shows that CorePoint’s ~30% hotel EBITDA margin would be at the very low end of Full-Service hotels. CorePoint’s hotels are Select-Service, which are generally much higher margin, so I don’t think it’s crazy to think there’s significant room for upside here.

1. The pushback here would be CorePoint’s ADR / target market is way below all these peers (I’ll discuss this more in the risk section), but I don’t think that’s a completely fair pushback. For example, INN’s ADR is <$150 versus RLJ at $165 and HT at ~$220 yet INN’s EBITDA margins are significantly higher.

4. Bottom line: I assume Wyndham buying La Quinta eventually adds another $10m in EBITDA for CorePoint (just over 1% of LTM revenues).

There are likely other areas of earnings upside you could point to if you wanted to get a bit more aggressive. For example, CorePoint’s biggest market is Texas, and the Texas hotels were hit hard by the oil downturn in 2015/2016 and have really just started to stabilize. I’d guess as we continue to move away from the oil bust those hotels see performance improvements. I’ve also been comping CorePoint to peers using forward multiples / earnings while using LTM earnings for CorePoint, so you could probably build a bit of growth into CorePoint as well.

Still, those “other upside” areas are likely smaller impacts long term. I’m just going to stick to the three things mentioned above (Wyndham synergies, Hurricane impact rolling off, and returns from their capital investment program); combined, they add another ~$31m to EBITDA, taking CorePoint’s “run rate EBITDA” to ~$239m. Note that this is by no means a heroic EBITDA number; even if we assumed all of the “addbacks” to get to run rate EBITDA flowed straight through to the bottom line (i.e. resulted in no change to LTM revenue), these EBITDA numbers would result in ~34% hotel EBITDA margins / ~29% adjusted EBITDA margins, still towards the low end of peers. Given most of these changes will almost certainly drive revenue growth (i.e. reopening the hotels shutdown by the hurricane drives EBITDA growth through selling more rooms), I think it’s clear these are not aggressive EBITDA estimates just based on the EBITDA margin potential versus peers. I’d also note that as recently as 2014 LQ’s owned hotels (which will become CorePoint) were doing >35% hotel EBITDA margins. There’s been a bit of asset repositioning (i.e. hotel sales) since then, but again I think this emphasizes that I’m not forecasting anything out of this world from these hotels.

There are a bunch of other things that I think could break correctly for CorePoint and reduce their multiple even further (for example, insurance recovery from the hurricanes could add another $20-40m in cash), but I think we’ve hit most of the obvious ones. So let’s put it all together: if we slap an 11x multiple on $239m of EBITDA and take out $1,035m of CMBS debt but addback $120m of excess cash, we come out with an equity value of just under $1.7B and a per share value for CorePoint of ~$14.48/share. Add that to the $8.40/share in cash from the Wyndham deal and shares should be trading of ~$22.90, presenting ~23% upside to today’s share price of ~$18.60 (or ~42% if I look through the $8.40/share cash payment).

Hopefully at this point I’ve showed a bunch of ways that CorePoint is undervalued. The question then becomes why management is lowballing numbers / not highlighting just how wrong today’s share price is. After all, most managers know that spinoffs have trouble finding an investor base and are constantly out pitching what a great deal the stock is leading up to a spin, particularly in a spin that’s part of a deal shareholders have to vote on / approve. I think the answer to that question lies in a hidden tax provision in their Wyndham deal.

The press release on the La Quinta sale contains a near throwaway line that Wyndham will “set aside a reserve of $240 million for estimated taxes expected to be incurred in connection with the taxable spin-off of La Quinta’s owned real estate assets into CorePoint Lodging Inc.” However, if you dig through the proxy and the merger agreement, you can see that the tax reserve amount was not a throwaway amount; in fact, it was the subject of a good deal of negotiation. But what’s really interesting is that the tax reserve is just an estimate of how much tax the spin will incur, and, to the extent the tax incurred is less than $240m, CorePoint gets to keep the difference (if it’s more than $240m, CorePoint has to pay La Quinta the difference, but as I’ll show in a second that’d be a happy problem for investors at today’s prices to have).

