Description

SeaWorld (SEAS) is a compelling turnaround situation led by a new CEO and has an attractive low-hurdle set-up heading into 2015.  At current levels (~$19.50 – $20.00 / share), SEAS offers a total return potential of >50% over the next 6-mths (PT of ~$29 / share using my base case + collecting a ~4.3% dividend) and ~100% in a slightly more bullish scenario discussed below.   

SEAS is under-appreciated: 8 regional parks are coveted by regional competitors + separable (likely worth in excess of $1.7Bln or >55% of the current TEV) / the flagship destination parks are operating at trough conditions after a dismal 2014E driven by a sudden and dramatic fall-off in non-local domestic traffic of which a portion is recoverable / recent evidence of improvement in attendance trend is largely being ignored by the market as the consensus views it as “too early” and a “show me story” = in the meantime, creating destination parks for <3x EBITDA and that doesn’t factor in ongoing FCF generation of >$150MM per annum.  While SEAS operates its 2 largest parks in competitive markets (Orlando and San Diego), Mr. Market has improperly valued the entirety of SEAS as an impaired brand and is extrapolating a continuance of negative trend into the future yet ignores recent evidence of stabilizing / improving traffic trends, the recent change in CEO and more proactive initiatives around marketing + PR 

SEAS is disliked: sentiment around SEAS is quite negative (and for good reasons) … the past: post its IPO from less than 2-years ago, SEAS has disappointed the market on several occasions driven by sloppy management execution, lousy communication efforts as well as a sudden fall-off in non-local domestic traffic at the flagship Orlando and San Diego parks in mid-2014 (these 2 parks drive ~35% of overall company attendance and ~40 – 45% of 2014 profitability by my estimates but higher on a “normal” year) … the future: the market is NOW ignoring positive shifts in the biz: (a) new CEO hired, starts next week and is the right leader, (b) in recent months, interim CEO (a brand expert) drove a more proactive approach to PR, advertising + promotions and (c) long overdue, SEAS has focused more efforts around improving the cost structure … (d) additionally, sell-side expectations provide a low-hurdle as my 15E FCF / share is ~25% above the Street and >30% on 16E given sell-side is punitively assuming 0% volume / 0% price and believes the brand is structurally impaired

SEAS is under-valued and downside is limited: creating SEAS for a ~10% FCF yield versus regional park competitors that are trading at less than 6% yields.  Additionally, SEAS pays out a ~4.3% dividend yield … this is notable given half the capital structure is comprised of term loan debt trading roughly at par and has a blended rate of less than 3.25% (recently refinanced expensive 11% notes at ~4% which will yield >$17MM of savings … and highlights lenders’ comfort level w/ the collateral value).  Regarding downside support, there are multiple areas of value that are “hidden” or underappreciated: (a) NOLs of >650 (NPV of ~150MM) plus heightened possibility of REIT in the out years, (b) excess ~2.1k acres of separable real estate in premier locations (heavy Williamsburg, Tampa and Orlando) that likely total up to >$250MM on the low end and as high as ~$500MM on the high end), (c) collateral value of existing parks that SEAS owns (10 of the 11 parks are owned by SEAS / rents San Diego under a l-term lease) / while theoretical, the “insurance value” of SEAS parks is pegged at >$4.5Bln and that excludes the excess ~2.1k land noted above as well as the animal value – orcas along likely worth in excess of >$200MM though PETA would no doubt fight this to the grave, (d) and growth opportunities are completely ignored (long awaited clarity on international to come on Q1 call … and domestic growth opportunities could include duplicating Sesame Street and Discovery Cove that both other fantastic unit economics – int’l and domestic opportunities each have the potential to add >3 – 5 / share in value but are being ignored by the market and my probability tree also excludes)

Founded in 1967 by the Busch family, SEAS has 11 amusement parks: (a) 3 flagship SeaWorld branded parks = ~60% of profitability of which 2 of the 3 are open yr-round / even though SEAS is a share donor in these competitive markets, it benefits from positive tourist trends + an attractive price umbrella provided by Disney and Universal of >3 – 5% per annum), (b) 8 regional parks including Busch Gardens, Sesame Street and handful of water parks = ~40% of profits / the regional parks unit economics very much mirrors SIX and FUN that trade for >11x 15E EBITDA and sub-5.7% FCF yields and the regional park operators have not been shy about voicing their interest in the SEAS’ regional parks).  SEAS was acquired by Blackstone in 2009 from Inbev (after they acquired AB in 2008) for approx. $2.7Bln and subsequently taken public at $27 / share in April 2013 (Blackstone has reduced their interest from ~63% post the IPO to ~20% currently).  The current TEV is roughly $3.1Bln factoring in NPV of NOLs. 

