SIX short

$62.50/share, $3.5B mkt cap, $4.3B EV

Note P/E above uses price less NPV of NOL over real sustainable economic earnings (after stock comp, after long term tax rate).  EBIT reflects EBITDA - Capex instead as mgmt is right that D&A>Capex sustainably.  

Quick summary --- Decent business, but can never come close to justifying its valuation.  Mgmt has a big “aspirational” target of Project $500m EBITDA – it’s a big IF whether they can hit this, but even if they do, SIX is ~2x overpriced with no secular growth going forward.  I think investors confuse one-off profit growth/price optimization for a sustainable growth trajectory that deserves a multiple, confusing cash generated from NOL consumption with sustainable cash and are completely ignoring SIX’s huge stock comp and dilution packages.  Mgmt promotes a $5.50 “cash” EPS in that Project $500 scenario, that really translates to ~$2 of economic earnings after you back out NOL benefits, stock comp, and a handful of other small items.  Stock is signficantly levered and still >30x real economic EPS if the Project 500 “aspirational” plan is achieved, with little growth from there. 

More Detail

Quick History – overlevered, went into bankruptcy, came out in early 2010

• Emerged with great management team – Jim Reid-Anderson (“JRA”) is absolutely revered by investors
• Walk out of any group meeting with a long and they’ll tell you on the elevator how Jim Reid-Anderson made a 10-bagger onDade Behring and how he will do it again with SIX.  In my opinion that’s not much of an investment thesis. 
• From the calls and meetings I’ve listened to, I find CEO to be a bit of a braggart who has made some pretty aggressive stock-pumping statements, though he’s done a good job operationally.  Listen to the recent 3Q12 call and you’ll get a sense.  First, JRA launches a five minute monologue on how excellent he and the management team is doing (which was very weird subject choice in the context of reporting a quarter that was bad enough to drive the stock down 15%).  Then, they make some vague comments about tax rates going forward which seemed to imply “REIT” and I interpreted as a effort to keep the stock up (though in multiple group meetings since the CFO has clarified they can’t REIT this business), then they announced a huge dividend increase to levels they can’t sustainably pay even if their aggressive “aspirational” case is achieved.  Along the way they also kept pointing out that one year forward season pass sales were up 30%, demonstrating their momentum (it really just demonstrates the effect of pulling customers & cash receipts forward by offering a 40% price discount, discussed below). 
• This is a so-so business at best.
• First, amusement parks do generate cash.  But people forget how incredibly capex intensive this business is (10% of sales, 30% of EBITDA), there is no reason to look at EBITDA-based valuations here unless its solely compared to other business with the same capital intensity.
• Tough business model – parks would not be economical to build today, it’s squeezing juice out of a dying business (fact that there will never be another US amusement park because the returns can't come close to justify building one is actually cited in the bull case as a barrier to entry -- with no acknowledgement of the secular decline this implies for the business because of course it was once very profitable to put up parks).
• Proliferation of entertainment options should continue to erode SIX’s visits.  I’ve debated the secular outlook with others, and I have to concede it is at least a debatable point.  But the debate is whether its flat or in decline -- definitely not secularly growing
• Business has very heavy seasonality, weather risk, rides need constant capex or attendance falls
• While you can do one-off cost cutting to boost profit, play with ticket offerings until you’ve got an optimized pricing model, those are one-off profit improvements, not a profit growth trajectory.  In the end the only sustainable growth trajectory you can hope for is inflation, maybe inflation plus if you’re bullish. 
• Mgmt has done well, but not as well as people think
• This year a near perfect weather year, rev was only ~4% higher than last really good weather year in ’08.
• Compare those two years, mgmt would point to $100m EBITDA improvement from ~$300m to ~$400m. 
• Some good cost cutting in there, but really $58m, half that improvement is just putting on a ton of costs into stock comp and pretending it’s free.  And the low-hanging fruit was easy --- Letting go ofPark Avenueheadquarters just north of Grand Central.  Cutting unnecessary advertising  -- “Mr. Six” (the dancing geriatric), was on TV in regions where they didn’t even have a park…
• Mgmt’s initiatives could have long term risks in reducing the quality of the experience.  It’s primarily a one visit a year business – so initiatives have immediate benefits this season (don’t know until you’re already at the park and paid), while any issues caused won’t show up until future seasons.  When you tick off all of management’s key initiatives, they all seem to have at least some potential risk.
• Pushing people into cheap season passes – crowd up park, increase wait times etc.    
• High priced “SpeedPass” (upto $2-300/head) that allows people to cut to the front of the line – So the regular guy digs deep to pay $250 to bring his  family to a SIX park, then watches rich kids keep cutting his kids in line all day?
• Cutting capex – no big exiting new coasters for SIX anymore, just moving around old tired rides from park to park.  That certainly has the potential to harm the experience.
• The big bull case is pricing.  People think SIX could price a lot higher (looking at FUN).  SIX tried that a decade ago and attendance dropped off drastically (mgmt would tell you the problem is they need to move pricing slowly this time around).  I think the entertainment value is what it is, you’re playing to an extremely price sensitive consumer, and real pricing comes as a trade-off with attendance for the most part.  What SIX is doing now is just pushing mix around, they’ve increased gate prices, cut season pass prices all the way down to equal undiscounted gate price.  Total achieved price was about zero this year.  This let attendance grow (5% on a very easy hurricane comp year).  Longer term I think bulls are talking about price growing moderately above inflation (but costs aren't subject to inflation?), this doesn’t seem like a particularly compelling thesis to me. 

