Great Wolf Resorts, Inc. WOLF
December 06, 2007 - 6:24pm EST by
highline1040
2007 2008
Price: 10.35 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 318 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Shares of this indoor waterpark operator have been indiscriminately oversold on fears of a consumer recession, ignoring an imminent step change in embedded earnings power as the latest resort additions mature to average profitability over the next few years. At the current level, WOLF shares trade at a 15% maintenance FCF yield, a discount to NAV, a 20% discount to its slower growth peers and even a discount to the value implied by the recent sale of the Company’s two worst performing assets.
 
We believe that even a moderately negative macroeconomic impact will be significantly overwhelmed by the dramatic ramp in EBITDA from $50m this year to a conservative estimate of $82m in 2008 and more than $115m in 2009 as the new properties come online.  At the current average hotel peer multiple of 9.5x 2009 EBITDA, this implies a value for WOLF’s existing properties of more than $17 per share (67% upside).  And additional upside exists as new resort developments are announced.  Based on our conversations with industry sources, we are already aware of two potential new resort locations that appear to be substantially far along in the approval process.  Both of these projects are located in premier vacation destinations (Foxwoods, CT and Lake Lanier, GA) and we believe represent ideal high barrier-to-entry locations.  We estimate the NPV of each of these projects to be at least an incremental $1.50 per share, bringing our fair value estimate for WOLF shares to $20 (nearly 100% upside).
 
While the Company’s stated intentions are to eventually build an additional 10-15 resorts, we are not including this longer term growth potential in our valuation, but only the impact from projects that have already been or are substantially close to being announced.  However, if management’s goals are met, we believe WOLF has the potential to very quickly ramp to more than $350 million of EBITDA, implying a share price of nearly $50 (a 400% increase from current levels).  While we recognize that this is a long-term upside scenario, we do believe that it is realistic and serves to highlight the tremendous growth and valuation potential of this successful and innovative concept.
 
 
VALUATION:
 
Stock Price Currently Reflects an Unrealistic Bear Scenario
The current stock price assumes that new resorts will achieve operating results even worse than the original Midwest resorts.  We find this scenario almost absurd as the new Great Wolf resorts have 65-75% higher Total RevPAR than their inferior predecessor concept resorts.  There are 4 key characteristics that drive this higher RevPAR:  1) New resorts have double the amount of space dedicated to revenue generating activity (restaurants, spas, conference centers);  2) New resorts are located in more affluent demographic areas that are able to support higher room rates;  3) New resorts are in locations that do not face the same hyper-competitive environment as the Ohio and Wisconsin areas; and  4) Larger and more expensive resort formats (coupled with the recent credit crunch) have pushed out the local (and sometimes irrational) competitor.
 
However, even if we assume that the new resorts generate a depressed Total RevPAR of just $195 (the estimated trough level for the Midwest resorts over the past 2-3 years), WOLF would generate unlevered returns of 7%, total company EBITDA of $88 million and a resulting stock price of $10.  Even this unrealistic (and almost absurd) downside scenario produces a stock price nearly equal to today’s share price.
 
Current Stock Price Below Historical M&A Value of Worst Performing Assets
In October 2005, Great Wolf sold a 70% interest in its two worst performing assets (Wisconsin Dells and Sandusky, OH) for $114.5 million.  Post-transaction, WOLF retains 30% ownership, continues to operate the properties for a fee and licenses the brand under a 25 year agreement.  The Company receives a management fee of 6% of gross revenues and 2% of room revenues for its management services.  (Based on our conversations with the Company, we estimate this fee income stream to be greater than $2 million per year).  At the time of the sale, both resorts were struggling with a weak Midwest economy that had been hard-hit from the downturn in the auto and manufacturing industries.  Furthermore, Sandusky had to contend with a competitor who had just opened a resort within a few miles of the Sandusky location.  Not surprisingly, this irrational economic move greatly hurt the results for both resorts.  The Wisconsin Dells resort location was also suffering from competing in an oversaturated and hyper-competitive local marketplace (Wisconsin Dells is considered to be the birthplace of the waterpark and has been greatly overbuilt during the last 4-5 years).
 
At the time of the sale transaction, analysts estimated the LTM EBITDA from these combined resorts to be $7.7 million, implying a 14.8x multiple or $250k per room key.  Applying this same depressed valuation to the current superior resort portfolio and including some value for the management fee contracts implies a downside share value of $11.25 (10% above today’s stock price).
 
