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MAR/VAC: VALUE CREATING TRANSACTION

We think some investors may be waiting for the spin-off to own MAR. 

 

 

Marriott Vacation Worldwide (Ticker: “VAC”) will start trading on an as issued basis tomorrow.  As we wrote about in “It’s Not the Economy, Stupid” (08/25)”, the spin-off of Marriott’s timeshare business will be a long-term value creating transaction positive.  

 

Most lodging investors do not love the timeshare business - capital intensive and cash flow negative during periods of revenue and GAAP earnings growth - but as long as the business is small enough, they generally ignore it when thinking about value and multiples.  As a separate entity, VAC should grow the business with their shareholders aligned with growing the company, while MAR benefits by getting a high multiple fee revenue stream that grows with the growth of VAC’s business – which should be at a faster rate than if VAC was still under the MAR umbrella.

 

We think that VAC is worth about $2.10 to MAR or approximately $1BN.  Stripping out the timeshare business, MAR is trading at just 10x 2012, close to trough valuation on a business where 90% of the gross margin is fee driven.  MAR should trade well above prior trough valuation levels since the business is of much higher quality.  Incentive fees are now a smaller part of the pie and the only timeshare exposure is fee driven, and we’re at a different point in the cycle.

 

We think that VAC will do about $135-140MM of EBITDA in 2012 and that 7.0-7.5x EBITDA (or 17-18x P/E) is an appropriate multiple given the quality of their business.  

 MAR/VAC: VALUE CREATING TRANSACTION - timeshare3

While management wants us to do a sum of the parts where we assign a high multiple to the fee part of their busines, we just don’t see the point since the fees that VAC collects basically equate to the royalty they pay out to MAR – so in our view it’s a wash.  What you are left with is a real estate developer, finance company and rental business - which typically trade at mid to high single digit EBITDA multiples.  There aren't many comps for this business but we would note that the Sunterra multiple included a takeout premium which occurred at the height of the market in 2007 and Bluegreen is a micro-cap stock which recently received an offer to be taken private from Diamond Resorts. 

 

For a vacation ownership business, there are a lot of things we like about VAC’s business:

  • Ability to grow without becoming too asset intensive
  • Seemingly competent management team and Board
  • Reasonable expectations from the outset
  • Opportunity for improvement by selling off excess land in their Luxury segment and de-emphasizing less profitable parts of their business

We are uncertain as to the near term trading, however.  On the negative side, there is a likelihood of technical selling pressure from uninterested funds inheriting this stub and the historical low multiples assigned to timeshare.  However, as we said from the outset, there appears to be a number of sideline sitters awaiting the spin-off to own the hotel company.


GMCR: TRADE UPDATE

Green Mountain Coffee is flashing bearish in Keith’s quantitative model and, as the chart below shows, is indicated to have no trade support to $59.11.  From a fundamental perspective, also, we see significant risks for the company going forward.

 

As we wrote in our Starbucks note on Friday, we have acute concerns about the ability of Green Mountain to generate cash.  In the Hedgeye Restaurants Sustainability model, the stock screens “UNSUSTAINABLE”.  The biggest red flags in the Hedgeye Sustainability model are Asset Turns and CFFO or, more importantly, the proportion of earnings yielding cash.

 

Some very pressing questions need to be answered to a satisfactory degree to change my position.  Is the company generating enough cash from its operating activities to continue without accessing new external sources of cash?  What if the capital markets dry up for GMCR?

 

We define CFFO as cash from operating activities less capital expenditures, less the benefits from the exercise of Employee Stock Options and adjustment for one-time gains/losses or restructuring items. 

 

Most of the companies we follow generate free-cash flow after significant investment in the growth of the core business, while other smaller, faster growing companies do not generate free-cash flow.  This is not necessarily a negative if the cash burn rate is within the limits of available resources.  To-date, the capital markets have been very generous to GMCR, but what happens when the music stops?   

 

Importantly, we are looking at the proportion of earnings yielding cash.  If GMCR reports strong revenue growth, good margins, healthy profits but those profits are accompanied by negative cash earnings yield, SBUX must be suspicious, or at least I hope they are.

 

GMCR: TRADE UPDATE - GMCR sustainability

 

GMCR: TRADE UPDATE - GMCR levels

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 



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NOV STARTING OUT SLOW IN MACAU

Early November GGR forecast of HK$20-22 billion

 

 

Average daily table revenues for the first 6 days of November slowed to HK$639 million from HK$678 million in the last week of October.  One week of data doesn’t make a trend and we don’t know the impact of hold.  We would caution, again, that November is likely to display a sharp slowdown from October (see “An Eye on November” published on 11/02/11).  October contained Golden Week, 31 days, and a high VIP hold percentage.  Our projection for full month November Gross Gaming Revenues is HK$20-22 billion, up 19-31% YoY.  At the midpoint of that range, HK$21 billion, November would represent a 19% MoM decline.

 

Market shares are pretty irrelevant at this point but SJM and Galaxy had the strongest week.

 

NOV STARTING OUT SLOW IN MACAU  - nov


COSI - DESTRUCTION IN DEERFIELD

There is an old saying that it is hard to kill a restaurant company and Cosi is living proof of that! 

