Tag: equity

CorePoint Q1’19 Recap: Asset sales are the real story $CPLG

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).

As I noted in my prior post, the real developing story, Core Point is looking to divest “non-core” hotel assets. They had conducted 2 sales at very attractive multiples when they initially announced this.

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.”

Is Uber or Lyft stock a Buy?

Should you buy Uber or Lyft’s stock following the IPO? Both have caught a lot of attention in the wave of tech IPO’s that have hit the market this spring. Lyft already IPO’d and surged initially, but has since fallen 33%, which in turn hurt Uber’s expected valuation. Uber priced its IPO at $45 – the low end of its valuation range

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.

Do I 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:

  • Larger scale – 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 the lead
  • Valuation seems less demanding – basing that only on Lyft’s valuation and other travel comps

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:

  • Singular Focus – 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 directions
  • 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.
  • Entering more capital intensive businesses – with the entry into scooters and bikes in scale, it appears Lyft is going to now be reinvesting in that business.  (Funny enough, I saw a piece that said Bird Scooters last less than a month)

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…

Perhaps investors are saying Lyft will grow core earnings faster. Perhaps they like the market share gains. Perhaps they view Uber’s other ventures as dilutive. Maybe there is negative view on autonomous given Otto was caught stealing trade secrets and that put them behind. Either way, I am a bit surprised to see Uber trading for the same price (long UBER / short LYFT anyone?).

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.

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. 

 

 

Warrant Update: Current trading levels imply a reduction in the strike… but also appears to be a catch… $NXEO $NXEOW

I haven’t provided an update on the Univar/Nexeo transaction in a while and given some questions I have received on the warrant mechanics plus general volatility in the market, there couldn’t be a better time.

First of all, let me just re-iterate that I think this is a good transaction. PF Univar is trading at a very cheap multiple and I see solid upside if the company realizes synergies and trades at just 10x EBITDA.

unvr target

The warrants in Nexeo should strongly benefit from this over time, if the higher price is realized. Following the acquisition, warrant holders will be entitled to receive the “Merger Consideration” through their expiration. For background on this, check the warrant agreement as well as recent proxies where it clearly outlines a PF balance sheet “adjustment to record the fair value of the Nexeo outstanding warrants (exercisable through 2021). Upon completion of the merger, the warrants will be converted into the right to receive, upon exercise, the merger consideration consisting of Univar common stock and cash, in accordance with the terms of the Warrant Agreement.” As we all know, the merger consideration swings based on the value of Univar’s stock.

As shown below, based on Univar’s stock price, the equity consideration as a % of total drops below 70%.  This is important because based on Section 4.4 in the Warrant Agreement, the strike price will be lowered.

unvr consideration

You can read the definition for yourself, but the strike price will be lowered by the difference in the strike price and (i) the per share consideration value and (ii) the Black-Scholes value.

As of right now, the “consideration” is around $8.83 (Univar is trading at around $19.50 at the time of writing) derived from the equity holder receiving $5.95 of value in Univar stock ($19.5 x .305) plus $2.88 in cash (minimum amount).

Therefore, taking the strike price of $11.50 less $8.83 less the Black-Scholes value of the warrant should get us to the new strike price.

What is the Black-Scholes value?

Well, Univar in its most recent proxy noted it uses an Option life of 2 years (the warrants don’t expire until 2021), volatility of 23.8%, and a risk free rate of 2.8%.  Plugging this into a spreadsheet and using Nexeo’s price today of $8.96 gets a implied value of $0.58.

In sum, we take $11.5 less $8.83 less $0.58 and that gets us $2.09. This is the amount the warrant strike will be reduced by. In other words, $11.50 minus $2.09 = $9.41.

What is the catch?

There seems to be one catch involved here. This is also from section 4.4 of the warrant agreement:

if less than 70% of the consideration receivable by the holders of the Common Stock in the applicable event is payable in the form of common stock in the successor entity that is listed for trading on a national securities exchange or is quoted in an established over-the-counter market, or is to be so listed for trading or quoted immediately following such event, and if the Registered Holder properly exercises the Warrant within thirty (30) days following the public disclosure of the consummation of such applicable event by the Company pursuant to a Current Report on Form 8-K filed with the SEC, the Warrant Price shall be reduced by an amount….

To me, the catch here implies that you must exercise the warrant within 30 days of close of the deal. However, the warrants may still be out of the money. That being said, if they are even slightly in the money (break even moves up to $21.5 for UNVR’s stock), it may make sense to take risk off the table.

I plan on following up with the investor relations folks to make sure I am thinking about this last component correctly.

What are your thoughts?

How much will rising rates actually impact stocks? A DCF-based impact analysis points to this selloff being overdone $SPY

With all the market volatility recently and the S&P near correction territory, investors are trying to find answers. One item that has been targeted is the increase in interest rates recently. Those who buy into this theory say that increasing rates will increase the discount rate on stocks and that will drive prices lower. Just from a competing for your-next-dollar standpoint, it is true that treasuries at 3% look a lot better than <2%.

10yr treasury.png

I have already argued that I am bearish on the notion that interest rates will rise much further from here. I have based that on (i) real long-term interest rates are lower than people probably think, but are skewed by the high rates of 80s & 90s, (ii) demographic headwinds (baby boomers aging will roll into lower risk securities), (iii) technological improvements are a large deflationary headwind, which will keep rates in check, and (iv) global interest rates remain very low compared to the US and the US is the best house in a bad neighborhood, which will drive increased demand for US$. A strengthening dollar also puts downward pressure on inflation.

I also argued that the Fed has little impact on long-term rates actually (and check that with Aswath Damodaran writings on the subject as well)

given rates moved up quickly from their lows to ~3.2%, I wanted to show the impact on this move on a hypothetical company. I have made these numbers up, but used average S&P EBITDA and EBIT margins for my starting assumptions, assumed a 25% incremental margin, and a 27% tax rate. I also assumed capex = depreciation as this example is a mature business and growing only at about GDP (3%).

Here’s a summary below of where it is currently trading and model:

mini model

As shown, the company is currently trading around 12x LTM EBITDA (average S&P company trades for 12.5x LTM). Let’s see if this particularly equity looks cheap based on a DCF. I use both the terminal multiple method and the perpetual growth method below.

DCFs

As you can see, the implied prices I get are right around the stock’s price today meaning the stock is trading for fair value. What’s the downside if interest rates go up 1%?

Well first, we need to access the impact on our weighted average cost of capital, or WACC. I assume the risk free rate is 3%, as it is today, the beta of this stock is 1.1, and the equity risk premium is ~5%, in-line with long-term history. I also assume the cost of debt is ~5.5%. It is important to remember that many company’s have fixed and floating rate debt. As such, a 1% increase in the 10 year won’t actually impact a company with fixed rate debt until they need to reprice it. But for conservatism, I assume it is a direct increase in their cost of debt. Bottom line: I increase the WACC by 1%.

WACC

So how does this translate into our company? Well, as seen below in the bottom right box, a 1% increase in the discount rate would have a ~5% impact on our stock value, all things being equal.

DCF Valuation

Bottom line: Interest rates really have not moved to 4% and so I am skeptical of the 10% correction in stocks today and the increase in rates thus far actually impairing their prospects.