Tremendous EBITDA Growth from New Resort Openings
After building the Charlotte resort and Grapevine expansion, we estimate WOLF will produce $115m of EBITDA in 2009. 
 
Great Wolf Resorts
Ownership
 
EBITDA
 
2007 EBITDA
 
 
 $       51
 
 
 
 
 
 
Increase in SG&A
 
 
       (3.0)
 
Growth of Base Resorts
 
 
        2.7
Assumes 2.5% RevPAR growth
Mason, Ohio
100%
 
        5.8
Reaches 14% Unl. Return in Yr. 2
Grapevine, TX
100%
 
       16.8
Reaches 12% Unl. Return in Yr. 1
Grand Mound Mgmt Fee
100%
 
        2.6
~6.5% of Revenue ($40m)
Grand Mound, WA
49%
 
        6.2
12% Unl. Returns in Yr. 1 - open 75% of year
2008 EBITDA
 
 
 $       82
 
 
 
 
 
 
 
Increase in SG&A
 
 
       (3.0)
 
Growth of Base Resorts
 
 
        2.7
Assumes 2.5% RevPAR growth
Grapevine, TX
100%
 
       12.6
Reaches 14% in Yr. 2 + 200 Room Expansion
Grand Mound Mgmt Fee
100%
 
        0.3
Incremental ~6.5% of Rev. ($45m)
Grand Mound, WA
49%
 
        3.4
Reaches 14% in Yr. 2 (open full year)
Charlotte, NC
100%
 
       16.8
12% Unlevered Returns in Yr. 1
2009 EBITDA
 
 
 $     115
 
 
At today’s stock price (and accounting for incremental financing needs), this analysis implies a 7.6x 2009 EBITDA multiple and a 15%+ FCF yield, well below multiples for other comparable lodging companies (9.5x average).  We believe such a high EBITDA growth profile deserves a premium to the more mature peer group, however, for conservatism, we have used the peer multiple in our valuation analysis.
 
Hotel & Resort Comparable Valuations
 EV / 2008 EBITDA*
 
 EV / 2009 EBITDA*
Gaylord Entertainment
 
12.0
 
9.8
Choice Hotels
 
11.9
 
10.8
Starwood Hotels & Resorts
 
10.3
 
8.8
Intercontinental Hotels Group
 
10.2
 
9.1
Morgans Hotel Group
 
9.6
 
9.8
Host Hotels
 
9.8
 
9.3
Lodgian
 
9.5
 
9.1
 
 
 
 
 
Mean
 
10.5
 
9.5
 
 
 
 
 
*Bloomberg consensus estimates
 
 
 
 
At 9.5x 2009 EBITDA, we believe that Great Wolf’s existing properties are worth roughly $17 per share.  Furthermore, our expectation that management will announce another two resorts in 2008 should add an incremental $3.00 per share to our valuation, resulting in a $20 share price (nearly 100% appreciation).
 
Intrinsic Asset Value Provides Downside Protection
The development costs of the physical buildings and land also help to provide a trough valuation that is above the current stock price.
 
 
Cost Basis
Wisconsin Dells, WI
 
 $      20.4
Sandusky, OH
 
 $      12.0
Traverse City, MI
 
 $      53.5
Kansas City, KS
 
 $      53.5
Sheboygan, WI
 
 $      41.0
Williamsburg, VA
 
 $    100.0
Pocono Mountains, PA
 
 $      92.0
Mason, OH (Cincinnati)
 
 $    115.0
Estimated Grapevine Costs
 
 $    140.0
Estimated Grand Mound Costs (49% share)
 
 $      68.6
 
 
 
Value of Niagara Franchise Fees*
 
 $      37.5
Value of Dell & Sandusky Franchise Fees*
 
 $      41.6
 
 
 
Gross Cost Basis
 
 $    775.1
Net Debt (2007 Year-end)**
 
 $   (401.0)
Equity Value
 
 $    374.1
# of Shares
 
         30.6
 
 
 
Equity Basis per Share
 
 $    12.24
 
 
 
* Assumes franchise fees are valued at 15x multiple
 
 
** Includes portion of Grand Mound JV debt
 
 
 
 
 
 
INVESTMENT HIGHLIGHTS:
 
New Resorts Produce Superior Returns
While the new larger resorts have doubled the total building costs due to waterparks that are 60-70% larger, these resorts are more profitable as they include double the amount of space dedicated to revenue generating venues (restaurants, spas, etc.).  This increase in cost, combined with the recent credit crunch, has also helped to serve as an additional effective barrier to entry and has closed the market to small under-capitalized local players.  Additionally, WOLF management has been successful in finding defensible locations for their new resorts by taking advantage of tighter zoning due to scarcity of attractive land sites in areas associated with natural vacation destinations (Williamsburg, Poconos, Niagara Falls for current resorts and Foxwoods, Lake Lanier, Mall of America for proposed resorts).
 
