You said it about the financing business of the industry confusing investors. I must admit I was surprised when I discovered how it works. |
I tried my best to analyze SVR correctly
valuestocks.net under the May Pick of the Month.
I'll repost most of it here:
May 18, 1999 (updated May 23, 1999): Silverleaf Resorts (NYSE: SVR) - Quick, first gestalt: time-share. Images of faded browns, unfashionably "retro" clothes and loud salesman fill my head. How about you? Well, now we have overtures of a growth industry. A pretty slick one too. Gone is "time-share." Now, we have "vacation ownership interest," or VOI. And forget those faded browns and past tenses. The story is much different, and it is happening right now. Big players such as Marriott and Disney have moved into the field, and the size of the VOI industry has more than doubled during the 1990's.
In fact, open-minded investors wishing to ride the biggest demographic trend to ever hit the US - the aging babyboomers - may have already stumbled onto this industry. It appears a good time - an entire industry's worth of stocks are in the dumps, and consolidation is in the cards with many players selling for at or below net asset value.
There is indeed value here, but the superficial numbers do not tell the whole story. One must dig a bit to understand.
There are several different types of operators in this field, and they appear to be accorded different valuations.
Despite the gross dissimilarities in returns, the general similarity in Price/Book ratios does suggest that the market is using current net asset valuations (note: book value is a decent proxy for net asset value, not its equivalent) to value these stocks rather than growth or return statistics. This makes sense, since the industry-standard way of accounting makes the growth and earnings numbers poor measures of value.
Silverleaf looks the cheapest. Notably, it is also by far the smallest market cap. This proves rather artifactual. If Silverleaf were accorded an industry multiple, it too would sit among the Trendwests and Vistanas in terms of market cap. So it really is not a size issue but rather a valuation issue.
And this is where it gets interesting. Silverleaf is an operator of "drive-to" VOI's. In other words, Silverleaf positions its resorts within reasonable driving distance from major metropolitan areas. The targets are middle-income customers, outside the targets of the Disney's and Marriott's. This greatly increases its potential customer base, and is a decent economic model that helps set Silverleaf apart from the crowd.
But the valuation is far from straightforward. Silverleaf is the cheapest of the bunch on both a price/earnings ratio and a price/book ratio basis. Its revenue gains are the greatest, but that is mainly due to a capital infusion in the form of $75 million in long-term debt last year. And the revenue gains are not sustainable without further capital infusions.
This is because Silverleaf, like other reputable VOI operators, typically books revenue at the time of sale of the interest, and matches expenses/costs of revenue generation to the period in which they are generated. However, most customers finance their purchase after a down payment, so Silverleaf is booking revenue that it has not yet received in cash. This is aggressive, and very important for intelligent investors to understand.
For instance, when a VOI is sold, the customer pays 10% down, and finances the rest over 7-10 years. However, for a given period, Silverleaf - using accrual accounting - books the entire purchase price as revenues. In addition, Silverleaf collects and books the interest received from customer notes receivable. There are also additional revenues from management fees for operating the resorts. But the key is that the principal payments - which will be received as installments over the next 7-10 years - have already been booked as revenue up front. This is aggressive accounting no doubt.
Because the remaining 90% of the principal has not been yet collected as cash, it goes into Silverleaf's accounts receivable. Silverleaf then uses the accounts receivable (the stream of future installment payments against principal) to secure up to 85% loan advances which it can use to help finance additional construction and development. These loans are the primary source of capital for Silverleaf. Other VOI operators use similar accounting. For instance, Fairfield regularly securitizes its accounts receivables to generate cash.
Because these loans are secured, the interest rates for such borrowings are lower, at a few percentage points over LIBOR, than they otherwise would have been. In fact, the weighted cost of Silverleaf's total borrowings including more expensive senior debt was just 9.1%, and interest income typical exceeds interest expense in any given period.
But in the most recent period, interest expenses amounted to a historically high 57.8% of the interest income received (via the steady stream of notes receivable). Blame the new, expensive long-term debt. Silverleaf cannot dip into that well repeatedly.
Now, there's the issue of inventories as well. What are they? The company's inventories are the VOI's it has either acquired, reacquired, or built but not yet sold. The inventories are on the books at the lower of cost or market price. The company did have a large amount of inventories acquired several years back at a low cost basis. It has depleted those, and is now selling out of inventory that it built at a higher cost. This is squeezing margins on VOI sales.
As well, management anticipates higher marketing expenses associated with several new ventures. The company may have miscalculated a bit and is being forced into stepping up marketing efforts more than it planned in order to sell interests in certain slower markets.
Future inventory will come from current inventory and VOI's not yet built. The wisdom of further long-term debt to finance this is questionable. So what happens when the company sells through its inventory and has maxed out its borrowing of 85% against accounts receivable at some reasonable level? The company's sales will basically crash. The lone recurring revenue will be net interest income (expiring over 10 years) and management fees.
The sum result is apparent in the company's cash statements, which show deepening negative free cash flow despite the record sales and earnings. Indeed, a risk factor listed in the firm's annual 10-K is "negative cash flow."
In an intended vote of confidence, the chairman, CEO, and majority shareholder Robert E. Mead has announced he will purchase up to half a million shares on the open market. The company's own share buyback plan has been stymied by covenants of its senior debt. So this is indeed a nice gesture, although he already owns over 50% of the outstanding stock.
Which brings us to a point that must be mentioned with regard to this inudstry - takeover valuations. As insinuated before, large players in the leisure industry such as Disney and Marriott are moving into VOI's. A confirmation of the demographic trends from some expert marketers, to be sure.
The greater meaning is obvious for players like Silverleaf which are trading well below book and up to a 50% discount from current net asset value. These are tantalizing numbers to would-be acquirers. In a takeover, just a fair price would be a big bump from current levels.
So given the inability to value this sector in terms of growth or simple ratios, the next step in the analysis is to figure out the current net asset value. We'll assume all liabilities are real, per Graham's instructions, and adjust the asset side of the balance sheet to reflect reality.
The inventories are recorded at cost. If we use recent history as a guide, those inventories are actually undervalued, as the company's cost of building VOI's is only about 1/7th of the amount received on sale. First, assuming conservatively that only 50% of the inventory is saleable, we get $40 million in saleable inventories. Allowing for the higher cost basis on more recent inventories, these will amount to nearly $200 million in sales. The present value of these sales would sit at about $160 million conservatively, or twice the recorded value.
According to industry standard the notes receivable have a securitizable value of about 15% more than their recorded value. This is due to the high 14+% interest rates charged to buyers. So the $198 million in accounts receivable could be adjusted to about $227 million. I'll stick with the $198 million figure to remain conservative.
The fixed assets are assumed worth 25% of stated value, cash is given full value, and minimal other assets are given 50% of stated value.
Using these adjustments, the adjusted total assets are actually about $400 million. Less total liabilities of $208 million, the net asset value sits around $192 million, or about $15 per share.
The market currently values the shares at about $97 million, or $7 1/2. Credit the huge disparity to the concentrated majority ownership - the market is betting that CEO and majority ownder Mr. Mead will not sell out. Still, the fact remains we have a dollar selling for about 50 cents. Makes one wonder when Mr. Mead himself will consider taking the company private rather than just buying a few shares.