So how is the tax owed determined? For a taxable spin, the value of the asset is not determined until the asset is spun; at that time, the share price for the first day of trading is used to determine the asset’s value. So, if you spin off an asset with a book value of $10 and it trades for $100, you would owe taxes on $90 worth of gains. If you spun off the same asset and it traded for $15, you would owe taxes on just $5 of gains.

You can probably see where I’m going with this: the CorePoint / Wyndham agreement calls for a fixed tax payment. If the taxes are lower than that payment, CorePoint keeps the proceeds. If the taxes are higher, CorePoint covers the excess. Because the tax payment is based on CorePoint’s share price at the time of spin, CorePoint is actually incentivized to try to keep their share price as low as possible heading into the spin, as doing so results in more cash coming on to their balance sheet / less going to Uncle Sam (Wyndham doesn’t really care what happens; they’re on the hook for $240m no matter what). (Note that this is not a completely unique situation: Disney / Fox have a somewhat similar issue with their taxable spin of the remaining Fox assets, though they use an increase in Disney shares to FOX holders to resolve the “lower than expected” tax “problem”).

In addition to the Wyndham tax incentive above, I’d note that this is a taxable spin, which means that shareholders are taxed as having a taxable event the day the spin happens. I think that tax hit also increases the incentive for management to keep the share price as low as possible heading in to the spin, as a lower share price = a lower near term tax bill for management (moderate insider ownership; could be higher but definitely enough to justify working towards a lower share price / tax payment) and Blackstone (who own 30% of the company with what I believe is a very low basis).

With that understanding of the tax issues and how they incentivize management to depress the share price, I think the whole CorePoint puzzle makes a lot of sense. Why aren’t they providing 2018 guidance? Why aren’t they providing more info on their post-spin balance sheet? Why haven’t they put out an investor deck highlighting the CorePoint business since July 2017 (and that one was extremely skimpy!)? Why aren’t they giving more info on the return from their capital investment projects? It’s because to do so would make this easier to value / show how cheap it is and result in a transfer of value from CorePoint to Uncle Sam. At current prices, I estimate that the company will owe only ~$150m in taxes; the difference between that payment and the $240m Wyndham will cover (so $90m net) will flow straight through to new CorePoint’s balance sheet, representing ~$0.80/share in extra cash and bringing my “post tax / excess cash” fair value for CorePoint to just shy of $15.30/share.

Before we move away from taxes, I want to point out one more data point we can get from the Wyndham tax payment. We know that Wyndham has agreed to pay $240m in tax payments, and we also know that the CorePoint assets have a tax basis of ~$1.7B (management gave that number on their split call). If we assume CorePoint will have a ~25% tax rate, that would imply Wyndham and CorePoint agreed on a ~$2.66B valuation ($240m / 25% + $1.7B) for the CorePoint assets (note if you used the current corporate rate of 21%, you’d get a bit over $2.8B). That’s slightly above the $2.62B valuation I used to come up with my ~$14.50/share CorePoint fair value estimate, which lends some credence to my valuation. Obviously there’s a bunch of assumptions on all sides here, but I think it’s just another sign pointing out that fair value for CorePoint is much higher than today’s prices.

At this point, I think I’ve walked through a credible case for CorePoint being undervalued and why management might be trying to undervalue the company. Let’s talk about how this plays out. The shareholder vote will happen at the end of April, and I’d expect the companies to close the transaction soon after the vote (they’ve already got HSR). Once the deal closes (and the low EV for tax purposes is locked in place), I’d expect management to be more open about potential levers for EBITDA growth, what the PF balance sheet will look like, etc. Management also has a history of being shareholder friendly (on top of this spin / sale, they have been aggressive share repurchasers in the past), so I wouldn’t be surprised to see some excess cash returned to shareholders if valuation’s remain low.