SEAS stock has languished in the $16 - $20 range for the past 7-months driven by an abrupt fall-off in traffic at its Orlando and San Diego parks and augmented by a management team w/ broken credibility.  In August 2014, SEAS cut its revenue guidance by ~150MM (-10% vs prior expectations) and EBITDA guidance by ~95MM (-20% versus prior expectations) with 2 key drivers to the revisions: (1) ~60% of the top-line revision driven by San Diego park (negative PR predominantly driven by CA legislation uncertainty that intensified in March – May 2014 timeframe); (2) ~40% of the revision driven by Orlando (mostly competitive intensity mostly driven by the Harry Potter 2 attraction at Universal).  Given the abrupt fall-off in biz trends (-20% fall-off in EBITDA and +15 – 20% step-up in the out-years capex), the resulting stock price was -40% (from ~$30 / share to ~$18 / share).  Additionally, sell-side expectations were similarly responsive cutting top-line expectations by -14% in the out years, EBITDA by -20 to -25% in the out years and raising capex by +20 to 25% in the out years (plus cutting price targets by -45% from $36 to ~$20ish current).  A more in-depth discussion of the 2 key controversies is below.  The sell-side largely takes the view that the issues at San Diego and Orlando are permanent + the entire SEAS valuation should be penalized given structural concerns / my view is that San Diego and Orlando traffic is recoverable and we are seeing early evidence in 2015 + the remaining 9 parks inclusive of the San Antonio SeaWorld are performing well and deserve to trade at a regional park multiple. 

Controversy #1: San Diego negative PR (~$90MM hit to revenue and ~$60MM hit to EBITDA in 2014)

1.       Cause: Events include (a) Blackfish the movie / Blackfish premiered early 2013, picked up by CNN in October 2013 and widely watched NFLX thereafter / while no great data, best educated guess is that ~300k viewed in movie theater w/ $2.1MM of domestic box office, less than 1 – 3MM viewed on CCN over 6-airings of the movie and perhaps ~1MM or so viewings on NFLX though they don’t release show-level detail = low single million viewership) … (b) led to PETA (animal rights organization) putting on full-court press w/ heightened campaign against SEAS including advertisements against SEAS, posters against SEAS in airport, picketing at the gate, and heavy use of social media … (c) PETA in turn led to proposed legislation against SEAS in CA (context is Hollywood assemblyman / Dick Bloom proposed old legislation that was initially drawn up in the early 1990s post the Free Willy “craze” attempting to ban use of orcas for performance purposes in CA) … the proposed legislation never really took hold and was put into research process (of particular note, Bloom recently / Jan 20, 2015 announced that he would NOT introduce legislation in the 2015 legislative session) … (d) lastly, the legislation and PETA campaigning led to heightened negative PR and celebrities refusing to participate in SEAS shows and speaking out about SEAS

2.       Effect: local and international traffic held up well even w/ all the negative PR (San Diego shifts more conservative in bent so perhaps local market more resilient to other in-state liberal views); the non-local (likely in-state northern CA) attendance fell off a cliff (most likely in excess of -45 to -50%) predominantly driven by negative PR especially around CA legislation (early 2014 w/ newspapers driving significant negative press in the March – May 2014 period which pretty much mirrored the timing of the steep fall-off in non-local CA traffic)

3.       Response: (1^st) Blackfish criticism: SEAS announced a major initiative (to be implemented over next 7-years across all 3 parks but more n-term for San Diego) that will 2x the size of orca tanks (Blue World); Also, trainers were pulled out of the water a long time ago; (2^nd) PETA / negative PR: Initially SEAS very quiet in response (given too quick to respond would highlight more corporate / offensive); Since then, SEAS hired PR firms including a crises mgmt firm to combat (more offensive) and in addition, has been more proactive in shifting the tone of the media with positive messaging touting the “good” of SEAS (animal rehab efforts, etc); (3^rd) Perhaps MOST important - CA legislation: current head of CA state legislation is Toni Atkins (speaker of assembly) – she took the role in March 2014 / she is very pro-SEAS and SEAS believes they have kissed the right rings + the orca Blue World initiative helps mitigate any concerns.  As mentioned above, Bloom announced that he would NOT introduce legislation in 2015 legislative session to curb orca captivity in the state (less headlines in CA press is a positive for SEAS); (4^th) Other data points: SEAS owns all its parks but for San Diego (leases the property) / pays San Diego >14MM per annum / in addition, has employed ~100k people over its tenure so big biz for the area 

Controversy #2: Orlando competition threat (~$60MM hit to revenue and ~$35MM hit to EBITDA in 2014)

4.       Cause: DIS and Universal are spending a lot more on new attractions (DIS Fantasyland, Universal Harry Potter 2) / these new attractions in some cases improve foot traffic flow in parks, allow for greater pricing power + are powerful and effective marketing; this past year, Harry Potter 2 was originally scheduled to open in May / June but delayed to July (which may have deferred some visitation as well)

5.       Effect: similar to San Diego, local and international traffic held up well even w/ all the negative PR (San Diego shifts more conservative in bent so perhaps local market more resilient to other in-state liberal views); the non-local attendance fell off mid-20% range … a lot of this driven by Harry Potter 2 at Universal; Notably, SEAS is NOT facing a price war given: (a) evidence of px umbrella by “big guns” in market (>4% per annum over the 2004 – 2014E period), (b) pricing initiatives across all non-SEAS parks in late 2013 and no impact

