Description

Capitol Acquisition II (CLAC) an SPAC that raised $200m for an acquisition in May 2013. The company agreed to purchase Lindblad Expeditions in March for ~10x EBITDA. I believe the combined company is undervalued and represents an interesting opportunity with several near and medium term catalysts for share appreciation.

Lindblad is a niche player in the cruise industry. They provide “expedition adventure” cruises to unique parts of the world. An example of one of their cruises would be a two week cruise to Antarctica or a 10 day tour of the Galapagos. The average cruise costs more than $1,000 per person per night (roughly $10k all in per person).

This is a very different model than the big cruise players for a few reasons. First, and most obviously, price: Lindblad’s cruises cost ~$1,000 per person per night versus mass market cruises typically priced at around $200 a person a night. This price differential makes sense given the different audience targets; Lindblad is targeting affluent people 50+ who are not bringing their kids; mass markets targets includes families who are bringing their kids.  Second, investment: Lindblad’s smaller ships costs less than $50m to build, while their blue water ships (capable of operating far from port and replenishing at sea) will cost less than $150m, while a typical mass market cruise ship will cost more than $1b. Third, size: Lindblad ships will fit 100-175 guests versus >3,000 for a mass market ship. Finally, cost to run: the average Lindblad ship costs around $700 per passenger a night while a mass cruise ship costs around $120 per passenger per night (illustrating the power of scale in cruise ships!).

The other really unique aspect of Lindblad is their relationship with National Geographic. The agreement between the two makes Lindblad the exclusive cruise line that can brand their cruises National Geographic; in addition, they have access to National Geographic experts for onboard lectures and excursions. This is a powerful source of both branding and traffic generation (about 20% of traffic comes from National Geographic). As part of Capitol’s acquisition, the National Geographic relationship was extended through 2025 and National Geographic will acquire a 5% stake in the company.

Combined, their differentiated model and National Geo relationship provide the company with a unique moat. It’s doubtful that one of the major mass market players is going to invest in trying to compete with Lindblad. To do so, they would need to order new, smaller ships (which would take several years) and spend time building out a completely new set of less trafficked ports and on-ship capabilities.

A new competitor deciding to enter the space is probably even more unlikely. These ships are expensive and take years to build, and it’s difficult to see an investor investing $40m in a ship that will take 3 years to build and then still be subscale versus Lindblad’s built out routes, on-board offerings, etc. They would also likely have problems getting the ships filled out in the beginning: almost 40% of Lindblad’s passengers are repeat travelers, and 50% of Lindblad’s traffic comes from internal generation (their website, phone number, etc.) while 20% comes from National Geographic. A start up would need to initially put out a ton of advertising to build out internal generation capabilities (again, because they are subscale, this would seriously hurt margins) or rely purely on more expensive travel agents, which would cut down on returns and probably leave them unprofitable.

And both groups (new entrants or the mass market players) would need to contend with branding issue. These vacations are very expensive investments, and the National Geographic brand resonates with baby boomers and would allow Lindblad to charge a premium over a potential competitor. I don’t think there’s a brand out there that would have the same appeal; Discover (the channel, not the credit card) has an exclusive agreement with Princess (part of Carnival), but Princess has used those to offer exclusive on shore excursions, not overall branding. You can also quickly compare the Princess offerings to the Lindblad offerings and see the difference. For example, Lindblad’s weeklong Alaska cruise for next May are priced at over $6,500 a person (all inclusive including excursions) and fits 62 passengers. Princess’s weeklong Alaska cruise next May is under $800 a person (not including excursions) on a ship that fits around 2,500 passengers. Lindblad’s ship has one staff member / expedition team leader per every 10 guests, so passengers can get to personally know their tour guides or even all of the staff members. There’s simply no way Princess is going to be able to meet that level of intimacy. In addition, there are many places and activities that a ~60 passenger boat can do that a 2,500 person boat simply can’t.

So with the moat covered, let’s turn to valuation. Capitol’s stock is currently trading for $10.80. Post-acquisition, the company will have 48m shares outstanding for a market cap of $520m. The company has already raised a $175m term loan and will have roughly $200m of cash on their balance sheet after close, so EV is just under $500m. LTM and 2015E EBITDA (as of mid-March, 80% of capacity is booked for 2015, so good visibility into their estimate) is $45m for an EV / EBITDA of 11.1x. This compares favorably to larger peers which trade for 12-13x 2015E EBITDA.

Looking forward, Lindblad is likely to grow EBITDA significantly faster than its larger peers. Following merger close, Lindblad will order three new boats (two coastal, one blue water), with one to be delivered in each year from 2017-2019. They expect these boats will add $42m in EBITDA in 2020; combined with EBITDA from their current boats growing from $45m to $55m and the company would be doing almost $100m in EBITDA in 2020 (see slide 29 of their investor presentation linked at the end for more).

I actually think those projections on their current boat fleet are conservative. From 2010 to 2014, Lindblad grew net yield from $685 to $953 while increasing occupancy from 89% to 93%. In Q1’15, net yield increased to $1,004 from $947, though EBITDA barely budged as occupancy went from 94.3% to 92% and net costs per available night increased from unusually low Q1’14 levels (excluding fuel, $572 in Q1’14 versus $636 in Q1’15, $640 for full year 14, and $655 for full year 13). Looking forward, I think the company can continue to realize strong price increases given limited competition and the unique value of their offerings. If you think the company can increase prices by 5% per year, EBITDA from their existing fleet in 2020 would be over $60m. There’s also probably a small tailwind from the lower oil prices; at today’s levels, they’d get ~$2m annual EBITDA boost versus 2014.

