|Shares Out. (in M):||89||P/E||0||0|
|Market Cap (in $M):||5,497||P/FCF||0||0|
|Net Debt (in $M):||1,915||EBIT||0||0|
|Borrow Cost:||General Collateral|
Prior VIC writeups on both SIX and FUN have documented reg’l theme park industry dynamics incl req’d capital intensity to sustain consumer demand and issues such as SIX’s mediocre business model, hefty SBC, over-stated earnings and relative under-investment. Nonetheless SIX has been a standout performer in the current cycle since a post-bankruptcy re-org owing to favorable business conditions, aggressive fin’l engineering, an effective albeit highly promotional mgmt team and a healthy dose of investor complacency. But multiple fund’l issues/red flags support short thesis suggesting support from this unique combo of dynamics is likely coming to an end which sets up asymmetric risk/reward to the downside.
Complacency has allowed SIX to continue to command a premium multiple despite multiple quarterly misses, an indicated Project 600 shortfall, reduced visibility on efficacy of int’l strategy, abandonment of REIT as offset to full cash taxpaying status, recent inconsistent strategy pivots, an abrupt CEO departure after just 17 months on job, expedient reinstatement of former CEO and insider selling signaling. In response to these challenges mgmt has seemingly doubled down on aggressive fin’l engineering by accelerating share repurchase near all-time highs to $417M YTD through Jul 21 vs $217M avg last three years and incl $312M bought from insider H Partners at near-high $61.36/share.
While cognizant of stock’s resiliency, recent red flags, likely cont’d disappointing fin’l performance vs extrapolated expectations and looming cash taxpaying status in 2019 are likely to begin eroding investor complacency. Seasonally the stock tends to outperform in 4Q-1Q (outside operating season) and arguably has already begun this predictable seasonal run. But risk/reward appears asymmetric on 12 months’ basis especially since extrapolated estimates appear too high, unsustainable efforts to stretch to make partial Project 600 target are already visible, Project 750 should increasingly be seen as a pipe dream and ability to continue to deficit spend should become more challenging thus changing the prior value-creation model and introducing sustainability concerns regarding return of capital incl dividend coverage.
Specifically, the following dynamics are likely to begin shifting the prevailing bullish narrative and/or contribute to change in sentiment incl a) 2Q-3Q throughput/margin issues owing to above-peak attendance levels and cost pressures; b) negative price elasticity on accelerated use of pricing in recent years and especially in-park spend on discretionary items (i.e. $100-130 fast passes); c) decelerating pass/membership sales and reduced passholder/member frequency on existing penetration/stagnant value prop (2Q-3Q above-peak attendance/crowding/under-investment, diminishing impact of season-extension initiatives, aggressive pricing); d) cont’d lack of visibility on ability of int’l licensing strategy to move the needle; e) lack of REIT path as offset to eventual full cash taxpayer status; f) uncertainty around divergent strategy pivot from reduced capital intensity to emphasis on waterpark roll-up opp’y; g) poor perf vs both internal (Project 600 no longer probable; req’d acceleration to reach Project 750 highly improbable) and Street expectations (consistent 2016-17 downward revisions; req’d 2018 acceleration to meet consensus highly improbable); h) fallout from abrupt CEO departure/uncertain tenure of re-instated former CEO; and h) aggressive selling by long-time largest holder and insider H Partners incl likely sale of remaining 8.5M shares that are already registered.
Sell-side ratings dispersion is bullish and SI is modest 7%. Believe bullish sentiment is overestimating sustainability of value-creation playbook which has been heavily dependent on favorable business conditions and ignoring signs of fund’ls topping (expect adj EBITDA to peak this year or next year well below Street consensus $589M). Nonetheless primary risk is accelerating growth and meeting expectations which would further diminish any concerns regarding impact of step up in cash taxes. Timing is a risk especially given 4.5% dividend carry and seasonal trading pattern also a consideration.