So a mediocre business in my opinion.  I find Project 500 questionable but not completely out of the question -- its fairly characterized as an “aspirational case:”.  What I really take issue with is the valuation that seems 2x too high even if Project 500 is achieved. 

• Mgmt points to highly adjusted “cash earnings” metrics that overstate real sustainable profit and free cash flow by 2x, yet SIX is still overpriced even on the outyear “aspirational” case. 
• Just for the sake of argument, let’s give them Project $500 and see where it’s valued.
• Mgmt points out that with Project $500, their “adjusted cash earnings” would be $5.50.  It looks slightly lower than that just running through the numbers but close.  However that “adjusted cash earnings” number is pretty irrelevant as a metric. 
• Note: I follow mgmt’s methodology of looking at capex in this calc instead of D&A b/c D&A is probably higher than ongoing capex requirements. 

• So what’s missing from their numbers? 
• Leaves out $1.15/share of stock comp ----  the huge ongoing stock dilution at SIX is certainly a very real expense – SIX has plowed $230m cash into share repurchases in the 2 years since emerging from bankrtupcy through 2Q, which has still not been enough to offset dilution from stock comp with the sharecount up 1.1% since bankruptcy (giving them credit for 1.1m bought back post 3Q close) and another 2.5% dilution to hit the numbers in either 4Q or 1Q.
• Leaves out $1.60/share of tax cost.  It’s not appropriate in 2015 to try and put a mutliple on a tax benefit that runs out in 2017/18.  I calculate the remaining NPV of the tax benefit to be $3.60/share at an 8% discount rate in 2015, which you can back off the stock price. 
• Leaves a few other miscellaneous items as well: ~25c of excess minority payments (contractually required to pay out in excess of what's expensed),  15c of pension payments, 27c if capex needs to get closer to historical levels (pre-bankrtupcy was running ~$150m/yr, so even $125m as shown above is assuming a decent capex stepdown). 
• >>>Note, all the 2015 numbers are PF for the recently announced debt funded buyback of 15% of shares out, which is why you see higher interest expense and a lower share count (offset by some dilution from ongoing stock comp).  Note share count will be even higher if they hit Project 500 and related stock grants. 
• So “$5.50 cash EPS” really looks like ~$2/share of economic earnings. 
• Give them NPV credit for remaining NOLs in 2015 – you’re at 30x earnings in FY15 if Project 500 is achieved

• On the 3Q call, SIX increased the dividend 50%, now a 5.5% yield – But they don’t have the FCF to pay this sustainably even in Project 500 case (PF for the stock buyback, that’s a $190m/yr obligation, 2x their real economic earnings). 
• SIX has now also announced they will issue debt and buyback ~$350m of stock at these prices (10% of mkt cap).  I’m perfectly happy to watch them swap debt for equity at this valuation.
• Hopefully they rushed out and spent the money quickly just like they did with the $70m of Dick Clark proceeds this past quarter, when they used all $70m to buyback stock at an average price of $62.  Looking at the stock chart that suggests they jammed all those purchases into just a week or so when the stock was at that high, in October.  I thought it was very curious to see them rush out to buyback so much at stock price highs when they new they were days away from announcing very disappointing 3Q results. 
• PF for this debt raise, SIX is ~2.9x levered during it's seasonal cash high point (4x EBITDA – Capex), has no secular growth, and is valued at a level they can’t even afford to pay a sustainable 5.5% yield, I'm ok with them buying a lot of stock. 

