Description

SHORT- Lindblad Expeditions Holdings Inc. (NASDAQ: LIND)

Description & Setup

Lindblad Expeditions (“Lindblad”) sells expedition travel experiences. Products include ocean or land-based itineraries lasting 4 to 35 days and priced from $3,000 to $100,000 per person. The company is undertaking an unprecedented expansion of their main asset, a fleet of 15 cruise ships. Market expectations and valuation underwrite a seamless ramp of two large blue water vessels over the next three years, achieving:

• Day 1 profitability breaking company records while running logistically riskier voyages
• Near 100% occupancy rates despite a 30% price premium to existing operations
• Returns on invested capital 50-100% higher than peers, despite demonstrably inferior unit economics
• A beautiful deleveraging just in time to meet covenants on new build financing
• Zero accidents while tripling daily operations in the polar circles
• Existing fleet maintains annual price hikes, utilization, and margins

This perfect scenario is the market consensus and the only outcome which justifies the current enterprise valuation. It defies history, peer performance, and general common sense. It is more likely that Lindblad is overleveraged with minimal cash generation two years out. The setup is asymmetric, with minimal upside to such a rosy consensus and literal boat loads of underappreciated risk. This could result in over 50% erosion to equity value. The holding company, originally an SPAC, also wears numerous red flags.

Expansion Plan Background

Lindblad is spending $290 million on two polar class ice vessels. These orders follow the purchase of two coastal boats for $110 million, delivered in mid-2017 and late 2018, to double the firm’s Alaskan summer operations. Collectively the expansions amount to a debt-fueled “bet-the-farm” sized acquisition marketed as a growth story but unsupported by history or facts. The 13 ships now in operation have a book value of $400 million and an average age of 22 years. The aging provides a deceptively high book ROIC around 20%. The polar ships cost over 50% of the firm’s current book value of assets.

National Geographic Endurance is expected for delivery in 2Q 2020 and is the driver of forecasted earnings growth that year. It was ordered in November 2017 for $135 million. 80% comes due on delivery. The ship is already generating customer deposits, helping to give the appearance of a healthy balance sheet. Financing is secure for delivery payments at either 5.8% or 3M LIBOR + 3.00% at the company’s option.

The National Geographic Resolution, a sister ship of Endurance, was ordered in February 2019 for $154 million. 20% was due on order, 50% is due in installments throughout the build, and the remaining 30% is due on delivery. Financing is secure at either 6.4% or 3M LIBOR + 3% at the company’s option. Delivery is expected in September of 2021. Credit facilities come with a max leverage covenant that we think is at risk for 2022 (more on that later).

Management provides scant information on the economic potential of these boats, save for a target ROIC in the “high-teens”. But revenue information for Endurance is available by going to their website as a customer and tallying the price of each cabin for every voyage on the ship’s calendar. We added up $73 million of potential 2020 sales for Endurance, priced at a 30% premium per available night versus the existing fleet. At the company average occupancy of 91%, and accounting for the April launch, that implies $177 million of revenue growth from Endurance and Resolution at full ramp assuming the ships run similar calendars. A “high-teens” ROIC at this sales level, call it 18%, would imply operating margins 13 percentage points higher than their all-time annual record of 17%. That doesn’t look realistic at all.

Management is too confident after the successful coastal expansion. The Alaskan operations were simpler and less risky, from both a marketing and marine operations perspective, than the planned itinerary of the polar class build vintage.

Sales & Profit Expectations

Consensus sales estimates for 2021 at $421 million are possible, but EBITDA estimates of $96 million are highly suspect. They reflect a flawless generation of record profitability. Recent delivery of the National Geographic Venture in late 2018 (following the NG Quest in mid-2017) reveals lousy trends for the legacy fleet that put pressure on new builds to perform. The Lindblad segment, home of the ships, is on track to deliver 9% growth in available nights and 1% growth in both occupancy and price in 2019. Using website analysis to count up revenue and available nights for the Venture, we estimate she contributed nearly all of the year’s new revenue while the legacy fleet barely grew at all. So we can expect that remaining new builds will dominate sales and profit growth in the next two years. Management comments on occupancy support our conclusion.

$421 million of sales for 2021 imply occupancy on new builds of about 70%, based on website estimates. At the firm wide occupancy of 90%, Endurance and Resolution bring Lindblad to $450 million of 2021 sales. We would tip our cap to such an outstanding ramp up at a premium price. But profit expectations are absurd even in the revenue outcome of management’s dreams.

The $28 million of consensus EBITDA growth from 2019 to 2021 is 25% of our sales growth estimates at 90% occupancy for new builds. That is multiple percentage points higher than the segment’s annual margin records, but YTD 2019 results suggest little margin benefit from the Venture & Quest expansions. While running four coastal vessels in Alaska in the 2019 summer as planned, Lindblad only expanded EBITDA margins by 70 basis points on a 9 month YTD basis and didn’t set corporate margin records. Management and bulls argue that growth will leverage earnings on fixed marketing overhead. But selling and marketing (including travel agent commissions) has expanded as a percent of sales in both the short and long run.

The two coastal boats were “plug and play” expansions of existing offerings in Alaska. If they did not generate record profits from either marketing or other operating leverage, riskier new polar itineraries are unlikely to do so. Endurance and Resolution will run new expanded routes to the polar circles that come with new logistics, contingencies, expert staff requirements, and risks. A grounding accident that cancelled two 7-day Alaska voyages in 2017 cost the firm $9 million in EBITDA, a third of the expected profit growth through 2021. We can only imagine how much an accident or diversion for a 35 day trip through the Ross Ice Shelf might cost. There is no room for error in this profit expectation, plenty of risk to the downside, and bulls have no hope for a beat.

