Description

The Company

Wyndham International, WYN, is a hotel owner and operator in the upscale and luxury segments of the hospitality and resorts industry in the U.S. and Caribbean. Prior to a reorganization of the company in June 1999, the Company was operating as a paired-share REIT. After the reorganization, the Company became a C corporation and completed a $1 billion preferred offering to a group of private equity investors led by Apollo and Thomas Lee as well as a new credit facility. Since its reorganization, however, the stock price has continued to erode from its range in mid-1999 of $4.50 to $5.00 per share to its price of below $1.00 today. The stock first sank below $1.00 immediately after the events of September 11, 2001, caught in the general downdraft affecting most hotel, hospitality, and travel businesses after the attacks. Unlike, several of the other better known owner/operators, however, it has not recovered to anywhere near its pre-Sept 11th levels.

The company is not an excellent business in the Buffett sense, however, it is an ok business that is currently over-leveraged. The company has some attractive, even trophy, assets that should be salable. In addition, although the company has excessive leverage, the current structure of the debt and preferred makes it functionally unlikely that Wyndham will be forced into financial distress anytime in the foreseeable future. Consequently, this opportunity is an interesting special situation. An investment in the common at this time is an inexpensive, highly leveraged, and long-term option on an improvement in Wyndham’s operations as well as an improvement in the Hotel and Hospitality sector.

Valuation

At current prices, the Company’s equity value is approximately $180M (approx 167M shares at $1.07 per share as of April 12, 2002). The Company’s key issue is its rather heavy debt load (almost $3.5B) as of December 31, 2001. Wyndham’s Dec 2001 balance sheet shows book equity of 1.58 Billion, which seems to suggest that the equity is trading at a substantial (i.e 90%) discount to book value. However, delving deeper indicates that the company is including $1.2B (face value) of its 9.75% Series A and B Preferred in the calculation of shareholders equity. Subtracting the $1.2B of Preferred Stock (at face value) that is owned mostly by the aforementioned private equity investors, it looks like there is less than $300M of book value left for the common shareholders and therefore, perhaps, not enough of a margin of safety given the high debt to equity ratio.

In this case, however, it pays to continue digging a bit deeper. Under the terms of the preferred as it was originally issued in 1999, each $100 face value of preferred converts into common shares at a conversion price of $8.59. The preferred stock cannot be redeemed by the company until June 2005 (its 6 year anniversary). After that date, the convert is redeemable solely at the Company’s discretion. Since the owners of the preferred have no ability to require the company to redeem the Preferred stock at any time, their only alternative is to convert into common if they want/need the liquidity.

Though the preferred hardly trades, it is safe to say that the market value of this security is well below face value. If the preferred is valued at market, of course, there is substantial upside in the common. Alternatively, think of the Preferred as being equivalent to approximately 140M shares of common stock today. Since the Company has stopped paying any cash dividends on the preferred, the preferred will now continue to PIK at a penalty rate of 11.75% (2% penalty). Therefore, the preferred will become the equivalent of about 220 million shares in 2005 or almost 356 million shares by 2009 (at which point the company will have no alternative but to make dividend payments in cash).

Assuming that the company’s 167M outstanding common shares becomes 200M common shares on or before 2005 due to dilution from employee option and stock grants, this means that Wyndham would have the equivalent of around 420M shares of common by 2005. This is a conservative figure and the actual number could be somewhat lower if, for example, the Company experiences a strong recovery before that time and resumes some of the cash dividends on the preferred stock.

Wyndham’s portfolio includes many four and five star hotels and resorts throughout the United States and also in the Caribbean. Though Wyndham as a chain is quite small relative to the big guys, their hotels are comparable to the Marriot or Westins (owned by Starwood) from a location and quality perspective. Both the current CEO and COO joined in late 1999 or early 2000 and were formerly at Starwood Hotels and Resorts with 25 years each of hotel industry experience. The Company has been focused on streamlining its operations and reducing debt through asset sales (without giving away the store). Assuming that the value of the hotels is equivalent to their book values (cost net of depreciation plus cap ex), the company owns a portfolio of hotels and resorts worth around $4.5B today. The portfolio includes a number of trophy properties including The Boulders in Arizona, the Golden Door in California, and several five star resorts/casinos in Puerto Rico. The above value does not put a number on the Wyndham brand name (which is certainly recognized and should have some value), the company’s reservation system, know-how etc, or the Company’s business providing franchise and management services to others.

Netting out debt of $3.5B leaves a value of $1.00B which can be attributed to 420M diluted shares on or before 2005, suggesting a value of $2.38 per share excluding any growth in the value of the portfolio (even to keep up with inflation). If you include brand, going concern value, etc. it might be north of $3.00 per share. Last year, the company had classified approximately $1.5B of properties as available for sale (consisting of 56 hotels which the company owns but which are not Wyndham branded). The Company had interest from numerous parties such that much of the portfolio was under LOI. After September 11, however, Wyndham decided to withdraw its sales rather than sell at revised/depressed values. While this year still represents a recovery period, there should be some asset sales prior to the end of the year, and certainly well before 2005. The corresponding de-leveraging that may occur, as a result, would simultaneously decrease interest expenses, strengthen the balance sheet and be viewed positively.