The real prize, however, is potential M&A. Being a REIT 100% focused on La Quinta is probably unacceptable to investors long term, so I would guess there’s some M&A in the cards in the near term. My preference would clearly be for CorePoint to be a seller, and I’d note that this transaction being structured as a taxable spin would allow for the company to immediately be sold. The Hotel REIT M&A market is pretty strong (just last year we saw a bidding war between Ashford and RLJ for FelCor), and the synergies from throwing CorePoint on to another player’s platform would be pretty sizable (both RLJ and Ashford saw ~$20m in G&A synergies from buying FelCor. FelCor was roughly the same size as CorePoint; assuming a similar synergy level and an 11x multiple would suggest just shy of $2/share in synergy value from buying CorePoint). Obviously the valuation is dependent on the ultimate EBITDA levels and what the balance sheet ends up looking like, but if a larger player is willing to underwrite $250m in EBITDA plus another $20m in synergies, a sale price could easily approach $20/share and still prove accretive to a buyer.

The other end of the spectrum would have CorePoint deciding to be a buyer to diversify away from La Quinta. Obviously I’d prefer they sell at a premium than embark on a risky M&A program, but an acquisition program is certainly a possibility (p.5 of the spinoff docs highlight that their target segments are “highly fragmented and could benefit from consolidation” and that CorePoint’s scale gives them “a significant opportunity to be an active consolidator of hotel assets”). Still, I think the odds of them being a seller are much higher than being a buyer. Management has been very shareholder friendly, and Blackstone will remain a 30% shareholder of CorePoint after the deal goes through so I’d expect they’d prefer a sale to give them liquidity to exit. If they do decide to be a buyer, it’s not the end of the world. Their SG&A could clearly handle a much bigger platform, so they’d gain some benefit from scale, and having a shareholder friendly team pursuing a roll up strategy (with a large, financially savvy shareholder watching over them) isn’t the worst thing in the world.

Other odds and ends + Risks

• Share reverse split: Note that CorePoint will do a 1 for 2 reverse split when the deal / spin closes, so if you’re reading this a few months from now and thinking “wow, this was a home run,” I hope you’re right but you’ll need to adjust for that split.

• Balance sheet: Obviously dependent on what EBITDA and net debt number you use, but CorePoint is going to be spinning with ~4x leverage (and likely dropping quickly given some of their earnings tailwinds). ~4x leverage is around their peer average, though given how easy it is to borrow secured against hotels some peers are a good deal more aggressive (HT, for example, is at 6.5x debt/EBITDA and 8.7x (debt+prefs) / EBITDA). CorePoint’s relatively conservative leverage should give management a lot of flexibility for capital allocation (dividends, repurchases, acquisitions, etc.).

• Corporate overhead / margins: Sorry to keep coming back to the low margins, but the more work I do around it the more I see room for serious upside. Consider this: LQ’s whole owned hotel segment (i.e. what will become CorePoint after the spin) did $250m in Adj. EBITDA before corporate allocation on $842m in revenue in FY17.  Corporate overhead for all of La Quinta in 2017 (i.e. both owned hotels and the franchised business) came in at $42m (before stock comp). CorePoint is guiding that they did $207m in Adj. EBITDA in 2017. Yes, they’ll incur a bit of extra overhead as a standalone public company, but it basically seems like they’re guiding that CorePoint will inherit all of the corporate overhead from La Quinta. I’d be surprised if there wasn’t some cost cutting available post spin (as a quick reference, if they don’t cut any SG&A, their SG&A (excluding stock comp) as a % of revenue would be ~5% versus peers in the 3% range).

• Why compare SG&A excluding stock comp? Obviously stock comp is a real expense, but LQ / CorePoint is a little funky right now given the split off and everything, so I feel like comparing across pre-stock comp numbers is a fairer right now.

