Description

Wyndham Hotels (WH) is a $5.6 Bn market cap company that is a result of a Spin-Merge that occurred nearly 2 years ago.  Wyndham Hotels spun out of the time share company, Wyndham Destinations, and just before the spin they acquired LaQuinta Inn and Suites, which is a leading mid-scale franchised hotel company.  WH is now the largest hotel franchisor in the world by number of hotels with over 9K hotels in 80 countries and enjoys a 40% share of branded Economy and Midscale segment in the US.  They have 3 of the top 4 ranked brands in each segment (Microtel, days inn, Hojo in the economy segment) and (Wingate, La quinta, AmericInn in the midscale segment).  

WH was originally written up near the time of the spin mainly on the thesis that it traded at an unjustified discount to its closest peer, CHH.   This discount has persisted and if anything has gotten even larger, with WH at 11.9x ’20 EBITDA (consensus) vs CHH at 17.2x, a spread of 5.3x. 

The most likely cause of the widening of this spread is execution.  Wyndham had an issue with the owner of roughly half of the La Quinta brand hotels, CorePoint Lodging (CPLG). Specifically, the Wyndham IT system wasn’t as flexible as the legacy La Quinta system and as a result when IT systems were switched in early 2019 after the merger, pricing wasn’t performed effectively leading to a hit to REVPAR at these properties. WH has settled these issues with a $20M payment to CPLG and the new pricing features are being rolled out, which should fix pricing issues in the coming quarters.

Given the similar franchise royalty growth rates (~4-5% for each company) and EBITDA growth rates (~4-5% for each company) we’d expect the multiples to converge.  And irrespective of CHHs valuation, we believe WH is a high quality, asset-light biz model with recurring revenue and FCF and a business model that’s structurally better positioned for weaker economic times. 

Midscale/Economy Segment Overview:

60% of the US hotel market is in the economy and midscale segment, which is $110 average daily rate per night and below and WH has 40% share here.  Their closest peer is Choice Hotels, which is also predominantly Midscale and Economy.  WH has been growing their presence in Midscale, most recently w/ LQ acquisition, and this mix shift towards higher rate rooms will be favorable to overall company RevPAR trends.  

We have a strong preference for the economy and midscale segment of the market for a number of reasons.  First, from a supply perspective, we see WH as insulated from what we believe are risks of oversupply facing the Upscale and Luxury end of the market.   Over the past 15 years, the supply of rooms has grown at a rapid clip in Upscale/Luxury Segment while Midscale + Economy segment growth has been more balanced.  Using STR data there are 70% more luxury hotel rooms than there were in 2004, 20% more midscale and roughly the same number of economy rooms.   Similarly when you look at hotel pipelines currently in construction, you have around 9% of existing rooms about to hit the market in the Upscale and Luxury segment, which should further pressure supply and overall occupancy, an effect which is not present in the midscale/economy segment. 

Another structurally defensive characteristic we like about WH is that the sharing economy disruptors are a significantly lower risk to the Economy and Midscale players such as WH.  Airbnb operates in a different market segment entirely with average daily rates significantly more expensive than the ADRs where WH plays. 

Overall Recession Resistance:

WH has shown strength during periods of economic weakness in its ability to grow rooms.  During the financial crisis they grew rooms at a healthy 2% clip. 

Furthermore, in periods of slower economic growth, midscale and economy players like WH enjoy a trade down effect.  Business travelers, representing around 30% of their guest stays, as well as leisure travelers, tend to trade down to Midscale and Economy options, which is why we see ADRs less pressured in recessionary times vs. what we would see at their Upscale peers (system-wide ADRs for WH are ~$70). Also when you look at WH’s business model versus upper scale Royalty driven franchise peers, its worth noting that WH has exited all but one of its management contracts as of the end of 2019/early 2020 so <1% of its EBITDA is exposed to the negative operating leverage associated with franchisee profitability linked royalties.   To the extent that franchise businesses should command higher multiples than operators because they’re less exposed to operating leverage, WH is more of a franchise business than MAR/HLT who have greater operating leverage. 

Structural Growth Drivers:

As a standalone public co, we believe WH has the ability to focus on low hanging fruit opportunities to accelerate growth.  WH has already done this to some extent by improving retention closer to industry averages.  They have increased their retention rate from 93% to 95% and in so doing returned to growth in the US, removing one of the biggest qualitative gaps to CHH.  WH also has further opportunity to focus on pipeline growth, which stands around 22% of total rooms open today. Importantly their pipeline is growing in higher ADR Midscale segment since the LQ acquisition.  LaQuinta itself is a nice growth driver.  LQ has ~91K rooms in its system today, compared with other midscale players Holiday Inn express and Hampton Inn which have more than double that.  Also, LaQuinta’s RevPar at acquisition was over 60% higher than WH’s average RevPar pre-merger.

Financials/Valuation

A quick look at WH’s legacy growth algorithm drives home their opportunity.  Prior to the spin, they were losing 7% of rooms, converting just under half of their pipeline, resulting in under 3% organic room growth and combining that w/ small M&A.  This effectively underlies our Base case assumption of 5% long term revenue growth.   With modest operating leverage this results in ~7% EBITDA growth and 12-14% FCF per share growth.  The company currently trades at a forward FCF yield of 7%. 

Due to the resiliency in their business model as well as substantial growth opportunities, we believe WH should command a similar, if not higher, multiple to peers.  

In a downside case, looking back historically, WH today Trades at a forward EBITDA multiple that most of these peers traded at in the financial crisis.   So while you would see declines in EBITDA in a recessionary environment, we don’t think you’d have the double effect of multiple contraction, leading to  a relatively muted downside.  In a 10% RevPar decline case, with flat room growth and 15% in other revenue (mostly credit card fee related), we think the stock holds in the mid 40s. 

Catalyst

7% FCF yield + 12-14% FCF growth should rerate, and if it doesn't, provide a solid return.