CorePoint reported Q1’19 EBITDA of $43MM compared to $40MM estimates and $37MM last year.
Net/net this was an OK result. Obviously, EBITDA beat expectations. RevPar was up 3% according to the company, which is ahead of their 0-2% growth guidance. Unfortunately, though, excluding the hurricane-impacted hotels of last year RevPar would’ve been down ~1%. EBITDA improved due to these hotels coming back online, but that was to be expected.
April was also looking slightly weak due to oil related market which the company noted was softer than Q1’19 as well as an outage at their call center.
Fortunately, the outlook was also left largely unchanged. The company filed an 8-K that shows they are taking steps to lower G&A (reducing headcount which should save 7% of G&A or $1.5MM).
They also announced 3 more hotel sales. The hotels carried an average hotel RevPar that was 25% lower than the portfolio average and the average hotel EBITDA margin was 700bps below the portfolio average.
Therefore the implied valuation for these 15x at EBITDAre or 2.5x revenue multiple, per the company disclosure. This is a great result. Let’s take a look at what that means so far for the five hotels sold:
We know from this chart below that there is still a lot of wood left to chop.
Since the 76 non-core hotels were already excluding the 2 asset sales sold for $4.5MM, there are still 73 hotels left worth $132MM of sales and $11MM of EBITDA.
This is important because the sales proceeds / multiples thus far have come well in excess of where CPLG is trading. CPLG currently trades at 9.9x 2019 EBITDA… If it can continue to divest non-core assets at multiples above where it trades, this could be very incremental to the stock, as shown below:
More than likely, the company will probably sell these assets for 2.0x Sales as they move forward, meaning CPLG would be trading at 8.4x on a PF basis. If the stock were to trade at 10x, this would mean it is worth $18.7/share, or 35% upside.
That said, I think that would still be too cheap given multiple ways to look at it, whether it be cap rate, book value, EV/EBITDA, etc. CPLG is too cheap. Imagine if CPLG just traded at book value… the stock would be worth $21/share.
It seems to me that the reported book value as well as the JP Morgan valuation is looking more and more accurate.
The company has also started to buy back some stock. Per the earnings call, “Our priority has been on paying down debt and opportunistically repurchasing our shares accretively at a discount to NAV.”
I’ll try to help provide some insights into the businesses and “what you need to believe” to invest in these companies. The bull case for Uber and Lyft is that “transportation-as-a-service” or “TaaS” is a new market. While Uber and Lyft are fiercely competitive today, and unprofitable, the market is really 2 players (in the US) and that should ease over time (“think of the great duopoly’s of Visa and Mastercard” the bulls will tell you).
So let’s rehash the investment case:
“TaaS” is a large market and growing
Upside possible from the “end” of car ownership (and entry of autonomous cars)
These are “platform businesses” that can leverage their user base to expand into adjacent markets (UberFreight, UberEats, third-party delivery, scooters, bikes etc.)
Only two players today. Now that they are public, competitive behavior should cool as the CEOs will be beholden to new investors
I struggle with the last point for several reasons. Uber and Lyft are not actually the only two players – taxi’s do still exist. While you may not take one every time to the airport, they wait for you when you arrive in a new city as the marginal provider of transportation. When the Uber wait is too long or there is surge pricing, yellow cab is still there… My point is that pricing for Uber and Lyft can only go so high. And who knows if the companies that have succeeded in China and elsewhere are waiting in the wings to enter the US market (and drive down prices).
If Uber and Lyft can’t raise the the price of your ride, maybe they take more of the driver’s fare. That’s possible, but they also have to incentize the drivers to drive and beat the hell out of their car. As I calculated in my post on what driver’s might make, it is a decent wage, but if you squeeze that too much, they just won’t drive anymore.
DoI think Uber is the Facebook of transportation? No. Facebook increased the return on investment for all advertisers and increased the total pie. Uber drove down the price of taxi medallions because it added significant supply to the market (everyone can now be a driver) and drove down prices.
