Description

SEAS Short Thesis

We view SeaWorld as an over-valued, over-levered, structurally disadvantaged theme park operator. Bulls have been calling a turnaround for years, and the industry is thriving, yet SeaWorld continues to struggle. Structural issues have been labeled as temporary, and the company has been left playing defense; changing orca shows, adding atypical attractions, and the company is now a late follower into the theme park/hotel space. Nevertheless, SeaWorld remains a consensus “contrarian” long. We see the risk/reward for SEAS skewed lower and think there could be up to 40% downside. If the US were ever to fall into a recession, SEAS could ultimately have to restructure. 

What turnaround?

SeaWorld experienced flat attendance and declining rev/capita in 2015 despite a less-competitive environment in Orlando (lapping Universal’s Harry Potter launch), easier weather comps vs 2014, the opening of a new attraction at Busch Gardens Tampa, strong consumer confidence, healthy domestic travel (low oil), strong results by competitors (SIX, FUN), and booming tourism in Orlando (Orlando RevPar, airline traffic, and other tourism data were strong all year (http://media.visitorlando.com/research/). The company continues to highlight challenges at two parks, SeaWorld San Diego and SeaWorld San Antonio, but we estimate these represent <30% of visitors and <25% of adjusted EBITDA, and mask SeaWorld’s biggest problem – that stronger and better capitalized competitors are increasingly positioned as better options for the consumer. Six Flags continues to invest and grow (vs declines for Busch Gardens) and two of the largest theme park operators (Disney and Universal) are in the early stages of a significant arms race.

Source: SEAS Fillings

Regional analysis and competitive outlook

While SEAS does not break out parks individually, this slide provided at the company’s November analyst day shows the relative importance of Florida and California, and Orlando in particular.

California: Management has highlighted poor performance at the San Diego park as animal activists and Californians have turned against the company’s brand. While checks suggest 4Q15 was down less than prior periods, and could be evidence of waning brand pessimism, it’s important to note that 4Q represents just 18% of sales for the park and it’s likely too soon to read into a trend. More importantly, going forward SeaWorld San Diego faces significant competitive threats as the Wizarding World of Harry Potter opens at Universal Studios Hollywood in April 2016 and Disneyland embarks on its largest expansion plan ever – building a ‘Star Wars’ land. These are the same types of attractions that created a void for SeaWorld in Orlando in 2014, and with checks suggesting that a majority of SEAS customers in San Diego drive in vs. fly, this poses a significant threat to volumes in 2016 and beyond. One industry contact noted that even the tourism board of San Diego and the convention bureau were concerned about the new attractions by their neighbor to the north.

Texas: SeaWorld San Antonio also continues to be highlighted as a drag on company performance. Too many animal rights activists in South Texas? No, just an underinvested and uninspiring theme park that continues to lose market share to Six Flags Fiesta Texas (in San Antonio) and other regional Texas attractions. Six Flags is continuing to invest in their park in 2016 (http://www.sacurrent.com/Blogs/archives/2015/09/03/3-new-rides-coming-to-fiesta-texas) after adding a new Batman ride in 2015. To combat this, SeaWorld is making its largest investment in the park’s 27-year history by expanding its Dolphin exhibit and mirroring the successful interactive dolphin experience in Orlando called Discovery Cove. These are very expensive tickets and can cost upwards of $500. It remains to be seen if this investment will reinvigorate interest in the San Antonio park and generate a sufficient ROIC.

Source: Google Trends

Orlando:

SeaWorld faces deep-pocketed and aggressive competitors in its core Orlando market, primarily Disney and Universal Studios. While bulls will say a rising tide lifts all boats, and that investments by competitors will benefit SEAS in the long-term, we believe that new attractions by competitors can create a healthy demand void. Even more concerning, competitors are doing everything possible to lock-in visitors for their entire stay. Theme hotels, discount multi-park packages, and new and exciting attractions are just some of the ways that Disney and Universal are trying to capture a family’s entire vacation (https://www.adventuresbydisney.com/). If Disney and Universal are successful in locking in larger market share, this will weigh on SeaWorld’s three attractions in Orlando – its main SeaWorld park, Discovery Cove (an expensive interactive dolphin park), and Aquatica (water park) – which account for a large portion of SEAS EBITDA.

Following the opening of Harry Potter Diagon Alley in 2014, 2015 was a relatively quiet year in Orlando on the competitive front. But competitive threats re-emerge in 2016. Epcot’s Frozen Ever After opens May 2016 (I’ve heard Frozen is popular), Disney Hollywood is opening Star Wars themed exhibits and Universal is relaunching its King Kong attraction called Reign of Kong in Summer 2016. Universal is also adding to its theme park hotels (where guests enjoy exclusive theme park benefits) with the Loews Sapphire Falls Resort opening in 2016. The threats intensify in 2017 as Disney opens an Avatar area within Animal Kingdom (the largest expansion in park history), Universal Studios opens Fast and Furious Supercharged, and Universal opens Volcano Bay – the 6^th water park in Central Florida and second owned by Universal. To combat this, SeaWorld is moving away from its “natural and relaxed” brand and will be opening Mako this Spring, the longest and fastest rollercoaster in the Orlando market. This is sure to help, but it remains to be seen how impactful one rollercoaster can be, especially when intuition suggests rollercoaster enthusiasts prefer roller coaster parks (Six Flags, Busch Gardens, etc.).

