Description

The Sunterra Corporation (SNRR) investment thesis in a nutshell is as follows – at current prices for SNRR you get a company that is (1) reasonably valued based on current FCF and EBITDA, (2) has the real ability to materially grow its FCF and EBITDA, (3) has meaningful downside support through its asset value, and (4) has real and specific catalysts to unlock value.

SNRR is a timeshare vacation ownership company with a network of resorts in North America, Europe, the Pacific, and the Caribbean. The company’s business model can be thought of in three pieces – (1) marketing and selling vacation ownership interests in properties that SNRR has acquired and/or developed; (2) providing consumer financing to purchasers of these vacation interests (note: in the U.S. SNRR finances about 75% of its sales while in its European operations SNRR provides no financing, but instead brokers and sells all loans on a flow basis); and (3) providing rental management and maintenance services to various resorts. It should also be noted that SNRR’s history includes a period of hyper roll-up-driven growth, which led to lack of internal controls, massive write-offs of receivables, and ultimately bankruptcy. The company emerged from bankruptcy in late 2002 with a new management team, newly instituted corporate legal and organizational structure and controls, stricter underwriting guidelines, and a cleaned-up balance sheet.

Now, back to valuation. For 2004, SNRR is expected to generate approximately $1.30+ in FCF per share and $60 million of EBITDA. At the current stock price of $10.70, these values yield multiples of roughly 8.2x FCF and 7.4x EBITDA. Not bad for a company with a large base of properties, 335,000+ timeshare owners, substantial asset value, and real catalysts. Where things get interesting is when one looks out another year or two. As a result of (1) an enhanced ability to sell timeshares the further the company distances itself from bankruptcy; (2) capitalizing on investments the company has made in its sales operations; (3) exploiting the opportunities provided by SNRR’s recent acquisition of Epic; (4) taking advantage of operating leverage as volumes grow; (5) and favorable industry dynamics and demographics; FCF and EBITDA should grow meaningfully from 2004 to 2005 – reaching $1.75+ in FCF per share and $75+ million in EBITDA. By 2006, FCF should be roughly $2.25 per share and EBITDA in excess of $90 million. This growth in FCF and EBITDA should drive roughly a “double” in the company’s stock price.

While the upside in SNRR’s share price is driven by growth in FCF and EBITDA, the downside from the current price is mitigated by the company’s net tangible asset value. The asset value is comprised of cash, restricted cash, mortgage receivables, other current assets, unsold inventory, equity in SNRR’s European operations, ownership interests in JVs, and PP&E. Netted against the asset value is accounts payable and accrued liabilities. Obviously, the current net tangible asset value depends on one’s assumptions regarding how much the assets are worth as a percentage of book value. CRT (the one shop that publishes on the company) calculates the net tangible asset value at approximately $10 per share. While one could quibble with some of CRT’s assumptions, we believe they are certainly in the ballpark. Thus, the $10 per share net tangible asset value provides downside comfort for a stock that can be purchased at $10.70.

Now turning to the catalysts for SNRR. There are at least four –

(1) Listing on the Nasdaq National Market. Currently the stock is traded on the Bulletin Board. Nasdaq National Market listing is expected within a few weeks. National Market listing should improve liquidity, add to visibility, and open the stock up to a set of buyers who are not permitted to purchase Bulletin Board stocks.

(2) Securitization of receivables. Since emergence from bankruptcy SNRR has held all receivables from its consumer financing operations on balance sheet. The company expects to securitize a large portion of these receivables by mid 2004. Such a securitization will enhance liquidity and lower SNRR’s cost of funding, as well as give skeptics more comfort with the quality of the receivables.

(3) Analyst coverage. The company currently has no analyst coverage from any major Wall Street firm (CRT does publish on SNRR). It is anticipated that over time SNRR will garner coverage from some analysts. Such coverage should again improve visibility and liquidity.

(4) Potential acquisition target. The ultimate catalyst for SNRR would be for the company to be acquired by one of the “Big Three” of the timeshare industry – Cendant, Marriott, and Starwood. While it can’t be said for certain the SNRR will be acquired by one of the Big Three, it should be noted that the Big Three are looking to grow their timeshare businesses and SNRR is the last remaining decently sized acquisition target. Looking back over the last few years, roughly comparable acquisitions in the industry have been consummated at +/- 10x EBITDA. Applying such a multiple to SNRR’s projected 2004 EBITDA of $60 million yields a +/- $20 stock price. While the possibility of being acquired is real, one should also not overweight the probability of a deal happening nor base an investment in SNRR solely on this pillar.

As with all investments, SNRR comes with its warts too. For SNRR these negatives/risk factors include – (1) ever present concerns regarding companies that finance a large portion of their sales (e.g., underwriting standards, quality of receivables pool, “realness” of the sales); (2) need for liquidity to support growth; (3) lack of association with a marketing/brand name gorilla (e.g., Marriott); (4) residual issues from the company’s roll-up history; (5) impact of the national Do-Not-Call legislation; and (6) potential dilution from outstanding warrants (3.2 million at $15.25 and 0.6 million at $20). While these negatives/risk factors cannot be eliminated, management, the cleansing of the bankruptcy process, and/or other due diligence has satisfactorily addressed our key concerns.

Catalyst

See above.
Listing on Nasdaq National Market
Securitization of receivables
Analyst coverage
Potential acquisition target