The other bull case is that Uber or Lyft win the race to autonomy. The reason why this would be so important to the stocks is that autonomy is viewed as a winner-take-all business (think google maps – do you really need another provider?).
There again, I struggle. Calling the winner in autonomy is anyone’s guess. Why would I bet on Uber or Lyft winning vs. Google? I can’t, I can only speculate. And to speculate, I would have to bet that others are not pricing it into the stock. Google spends over $1bn on Waymo a year. I have no insight into this market
Next, to the notion of Uber reducing car ownership. There have been anecdotes of people forgoing car ownership, but that doesn’t seem to be impacting car purchases yet. Car sales, measured by units, are at all-time highs. It’s slowing, but its because we are selling nearly 17MM cars per year and have been for ~5 years.
Prices too have marched up since the Great Recession. In December 2018, the average price paid for a car was $37.5k, up from $30K in 2013. If Uber and Lyft are having an impact, it is hard to decipher this from the data.
Indeed, while Uber is growing bookings significantly and reported revenue, their growth rates have slowed dramatically. As shown below, Q1’19 adj. rideshare revenue growth is only +9%.
That is materially different than the +21% for the reported bookings. This is revenue that is adjusted to reflect driver earnings as well as incentive comp. An example is provided below:
As you can see, the driver pay and incentives matter materially here. “Excess” incentives are defined as “payments, including incentives but excluding Driver Referrals, to a Driver that exceed the cumulative revenue that we recognize from a Driver with no future guarantee of additional revenue.”
Is this number improving for the Company? Hmmm…
Granted, this does include incentives for UberEats and Rideshare incentives are expected to improve for Q1’18 compared Q1’19, but hard to see that the conditions overall are less competitive.
As an aside, I recently had an Uber driver tell me he was going to buy the Uber IPO (he admitted he didn’t study it much, just knew they were growing). That actually could be an interesting employment hedge… if the drivers are hurting, Uber may be doing well – and vice versa!
There are two players so we should compare what they look like. For starters, Uber is much bigger than Lyft and is global. How has that scale played out on the financials? Still a bit too early to see benefits. It’s clear you can see Uber expanding into other markets, while Lyft is focused on the core.
Clearly, they both burn cash. This actually surprised me a bit. Before the financials were released, I would have viewed the companies as platforms and apps, or asset-light businesses, whereas all the asset-heavy stuff is left to the drivers. Similar to AirBNB, where the homeowner faces the cost of serving the guest and the platform just takes a fee.
Clearly, that is not the case. They spend a lot on data centers and other infrastructure (more on cash flow at the bottom of this post)
We should compare and contrast the two players as well (feel free to add anything in the comments):
Pros of Uber:
– ride sharing is 5x the size of Lyft.
More diverse business with options – UberEats, UberFreight, autonomous… with the added
scale. You could argue Lyft is also entering these, but Uber appears to have
Valuation seems less demanding – basing that only on Lyft’s valuation and other
Cons of Uber:
Clearly losing share to Lyft
Operates in highly competitive markets – as if ride sharing wasn’t competitive enough, Uber
got into UberEats (a zero barrier to entry business, but I get why they did it),
and freight brokerage
Pros of Lyft:
– nothing other than “transportation-as-a-service”. There is some support of companies
that focus on one goal tend to execute on that rather than be stretched in all
Increasing Share – overthe past 2 years,
Lyft’s share has grown from 22% to 39%, taking advantage of Uber’s PR mishaps
while also being competitive
More Upside in Core Market – Similar to the bullet above, if Lyft continues to
take share, it seems clear that it will be at the expense of Uber. Given Lyft is
1/5 the size of Uber, there is plenty of share to give
Cons of Lyft:
Smaller company / less scale
No “other bets”
– Similar to google’s “other bets” segment, Uber benefits from its core
delivery business, cross-synergies with UberEats, and other bets. Lyft has autonomous capability, but its anyone’s
guess on who wins the war here.
