Description

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.

Recent inconsistent strategy pivots - Following abandonment of REIT alternative earlier this year mgmt initially emphasized ability to gradually reduce cap ex below rigid 9% of revenue target as an offset. At the time this reduced concerns about dividend coverage upon resumption of full cash taxpaying status. More recently at 1Q 2017 and seemingly in response to tepid growth, mgmt pivoted to emphasizing a more capital-intensive strategy namely the ability to roll up complementary waterpark assets. These seemingly inconsistent shifts appear to be attempts to simultaneously address concerns about both requisite growth and deployment issues to sustain existing dividend levels upon eventual run off of the company’s advantaged tax status.

Poor performance vs Internal/Street expectations/Project 750 well out of reach - Recent performance vs Street expectations has been poor with misses in four of the last five quarters despite “game-changing” VR hype in 2016. Mgmt also had to reverse probable status of Project 600 achievement at 2Q 2017 despite deeming it probable for accounting purposes at 3Q 2016 to offset another quarterly miss and the fact it would have required cycle-high +LDD% growth to achieve. Street 3Q EBITDA estimates still look aggressive at +8% y/y to $323M despite the fact consensus was +13% y/y to $339M as recently as 1Q 2017. Similar to 2Q expect mgmt to pull out all the stops on cost side to stretch for partial Project 600 achievement (in line with consensus) and blame weather on any shortfall.

SIX has seen consistent downward revisions over last 18 months as 2016 EBITDA was $540M prior to 2Q 2016 miss and wound up at $506M while 2017 consensus EBITDA has declined from $585M to current $540M which still looks aggressive. After another miss in 1Q 2017 left an even steeper hockey stick required to reach Project 600 target this year, the call was ridiculously bullish. Mgmt was "very pleased" w/ 1Q results, felt "very good" about everything and indicated Project 600 was on track in part owing to pivot out of nowhere to "aggressively exploiting pricing opp'y" (despite years of taking +MSD pricing) and buying water parks. Growth rates for int'l (asset-light strategy) went negative in 4Q and 1Q but "pipeline remains full" so there was apparently nothing to see there either.

The Project 750 target implemented last year ($750M modified EBITDA by 2020) after another quarterly miss in 3Q also looks wildly aggressive based on implied accelerating growth nine years into a domestic expansion and recent consistent deceleration. Implied Project 750 CAGR is +7.7% off $600M (+9.2% off $576M consensus) and +10.1% off below-consensus $562M. All three implied CAGRs imply acceleration vs Project 600 targeted and actual CAGRs of +7.5% off actuals and +9.5% off $500M prior target and mgmt expects to fall short of Project 600. As shown below and despite two downward revisions already this year, incremental EBITDA, flowthrough and margin improvement all still appear overly aggressive in both 2017 and 2018.

Abandonment of pursuit of REIT structure/Doubling down on aggressive fin’l engineering - For several years mgmt had talked up potential to pursue REIT structure to placate investor concerns about the impact of eventual full cash taxpayer status. But on Mar 30, 2017 the company ann’d plan to accelerate share repo by authorizing incremental $500M plus $322M remaining as an offset to ann’d decision not to pursue spin-off of real estate assets into a REIT (and right in front of 1Q miss). Street largely yawned at the REIT announcement but it does carry LT negative implications since a key page in the SIX value-creation playbook is aggressive return of capital. This includes paying out $1.41B in excess of FCF from 2012 through 2017E to maintain 2.5-3.0x net leverage vs 3.9x current (seasonal; 3.8x YE17) and $228M dividend outlay (expected to rise +HSD-LDD annually). As a result net debt has risen from $725M in 2011 to $1.91B currently.

Free Cash Flow Dynamics 2012-17E

Despite increased fund’l uncertainty and FCF plateauing at $280-290M in 2015-17E, mgmt/BoD decided to accelerate return of capital in 2017 by repoing $417M of common stock YTD through Jul 21 at $61 avg cost.

Abrupt CEO departure/Uncertain tenure of re-appointed former CEO - Just days before missing 2Q estimates in Jul 2017 CEO J Duffey abruptly resigned effective immediately and former CEO and Executive Chair J Reid-Anderson was reinstated as CEO. Street predictably cheered his return for “the long term” but he may just be acting as a temporary fix to eek out a partial Project 600 award for his own benefit as well as to facilitate H Partners' exit. His (predictably hefty) comp package is heavily weighted to Project 600 (had 250k shares, getting 185K more w/ five months to go for 435K total) vs 2020 Project 750 (150K shares) and he's apparently not moving back to Dallas (company providing an office at Illinois park). His base is also $1.6M w/ 200% bonus target vs former CEO's $1.05M w/ 125% target (and former CEO had 250K Project 600 shares of which he retained 50%). The explicit language around non-disparagement and confidentiality in former CEO's "retirement" agreement also supports thesis he may have left owing to increasing concerns about something?

