DIAMOND RESORTS INTL DRII
September 09, 2014 - 9:09am EST by
dle413
2014 2015
Price: 24.00 EPS $1.00 $2.00
Shares Out. (in M): 76 P/E 24.0x 12.0x
Market Cap (in $M): 1,800 P/FCF 8.7x 6.7x
Net Debt (in $M): 325 EBIT 300 350
TEV ($): 2,125 TEV/EBIT 7.0x 6.0x

Sign up for free guest access to view investment idea with a 45 days delay.

  • Hotels
  • Timeshare
  • Leisure
  • Hospitality
  • Real Estate Monetization
  • Small Float
  • Potential Dividend Initiation
  • Potential Buybacks

Description

Business Description

Diamond Resorts International, Inc. operates in the hospitality and vacation ownership industry in the United States, Hawaii, Canada, Mexico, the Caribbean, Central America, South America, Europe, Asia, Australia, and Africa. The company operates in two segments, Hospitality and Management Services, and Vacation Interest Sales and Financing. It provides hospitality and management services. The company has 92 managed resorts, 210 affiliated properties, and 4 cruise itineraries, representing the equivalent of roughly 3 million room nights. It also offers a vacation ownership program. The company was incorporated in 2013 and is headquartered in Las Vegas, Nevada.

Diamond sells an "interval" or points exchangeable for a week's worth of stay at its resorts for about $23k and helps finance the sale. The company then securitizes these receivables collecting a spread. DRII also receives a management fee for operating the resorts on a cost-plus basis. The customer pays for the management fees through a maintenance fee on his ownership in addition to an annual membership fee in THE Club which provides the ability to exchange his points for stay at other resorts across the network.

Unlike other public time-share companies like WYN and VAC, who source inventory from their pipeline of developments, DRII can sell points reclaimed from owners who ceased paying their maintenance assessments, essentially reselling churned inventory. The cost to re-sell this inventory is about $1,500 vs. the $23,000 selling price. For WYN and VAC who are selling out of construction inventory the cost is about $7,700 for a week. Since DRII is not developing time-share properties for resale, it is a more capital efficient, high-margin, higher return business - with less risk.

Market View

  • Diamond Resorts is a roll-up with no organic growth
  • Timeshare is a declining business
  • Diamond management has excessive pay structure and an opaque management contract
  • Free cash flow will remain low as further inventory is captured and acquired
  • Diamond has no pricing power

 

Post Road Capital View

  • High Single digit organic growth for the management business / low-to-mid teens for VOI – each with ~50% plus incremental EBITDA margins – i.e. inordinate operating leverage
  • Timeshare is at the heart of the shared economy and has great future growth prospects
  • DRII management owns over one-third of the company and has a focus on FCF and returning capital to shareholders – the small float currently stymieing buybacks
  • Asset light model allows for 35%-40% EBITDA margins with free cash flow per share accelerating from over $2 in 2014 to over $3 FCF/share over the next twelve months.
  • Average transaction price has increased 34%+ in 2013 and should continue to rise low double-digits this year and beyond.

Three Ways to Win

  1.       Organic Growth with Returning Capital:

 

In its current form, this business is capable of high-single digit growth and 30%+ EBITDA margins without much risk. Assuming some $200mn in FCF (and applying the 50% FCF sweep which should rapidly decrease to 25% and then zero by 1Q:16), we can assume $100mn of distributable FCF to shareholders which could represent a 5% dividend yield at current prices. Most likely we expect a modest dividend to be implemented until more trading liquidity followed by share buybacks.

 

  1.       Leverage with Accretive Acquisitions

During its 2013 IPO, DRII used roughly $120mn of proceeds to acquire Island One & PMR which have been immediately accretive. In just one-year these two acquisitions have added roughly $140mn of revenue at very attractive incremental margins (~50%). The company will be under-levered once the cash flow covenant requirements are completed (1Q:16). Below using modest assumptions we estimate for every $100mn of additional debt, DRII could generate roughly $117mn in revenue, $58mn in EBITDA and roughly $31mn of incremental FCF ($0.38/share).

 

  1.       Take Out by Competitor or Private Equity

A couple weeks ago Hyatt sold its timeshare business to IILG. On a forward basis including synergies (excluding inventory) the transaction implies a 15x forward EBITDA multiple. While we note DRII would be a far larger acquisition, on that same metric, DRII would be worth $60/share based on forward 2015 EBITDA.

 

 

Upside Case

With accretive M&A and strong organic growth we paint a scenario where DRII is achieving low teen growth over the next two years or $1.1 billion in revenue, 60% incremental margins or $430mn in EBITDA and achieving $350mn in free cash flow in 2016. That would translate to $4.31 per share of FCF which could warrant a 20x given the accelerated timetable. That would imply nearly 4x our investment at current levels of $23/share.