 

I have been analyzing the restaurant industry for twenty years now and I have witnessed only a few other companies that have destroyed more shareholder value than Cosi.  Investing in a small capitalization company, particularly a restaurant company, you are really investing in management and management’s ability to grow and create shareholder value.

 

With the current Board and interim CEO being pressured by the Blum Growth Fund to make significant changes to the management and operating structure it was interesting to dive into the company latest addition to the company’s Board.

 

On October 24th, Stephen F. Edwards was appointed to the company's Board of Directors.  Naturally you would think that the Board would be interested in adding some one to the Board that has a keen insight into operating a restaurant company.  That being said, why not wait till you find the new CEO and let him or her appoint people to the Board that will be helpful to the new turnaround effort?

 

I believe that there could be another motive behind the appointment, like trying to find a buyer for the company.

After doing a little digging it appears that the “good old boy network” is alive and well on the Cosi Board.  It appears that two of Cosi’s Board members brought in a friend to help sell the company.  

 

I come to that conclusion by looking at the proxy for Champps.  Two current Board members of Cosi (Michael O’Donnel and Karl Okamoto) were involved with Chammps at the time it was taken private and the new Board member Stephen F. Edwards was involved with  F&H Acquisition Company, which bought Champps.  At the time that Chammps was sold, the CEO was Michael P. O’Donnell and Karl Okamoto was a member of the Board.

 

I would suggest that while Stephen F. Edwards may have knowledge of the restaurant industry, he does not bring to the board the operational knowledge the company so desperately needs.  He may be a great investment banker, but I do not think that selling the company is in the best interests of shareholders given that much shareholder value has been destroyed of late and, given the potential of the brand, it could be regained with interest under the right leadership. 

 

If my reasoning is correct here, and the current leadership is angling the company toward a sale, I would not accept less than $2 per share for my stake. 

 

I do not know Mark Demilio and have never engaged in a conversation with him, if I did here are some of the questions I would ask him about this move and other outstanding issues. 

  1. Why did the company feel the need to appoint a new member to the Board? 
  2. Why did you wait until October 28th to make the announcement when Stephen Edwards was appointed on October 24th?
  3. What are Mr. Edwards’s qualifications that will help the company move on from the desperate financial condition?
  4. Any progress on finding a new CEO?
  5. What qualifications are you hoping to find in the new CEO?
  6. Have you engaged Mr. Blum on his plan for the company?
  7. What is your plan for the company?
  8. Why are the company's sales trends underperforming the category?
  9. Have you seen the results from the Blum Growth fund survey?
  10. Do you believe that you have shareholder support as Chairman of the Board?
  11. Do you think you can survive a proxy fight?
  12. What are thoughts about the next capital raise for the company?

 

I get a lot of questions why I spend time on Cosi.  The easy answer a year ago was that I saw an opportunity for investors to make money.  That is still the case today, but now it might be more appropriate to make sure people don’t lose money on a company that could be headed for bankruptcy. 

 

In the past I have had numerous dialogs with the previous CEO Jim Hyatt and know of several board members of the company.   I have a lot of respect for them and their knowledge of the industry and I also have faith in their integrity.  

 

Nevertheless, the current situation at Cosi is deeply disconcerting.

 

Why is there no sense of urgency in getting the right CEO in place?  While it’s not politically correct for the interim CEO and Board to acknowledge publically that Cosi is in desperate financial shape, the reality is clear for all to see and time is running out.  The current situation seems to be completely dysfunctional and it appears that management might have other intentions besides pursuing a focused turnaround plan.

 

According to the Blum Growth Fund survey (available here) management needs to go.  As you can see, there are only 2 respondents that do not want to see a new CEO and Board of Directors him and his plan enacted.  70 of those that replied to the survey do want a new CEO and Board of Directors.  If the survey is an accurate representation of shareholder sentiment, it would seem that Mr. Demilio would have his work cut out for him in a proxy fight.  Unfortunately, it would appear that the company cannot wait until June to see what the results of a proxy fight would be. 

 

By then, the company will have burned through its cash and will be headed for Chapter 11.

 

 

Howard Penney

Managing Director

  


THE HBM: SBUX, CBRL, GMCR

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

The chart below shows gasoline prices trending lower as we go through 4Q.

 

THE HBM: SBUX, CBRL, GMCR - gas prices

 

 

SUBSECTOR PERFORMANCE

 

THE HBM: SBUX, CBRL, GMCR - subsector fbr

 

 

QUICK SERVICE

 

SBUX: The price target for Starbucks was raised to $52 from $45 at RW Baird.

 

 

CASUAL DINING

 

CBRL: Cracker Barrel reported preliminary 1QFY12 results this morning, guiding to EPS of between $0.99 and $1.04 for the quarter versus consensus of $0.90.  Comparable restaurant sales were -1.6% for the quarter with average check up 2.2% and traffic down -3.8%.  Trends improved over the course of the quarter. 

 

GMCR: Green Mountain shares should be sold into strength, according to Stifel Nicolaus, citing doubts about the company’s long-term market penetration rate.  The firm maintains a Sell rating.

 

THE HBM: SBUX, CBRL, GMCR - stocks 117

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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