Lodging play trading at a substantial discount to asset value. High margin of safety + solid dividend means we are paid to wait for value to be realized $CPLG

Margin of safety is the theme today. Made famous by Seth Klarman, the famous value investor harps on this notion given that predicting the future is an imprecise science.

The stock is CorePoint Lodging (ticker CPLG) and represents the owned assets of La Quinta that were spun out on their own in early 2018. When I think of La Quinta hotel, I first ask myself “when was the last time I stayed in a La Quinta??” and I think the answer is once, maybe never. But just because I also don’t shop at a discount grocer like Dollar General, doesn’t mean that the market isn’t huge for low-to-mid economy businesses.

In mid-2017, La Quinta decided to spin its owned real estate into a new company and the remain-co would be an asset-lite franchise and management company, which tends to garner high multiples. Then, in 2018, Wyndham announced it would acquire the La Quinta business (i.e. the high margin franchise business) for $1BN. Therefore, the La Quinta brand and management of the hotels would be folded into Wyndham’s portfolio and plans for CorePoint remained for it to be spun out to shareholders before the Wyndham acquisition was consummated.

CorePoint currently consists of 315 hotels in 41 states, with high concentrations in Texas, Florida, and California with most of the hotels being in the midscale range.

geography

Importantly, and discussed a bit more below, the company is ended a capex program to renovate its hotels. This should help the dated-looking portfolio compete with other chains. As shown below, this appears to be a positive step:

Hotel refurb.PNG

There are also a few benefits of being folded into Wyndham. For example, La Quinta hotels will now be included in the Wyndham network and endorsed by Wyndham, which includes their rewards program.  Additionally, there are cost efficiency opportunities to be had from Wyndham’s scale and procurement strategies.

All this sounds good. So what has happened with the stock?

CorePoint’s stock is down 50-55% from the initial spin at the time of writing. What happened?

  • Spin off dynamics
    • As is typical in spin-offs, you can have a dynamic where shareholders are left holding a stub business that doesn’t meet the characteristics of what they wanted to buy in the first place (whether it be size, industry, or other business attributes)
    • This was a taxable spin as well, meaning not only would taxes be owed at the corporate level, shareholders would also owe taxes. This also creates selling pressure
  • Poor communication / expectations setting
    • Following the spin, it seems as though there was poor communication by management on what “real” earnings for CorePoint would be. This was no easy task, as the businesses had historically operated together with the franchise business. Estimating stand-alone cost structure is tough, but I’m of the mindset that you always underpromise and over delever (or just promise and deliver…)
    • The Form 10 (essentially the S-1 for a spin-off) highlighted that PF adj. EBITDA was ~$207MM. When the company had its first investor call post-spin for Q2’18, they guided to $182MM of EBITDA, a significant drop. Part of this was due to Hurricane comp, but even worse, they had to guide down 2018 again to $177MM following a weaker than expected Q3’18
      • Part of the decline to 2017 was due to ~$20MM of Hurricane disruption, which management called out and was expected
      • But a second component that I think the street missed / management did not communicate well is higher royalty & management fees as well as stand alone costs than I think many on the street were expecting

EBITDA Bridge.PNG

  • Concentration:
    • The brand is clearly concentrated here on La Quinta hotels, which can give investors a but of heart burn
    • The assets are also mostly in Texas, Florida, and California. Florida and Texas were each heavily impacted by Hurricanes, Florida is known for its cyclicality (tourism driven state) and Texas is impacted by the oil markets.
    • That being said, taking a step back, it does make sense that there assets are in these regions, as they are some of the fastest growing states and have high populations, so I think this risk is often overblown
    • The company also includes this slide below, detailing RevPAR is more stable than other markets

REVPAR.PNG

 

Investment Thesis

But here lies the investment opportunity. The stock, down some 50-55% since its spin has been left for dead. There’s also only one sell-side analyst covering it (who is negative) and the calls are brisk given the lack of following.

I really like situations like this, as it presents an opportunity to buy something that people are missing (I should note, its hard to find CorePoint on a stock screen unless you are looking for it specifically) or have actively thrown out (from the spin)

My thesis comes down to the following points:

  • Comps should improve due to:
    • (i) hurricane assets back online
    • (ii) reinvested assets garnering higher revPAR
      • The company re-positioned ~50 hotels so that it could upgrade the facilities. The capex ran at about $200MM of refurbishment, fortunately mostly funded by the legacy business.
      • The company has noted that the RevPAR for these hotels is growing faster than the balance of the portfolio, though 2019 will have some higher expenses as they ramp. For longer-term investors even looking out to 2020, these renovated hotels should be online and the company will benefit from their full contribution
    • (iii) no longer lapping Q’s with increased stand-alone expense (note the bridge below assumes no cost benefit from Wyndham’s purchase)
      • I think it is underappreciated that La Quinta had 15MM loyalty members, but Wyndham had 55MM in 2017. Those Wyndham loyalty members will now be able to book La Quinta’s in 2019.

2019 EBITDA Bridge.PNG

  • Downside protected by solid asset coverage
    • The company issued CMBS debt to fund the business post-spin. As part of that, CMBS lenders wanted to know what the asset-value was backing their collateral.
    • This is shown in the SEC filing here. I think the interesting quote is that the properties are valued at ~$2.4BN. Subtracting out net debt of $960MM gets you to $1.4BN of equity value. This compares to current equity value ascribed by the stock market of ~$775MM
    • This is also supported by book value reported on the balance sheet, which is $24.7 per share compared to ~$13.0 stock price.

CMBS Valuation.PNG

  • Upside from take-out or further acquisitions
    • CorePoint currently trades at 8.75x 2019e EBITDA of $200MM, a discount to where comps trade (ranges from 9.0x-11.0x for Extended Stay, Summit Hotel Properties, Apple Hospitality, Chatham Lodgin, and RLJ Lodging)
    • The discount is actually wider when you factor in $200MM of EBITDA includes no upside from Wyndham’s scale and operating efficiencies
    • Given that CorePoint is also the only mid-economy REIT on the market, an acquirer could look to take-out the portfolio at a significant discount to appraised value, and fold it into its operations for diversity
    • Alternatively, the company notes in its filings that it has a clean balance sheet and that it will “be well-positioned to be a consolidator given our scale….We expect to develop a disciplined acquisition strategy which will allow us to expand our presence in target markets and further diversify over time, including through the acquisition of hotels that are affiliated with other respected hotel brands and operators.” An acquisition of another portfolio may mean diversification as well from just La Quinta

This thesis isn’t without risk and, given the learning pains so far coming out of the spin, there may be additional costs the company finds or faces as a stand alone entity. However, the dividend yield is now ~6%, so I’d argue we are getting paid to wait here.

There is another item that I didn’t touch on and that is a potential tax payment. You see, La Quinta and Wyndham set aside $240MM to pay for corporate taxes of the Core Point spin. If taxes were less than that, CorePoint keeps the balance. It is estimated that taxes will be less than $240MM and originally the company thought they’d be getting $56MM, but this is uncertain. I ascribe no value to this given the uncertainty, but it could be a nice surprise.

I think the stock is worth at least $24, assuming only 1x book, with upside as comps get easier. This represents ~87.5% of upside from today’s levels plus a 6% dividend. 

 

 

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