Perhaps Uber should trade at a significant premium to Lyft due to scale, global presence, and “Amazon” view of transportation. Jeff Bezos wanted the everything store, Uber will be the transportation store. Conquer all, forget profits in the near term, it is all about the next 10+ years…
At $45/share, that means Uber is valued at $82.4BN while Lyft is valued at $15.7BN at $55/share. That places them both at exactly 7.3x 2018 sales…
I will be passing on both. I just don’t see this as a great market and I think it will be forever competitive. It seems like a race to the bottom for both attempts to gain and retain riders and drivers. Yet, there is nothing binding one to either. Therefore, I don’t see much pricing power here, as noted above.
Interesting Insurance Dynamic Not Discussed Often
One last thing — as I was building the cash flow statement for these companies, I noticed working capital changes were an inflow of cash, largely due to changes in an insurance reserve.
At first, it seems that Uber and Lyft are negative working capital businesses (i.e. the more sales grow, they actually get cash in the door like an insurance company that they can reinvest). That could possibly be a great thing. Lo and behold, I learned Lyft and Uber actually have self-insurance.
In other words, when a driver
accepts a rider on Lyft, up until the ride is finished, Lyft is responsible for
insuring the trip. This is a huge cost.
In fact, cost of revenue is
really made up of two main items: Insurance costs and payment processing
charges. Payment processing is the merchant fees that credit cards charge. Insurance
costs include estimated losses and allocated lost adjustment expense on claims
that occurred in the quarter. It also includes changes to the insurance
reserves. These latter two items make up the bulk of COGS.
Lyft says in its S-1 that, “By
leveraging our data and technology, we are seeking to reduce cycle times,
improve settlement results, provide a better user experience, drive down our
cost of claims and have fewer accidents by drivers on our platform.”
Clearly, this would be great. But insurance is also one of the items that can be gamed in the future. By reserving less, Lyft and Uber and report higher earnings. This often happens in good times for banks, where they reserve less for bad loans to boots EPS until a recession hits and they realize they didn’t reserve enough.
Analysts typically are wrong in their expectations, but this could be something where they are especially wrong. If analysts think they can leverage COGS more than reality, the forward estimates people are baking in could be too high.
CorePoint had a nice run from my recent write-up in January, up 12.5%. Q4’18 earnings beat expectations too, reporting comparable RevPAR growth of 9.9% and adj. EBITDA was $30MM, 13% higher than street expectations.
However, the stock was taken to the woodshed on Friday (March 22) when the company’s outlook disappointed.
The company’s outlook called for $173MM to $184MM of EBITDA compared to $199MM by consensus (though only one analyst covers the stock, so hard to say there is much of a consensus). Like many others have announced, CPLG is cost inflation in its operating costs (e.g. payroll).
In addition, the company’s hurricane-impacted hotels would not be adding as much EBITDA as originally expected. The company previously said it lost $20MM of EBITDA from the hurricanes on these assets. Instead of getting the full EBITDA back, mgmt expects just $10MM of EBITDA. It also expects $7MM from re-positioned hotel portfolio, but expects pressure in its oil-related market (company’s largest state exposure is Texas).
This is clearly disappointing, but not sure its worth the 26% drop on Friday. Like anything, it is likely a mix of factors. Part of this could be spin dynamics. In other words, people decided to blow out of CPLG now because they didn’t want to hold the stub piece long-term anyway. Another piece is likely due to the recession fears that were re-ignited on Friday that led to the S&P being down 1.9% in one day (the worst day so far for 2019). Hotels do not do particularly well in downturns.
Silver Lining -> Strategic Opportunities
There were several silver linings that management highlighted on the call, overshadowed by the market’s focus on the 2019 EBITDA outlook.
First, there are several strategic priorities for 2019:
Improve Operating Performance
Clearly, the company is facing cost headwinds. Therefore, its strategic priority is to identify underperforming hotels that have revenue and cost synergies available
Benefit from Wyndham Relationship
CPLG transfers onto Wyndham’s platform in April 2019 and full integration will be complete in 1H’19.
