Background:

SeaWorld (“SEAS”) is a theme park and entertainment company that operates a diversified portfolio of 11 destination and regional theme parks that are grouped in key markets across the United States.  The company owns or licenses a portfolio of globally recognized brands, including SeaWorld, Shamu and Busch Gardens.  Offering the company unique intellectual property, SEAS maintains one of the world’s largest zoological collections with approximately 67,000 animals, including approximately 7,000 marine and terrestrial animals and approximately 60,000 fish.  The company was brought public by Blackstone earlier this year (April 2013). 

As a general rule, theme parks are consistent/durable business models with huge barriers to entry that generate a lot of cash, which is typically paid out to shareholders in the form of a healthy dividend.  SEAS is no different and should see FCF improve markedly over the next couple of years as the company’s capital spending plan normalizes at lower levels.  SEAS has spent the last few years playing catch up after being capital starved by its original owner, Anheuser-Busch Inbev. 

How we got here:

After peaking at almost $40/share, the company missed street expectations in its first quarter out of the gate as a public company.  While never an encouraging sign, to management’s credit they tried to talk the street down coming into the print.  However, the company is/was still pretty green with respect to properly setting and managing Wall Street expectations and these warnings were ultimately dismissed as conservatism.  It’s important to note that the company did not miss any company provided projections, only street estimates.  Moreover, SEAS only guides to full year results and on that basis they cut 2013 revenue estimates by $10m on a base of $1.5B and left their $430-440m EBITDA guide unchanged.

Investors were particularly concerned by a 9.5% decline in attendance.  According to the company there were 3 contributors to the decline, each accounting for ~1/3:

1. Deployment of pricing and yield management strategies
2. Adverse weather (FL and VA); this was the rainiest season in ~100 years
3. Calendar: compression of Easter and spring break

Thoughts on attendance declines:

The deployment of new yield management strategies is not new and actually a big part of why we like the stock.  Through the road show, management spoke extensively about the rollout of this plan and the short-term adverse impact it would have on traffic. 

By way of background, up until recently, the industry had largely been focused on driving attendance.  The basic view was that as consumers came to the park, in-park spending would benefit. However, this approach undermined pricing integrity as ticket discounting was pervasive and failed to maximize in park spending potential.  Under a revenue yield-management approach, operators look to maximize net ticket yields (a function of daily ticket pricing per guest and available park attendance capacity) while maximizing net in-park spending yields (a function of daily in-park spending per guest and available park attendance capacity).  This holistic approach collectively leads to a more disciplined business model, revenue and profitability.  Disney has been the industry leader in yield management, utilizing data-based analytics derived from the company’s ticketing, customer relationship management (CRM), and point of sale (POS) systems to make more informed pricing decisions.  Data-based analytics are also used to more effectively manage costs and enhance the guest experience (line queuing and in-park capacity flow management).  For Disney, data-based analytics encompasses not only theme-park operations (tickets, in-park spending) but also the company’s cruise and lodging operations.

SEAS is probably in the 2^nd or 3^rd inning of rolling out similar functionality.  If we believe management that the balance of the attendance decline (that not related to yield management) was an anomaly, then adjusted the attendance was down ~3%, but per cap. attendance was +8.7%.  All else equal this implies that revenues would have grown mid-single digits.  Even more encouraging is management commentary that the parks where the company was more aggressive on price are not the markets where they struggled. 

With respect to the other excuses offered, they are what they are.  While I’m never a big fan of using weather as an excuse the plausibility is high given what we know about the nature of the business and a colder and wetter than normal spring.  Similarly, calendar compression decreasing visitation is also easily verifiable. 

In light of the quarterly results, management attempted to regain control of the narrative by going on the road and relaying a confident message.  Concurrent with these meetings, they released an 8-k reiterating their full year guidance based on the results through August, which represents ~80% of their EBTIDA for the year.  Despite this reiteration, the stock remains 25% off its peak. 

Margin potential underappreciated:

Do to animal care costs (which are implicitly not seasonal), SEAS margins are structurally lower than that of peers FUN and SIX.  That said investors don’t fully appreciate the opportunity in front of the company afforded by the abovementioned yield management strategies.  Since 2005, the company’s incremental margins have consistently trended in the low 30’s.  This changed in 2012 when they accelerated to 36% and the trajectory has continued higher to ~40% in the 1H’13.  Using management’s 2013 guidance (80% of which has been reiterated) reveals that the company is externally forecasting incrementals of 47.5-76.5%, well above historical norms:

Asset light opportunity:

Management has spoken repeatedly about the opportunity for asset light international growth.  The company could theoretically partner with a developer who would build the asset (SEAS would likely still make a minority investment) and sign a fee based management contract to operate the property.  Conceptually, SEAS has a comparative advantage relative to its peers with respect to international growth.  First off, since the company owns all of its IP, the complications associated with cross border licensing deals are not an issue.  Moreover, animals translate pretty universally to other geographies and cultures.  As a result there is no need to spend time and marketing dollars educating the locals on Western character equities that they may not be familiar with. 

While I think most investors familiar with the stock view this as an abstract pie in the sky opportunity I view it as inevitable.  The company has openly commented that capitalizing on international asset light development is not a matter of demand, but more a matter of choosing the right projects and partners.  They’ve further noted that given the growth opportunities they see, it probably doesn’t make sense for them to have a dividend payout ratio as high as their peers. 

Other non-fundamental catalysts:

• Refinancing of $260m 11% Senior Notes due December 1, 2016; callable Dec. ‘14
• Capex step-down of $30m next year, which could lead to shareholder friendly capital allocation decisions
  • 3.25x has been set as the long term leverage target for the business and the company has talked openly about dividends and share repurchases; They should reach those levels by early 2014
  • SEAS has an NOL that will keep cash taxes low through 2016-17, but management has spoken openly about REIT conversion

Valuation:

Given that this is a deleveraging story I value SEAS on a 2015/2016 basis (discounted back) as this best demonstrates how value accretes to the equity holders even in the event that the multiple compresses.  However if the company were to successfully close the margin gap and execute on some asset light international growth opportunities I believe it reasonable to assume that the stock could trade closer to SIX at the high end of the peer group.  I’d also point out that the projected leverage ratio in 2015 is well below the stated target of 3.25x, thus leaving ample room for shareholder friendly capital allocation decisions (which I do not incorporate into my valutation).  Finally, for added conservatism, I give the company no credit for its NOL or potential REIT conversion:

• Printing an inline quarter
• Updates on capital allocation
• Asset light/international growth announcement