Value Investors Club / Wyndham Worldwide (WYN)

Description

WYN is an attractively priced spin-off and very good business that trades at approximately 2/3 the sector valuation. With an excellent balance sheet, incented management, and a recently announced share buyback we believe the pieces are in place for a successful investment.

WYN is a leading player in the travel & hospitality industry. The company operates three business segments: Wyndham Hotel Group (“Lodging”), RCI Global Vacation Network (“RCI”), and Wyndham Vacation Ownership (“Timeshare Development”). The Lodging segment is the world’s largest franchisor of hotels, accounting for 26% of 2005 EBITDA. RCI is the world’s largest vacation exchange network, operates in a duopoly structure with Interval International, and accounted for 37% of 2005 EBITDA. Timeshare Development is the world’s largest vacation ownership business and accounted for 37% of 2005 EBITDA. The company was spun-out from Cendant Corp. in late July.

WYN has attractive growth characteristics of probably high-single digit organic top-line growth over the next five years. The businesses have medium to high ROIC with good cash-flow, well-known brands, and leading industry positions. Margins are high and stable, with consolidated operating margins ranging between 17-21% over the last five years. On an underlying basis, margins have been somewhat more stable than this as segments with different margins have grown at different rates.

The current valuation of approximately 7.5x 2007 EBITDA is a significant discount to industry comps of 10-16x. Although a reasonable absolute value, there are a number of ways to hedge-out some of the exposure to the travel and lodging industry by shorting other public company stocks. This spin-off also comes in a sector in which private equity has been very active. More specific to Cendant businesses, Blackstone recently purchased Travelport using debt financing of approximately 6.5x debt/EBITDA. We believe WYN’s business is suitable to even more leverage on a comparative basis. Interestingly, the company has an excellent balance sheet which is better than it appears. Were it not for transferring some “program debt” that was above the line to “corporate debt,” WYN’s enterprise valuation would be a half point lower.

This opportunity exists in part because:

· RCI is being mis-analyzed by some in the market. There is a thinking that goes: “Lodging is 26% of EBITDA, the rest is Timeshare. Lodging deserves 10-13x and Timeshare deserves 8x.” I believe this thinking is flawed because:

§ Lodging is 26% of EBITDA, but RCI is 37% and Timeshare Development is 37%. RCI is not the same business as Timeshare Development.

§ Lodging looks the most like Choice Hotels (“CHH”), which trades at 16x EBITDA. The 10-13x Hotel Management comps are inferior to WYN Lodging because they have very little franchise income and they include large timeshare development businesses themselves.

§ RCI is at least as good a business as Hotel Management, I would argue it’s better since it’s less cyclical and operates in a duopoly. It is vastly better than Timeshare Development

§ Conclusion: The case can be made that WYN deserves at least the same multiple as the large hotel management companies. While Timeshare Development is modestly above sector average EBITDA contribution, the other 63% of EBITDA is a higher quality earnings stream than hotel management.

· We believe the net debt being quoted on the sell-side is arguably too high. Wyndham transferred $575MM of “program debt” into “corporate debt.”

§ Program debt interest runs through the EBITDA line, while corporate debt runs through the interest expense line.

§ We believe it is likely that Wyndham will nicely cash-flow and build back up its program debt. (e.g. FCF may be higher than normal as WYN’s timeshare development business can increase program debt rather than using FFO to fuel growth)

§ Bottom-line is that Wyndham has some cash and/or earnings power in the securitization stub. It is levering receivables at 50% that some comps lever at 90%.

· The spin-off occurred in a tough market and disgust with Cendant is running high. Cendant has been widely owned by investors who owned it as a break-up story looking for the spin-off “event.” As WYN’s sister companies have had various disappointments (see zzz007’s timely short write-up of the Avis business) we believe WYN has suffered from indiscriminate selling now that the “event” has occurred.

A significant component of management options and restricted stock were set at prices in the low $30s when the spin-off went effective. Subsequent news flow has been positive with the company reaffirming 2006 guidance, providing more details on its hotel pipeline, and announcing a $400 million share repurchase program.

Business overview:

The Lodging segment is the world’s largest franchisor of hotels, with 10% of total hotel room inventory in the U.S. belonging to the network. The brands are principally economy & mid-scale (Days Inn, Ramada, Howard Johnson). This business has EBIT margins in excess of 30% and very high returns on capital. The franchise model basically takes revenue “off the top” and exhibits much less cyclicality than hotel management or ownership businesses.