Even ignoring future price increases, after those boats are delivered, Lindblad will generate significant FCF- maintaince capex is low (currently around $10m a year, about $15m a year after the new boats are delivered. These make sense: CCL is forecasting low double digits capex as a % of revenue going forward, and with pricing 5x higher here, I would think 3-4% of sales for maintaince capex is a good estimate), taxes are almost zero, and the company benefits from negative working capital as customers pay 9 months in advance. With almost $100m in EBITDA projected in 2020 the company would have $85m in cash flow before interest expense, dividends / share buybacks, or future boat build outs.

It’s worth discussing the possibility of near term boat build outs or acquisitions. The company originally planned on raising $120m in term loan to help fund the acquisition, but they increased the size to $175m and will have roughly $200m in cash on their balance sheet post acquisition. Some of that will go towards paying for their current set of newbuilds ($86m in capex in 2016 and $75m in capex in 2017), but given the cash generation of the business the company has $100-150m in additional cash to allocate. The company projects their ROIC for new builds at over 15%, and in 2013 they acquired the NG Orion for $30m and it currently does “$8-9m of annual EBITDA with significantly more anticipated in the years ahead”. I think Lindblad can continue to create significant value by buying smaller puts and putting them onto their platform / brand and additional acquisitions or boat builds will create significant value. If they don’t find any, it would be disappointing, but with peers all having 3x or more net leverage, Lindblad could pay out a significant dividend with that excess cash and still remain below peer net leverage levels (they have a term loan covenant limiting them to 4x net leverage, but they could make a significant payment before coming close to that).

Before discussing future price, it is worth discussing share structure since it’s a bit complex. Post close, there should be about 48m shares outstanding. In addition, there are 15.6m warrants (traded as CLACW) outstanding with a strike price of $11.50 and 1.25m of management warrants that are exercisable at $13, so (unfortunately) a good deal of the upside is taken by the warrants, though those obviously also make attractive investments as levered upside play here.

Assuming the company can hit $100m in EBITDA by 2020, the company would likely be worth 10x EBITDA (at the lower end of what the larger players have traded for over the past few years). They’d have generated about $100m cash over that time. All the warrants would be exercised as well for another $200m in cash. Including the $25m in excess cash now, the company would be worth $1b and have excess cash of $325m. With all the warrants exercised, there’d be about 65m shares outstanding and shares would be worth almost $20 a share. The warrants, which are currently at $2.50, would be a home run and worth $8.50.

I also think the company would make an interesting acquisition candidate eventually. While I think the company would need to be kept as a semi-separate sub given the difference between running Lindblad’s cruises and mass market cruises, there would likely be good synergies on the cost side in a potential merger. In addition, I would think a bigger cruise line would see significant value in expanding the NatGeo license to the mass market segment’s expedition branding (a la Discover / Princess), though that would likely need to be negotiated. A stock for stock deal could also make sense for the management team: the CEO founded the company in 1979. He is 65 and will own ~30% of shares outstanding after the deal closes; a scenario where he oversees the new build program, doubles EBITDA over the next five years, and then sells for a premium in 2020 (at age 70, and likely for stock to avoid taxes) is certainly reasonable.

What could go wrong?

Economic sensitivity- $10k+ vacations probably aren’t where you want to be during a serious economic downturn.

Boat issue- If one of their boats were to have a huge malfunction (similar to Carnival 2012/13 issues), it could seriously impair the brand and lead to huge legal issues. A boat sinking off the coast of Italy is a disaster; a boat sinking off the coast of Antarctica would probably be much worse.

Expansion oversaturates market- Lindblad is building three new ships through 2019, and given the upsize of their TL and cash on the balance sheet I am sure they plan on either finding more new builds or bolt on acquisitions. If it turns out they have oversaturated the market, pricing would go down and EBITDA would be much worse than forecast. I don’t think this is likely given the price increases recently and steady / increasing occupancy plus the untapped foreign market (84% of passengers come from the U.S.), but certainly a possibility.

Growth fails to materialize- Unearned passenger revenue was flat sequentially in Q1. All of the major cruise lines generally report strong unearned revenue growth in the first few months of the year before leveling off in the back half. It’s likely that Lindblad simply has different unearned revenue trends (their Antartica cruises don’t run over the summer) or this is just noise from one quarter, but it’s possible this is an early sign the model has maxed out.

Share overhang- due to the SPAC nature, there are a lot of warrants outstanding that could present some overhang for the stock.

Merger fails to close- all indications are this closes in the near term, but you never know. This wouldn’t be a horrible outcome for the stock as it would liquidate and receive $10 for a small haircut, but it’d be a disaster for the warrants, which would be worth nothing.

For investors looking to do additional work, I would highly recommend this company presentation on the merger, as well as their proxy and this article by Dane Capital on seeking alpha.

Catalyst

Merger close

Announcement of newbuilds or acquisitions