Earnings Upside if New Resorts Perform Equivalent to Williamsburg and Poconos
Williamsburg and Poconos have achieved 17-19% unlevered returns.  If Grapevine, Grand Mound and Charlotte can achieve similar results, then 2009 EBITDA would be over $135 million.  At a 9.5x multiple, this results in a $23+ stock price, implying nearly 130% appreciation from current levels.
 
First-Mover Advantage in Underpenetrated, Fragmented Market
Indoor waterparks represent a relatively new and under-penetrated concept.  Industry surveys indicate that only 30-40 facilities have waterparks larger than 10,000 sq. ft. that could be considered reasonable comparables to Great Wolf Resorts.  All of these entities are privately held and, to the best of our knowledge, no single operator has more than three resorts.  Furthermore, indoor waterparks remain geographically concentrated in the Midwest, with over 60% of the country’s indoor waterparks located in Wisconsin, Minnesota and Michigan.  Currently, only one large indoor waterpark exists west of the Mississippi River.
 
New Management Team Focused on Finding Defensible Locations
In a break from the pre-IPO strategy, Great Wolf’s current management team is committed to finding locations where the Company has a first mover advantage, the demographics are more attractive than the original Midwest locations (particularly average income per capita) and the new location can support Great Wolf’s larger and more profitable resort format.  This is in contrast to the Company’s original Midwest resorts which suffer from both a weak regional economy and intense competition. 
 
International Expansion
Great Wolf is in active discussions with international developers about expanding overseas.  The Company would receive a licensing and management fee for helping to develop and operate the resort, but would not be required to put any capital into these deals.  A single arrangement should produce $2.5-$3.0 million of management fees.  We believe an announcement of a multiple site partnership is imminent over the next 12 months, however, we have not ascribed any value to this in our analysis.
 
Attractive Lodging Concept
Once fully ramped, the new larger format resorts (Poconos, Williamsburg, Niagara Falls) should continue to grow and generate high-teen unlevered returns.  In contrast, hotel resort and lodging concepts typically generate low-teen unlevered returns (based on our conversations with industry analysts).
 
Solid Balance Sheet
All of Great Wolf’s projects are fully funded.  Despite the recent credit turmoil, the Company just last month secured construction financing commitments for its Charlotte, NC resort.  In 2009, WOLF should be levered at roughly 4.5x Debt/EBITDA, in-line with other comparable hotel companies.  Great Wolf finances all of its projects through non-recourse debt tied to specific resorts and with minimal/no covenants.  Additionally, Williamsburg does not have any mortgage debt tied to the property, allowing the Company additional financing flexibility.  Furthermore, management remains in active conversations with potential equity partners regarding the financing of future projects.  We expect a positive announcement around these discussions within the next 3-4 months.  Such a development would be significant, as it would not only further alleviate funding requirements going forward, but would also allow Great Wolf to keep the economics from the valuable management fee for operating the resort.
 
Future Upside Optionality from Recapitalizing the Balance Sheet
We believe significant opportunity exists to create value from developing resorts that provide over 15% returns and selling these projects to yield seeking real estate funds with much lower costs of capital.  While this recap scenario is clearly shut-off in the current credit environment, we know at some point normalcy will return and real estate investors will begin re-seeking attractive yields.  At that stage, Great Wolf will have multiple resorts with track records and the company can divest these assets to create an asset-light balance sheet and in turn, become a company where a large percentage of its earnings come from management and licensing fees for operating these divested resorts.  We believe such a transaction could be worth $25-30 per share as the resulting earnings stream would command a significantly higher multiple and the asset sales would produce an attractive dividend.
 