Our point is supported by historical analysis of peers during expansion periods.

Peer Unit Economics

Analysis of peer group data shows that Lindblad’s premium offering has inferior unit economics for the operator, making the long term profit expectations and ROIC guidance look all the more absurd.

During capacity expansion from 2014-2018, Royal Caribbean, Carnival, and Norwegian generated cumulative incremental EBITDA margins of 92%, 64%, and 36% respectively, crushing Lindblad’s 5%. The contrast is even more dramatic per travel day. For a narrative discussion of the details, Norwegian is closest to Lindblad in terms of price per night and company size. Norwegian grew unit sales by $72 against cost growth of $38 for unit incremental EBITDA of 48%. Lindblad grew sales per day by $125 while cost grew by $135.

Plainly, Norwegian’s product is a quarter of Lindblad’s in price and infinitely more profitable on a day of growth. The data matches common sense: it is economically different to anchor amidst arctic sea ice and take portrait shots of a polar bear than it is to anchor in Puerto Vallarta and take shots of tequila. Not to mention a 40 fold difference in the number of people on board, premium meals, transit contingencies in remote places, and expert wilderness guides on staff. Guiding investors to a high-teens ROIC, well over the high single digits of peers, is a moon shot on these unit economics. If this were doable, any of these large competitors could have bought them out in their 50 year history. The high historical ROIC for Lindblad is a product of the aged fleet, not unit economics.

Free Cash Flow, Pro-Forma Debt, and Covenants

Lindblad has failed to generate free cash flow since the SPAC buyout without excluding new build payments. We therefore expect that the company will not generate cash to pay down debt until 2022, a risky proposition given the covenants on new build financing. 

While down payments are made, $93 million of progress payments on Resolution will come due within 2 years and the other $108 million on Endurance will come due at completion. That amounts to $201 million of new debt in the next two years or over two times 2021 EBITDA estimates. To meet their debt covenants in 2022, the new ships will need to generate considerable profits. The most restrictive covenant comes from an export credit agreement to pay off the Endurance, with a maximum 4.5x net debt to EBITDA ratio allowing only $25 million of cash to be netted out in calculation. We estimate the company will have a net debt per the covenant of $392 million at year end 2021 based on:

• Current total debt of $216 million
• Maximum cash exclusion of $25 million (current cash is $104 million)
• Excess cash before covenant limits cover working capital needs on new builds
• Remaining new build payments of $200 million

Pro-forma net leverage of $392 million requires $87 million of EBITDA to avoid tripping the covenant. This is doable if the Endurance and Resolution generate the anticipated profits, bringing the firm to around $100 million of EBITDA for 2022. But a 13% buffer to the covenant, over 2 years out, is tight for an expensive and logistically challenging product. A slew of factors could push costs up and bookings down unexpectedly:

• An accident similar to the 2017 grounding generates cancellations and accommodation costs
• The Arctic ice cap prevents the 26 day Russian Coast voyages from proceeding as planned
• Publicity around any sunken ship in any extreme climate
• Putin denies access to the Russian Arctic
• Argentine socialists close (or gouge users of) Antarctic access ports
• Rich Americans cut spending in fear of a wealth tax
• Environmentalists block visitation to at risk areas
• Expensive new itineraries cannibalize other routes

The unearned revenue line, essentially voyage deposits, will also generate a lousy dynamic in recessions: bookings fall before sales, generating cash needs and higher debt levels just before profit declines. Given there will not be free cash until the Resolution operates, the margin for error is razor thin while only a fantasy of new build profit ramping provides safety.

Some Other Short Red Flags

Since the SPAC acquired Lindblad in 2015, the SEC uploaded 13 separate requests for comment and correction on EDGAR with 86 topics for review. 79 regarded the merger between the SPAC and the operating company and seven came over three years later.

The most egregious management error was to present “Total tour revenues excluding voyage cancellations” for 2017, as if cancelled revenue had been recorded according to plan. Another item from the same SEC letter challenged revenue recognition on airfare that management considered part of expedition services. Obviously the company does not fly planes, but defended revenue recognition via its influence on the airfare contract.

Another red flag is the tax expense. With $88.6 million of GAAP pre-tax earnings from 1/1/2013 to 6/30/19, Lindblad has only recorded $6.7 million or 7.6% tax expense and paid $6.1 million or 6.9% in cash taxes. The rate is driven lower by a steadily growing pre-tax loss in the U.S. and an offsetting profit in foreign operations. Deferred tax liabilities related to PP&E are growing rapidly. That means the company is deferring cash taxes with the shipbuilding program. These payments will eventually come due. It will be difficult to continue delaying payment by building polar icebreakers in perpetuity.

Management would like you to think of adjusted EBITDA as earnings power. The $268 million they generated since 2013 compares to $66 million in GAAP net income, includes $50 million of add-backs, and ignores maintenance expense on half-a-billion-dollars’ worth of ships. Cash from operations is $257 million, but comprises 50% of depreciation, stock compensation, and non-cash amortization of the National Geographic agreement (in place until 2025 and an economically real expense). Maintenance capital expense is also less than half of D&A even though the ships are 22 years old. This suggests chronic under investment.

And why exactly is a company that sells encounters with Mother Nature headquartered in Greenwich Village?

Valuation

The market gives Lindblad a total enterprise value of $846 million, which is 10.2 times 2020 EBITDA estimates and 8.8 times the 2021 estimate at today’s share price of $15 and net debt of $112. We value the stock at $9.50 in a DCF or 8 times our 2022 EBITDA estimate with pro forma net debt of $360 million. 

Catalyst

Management guides EBITDA below consensus.

Any marine operations accident.