• Risk: Deal Collapse: I can’t see a regulatory reason for the deal to break (they’ve already gotten HSR), but deals can break out of nowhere. An obvious tail scenario for a break would involve a huge data hack at La Quinta. Ultimately, the deal breaking for a crazy reason is a risk I’m willing to take: I don’t think there’s tons of fundamental downside at today’s prices, management has proven themselves shareholder friendly, and, for what it’s worth, the proxy reveals other strategic interest in buying LQ.

• Risk: La Quinta / Wyndham screws CorePoint: Certainly possible, but I’m comforted here by a few things:

• CorePoint represented just under 50% of La Quinta’s total franchise fee in the first half of 2017. They are a critical partner for La Quinta; without CorePoint, the whole La Quinta franchise is completely subscale.

• CorePoint just signed their La Quinta franchise agreement with multi-decade terms. The agreement was a point of negotiation in the sales process. The La Quinta CEO who put the agreement together is going to be the CEO of CorePoint. I doubt he’d sign an agreement that blows the company up.

• Management agreements are common throughout the industry. If Wyndham / La Quinta tries to screw over their largest franchisee in CorePoint, what are the odds of them signing up other franchisees?

• Risk: La Quinta / CorePoint hotels are not comparable to the peers I’ve comped them to. The publicly traded peer group is unquestionably a higher end peer group than CorePoint (there aren’t really great comps to CorePoint publicly traded), so it’s an open question if my assumption CorePoint can come close the margin (and trading multiple!) gap versus peers.

• Just to show the difference among peers and CorePoint, INN’s ADR is just under $150 versus ~$85 for CorePoint.

• Still, I don’t think the ADR difference should prevent CorePoint from approaching peer margins. STAY, for example, has a bit of a different business model, but their ADR is <$70 and their hotel EBITDA margins blow everyone’s out the water.

• I’d also again point out that CorePoint was doing >35% hotel EBITDA margins as recently as 2014 (i.e. before the oil bust).

• It is also an open question how much demand there will be for the CorePoint assets from acquirers, as basically none of them have exposure to the La Quinta system (and La Quinta is generally a step below the Premium Marriott / Hilton / Hyatt hotels most of them have focused on).

• Ultimately I think acquirers (whether it’s public companies or private buyers) will be very interested: CorePoint will represent a way to diversify and grow very quickly, and I think buyers will be excited once they start to see some upside momentum in the La Quinta franchise from Wyndham taking over the brand.

• Risk: (related to above) The reason margins are so low is these hotel assets aren’t that great, so earnings aren’t going to grow. This is a reasonable worry, as the same management team that has been overseeing these hotels will be going to the spin. Given margins have been subpar for the past two-tree years, are they really going to improve post spin?

• It’s not like we’ve underwritten massive margin improvement: even at my projected earnings level, margins are still at the lowest end of peers, and I’ve really only underwritten some return from the capex projects and the hurricane closures rolling off.

• This margin dynamic / argument is somewhat of a classic spin dynamic. “You can’t underwrite them getting margins within spitting distance of peers; they’ve had years to do that and never come close.” I’ve seen that argument so many times and it always falls away once management has a massive equity incentive to focus on margin improvement in one specific segment…

• As pointed out in the main write up, owned hotels have dramatically underperformed franchised hotels (particularly over the past two years), which backs up the thought that with more focus there could be substantial upside here.

• While management is heading to the spin, Wyndham is taking over the actual management of the properties, so how they perform will have much more bearing on improving hotel level EBITDA margins.

• Risk: (related to above) Most peers are diversified among more premium brands, and the market will assign a discounted multiple to CorePoint due to concentrated La Quinta exposure: Again, a worry, but I take comfort in a few things:

• Having a discount due to excessive exposure to one brand is catnip to diversified strategic buyers. If you trade at 10x and they trade at 12x and there’s synergies, they can offer a big premium at 11.5x and still find a very accretive transaction.