There are clearly cross-selling opportunities and increased distribution for their hotels.
I continue to 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.
Divest Non-core Hotels
CPLG sold 2 hotels in Q4 for $4MM. Mgmt noted these hotels were operating at significantly depressed margins.
More importantly, the company has identified 76 other non-core hotels that are operating at a hotel adj. EBITDA margin of 8%, well-below the 26% average of the core portfolio. In addition, RevPAR is 40% below the core average.
I have written about the first two points in my previous post, but I want to focus on the last point because divesting these hotels could be extremely accretive to the equity. Recall, the SEC document here cites $2.4BN of hotel value compared to $1.6BN of EV. To me, if the company can sell these hotels at higher prices than what the market has ascribed to them (currently a 33% discount to the 2018 appraisal), that will be a solid catalyst for the equity.
When reviewing the portfolio as a whole, and what constitutes “non-core” it becomes more clear why it makes sense to divest these assets. The company will lose $138MM of sales, but very little EBITDA in the grand scheme.
What I think is the most compelling case for upside on the equity is what the 2 under-performing hotels were sold for. Very low EBITDA margin, these hotels were sold for $4.5MM. As Sam Zell has said, investing in real estate many times comes down to replacement value. Perhaps what this sale represented.
Anyway, I don’t think it would be appropriate to think that these 2 sales are data points we can anchor on, but let’s run through some scenarios. First, let’s sale they get the same price/sales multiple.
Translating that into what happens to the valuation of the company:
This math roughly lines up with what is presented in the chart above provided by the company. And what this means is that if you think the company can get $230MM for these assets, the core portfolio is trading for ~8.0x and a 12% cap rate!
Indeed, no matter how you cut it, the PF valuation is very attractive.
So let’s say you think the portfolio should be 8.0% cap rate (a discount to the valuation given in the CMBS report). This points to a $21.6 price target. And this doesn’t bake in any growth for the next 2 years, it simply excludes the non-core portfolio.
As I covered in my case study post, when companies face transition periods, investors often shoot first and ask questions later. This often results in leaving significant money on the table.
Investors talk themselves out of investing in great businesses for a variety of reasons, but I usually boil short-term blips down to this internal statement: “This [current trend] may get worse in the near term, perhaps also longer term, so I’m not comfortable investing yet”
Investing will always have uncertainty and that’s the risk. But that is also precisely why the returns are higher for those investors that can see through the fog of negative headlines or short-term roadblocks and make superior results.
I think Facebook today is in such a situation. The company is facing negative headlines on a variety of fronts, but mainly related to how we will deal with privacy in this new age.
My investment thesis looks through the fog and comes down to the following points:
Facebook is a dominant platform with 2.5 billion unique users
Advertising via social media platforms is still in its infancy
The ROI advertisers receive from using social media platforms is much higher than traditional methods, which will grow the pie
Expect high growth from FB as it monetizes Facebook and ramps Instagram, video, Whatsapp and FB messenger
Before I get to the positives, my guess is that you are likely reading this and saying, “yeah, yeah blah blah, I’ve heard that story before. But what is Facebook going to do in a more privacy concerned market?”
One big concern, is the new legislation in the EU called GDPR (General Data Protection Regulation) which went into effect in May of 2018. The purpose of the legislation was to give consumers more control over their personal information. You probably have noticed the pop-ups asking if you are OK with websites collecting cookies and this is why that exists. GDPR applies to all companies processing and holding personal data of consumers residing in the EU, irrespective of the company’s location.
This has created uncertainty for digital advertisers as it creates additional friction in the process (i.e. users must opt-in, which may mean less data is available). However, I think Facebook is practically embedded with users’ daily lives which is a strong benefit. In other words, users are already proactively sharing personal data on a daily basis. I assert that Facebook’s platform then is one of the best positioned to deal with this new regulation. I think Facebook and Google could likely update their terms of service which would permit Facebook to continue their existing path. In any case, if users do not accept, the downside is that Facebook will show non-personalized ads. Worth less to advertisers, but still worth something.