Another, more radical possibility would entail selling a larger percentage of its owned portfolio to pay down all but around $500M of the company’s debt which would make Wyndham a profitable management company and franchisor. This is a possibility that would quickly unlock the value inherent in the franchise. One complication with this possibility is that the Preferred does have a change in control provision that could be triggered by substantial liquidation or sale of assets. However, if this were on the table, it is likely that Management would seek the consent of the Series B Preferred holders (who have 8 out of 19 seats on the board) and come up with a solution that results in some equitable distribution between preferred and common holders (given that employees just exchanged their options for restricted shares as discussed below, it is clear that management will be focused on preserving and growing the value for common shareholders).

Another potential source of value, which is hard to quantify at this point is that Wyndham has filed a claim for recovery under its business interruption insurance policies due to the events of September 11th. While the company believes a recovery may be 2 to 3 years away, this claim also has some positive expected value that might be used to pay down debt. On the negative side, the Company is still defending itself from some old litigation related to its activities in rolling up assets prior to 1999. Though several of these suits have been dismissed once, they are still being appealed as well. Perhaps these factors could be considered offsetting.

Risks

A key risk to examine would be the possibility that Wyndham defaults on its loans or other obligations which would force a bankruptcy filing or other liquidation prior to an improvement in the fundamentals or a sale of assets (a scenario that would be terrible for the common shareholders given the priority that the preferred shareholders enjoy). However, this scenario does not seem very likely. First, the company just completed an amendment to its credit facility which removed all its covenants except the interest coverage (which dropped to 1.05 to 1.00 until the end of 2003). The Company also agreed to limit cap ex to a maintenance level of $125M per year (with an additional $25M emergency cushion) which it believes is more than adequate since it has just completed a 3 year program of extensive investments and upgrades of its properties. In 2001 which was far from a good year, the company generated $446M of EBITDA and is expecting to generate around $460M of EBITDA in 2002. This level of EBITDA is sufficient to meet its cash interest and cap ex needs allowing the company to maintain or even slightly reduce its debt levels from here.

Another risk would be that of a sale or other transaction which would provide for some recovery to the preferred holders, but not to the common. Again however, this does not seem likely. The Company recently launched a voluntary exchange offer allowing employees to exchange out of money options for restricted shares. These restricted shares will vest 1/3 each in the third, fourth, and fifth years after the grant. It is clear that management and employees have a strong incentive to work towards scenarios that result in the common stock rising to north of $2 from these levels.

Obviously if we experience another terrorist attack or major disruption that would cause the recovery to grind to a halt and people to stay home, this could have a significant negative impact on the company. However, even in this scenario, it is likely that lenders would continue to work with the company to avert a bankruptcy or liquidation because their recovery would be greater by doing so. Given the adjustment in attitudes after September 11th, it is also likely that it would take a significantly larger event to have the same impact on business. Smaller attacks, while they would be temporarily debilitating and garner media attention, would be less likely to have the same crippling effect as September the 11th when America and the world were psychologically unprepared.

Finally, the Company may, in the future suffer if interest rates rise significantly. Much of the bank debt is tied to Libor, which is at levels below 3%. A significant increase would result in higher interest payments. Once again, Wyndham has alternatives. For example, in such a scenario, it might make sense to accelerate asset sales and pay down debt, even if it would mean leaving some money on the table as regards to the sale price.

Other Holders

It turns out that The Baupost Group is the single largest holder of Wyndham (with over a 10% stake) as of January 2002 (it helps to be in good company). I believe that both Baupost and Southeastern (Longleaf) started buying early last year at prices in the $2.00+ range. However, Longleaf has completely sold its position (perhaps related to the liquidation of the real estate fund) while Baupost appears to have continued adding to its position after the events of Sept. 11th.

UPDATE

Please Note, This was written on April 15, 2002 when the price was a bit lower than it is today. However, most of the upside still remains. Company announced that it is planning to proceed with a $750M offering of notes (high yield notes). If successful, company will use proceeds to pay down bank debt. This move should alleviate some of repayment pressure and increase duration of the capital structure. Also, company;s ability to access the capital markets would also be a positive sign.

Catalyst

Catalysts

The Company could benefit from several catalysts over the next 18 months to 2 years. First, it is likely that at least some of the additional asset sales that it contemplates would have occurred by that time. Secondly, the industry is obviously cyclical and has gone through one of its worst periods in some time. Assuming we are into an economic recovery by then, Wyndham’s assets values and business should both benefit from an economic upturn. The Company has generated over $600M of EBITDA with substantially the same assets and might do so again in 2003 or 2004 if the environment improves. The supply demand equation should also remain favorable on the supply side as few new properties are planned industry wide and marginal properties are being shut down in light of the economic environment.. Third, any debt reductions would be viewed positively and attract additional interest from investors. Finally, there is some chance that the entire company gets purchased in an improving environment by one of the larger and stronger operators. In any case, at current values, the common stock represents an option on approximately 100% or 200% appreciation from current levels without significant risk of permanent loss of capital.