• Private market values are also generally supportive of the valuations for LA Quinta hotels I’ve put out. In FY15 the company sold owned hotels at ~13x EBITDA (see Q4’15 earnings call), while in FY16 they sold assets in the 8 to 10x range (see Q4’16 call). Based on commentary around the 2016 sales, it seems like those assets were lower quality than the rest of the portfolio (EBITDA margins significantly lower than the rest of the portfolio’s already depressed margins). Put together, I think the private market sales we’ve seen support the valuation multiples I’m discussing.

• Turning back to STAY, on their Q4 call they said their recent hotel sales were done at >15x EBITDA, which again enforces that a low ADR isn’t a barrier to a strong multiple and that the multiples we’re discussing above are by no means aggressive.

• Given the leverage CorePoint will have, the cash flow to equity gets very interesting very quickly if shares trade too far down. CorePoint has guided ~9% of revenue as maintenance capex/year (see spin docs p. 133). That puts annual MCX at ~$75m, roughly in line w/ what they spent in FY2014 and 2015 (before the refresh cycle started). Just using LTM numbers, $207m in EBITDA and annual interest expense running ~$45m per year (their CMBS is L+275) would get you to free cash flow to equity should be $85-90m/year, or about $0.73/share, and growing very rapidly given both the operational and financial leverage (holding everything else constant but taking EBITDA to $240m would get you to just over $1.00/share in FCFE). Given this is a REIT, I think the potential high dividend yield (most peers trade in the 5-6% yield range) / share buyback potential (management was aggressive in repurchasing shares in 2015 and 2016) will provide strong support for shares if they trade anywhere near today’s implied prices.

• Risk: economy collapses, earnings go to hell. Another big piece of the thesis is CorePoint is under-earning and will grow earnings aggressively post-spin, driven in large part by some operating / financial leverage and one-time items (hurricanes) rolling off. Unfortunately, leverage cuts both ways, and if the economy collapses room rates and earnings will join them. Again, I think you’re buying it cheap enough to justify that risk, and you could hedge it by shorting a basket of peers if you wanted to, but it’s a risk that certainly exists. FWIW the spin docs note that the CorePoint hotels weather the Great Recession much better than the average hotel.

• Risk: Interest Rates Rise Rapidly; cap rates / yields rise with them. A lot of this thesis is based on “buy CorePoint at ~10x and wait for it to join peers at 11-12x”. That works great assuming peers stay at 11-12x, but if rates rise rapidly and all peers drop to 8x it’s a recipe for a capital loss. Unfortunately that’s a risk in all investments. I think you’re buying it cheap enough to more than make up for that, and you could hedge a basket of peers to somewhat protect yourself if you wanted to, but it’s certainly a risk.

• Risk: Online Risk. I’ll use this as a catchall for AirBNB risk or Priceline coming out with a hotel brand. These are industry wide risks, and I tend to think a lot of these tail risks would hit the brands / franchisors harder than the hotels themselves.  FWIW, CorePoint thinks their select-service / midscale focused hotels are less exposed to AirBNB’s than other hotels, which makes sense to me.

• Is this a taxable spin? I mentioned in the incentives piece that this is a taxable spin, which encourages management to keep the stock price lower to take less of a tax hit. This belief is backed up by both the original form 10 (from July) as well as my read of both the deal proxy (see p. 118) and the 2017 10-k (see the top of page 18). However, I’ve talked to several event desks who don’t think the spin will be taxable, and a deal like the current FOX / DIS spin lends further credence to this not being taxable at the shareholder level. I haven’t been able to confirm one way or another with LQ’s IR. If this isn’t a taxable spin, a bit of the incentive for management to keep the share price low falls through and a near term acquisition probably isn’t in the cards given the tax issues, but I don’t think the spin being non-taxable would change the major crux of this thesis.

• Other ways of looking at valuation: Just to show I’m not cherry picking from one peer to make my point, below is a valuation slide from an AHT deck, which backs up that the valuations I’m using for CorePoint are likely conservative.

Catalyst

Merger / Spin off close

Updated guidance / balance sheet

2019 numbers with no hurricane impact