• There has been debate over whether SIX could figure out some tax solution when NOL runs out in 2017.  CFO says its not a REIT structure, so I’m not sure what they could be thinking 5 years out other than just regular tax management.  Only REIT-ish structure that seems it could apply is a REIT spin similar to Penn Gamaing just did (though that is a gaping loophole in the tax code, good chance this option is not available in 5 years when SIX comes looking).  But even if they pursued this option and saved ~50% of their tax going forward, they still look overvalue.d 
• In fact, EVEN IF they never paid tax again, this looks overvalued – 17x economic earnings, 15x EBITDA – Capex in Project 500 case (in both cases including the very real cost of stock comp)
• A good read across --  Cedar Fair has a publicly traded partnership grandfathered from pre-1987 tax change.  They trade at 8.1x forward EBITDA, are heavily levered (50/50 debt/equity) and pay out all FCF to generate a ~5% yield (easy to forget how much cash needs to go to capex even  when you’re not paying cash).  FUN has long been considered the best operating company in the amusement park business.  So perhaps 8.1x is a good indication of what a permanently tax free operator should be worth. 
• On the other had, SIX is 9.5x “Project 500” EBITDA (if they get there, three years out), and 10.5x EBITDA when burdened for the real cost of stock comp.  So SIX already a huge premium even vs. a real tax free structure, when valued on “aspirational” 3-yr targets.  It’s just crazy. 
• Put it together, value just seems outrageous in any scenario.
• IF you blindly assume Project 500 can be achieved in three years:
• I think SIX should be worth no more than $32.50, 3 years from now (equates to ~14x levered economic earnings, 10x EBITDA – Capex, in both cases giving full credit for the NOL NPV, a generous valuation for a growth challenged company)
• IF you blindly assume not only will Project 500 be achieved, but SIX will never pay taxes again (no justification for that thought, but still)
• I think SIX should be worth no more than $50 on similar metrics.  And again, I don’t think there is any reason to believe this no tax situation is credible.
• Those  are 3 year forward values that need to be discounted back, and assume zero risk the "aspirational" case is achieved.   
• On a real valuation – if we look at FY13 and get aggressive – say they can generate $450m of consolidated EBITDA which would be significant growth despite the headwinds discusseed below --- I think this stock should be $26.50 (14x economic earnings –  giving full credit for the NPV of NOLs but using sustainable tax rates, and considering the very real economic cost of dilution).  Again, I’d view 14x as a very aggressive valuation for a levered no-growth company. 
• That's 60% downside to putting this stock at a reasonable valuation

• Also interesting (but not really a crux of my thesis) – there will be some tough comps coming up.  FY12 was a close to perfect weather year (incidentally comping a bad weather FY11 with hurricane impacts etc.).  FY13 will have a tough comp unless it is again perfect weather.  There’s also the elimination of >$10m EBITDA since a stake SIX owned in the Dick Clark production business was just sold in 4Q12. In 1Q12 mgmt booked $3m of insurance proceeds (from Hurricane Irene in FY11), which won’t recur in 2013.  There will be ~1.5m shares of additional dilution hitting in either 4Q12 or 1Q13 (~2.5% of shares out)

-----------------------Biz overview------------------------------

General overview

• SIX operates 13 park locations with 19 distinct theme park gates (e.g. NJ location has Great Adventure thrill park, Hurricane Harbor water park, Wild Safari – 3 gates).  CFO didn’t know sales concentration but I expect the 4 largest parks in NJ, Chicago, LA andTexasare probably over half of revenue. 
• Revenues are
  • 54% admissions – attendance split is 35% group sales, 28% season pass, 37% regular gate. 
  • 41% in-park sales (parking, concessions, toys/gifts)
  • 4.2% sponsorship & advertising
  • 1.5% lodging
• Highly seasonal, with significant weather exposure
  • ~80% of revenue is earned in Q2 and Q3. 
  • Summer weekends average ~20% higher than weekdays, implying weekends are ~1/3 of revenue.  Big event weekends like 4^th of July, Memorial Day, Halloween, can be ~33-40% jumps in attendance.
• 1,900 full time employees with 27,000 seasonal employees – 18.6% of full time employees and 10.6% of seasonal employees are unionized.  Labor is cheap -- $9/hr for tickettaker, $10/hr for more skilled animal handler. 
• Licensing agreement with Warner Bros & DC comics – rights to use characters in US.  Royalties are $3.6m/yr +12% of merchandise with characters on it. 
• SIX has a few parcels of excess land adjacent to parks –700 acresin NJ,300 inMD,240 inMO.  I don’t think there is a ton of hidden value here.

SIX became controlled by Dan Snyder & Red Zone in ’05 before seeking bankruptcy protection in June ’09.  SIX emerged from bankrtupcy on 4/30/10 led by the prior CEO who was then fired and replaced by a new management team in August 2010 led by CEO James Reid-Anderson (ledDade Behring out of bankrtupcy to a Siemens acquisitions, terrific reputation), and COO Al Weber (prior CEO of Paramount Parks). 

Over the past decade SIX has struggled with flat/declining revenue.  EBITDA vacillated between $180-275m for the 7 years leading into the bankruptcy.  The new CEO aims to turn this around with cost cutting, capex cutting and better pricing strategies. 

New management has done a good job boosting EBITDA generation from the same assets as the old team. These actions are surely net value creative.  A few easy long hanging fruit items have contributed quite a bit of easy cost savings –Park Aveheadquarters, excess advertising.  However it is important to remember that these types of decisions can have some negative longer term impact on the core business.  Because this is a destination trip, customers who show up at the gate and find higher than expected ticket prices will probably buy the ticket anyway, but might be less inclined to return.  In the same way a customer might be less likely to return if lines are clogged with cheap season pass holders or if they are frustrated that rich kids with flash passes keep cutting their kids in the hourlong line for Kingda Ka.  Eliminating capex on big headline rides, and cutting advertising budget should also have negative long term effects. 

Importantly, these price initiatives don’t create a sustaining growth trajectory, they are just one-off price growth levers.  Once optimal price is reached, sustaining growth is just inflation-type pricing, which doesn’t deserve much of a multiple.  The question is how far above last year’s $350m EBITDA and $3.50 “cash” EPS (really $2.03 of sustaining cash EPS) should you apply an inflation-growth multiple.