On cont’d growth below expectations sustainability of fin'l engineering-driven return of capital strategy should become more of a concern. Assuming full cash taxpaying status an inability to reach $550M of adj EBITDA in 2019 (vs 2016 at $506M and mid-cycle at $382M) would push net leverage close to 4x and take dividend payout ratio above 100%. Scenario analysis assuming compression to 2015 attendance plateau and 2012 per-caps in 2019 when SIX is assumed full taxpayer implies -18% decline in EBITDA to $415M, 152% dividend payout ratio and 17x EV/EBITDA with every turn ~$5/share. This scenario would likely see stock trade -50% or into high 20s where it would still trade at 10.5-11.0x 2019 EBITDA.
Fund’l Issues/Red Flags
Throughput/peaking margin issues - Part of the negative thesis here is based on throughput issues and peaking margins during full-time operating season. Former is a consequence of the successful strategy to drive attendance through aggressively pushing pass/membership sales at discounted levels at or below non-discounted single-day ticket pricing. And despite aggressive pricing actions the margin issue is based on combo of lower per caps on increased pass/member mix and rising labor costs (+MSD). Despite mgmt’s claim to contrary it seems clear 2015 attendance benefited from lower gas prices. And 2Q-3Q underlying attendance trends (adjusted for holiday shifts) since have been essentially flat. Belief is that higher post-2105 attendance plateau makes incremental throughput during seasonally concentrated operating period a challenge. Of the 1.6M incremental attendees in 2016, 1.7M came from outside the 2Q-3Q.
Incremental cost cutting to make Project 600 (recently deemed no longer probable) also appears unsustainable. Shown below, despite labor pressures/input cost inflation incremental costs have been virtually non-existent on trailing four qtrs. basis. And while seemingly unsustainable, look for these expense trends to persist in 3Q. Notably mgmt also reduced expense disclosure as the incremental dollar increase in labor expense was dropped from 2016 10-K). The impact of reduced spend is likely to have a LT impact on customer experience incl potential for safety-related issues. It’s hard not to wonder whether abrupt CEO departure may have been somehow related to decision to rein in costs seemingly to achieve Project 600 target?
Negative price elasticity - SIX mgmt has recently increasingly highlighted its ability to take price incl ticket pricing +3-5% annually that per mgmt “will grow for years to come.” In fact, recent Pass/membership pricing during company’s 4th annual Flash Pass sale was +2.5-4% at Great Adventure but +6.5-8% at Magic Mountain. However, thesis suggests declining per-cap trend is likely more than just mix shift and driven in part by negative price elasticity that will only likely get worse as consumer cycle matures amid growing evidence of belt tightening. Belief is that six years of consistent +MSD pricing increases, reduced discounting and pricing optimization is starting to have an impact on demand. Look for increasing push back on in-park pricing and downside of price discrimination/optimization in the form of reduced demand for discretionary sales (i.e. $100-125 Platinum flash-pass) and/or trade down.
Diminishing benefit of incremental operating days - Owing to throughput issues and increased weather variability with operating season attendance above peak, SIX has relied on incremental op days for growth especially by adding add’l parks to 4Q holiday events (Frightfest, Holiday in the Park). For example, Holiday in the Park is already in nine parks and will only be added in one add’l park this year (New England despite potential weather issues). In addition, the shift to straight-line accounting for membership sales that went into effect in 2016 has boosted 1Q/4Q income as a result of lower cost base. We see diminishing incremental impact of shoulder season opp'ys on both financials and consumer value proposition. Nonetheless in an effort to offset another likely 3Q miss, mgmt appears to be redoubling efforts (recent incremental discounting) to drive pass growth and deferred revenue beyond Labor Day flash sale (4th annual) that offers benefits through year end 2018 as long as credentials must be picked up at park this year.
Lackluster fin’l impact of int’l licensing strategy - Despite being hyped by mgmt the “asset-light” int'l opp'y continues to appear overestimated and remains inherently unpredictable (i.e. Vietnamese partner just defaulted in 4Q 2016). After spiking from 3.8% of revenue mix to 4.9% in 2014 sponsorship, licensing revenues dipped to 4.7% last year and are modeled to remain sub-5% in 2017.