 
RISKS:
 
Consumer Slowdown
We believe the Great Wolf concept is actually better positioned than most resort/lodging concepts with respect to its ability to weather a consumer slowdown.  WOLF’s core customer base consists of middle to upper class families that we believe will continue to take some type of family vacation irrespective of the broader economic outlook.  Most importantly, however, the regional Great Wolf concept represents a cheaper alternative to a far away resort destination and the shorter-stay format and driving distance proximity acts as a compelling substitute for many families during such periods.
 
Furthermore, we believe that Great Wolf’s valuation is supported regardless of one’s assumption about the near-term performance of the original Midwest resorts or the new projects.  To illustrate this point, we have created the tables below to show the effect of increasing/decreasing Total RevPAR at current resorts as well as the assumed Total RevPAR needed to achieve a certain unlevered return at a new resort.  Since Great Wolf no longer provides per resort performance data, we have relied on conversations with management along with some triangulation of historical data.  We believe current large format resorts that have had time to ramp-up (Williamsburg, Poconos, Niagara) are generating ~$350 Total RevPAR (includes room fees plus F&B) and ~40% fully loaded unit margins.  The chart below makes some general assumptions to show the directional effect on profitability of changing resort top-line assumptions.  The key takeaway is that this stock offers tremendous upside from current irrationally depressed levels, even in a moderate consumer downturn.
 
2009 EBITDA
 
 
 
 
 
Implied Total RevPAR
Unlevered Returns of New Resorts
     SSS Growth of Base Resorts
 
 
 
 
-5.0%
-2.5%
0.0%
2.5%
5.0%
$        290
12%
        $101
        $104
        $107
        $109
        $112
$        320
14%
        $110
        $112
        $115
        $118
        $120
$        350
16%
        $118
        $121
        $123
        $126
        $129
$        380
18%
        $126
        $129
        $132
        $135
        $137
$        400
20%
        $135
        $138
        $140
        $143
        $146
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Resulting Stock Price (assuming 9.5x multiple)
 
 
 
Unlevered Returns of New Resorts
     SSS Growth of Base Resorts
 
 
 
 
-5.0%
-2.5%
0.0%
2.5%
5.0%
 
12%
 $   12.79
 $   13.72
 $   14.64
 $   15.57
 $   16.50
 
14%
 $   15.39
 $   16.32
 $   17.25
 $   18.17
 $   19.10
 
16%
 $   17.99
 $   18.92
 $   19.85
 $   20.78
 $   21.70
 
18%
 $   20.60
 $   21.52
 $   22.45
 $   23.38
 $   24.31
 
20%
 $   23.20
 $   24.13
 $   25.05
 $   25.98
 $   26.91
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Resulting Stock Price Appreciation (assuming 9.5x multiple)
 
 
Unlevered Returns of New Resorts
     SSS Growth of Base Resorts
 
 
 
 
-5.0%
-2.5%
0.0%
2.5%
5.0%
 
12%
28%
37%
46%
56%
65%
 
14%
54%
63%
72%
82%
91%
 
16%
80%
89%
98%
108%
117%
 
18%
106%
115%
125%
134%
143%
 
20%
132%
141%
151%
160%
169%
 
 
Entrance of New Competitors
Due to the 2-3 year timeline it takes to permit, secure financing and develop a new resort, we have fairly good visibility on the competitive pipeline.  Based on our conversations with management and industry sources, we are not aware of any new waterpark developments that have achieved permitting or secured financing in Great Wolf Resorts’ current locations.  Obviously with a successful concept, it will only be a matter of time before a new competitor enters one of WOLF’s current markets.  However, with such an underpenetrated national market opportunity, we would expect a rational competitor to first select locations that do not overlap with Great Wolf’s current footprint.
 
Due to the large capital expenditures required to build out the new resort format, we believe Great Wolf’s current strategy of partnering with branded partners (i.e. – Paramount, Ripley’s and the Chehalis Reservation) not only helps to mitigate capital costs, but also helps to eliminate potential competitors.
 
Construction Delays and Cost Overruns
Historically, the Company has not had an issue finishing projects on time and on budget.  Great Wolf’s high unlevered returns have been achieved despite operating in a robust and inflationary construction market – and we expect to see an easing of cost pressures going forward.  In terms of the Grapevine and Grand Mound projects, management continues to believe that both resorts will be finished on time and for around $350,000 per room key.
 