In addition, similar to my discussion on why “sin stocks” outperform, I think this entrenches Facebook’s leadership position going forward, meaning that it will be much harder for new social media platforms to launch. Just like when tobacco advertising was outlawed, it effectively barred new brand entrants, more onerous restrictions on data may make it difficult for new platforms to launch and “steal” users / vie for advertising dollars.
Bottom Line: Transition periods can be painful, and more regulation likely is coming, but in assessing whether this is a lot of noise or whether the business model is impaired, I go with the former.
Back to the positives
I’ll make this brief, as I tie much of the positives into the growth / valuation discussed below, but I think there is a chance that not only are investors being overly punitive on FB, they are missing the long positive road ahead of its platforms.
At this point, I think we all can see the value of Instagram as the Company’s next growth engine. It has become just as ubiquitous with millennials as Facebook was and is. The interesting turns are how the company has monetized the business. Advertisers are obviously involved now, and the ads placed represent high return on investment for them. In addition, some polls have showed that people, if they had to choose, enjoy ads that are more personalized to them, rather than random ones that do not apply.
Now I have seen shopping on the platform, which is so early in its stages, I do not think Wallstreet understands the opportunity. Facebook can now move from just an ad platform to possibly taking a modest skim off of items sold on the platform, similar to eBay’s business model.
Lastly, Facebook has just launched ads on Whatsapp, the messaging platform with 1.5 billion users. Is this priced into the stock today? I’d argue not. Most sell-side models break out the company’s revenue into Facebook Ads, Payments, Instagram, and Oculus. Turning the switch on for Whatsapp could be a large incremental opportunity that is not accounted for.
Now to get back to what I entitled this pitch: Growth can pay for a lot of sins.
With Facebook growing at 17% per year on the top line from 2018-2021, that growth can offset a lot. Of course, you have to bank on that occurring, but let me run through some numbers.
Even with assumed margin headwinds from additional investments in securing data and privacy initiatives (I model EBITDA margins moving from 66.5% of sales in 2017 to 60.0% of sales by 2021), the company grows EBITDA at a ~17% rate. Despite some capex spend to support growth, the company generates good FCF and as you can see, that cash builds over time (the company is already in a net cash position).
This means we are essentially buying FB for 7.2x 2021 EBITDA, which is very low. What multiple should the company trade at at that time?
I would argue for a very high multiple driven by the company’s high return on invested capital (ROIC). If you want to learn more about the relationship between ROIC and EV/EBITDA multiples, I highly suggest you read Michael Mauboussin’s recent article here and also this baseline one here for more. In it, he explains that what matters is investing in companies that generate a positive return on newly invested capital, in excess of their weighted-average cost of capital. It makes intuitive sense to me… if I am continuously investing new capital in projects that don’t earn my cost of capital, that destroys value.
As shown, Facebook is clearly earning well in excess of its cost of capital. This makes sense given how much operating leverage the company has. It is similar to an old newspaper model which also has substantial operating leverage — a newspaper with 1 advertisement slot that widens it to 2 slots will earn very large incremental returns on that second ad slot sold. The same is true of Facebook and its various platforms.
There are limits, of course. With return metrics like these, we should hope Facebook reinvests every dollar possible into its business and see stellar return prospects, but that is not always possible.
(note, NOPAT = Net Operating Profit After Tax)
Either way, I think Facebook is grossly undervalued at current levels. Currently, the median S&P 500 company trades at 13.7x EBITDA. Do I think a company that earns nearly all the capital it invests back in one year as better than average? You bet I do. If Facebook trades at just 10x EBITDA in 2021 (which is closer than you think), that foots to $215 stock under my estimates. That is ~33% upside, or ~10% CAGR.
Although I do not think the company is worth 10.0x, I think using a 10.0x multiple accounts for a couple things . It helps handicap for whether or not I am wrong on my thoughts on the stock performing amidst all of this political uncertainty. However, on the high end, you can see the result looks very, very attractive.