Unit growth has been stagnate (actually negative) over the last few years, largely because the company was pruning underperforming properties. However, over the next five years the company plans to grow room count at a 7-8% CAGR. This will largely be driven by expansion of up-market brands and international growth and will probably include a mix of organic and bolt-on franchise acquisitions. Along with 2Q results the company released more details about the hotel pipeline, which should help calm concerns about the organic growth prospects. Choice Hotels (“CHH”) is a very close comp for this business segment and trades at a little over 17x 2006 EBITDA.

RCI operates the world’s largest timeshare exchange business (“Exchange”) as well as a vacation rentals business (“VRG”). This segment has EBIT margins in the mid-20s and high returns on capital. There are no public comparables for this business (Interval International is a division of IAC/Interactive), and we believe this has hurt the public company valuation to date.

The Exchange business is a wonderful business, which operates in a duopoly market structure. The business essentially works as so:

When a consumer goes to buy a timeshare, one of the most important selling points the salesperson has is a huge binder with 3,000 properties the consumer can “exchange” his week for. Being locked into Orlando once a week for the rest of one’s life is not nearly as interesting as a week in Orlando that can be exchanged for a week in Tuscany, or Hawaii, etc.
The consumer does not choose between RCI and Interval International, the network is already chosen and frequently the consumer gets the first year free with his timeshare.
Subsequently the consumer pays $80/yr to be enrolled and a $150 exchange fee if he decides to exchange his week. Both these figures are fairly immaterial compared to a $15k timeshare purchase or the overall cost of a trip.
This is a business with substantial network effects, annuity-like streams, discretionary pricing power, and reasonable organic unit growth linked to the growth of timeshare customers.

VRG is also an attractive business, albeit not as good as Exchange. This business typically functions as an intermediary helping match fragmented consumer demand with fragmented cottage owners. The business is lumpier than the recurring revenue Exchange business, and has suffered in the last couple of years from sluggish demand in Europe.

Timeshare Development is the world’s largest vacation ownership business, with 140+ resorts and more than 750k owners. This is a business with moderate ROIC, but very attractive growth characteristics – it is the fastest growing segment of the hospitality industry. Since 1990 industry revenues have had a 10% CAGR and no down years. What was historically a sleazy business has become more respectable as major hotel chains have become the large players in the industry. We frankly have our own skepticism about whether this industry will continue to be as immune to economic slowdowns as it grows off of a higher base, but channel checks thus far have not provided any evidence of a slowdown.

There are three earnings streams for this business.

Vacation Ownership Interest (“VOI”) sales. This is the earnings stream from the actual timeshare unit sale and is “eat what you kill”.
Approximately 2/3 of customers finance their VOI purchase. WYN sets up a receivable that pays 13% and offsets some of this against non-recourse debt that costs 5-6%. This earnings stream has approximately a four year duration.
Maintenance revenue (this is a pretty small component).

We expect continued solid growth in this business, and earnings/revenues should actually accelerate at WYN over the next few quarters as the company anniversaries an industry accounting change and benefits from the lag-effect of accelerating gross sales. Finally, over a longer time horizon we think it is interesting that WYN has successfully become the largest player in the industry and competed well with firms like Marriott without the benefit of a national hotel brand. The late 2005 acquisition of the Wyndham brand should enhance the company’s ability to compete and market in the timeshare business.

Earnings & Valuation:

We believe the company should have good earnings growth into 2007 and 2008. Getting a median sector multiple puts the equity at almost $45/shr today. We have taken a somewhat more conservative stance but feel the upside to the low $40s over the next 12 months is reasonable.

Income Statement:
	2001	2002	2003	2004	2005	2006	2007	2008
Revenue	1,556	2,241	2,652	3,014	3,471	3,854	4,247	4,659
EBITDA			602	719	751	776	868	976
D&A			107	119	131	148	156	162
EBIT	320	488	495	600	620	628	712	814
NI (adj)						380	420	499
FCF						400	440
EPS (FD)						1.86	2.06	2.45
FCF/shr						1.96	2.16
P/E						15.4	14.0	11.7
P/FCF						14.7	13.3
Revenue growth y/y		44.0%	18.3%	13.7%	15.2%	11.0%	10.2%	9.7%
EBITDA growth y/y					4.5%	3.4%	11.7%	12.5%
EPS growth y/y							10.4%	19.0%
EBIT margin	20.6%	21.8%	18.7%	19.9%	17.9%	16.3%	16.8%	17.5%

EV/Revenue				2.17	1.88	1.70	1.54	1.40
EV/EBIT			13.2	10.9	10.5	10.4	9.2	8.0
EV/EBITDA			10.9	9.1	8.7	8.4	7.5	6.7
Adj EBITDA						731	822	930
EV/EBITDA (adj)						7.9	7.0	6.2

