Description

Recommendation

SEAS is an attractive short with 28 to 34% downside.  It can also be used as a hedge if you are long “reopening" stocks.

Why does this opportunity exist?

Management has reversed sandbagged and provided an EBITDA number that grossly overstates true earnings power. While this is not official guidance, the number is interpreted by market participants as normalized earnings, driving the stock to an all-time high along with upgrades and PT changes by the sell-side in the last 2 days. 

Pre-covid (Feb 2020) Market Cap: $2.9B;  today: $3.9B

Pre-covid EV: $4.5B; today: $5.7B

Management-defined, normalized EBITDA: $690mm.

Optically the valuation seems reasonable. EV/Management-defined EBITDA is at 8.3x with a re-opening tailwind.

Thesis

The valuation is obscured by disingenuous disclosure. Economic earnings or FCF is nowhere near the implied number.  Investors have, and I believe they will look past temporary increases in earnings related to Covid for old-economy business models such as SEAS (they did for Covid winners like Kroger).  The cash burn and the heavy interest burden will highlight the gap between FCF and management-defined EBITDA to investors and cause a re-rate.

Aggressive/unrealistic assumptions baked into EBITDA

• Per capita spending is kept at 2020 level, which is 10% higher than 2019. The metric was flat between 2015-19 ($61.01 vs 61.80), a period of strong job growth and economic growth.

• Every dollar of incremental revenue drops down to EBITDA which does not make sense. Although theme parks have high operating leverage, 40%, or $27 per capita is in-park spending e.g. food and beverage that have costs of goods sold.

• 10% of the business is from international travel. Given the tight supply of vaccines, the international part certainly won’t be back meaningfully in 2021 and may or may not be back in 2022.  This puts $153mm EBITDA at risk since 100% of revenue drops to EBITDA in their model, which again, is unrealistic.

• The $100mm cost savings are framed as permanent cost savings but only half, or $50mm is fixed. Below is an excerpt from the call.

So I guess the question I'm trying to understand here is that is the $100 million expense savings, how much of that is variable depending on attendance versus not being variable depending on where attendance is if that makes sense.

Marc G. Swanson SeaWorld Entertainment, Inc. – Interim CEO

Yes. Steve, it's Marc. I can take that question. So when we look at the cost savings that we've identified and implemented, roughly half of that is I would consider more fixed in nature and probably about -- and roughly half is more variable in nature. So obviously, the variable piece is going to come back over time as we grow the attendance over time.

Source: 4Q20 earnings call

• The $50mm fixed cost savings is before cost inflation and pressure. SEAS will be both directly (higher wages as most on-site personnel are low wage earners) indirectly (higher vendor cost) impacted by the $15 federal minimum wage but the impact is unknown at this point.

• Furthermore, SEAS is permitted to add back estimated cost savings for the next 18 months per their lending documents. The reason why I believe management is disingenuous is that they expect zero cost savings for the next 6 quarters. Using 2019 as a starting point, cost savings is $11.3mm, a far cry from $100mm.

Source: 2020 10K

Contribution margin and fixed cost

• Because SEAS adopted ASC 842 for lease accounting, a relatively “clean” contribution margin can be calculated by comparing 2019 and 2020 financials.

• Using the adjusted EBITDA from the 10K, incremental Revenue was -$966.5mm; incremental EBITDA (management-defined) was -$541.4mm.  The contribution margin ratio is therefore 56% which implies the fixed portion of operating cost is $283mm.

Normalized earnings power

• I think of this as 2022 or 23 normalized earnings, assuming full reopening.

• I assume revenue will fully recover to 2019 level based on 2020 per capita spend.

• Putting this together, $1,400 * 56% - $283 fixed cost = $500mm EBITDA.

• Capex ranged from $197mm to $230mm in 2017- 19.  SEAS was underinvesting in 2015-16 as evidenced by declining attendance performance.  I will assume $230mm to account for cost inflation.

• Unlevered FCF = $500 - $230 (capex) = $270mm.  FCF to equity = $270- $127 (interest), zero cash tax = $143mm. 

• True earnings power is lower than my calculations above for the following reasons:

• Per capita spend was flat during 2015-19 despite record low unemployment. This makes a difference as higher per capita spend carries higher contribution margin. If per capita stays at 2019 level, contribution margin would have been 51.7%, not 56%.

• SEAS only operated 8 to 10 parks in 2020. Fixed costs running all 12 parks are materially higher than $283mm.

• Near-term capex will definitely be higher than $230mm as SEAS needs to catch up with capex deferred in 2020 and 2021.

• The way SEAS adjusts EBITDA is a poor proxy for cash flow.  SEAS reported $22.7mm EBITDA for 4Q20, but burned $46.5mm from operating and investing activities. 

Liquidity and cash burn

As of 1Q21, It is burning cash at a rate of $25 - 30mm/month.  Cash was $434mm at the end of 2020.  It should be down to $359mm at the end of 1Q21.

2020 capex should represent the absolute minimum. Capex, excluding the expansion project, was $107mm. Fixed cost plus minimum capex plus interest is $517mm. The company only needs to generate around $160mm to survive 2021.  Bankruptcy is not a risk in 2021.

Valuation

For context, SEAS is a mediocre business. Despite the high barrier to entry, monopolistic nature of theme parks, and with a strong economic tailwind, fundamentals were lackluster. 

It was growing at a rate below US GDP. There is no reason to expect the trend will change after the initial bump from reopening.

The stock trades on EBITDA.  EV, adjusting for 3 months of cash burn, is $5.8B. 

EV/Normalized EBITDA = 5,800/500 = 11.6x. During 2015 - 19, EV/NTM EBITDA averaged 8.8x, or 9.4x after adjusting for lower interest rate. The stock is worth $35.9 at 9.4x EBITDA ~ 28% downside.

Given the capex intensity of the business, UFCF is a better measure. 6% UFCF yield (WACC: 8.5%; Growth: 2.5%) implies the stock is worth $33.1/share ~ 34% downside.

Catalyst

Continue cash burn beyond 1Q21

Construction cost has already spiked in 2020. Capex spend will highlight the lack of FCF.

Wage inflation will call attention to margins.

Weak guidance for 2022 or negative revisions to the illustrative EBITDA number