The bottom line is, it is very hard to see over the medium-to-long term how you lose money in a company growing earnings as fast as Facebook is and at the quality it is. This ties back to my thoughts on growth vs. value stocks (i.e. Facebook is a growth company, but still is a value).
In this post, I’ll go through what I think of the transaction, the mechanics as they are presented so far, and what to do with the stock and warrants.
The transaction is broken down into a cash and equity consideration, as shown below. Each holder of Nexeo’s common will get 0.305 of Univar’s shares (worth $8.36 based on Univar’s close price) and $3.29 in cash, representing a total value of $11.65. This represents 9.5x Nexeo’s LTM EBITDA.
I think is honestly too cheap to sell at, but the TPG and First Pacific own over 60% of the shares and voted in favor of the deal, so there’s not much investors can argue for here. Univar trades at 10x LTM EBITDA and Brenntag trades for ~12.5x. Considering the fundamentals were moving in the right direction and you can realize a signficant amount of synergies here (you don’t need 2 sales people in the same region, you can consolidate warehouses, etc.), I think the stock should have gone for a higher multiple. Univar is targeting $100MM of synergies, so in reality, you could view it as the company paid ~$2bn for $300MM of EBITDA, or 6.6x EBITDA.
Either way… I digress… and there’s no point complaining when it appears the deal is done. When you put two and two together, you actually arrive at a ~$940MM EBITDA company, as shown below. If you assume Univar is worth 10x EBITDA, where it has historically traded, I also show that I think Univar should trade up to $33 a share.
That foots to ~20% more upside in Univar’s stock based on the closing price today, accounting for the additional shares needed to be issued and the additional debt.
What should we do with Nexeo Stock and Warrants?
Well, as mentioned, I don’t think a higher price is coming for Nexeo and I would sell the common stock as it approaches $11.65. The transaction is expected to close in the 1H of 2019. I don’t think there will be much in the way of regulatory hurdles given how fragmented to chemical distribution space is.
Now to the meaty part. I recommended Nexeo’s warrants in this post, and they haven’t moved much since then. With a $11.65 take-out and a strike price of $11.50, that implies the value of the warrants is then $0.15… but it is more complicated than that.
All the press release says is, “Following the close, existing Nexeo equity warrants will be exercisable for the merger consideration in accordance with the terms of the warrant agreement.”
That is very vague. On the call, management only said that, “The structure of the transaction that we have presented today, addresses all of those equity features [meaning the warrants] in a complete way and a satisfactory way to all the holders of those investments.”
So what does satisfactory mean? Pretty vague.
That is because the value of the warrants are going to be tied to Univar until the transaction closes. Significantly. Here’s why:
When we bought the warrants, that gave us the right to acquire 1/2 share for $5.75 (or a whole one for $11.5 if you buy 2 warrants). That means we can exercise 2 warrants between now and the close and and buy the stock for $11.50. So if we exercise the stock , our total cost will be the cost to exercise + the cost of the warrants. I lay out an example below of what that means if you bought 1,000 warrants to keep it simple. This essentially means if you bought the warrants at $0.60, our new breakeven is $31.
As you can see, this is not the best outcome for the warrants, but hey, at least they are not worth zero…. They also shouldn’t trade down from $0.60 to $0.15, as that would present a major buying opportunity!
Plus, there is a decent amount of time until close (1H’19), which leaves time for both companies to increase earnings which may result in Univar’s stock appreciating above my $33 price target above. When looking at Univar’s call options, it’s March 2019 call options with a $28 strike price are trading at $4. Part of this is time value… Nexeo should also reflect time value.
Unfortunately, I did see some questions of whether the warrants will stay outstanding post-transaction. I’m still a little unclear on this and what ability Univar has to tender for the warrants, but the language in Section 4.4 of the Warrant Agreement does seem to imply that they will stay outstanding, meaning we should have some time value built into the warrants on what is arguably a better pro forma company.