Limited Portfolio Diversification
Due to its small number of current resorts (12 including projects already underway), a disruptive event at a single resort could potentially have an adverse impact on the Company’s overall performance.
 
 
BACKGROUND
 
Great Wolf Resorts is the largest owner and operator of indoor waterparks in North America.   These resorts are family-oriented destinations that typically feature a 300-400 room hotel combined with a 50,000 – 100,000 sq. ft. indoor waterpark.  These waterparks include elaborate slides, a lazy river, treehouse water forts, indoor wave pools, etc. (For a visual overview of one of their indoor waterparks, see the following link: http://www.greatwolf.com/Locations/Poconos/waterparks/index.aspx ).
 
WOLF’s resorts target middle to upper class families that are usually within a 100-250 mile radius from its properties, have children under the age of 14 and are looking for a fun, drive-to vacation that can generally be booked on short notice.  Room rates typically range from $200-$350 per night, with an average rate of $250.  It is important to note that these rates include free access to the waterpark.  Non-room spending averages an additional $122, resulting in total revenue per occupied room (RevPOR) of $362 per night.
 
A key characteristic of the Company’s concept is that it provides an experience of family togetherness in a safe, welcoming environment and all for a reasonable value.  At Great Wolf, parents can join their kids for some of the action, yet also feel safe about letting their kids run off while they choose to relax and enjoy some downtime.  This experience differs greatly from the larger theme parks, which are typically geared toward older teenagers and which have crowds which can be overwhelming, often resulting in atrocious lines to get on the rides.  This is obviously not the type of environment in which a parent will let their 8-12 year old run around unsupervised, which means as a parent, you also have to wait in those painful lines.  In contrast, only guests staying at the Great Wolf resort are able to access the waterpark. We believe this is a critical aspect that limits crowds and guarantees easy access to the rides. 
 
 
OVERVIEW OF RESORTS
 
The new and larger resort format typically costs around $350,000 per room key to develop and, based on recent experience at the Poconos and Williamsburg resorts, generates very healthy 17-19% unlevered returns.
 
Existing Properties
Opening
Great Wolf Ownership
# of Rooms
Total Indoor Entert. Sq. Ft.
Waterpark Sq. Ft.
Conference Center
 
 
 
 
 
 
 
Wisconsin Dells, WI
1997
30%
386
 102,000
      76,000
 
Sandusky, OH
2001
30%
271
   41,000
      34,000
 
Traverse City, MI
2003
100%
281
   51,000
      40,000
Yes
Kansas City, KS
2003
100%
281
   49,000
      40,000
 
Sheboygan, WI
2004
100%
246
   54,000
      43,000
Yes
Williamsburg, VA
2005
100%
405
   78,000
      67,000
Yes
Pocono Mountains, PA
2005
100%
401
   91,000
      78,000
 
Niagara Falls, Ontario
2006
0%
406
   94,000
      82,000
 
Mason, OH (Cincinnati)
2006
100%
401
   93,000
      75,000
Yes
 
 
 
 
 
 
 
Under Construction
 
 
 
 
 
 
Grapevine, TX (Dallas)
Q4 2007
100%
402
   98,000
      76,000
Yes
Grand Mound, WA
Q1 2008
49%
398
   78,000
      56,000
Yes
Charlotte, NC
2009
100%
401
   98,000
 TBD
Yes
Grapevine Expansion
2009
100%
203
 TBD
 
Yes
 
 
CATALYSTS:
 
1.      Continued execution.  EBITDA will more than double from 2007 to 2009, even without further project announcements.
 
2.      Announcement of new resort developments (Foxwoods and Lake Lanier, among others).
 
3.      Announcement of an equity partner for financing new resort developments.
 
4.      Potential take-out target.  Active shareholders have filed 13-Ds.
 
5.      Opening of Grapevine, TX resort in Q4 2007 and Grand Mound in Q1 2008.
 
6.      Shift from a value (turnaround) stock to a growth stock.

Catalyst

1. Continued execution. EBITDA will more than double from 2007 to 2009, even without further project announcements.

2. Announcement of new resort developments (Foxwoods and Lake Lanier, among others).

3. Announcement of an equity partner for financing new resort developments.

4. Potential take-out target. Active shareholders have filed 13-Ds.

5. Opening of Grapevine, TX resort in Q4 2007 and Grand Mound in Q1 2008.

6. Shift from a value (turnaround) stock to a growth stock.
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