6.       Response: in August 2014 (in conjunction with earnings surprise), SEAS highlighted it needs to spend more on new attractions in destination markets (previously, guided to ~3% maintenance and ~10% for overall capex / NOW guiding to ~13% capex with the additional ~3% for Orlando and San Diego) to combat the large scale investments by peers; These new attractions historically have drawn traffic away from other parks BUT ultimately drive improved traffic trends to the region lifting all boats.  This step-up in capex negatively surprised the market which also led to the negative stock reaction in August

Why now: Recent data points have provided evidence of stabilizing trends at the destination parks (San Diego lease payment data highlights trend has improved by approx. +20 pts in December versus peak YoY fall-off ... and approx +10 pts in Q4 versus Q3 … additionally, YTD trends have been positive) and accelerating positive trends at the regional parks.  Additionally, as the old CEO was removed from the biz in late 2014, the interim CEO (David D’Allessandro) took a proactive approach to turning around the brand with tweaks to PR, promotions, advertising (D’Allessandro has a long history in brand building and repair so was well equipped for these proactive moves).  More recently, SEAS hired a new CEO (Joel Manby) who will join SEAS next week and is the right person for the job.  Given his experience at Herschend Family Entertainment, I would not be surprised if SEAS takes a more proactive approach to partnering more closely with hotels    

Valuation: in contrast to the market, I believe: (a) a significant portion of the 2014E fall-off in the Orland and San Diego parks is recoverable (i.e. ~$100MM of EBITDA is “hidden” using 2014E figures), (b) asset value of SEAS is robust (discussed above), (c) current valuation effectively allows us to “create” the controversial destination parks at an implied ~3x EBITDA and ~6x EBITDA-capex (too cheap) and (d) upside optionality around additional growth is being ignored (long awaited clarity around international opportunities to be discussed on the Q1 call / and Sesame Street and Discovery Cove have very attractive economics and are duplicable domestically … international and domestic opportunities each have the potential to add >3 – 5  share of value that I am NOT including in the probability tree below).  As noted above, the SEAS term loan (~50% of enterprise value) trades at a sub-3.25% blended rate and continues to trade roughly flat to where it was in August 2014 at ~98 cents (OID at 99.75) versus the equity that is down ~35% from the August levels.

BASE: assumes +5% improvement in traffic at Orlando and San Diego driven by a bounce-back in the non-local traffic (recall San Diego down -45%+ in 2014E and Orlando -25%+ for this non-local category) and +1% improvement in traffic in the other parks + 2% pricing (NOTE that DIS has announced 3 – 6% pxing across its parks and regional parks are likely going after >3% in 15E so conservatively assuming +2% at SEAS as stabilize the brand); assuming 8x EBITDA multiple to 16E base case forecasts / ~6.6% FCF yield = $29 / share (vs current of $20 / share or >50% upside inclusive of ~4% dividend yield)

UPSIDE: assumes +7 - 11% improvement in traffic at Orlando and San Diego driven by a bounce-back in the non-local traffic (recall San Diego down -45%+ in 2014E and Orlando -25%+ for this non-local category) and +1% improvement in traffic in the other parks + 3% pricing (NOTE that DIS has announced 3 – 6% pxing across its parks and regional parks are likely going after >3% in 15E so STILL conservatively assuming +3% at SEAS); assuming ~9x EBITDA multiple to 16E forecasts / ~6% FCF yield = $41 / share (vs current of $20 / share or >100% upside inclusive of ~4% dividend yield)

DOWNSIDE: assumes another -2% to -4% fall-off in traffic at Orlando and San Diego in the non-local traffic (recall San Diego down -45%+ in 2014E and Orlando -25%+ for this non-local category) and +1% improvement in traffic in the other parks + 2% pricing; assuming ~6.5x EBITDA multiple to 16E forecasts / ~8 – 8.5% FCF yield = $17 / share (vs current of $20 / share or -11% downside inclusive of ~4% dividend yield)

Regarding key risks: (a) falling knife / 2014E not trough if brand is permanently impaired, (b) economic sensitivity esp around destination parks that require longer travel, (c) CA legislation re-appears (though this risk is off the table in 2015E per above), (d) safety incident risk (like all theme park operators)

DISCLOSURE:  We and our affiliates are long SEAS, and may buy additional shares or sell some or all of our shares, at any time.  We have no obligation to inform anybody of any changes in our views of SEAS.  This is not a recommendation to buy or sell shares.

Catalyst

(1st) Q1 call / less than 6-wks: clarity on early 2015 traffic trends (re: 2015E outlook, I'm assuming mgmt provides a low-hurdle as regaining credibility), (2nd) Q1 call / less than 6-wks: clarity on international partnerships, (3rd) next few mths: clarity around traffic trends as we get into the peak season of April - August (focus will be on San Diego and Orlando in particular), (4th) next few qtrs: more clarity on domestic opportunities (replicable opportunities in the US or partnership opportunities with hotels), (5th) opportunistic share repurchases ($250MM authorization) / given collateral value, comfort w/ leverage 4x+ provides ample flexibility for large share repurchases (plus history of company pursuing opportunistic repurchases in the past)