Insider Sales Signaling/Overhang - Insider H Partners has been the company’s largest shareholder since the 2010 re-org reaching a peak of 17% or 16.4M shares in 2014-15. H Partners hadn’t sold any stock since 2012 and in Oct 2105 started selling with the intention of reaching 12M shares and as of May 24, 2016 13-D/A they “intend to hold remaining stake of 12M shares.” As of Mar 8, 2017 proxy H Partners owned 13.6M shares. Despite missing 1Q Street estimates mgmt was asked about confidence in cycle-high double-digit EBITDA growth in 2017 on 1Q call and response was "very confident." Just days later on Apr 28 the company bought back 5.06M shares from H Partners for $310M at near-high $61.36/share (less than -2% discount from prior-day close and highest repurchase prices ever paid). Represented 37% of H Partners' stake and takes ownership from 14% to 9% - having now sold down 48% of stake since Jan 2016 after not having sold any stock since May 2012. Hardly seems "opportunistic" as SIX had never bought back stock >$59/share and $61.36 is just -5.5% off ATHs hit days prior. On Jun 17 H Partners then registered to sell their remaining 8.5M SIX shares.

Reinstated CEO recently executed and publicized an exercise and hold transaction in Aug and despite its apparent bullish signaling he has historically followed such moves with sales. It’s also relatively meaningless since Reid-Anderson has been a big beneficiary of SIX’s heavy SBC scheme (current 3.9M-share ownership) and a heavy seller generating proceeds net of exercise of $95M from Jan 2015 through his move to executive Chair in Apr 2016.  

Risks

SIX has been resilient and trades within a turn of ATHs despite multiple quarterly misses/Project 600 miss, downward estimate revisions, REIT abandonment, disappointing int’l growth, abrupt CEO departure and material signaling from a large insider exiting. Prior to now EBITDA had to go lower but NOL rolling off in 2019 suggests lack of material growth in 2018 will raise sustainability concerns. But primary risk is that trend-line EBITDA growth is achievable and/or mgmt can stretch out inflection in cash taxpaying status and complacent market continues to ignore sustainability of current model based on return of capital well above FCF generation. Other risks incl the following:   

• Timing should be a material consideration here especially given 4.5% dividend carry and seasonal trade that appears to have already started as stock tends to outperform during off season.

• Extrapolated estimates prove achievable and/or int’l signings accelerate materially.

• Tax code change - full cash taxpaying status pushed for at least 2018 to at least 2019.

• Complacent, low-rate environment makes M&A a possibility particularly potential to acquire to offset flagging organic growth but risks of such a move at this stage of cycle appear hefty.

Valuation Considerations

SIX trades with a turn of its ATH NTM EV/EBITDA multiple and while multiple expansion on NT seasonal pattern represents a risk, expected incremental downward revisions represent an offset. On cont’d growth below expectations sustainability of fin'l engineering-driven return of capital strategy should become a material concern and limit multiple expansion potential. 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%.

More realistic scenario analysis assuming compression to 2015 attendance plateau (benefit of pass/member penetration) and 2012 per-caps (pass mix, reduced in-park spend on weaker consumer dynamics and negative price elasticity) 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 with a supportive dividend yield of 5% assuming a cut to 75% payout ratio. This scenario also roughly corresponds to 11.5x mid-cycle EBITDA of $380-400M. And on an overshoot to low end of 5-yr avg NTM EV/EBITDA range or 8.5x mid-cycle EBITDA stock could trade -60% or sub-$25/share.           

Free Cash Flow Dynamics 2012-19E

Notably, the embedded expectations to arrive at fair value of $60/share appear completely unrealistic and include 10 years of uninterrupted growth in line w/ current cycle's trend (+MSD revenue and EBITDA growth). And even assuming material incremental positive impact from "asset-light" int'l growth (12% of revenues vs 5% currently) this scenario assumes +50% attendance above current peak levels 10 years out (45M vs 30M current and 24M trough).

Potential Catalysts

SIX has held up despite consistent misses, insider sales so it seems reasonable to expect it will take more for the short to work. But those prior dynamics may matter more in a less-complacent market environment and/or as NOL roll off gets closer and the potential material negative consequences of fin’l engineering become increasingly top of mind. Nonetheless the following catalysts appear to be in play:

• Diminishing complacency incl greater awareness of unsustainability of aggressive fin’l engineering as full taxpaying status in 2019 approaches.

• Increased visibility on potential for negative inflection in adjusted EBITDA growth incl slowing consumer spending trends, cont’d deceleration in pass/membership sales and/or further per-cap spending declines.

• In-park issue highlighting potential consequences of under-investment.

• Cumulative impact on sentiment of add’l misses vs consensus, additional insider sales incl H Partners full exit, strategy pivots, etc.

• Rising gas prices/consumer spending contraction.

DISCLAIMER:  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

• Diminishing complacency incl greater awareness of unsustainability of aggressive fin’l engineering as full taxpaying status approaches

• Increased visibility on potential for negative inflection in adjusted EBITDA growth incl slowing consumer spending trends, cont’d deceleration in pass/membership sales and/or further per-cap spending declines

• Cumulative impact on sentiment of add’l misses vs consensus, additional insider sales incl H Partners full exit, strategy pivots, etc

• Rising gas prices/consumer spending contraction