Uncertain cost cuts

SEAS bulls continue to believe that the company can cut its way to improved profitability. At the analyst day in November, new management  presented a plan which targeted 200-250 bps of opportunity over the next 2-3 years, with little detail or specifics on how this could be accomplished. Nevertheless, this hasn’t stopped some bullish analysts (see FBR 12/22/15 note) from modeling 300bps improvement in 2 years, and discussing “500-plus bps” of margin improvement opportunity. Implied in these assumptions is that Blackstone, which purchased SEAS in 2009 and took it public in 2013, was an inefficient operator. Instead, industry contacts suggest the opposite may have occured – that Blackstone cut costs aggressively and underinvested in the business to operate at peak margins when taking SEAS public in 2013. We suspect there is limited remaining opportunity to cut costs that wouldn’t exacerbate SEAS's competitive disadvantage.

Resort strategy is defensive – International development strategy is not new

After seeing its competitors expand resorts and lock-in customers, SeaWorld is exploring building its own resorts on undeveloped land. We see several reasons that bulls might want to temper their enthusiasm; 1) SeaWorld is generally a day-trip park, not a week long, multi-park immersive experience that Disney and Universal are trying to capture (you can see the entire SeaWorld park in one day), 2) SeaWorld already has multiple partner branded hotels in key markets (Orlando, etc.), 3) the hotel industry is hypercompetitive in all SEAS operated regions and could be at the peak of the hotel cycle.  Also, while management has recently played up its asset-light development opportunity and a potential Middle East partner, this is not a new opportunity for SeaWorld (has been discussed for many years) and any incremental growth would be many years away in a best case scenario.

2016 Outlook

Expectations were for management to provide 2016 guidance with 4Q results, but instead management postponed 2016 guidance until they report 1Q16. To us, this suggests management has limited visibility into the success of its turnaround initiatives. In addition, a flurry of management changes prior to 4Q results also suggests that turnaround initiatives may be off track. We prefer not to read tea leaves and would instead suggest that 1) 2016 estimates are too high and do not adequately discount the competitive threats discussed above, and 2) estimates imply a reversal of trend in attendance and per capita spend. Street estimates have 2016 sales growing 2% (after declining in 2014 and 2015), and EBITDA growing 5% (after also declining in 2014 and 2015).

Combining continued low single digit sales declines with a high fixed cost structure can lead to a larger decline in EBITDA and earnings. SEAS currently has $1.56b of debt and is levered at 4.3x LTM EBITDA. The company has spent ~$155-$160mm of capex per year the last two years (vs. DD&A of ~$180mm) and has spent 100% of FCF on dividends and buyback. Going forward, SEAS will be entering an investment phase – new Blue World orca tanks will cost $100mm per park – where capex is expected to be above DD&A. This leaves much less FCF for shareholder friendly initiatives that have helped support the stock the last few years. The company’s $0.81/share dividend (4.5% yield) has been above Adjusted EPS the last two years, which is ultimately unsustainable, and will need to be cut if SEAS struggles continue into 2016 and 2017.

Comps/valuation

We believe SEAS is overvalued on an absolute and relative basis. In addition, we believe adjusted EPS and EBITDA less capex are the two metrics that best represent FCF and are the two best ways to comp SEAS to peers. Not surprisingly, analysts often chose to ignore SeaWorld’s higher ongoing capital requirements and look solely at EBITDA multiples, where SEAS looks cheap vs. peers. We believe this analysis is flawed and misleading, as even on what we view as optimistic sellside assumptions, SEAS is still trading at parity/slight premium with advantaged peers.

Our $10 target is 20x our 2017 adjusted EPS estimate of $0.50 and also represents 16x EBITDA less capex multiple on our 2017 estimate ($330mm of EBITDA - $180mm normalized capex). If our financial projections prove true (declining EPS and increasing leverage), there could be additional downside to those multiples.

Risks

• SEAS sells Busch Gardens at SIX flags multiple to pay down debt to de-lever.
• Competitive threats are masked by temporary boost from Mako in 2016 and analysts/investors extrapolate reversed trends causing a short squeeze (~20% short). This would likely be a great chance to add to short position given competitive pressures and tough comps in 2017.
• CEO is able to improve brand and boost attendance. CEO channel checks have come back positive. 

Disclaimer: The views and opinions stated are the personal views of the author and are not the opinions of the author’s employer. Do not rely on the information set forth in this write-up as the basis upon which you make an investment decision - please do your own work. The author and his family, friends, employer and/or funds in which he is invested may hold positions in and/or trade, from time to time, any of the securities mentioned in this write-up. This write-up does not purport to be complete on the topics addressed, and the author takes no responsibility to update this write-up in the future.

Catalyst

EPS miss and lowers.