Description

It's finally time to short WBR. The common has $3.4b of debt and preferred in front of it against assets worth $2b. Management has prepped the company for sale and left the building. Cash flow covers interest and capex, but not the $180m preferred service so there's no hope of the company growing into its valuation. The issue is not whether to short WBR, it's when. The time is now: I believe WBR will be sold, probably via pre-pack Chapter 11, later this year with the common being more or less wiped out. But there's no downside even if I'm wrong.

HISTORY

In the beginning God created the heavens and the earth. Some time later a misguided management team blew up a REIT called Patriot American Hospitality by borrowing to buy every hotel in sight, plus a horse racetrack near San Francisco and God knows what else. Apollo's Thomas Lee led a recap in 1999, injecting a billion in cash and a sane management team. CEO Fred Kleisner and team have unwound the Patriot madness by selling assets and cutting costs. It was a good effort, if not for 9/11 they might have pulled it off.

VALUATION/CAP STRUCTURE (MMs)

1700 Debt
1700 Preferred (incl accruals)
200 Common
-------
3600 TEV

All numbers are estimated pro forma for recent asset sales which will close this quarter. EBITDA is 200m going forward, which covers the 120-130m of interest and 50-60m of maintenance capex, but can't touch the 180m preferred dividend. PIK compounding will grow the dividend run rate to 200m by yearend, so even if hotel EBITDA climbs a spectacular 10% per year there is no hope of catching up. The 33 hotels are carried at a bit less than $2b on the books. WBR has been a serial impairer and assets have generally sold below book, but I think the $2b is reasonable.

OK, BUT WHY NOW?

1. Downside is gone. Prior to 9/11 and even for a year or so after it was possible to visualize WBR EBITDA recovering enough to justify the common, but WBR's continued liquidation sale removed that threat. The current assets are stable at 200m EBITDA, there is no scenario where they produce the 450m needed to justify the common price.

2. WBR is prepped for sale. When Kleisner took over in 1999 WBR owned 212 hotels, with more Marriotts, Hiltons and such than Wyndhams. They sold 179, leaving WBR with a core holding of 33 owned hotels plus 100 or so franchisees and management agreements. It's almost 100% Wyndham now, making a nice, clean package for an acquirer. Last quarter President & COO Ted Teng, CFO Richard Smith and two EVPs resigned en masse. They were replaced internally or not at all, another sign the end is nigh.

3. Apollo needs out. With the cleanup complete and hotels valued richly due to low interest rates Apollo has no reason to wait. The common has been pushed so far out of the money the annual 180m PIK accrual no longer does Apollo any good. Go forward ROI is below 10%, far shy of their hurdle rate but OK for a strategic buyer who can re-fi at better rates.

OPTIONAL HEDGE

A tiny fraction of the preferred does trade (WYHMP.PK, last quote 28.00). It's completely illiquid, but a small investor could buy enough to hedge the short. It converts at 8.59 and pays 11.75% of par (9.75% if WBR ever paid the $6+ of accrued cash dividends). At 28% of par the preferred is reasonably priced, and probably has some upside in an acquisition.

RISKS

Loss of borrow. Rip-roaring economy combined with sky-high inflation.

Catalyst

Sale of company, probably via pre-pack Chapter 11.