 

Risks

  • Opaque management structure where the Founder operates a subsidiary HM&C structure. Thus overall executive comp is unclear although HM&C does not run at a profit (no special dividends). In other words, we know some 40 executives including the Founder, CEO and CFO were paid nearly $30mn in total in 2013, but we do not know how that was allocated by individual.
  • DRII is highly reliant on the securitization market. The business could be materially impacted if they are unable to securitize the time share receivables.
  • Timeshare is a competitive industry from incumbent players such as Wyndham and Marriot as well as disruptive technologies such as VRBO/Homeaway.
  • Excessive equity grants – though management has assured us that the top 30 managers collectively will receive less than 1% of the company in options each year with potentially some overage in high return years.

 

Catalysts

  • Accretive M&A
  • High and accelerating FCF forces a re-rating of the stock
  • Small float coupled with a high-quality base of recent investors creates scarcity for the shares
  • Narrative of being a shared economy company evolves and drives a re-rating of the stock
  • Initiation of a dividend and/or buyback

 

Management

Senior Management owns over 30% stake in Diamond

David F. Palmer – CEO since January 1, 2013. He served as President of Diamond LLC from September 2010 until the merger of Diamond LLC with and into the Company in July 2013. Mr. Palmer served as an Executive Vice President of Diamond LLC from April 2007 through his appointment as President in September 2010, and as Chief Financial Officer of Diamond LLC from April 2007 through December 2012. Mr. Palmer has over 25 years of experience as a private equity/financial professional.

  • Owns 3.9mn shares or 5% of company

C. Alan Bentley- CFO since January 1, 2013. In addition, since September 2008, Mr. Bentley has served in various officer capacities, including as Executive Vice President, and as a director, of certain subsidiaries of the Company.

  • Owns very little stock ~ 52k shares but significant options

Stephen J. Cloobeck- Founder and Chairman of the Board since January 1, 2013. Served as Chairman of the board of managers of Diamond LLC from April 2007 until the merger of Diamond LLC with and into the Company in July 2013. From April 2007 through December 2012, Mr. Cloobeck also served as Chief Executive Officer of Diamond LLC. Mr. Cloobeck has over 30 years of experience in the vacation ownership industry, and the development, construction, management, operations, marketing and sales of real estate properties, including vacation ownership resorts, hotels, retail shopping centers, office and apartment buildings.

  • Owns nearly 18mn shares or 23% of the company. Recently filed 10b5-1 to sell 2mn shares not prior to September 2014


I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Investment Thesis

Diamond Resorts, the second largest timeshare operator (between Wyndham and Marriot) measured by properties, really is an asset-light club business with multiple revenue streams and lifetime contracts.  An innovator in its field, its asset-light model provides high operating margins, free cash flow and returns on capital.  Its incredibly high margins on incremental revenue and tuck in acquisitions creates not only significant operating leverage; perhaps more importantly it creates exponential returns on equity. 

Essentially DRII represents an investment in the best segments of a timeshare business model 1) selling and financing ~80% of total timeshare sales at ~15.5% interest to the consumer; and 2) hospitality management at cost plus ~13% contracts – both very high margin businesses.

Having recently turned public, the company and its management are still not well known – though management of late has been aggressively meeting with potential and current investors.  In addition, there are many near, mid and long-term catalysts that could drive this business and in turn inordinate returns to shareholders.

The combination of improved profitability (EBITDA margins north of 30% on its existing business and over 50% on new business due to minimal incremental G&A requirements), debt refinancing, expected tuck-in acquisitions, and new revenue streams (from data mining, club sales, etc.) will drive accelerated free cash flow over the next few years (with NOLs to protect that cash flow).  The use of leverage for acquisitions (as the company is under-levered) as well as future share buybacks could and should accelerate returns to shareholders.

Organic high SD/low DD topline growth should generate north of $2.50 on 2014 and over $3.50 of FCF/share in 2015.  Acquisitions could drive the 2015 and our expected 2016 figures materially higher. A conservative 10x FCF multiple gives us valuation support at $23/share – roughly our acquisition cost – while upside could be $60+ or 15x 2016E, depending on how quickly management can execute and investors can get comfortable with management and the business. Thus we see downside protection at 8x trough FCF/share or $17 or 25% downside (in the near term as FCF is rapidly growing) vs. reward of $60+/share or >160% upside. Applying average multiples to our base case assumption implies an average target price of $42/share or 14x 2015E FCF as a base line target or 83% upside.  Over the next three years, multiple levers could create FCF of up to $4-5.  If rebranded as a true shared economy company / stock, a 20x multiple on this higher figure is not pie-in-the-sky.

Clearly, this asymmetric reward/risk commands a large position in the portfolio.  We need only be half right on our out year expectations for this stock to be at least a double.

    show   sort by    
      Back to top