Valuation:	EBITDA
	2004	2005	2006	2007	Mult. ('07)	Value	Per shr
Timeshare Dev	265	283	335	386	7.5	2,898	14.21
RCI	286	284	265	318	12.0	3,820	18.73
Lodging	189	197	213	233	13.0	3,026	14.84
Corporate	(21)	(13)	(37)	(70)	10.4	(728)	(3.57)
Enterprise	719	751	776	868	10.4	9,017	44.20
Less: Net debt						(674)	(3.30)
Equity value						8,343	40.90
Adj for excess cap	5.7%					326	1.60
Adj equity value						8,669	42.49

Comparables:

	MAR	CHH	HLT	HOT	IHG	Median	FS	WYN	Vs. Median
Price	38.67	42.68	28.05	59.69	9.47		63.79	28.77
FDS	444	67	417	228	434		37	204
Mkt cap	15,632	2,829	10,821	13,001	4,098		2,347	5,869
Net debt	1,197	203	8,779	2,514	315		(237)	674
Enterprise value	16,829	3,032	19,600	15,540	4,426		2,110	6,543
Net debt/EV	7%	7%	45%	16%	7%	7%	-11%	10%

EPS 2006	1.57	1.45	1.11	2.37	0.40		1.41	1.86
EPS 2007	1.87	1.66	1.35	2.69	0.50		1.78	2.06
EBITDA 2006	1,308	175	1,738	1,249	306		76	776
EBITDA 2007	1,491	191	1,974	1,384	343		94	868
Revenue TTM (MM)	11,911	514	5,908	5,958	906		240	3,634
EBIT TTM (MM)	752	157	958	880	215		(22)	622
%margin	6.3%	30.6%	16.2%	14.8%	23.7%	16.2%	-9.1%	17.1%	106%

P/E (2006)	24.6	29.5	25.4	25.2	23.8	25.2	45.2	15.4	61%
P/E (2007)	20.6	25.8	20.8	22.2	18.9	20.8	35.8	14.0	67%

EV/EBITDA (2006)	12.9	17.4	11.3	12.4	14.5	12.9	27.6	8.4	66%
EV/EBITDA (2007)	11.3	15.9	9.9	11.2	12.9	11.3	22.5	7.5	67%

EV/TTM Revenue	1.4	5.9	3.3	2.6	4.9	3.3	8.8	1.8	54%

Stock price change:	4.9%	-28.5%	6.7%	4.0%	3.3%	4.0%	11.0%	-11.5%
7/19/2006	36.86	59.70	26.30	57.38	9.16		57.46	32.50

Catalysts:

Analysts initiate coverage with positive views. It’s not unreasonable to see it being well received given the asset light model and the cheap valuation. Right now the company is covered by two analysts vs. double-digit figures for most comparably sized hotel stocks.
Now that management has its $80 million of stock compensation struck, they may start talking more positively about earnings and the balance sheet opportunities.
Investors get better understanding of the RCI business and decide it deserves a much higher multiple than time share development.
If the company trades at a discount to the industry for long, I think it is reasonably likely private equity would step up.
The balance sheet is inefficient. Cash could be unlocked from securitzation subs or at the corporate level to buyback stock.

Key Risks:

I do not view the hotel industry overall as cheap, and thus WYN is cheaper on a relative basis than an absolute basis. Multiple compression across the group or an economic slowdown could impact the stock. Note: I believe there are a number of appealing ways to hedge this risk out against other hotel stocks.
Timeshare Development could show more correlation with the housing market than has historically been the case (there has been little).
The company could do a large acquisition or series of acquisitions in the Timeshare Development space, which could cause multiple compression.

Catalyst

• Analysts initiate coverage with positive views. It’s not unreasonable to see it being well received given the asset light model and the cheap valuation. Right now the company is covered by two analysts vs. double-digit figures for most comparably sized hotel stocks.
• Now that management has its $80 million of stock compensation struck, they may start talking more positively about earnings and the balance sheet opportunities.
• Investors get better understanding of the RCI business and decide it deserves a much higher multiple than time share development.
• If the company trades at a discount to the industry for long, I think it is reasonably likely private equity would step up.
• The balance sheet is inefficient. Cash could be unlocked from securitzation subs or at the corporate level to buyback stock.

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			2006	2007
Price:	28.75	EPS
Shares Out. (in M):	0	P/E
Market Cap (in $M):	5,860	P/FCF
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT