Description

ILG is a vertically integrated timeshare developer, operator and exchange network. After its recent merger with Starwood’s ("HOT") timeshare operator Vistana, ILG is a transformed company with sustained EBITDA growth potential. We believe the market is currently discounting two significant aspects of the merger: 1) the complementary nature of the combined businesses and 2) its ability to unlock the sales and development potential of Hyatt Vacation Ownership, a previously acquired asset. ILG’s EBITDA should be able to grow at a ~10% CAGR over the next few years and free cash flow should more than double from 2017’s run-rate of $120-140MM. With our 2018 EBITDA estimate of ~$400MM, a multiple of 10x would yield 30% upside.

Founded in 1976 and spun-out of IAC/InterActiveCorp ("IAC") in 2008, ILG is a leader in the vacation ownership (VO) interval exchange business. Given the historically fragmented nature of the industry, interval exchanges played a vital role in enabling an owner of fixed week intervals to swap for a comparable use of another resort. Recently, industry consolidation and slower net owner growth have weighed on the exchange’s growth. With the acquisition of timeshare developer/operator Vistana, ILG has been simultaneously vertically integrating its sourcing of new exchange members while providing new substantial opportunities for growth.

In merging with Vistana, ILG has acquired a VO development business primed for substantial growth. Since the financial crisis, due to Starwood’s shifting capital priorities, Vistana was not managed for growth. When Vistana prepared for a spinoff in 2015, management outlined a substantial brownfield development pipeline that included expansions of various properties and the conversion of five hotels. We believe the combination of pent-up demand for new units along with a low-risk brownfield expansion plan creates a unique inflection point for growth. In merging with Vistana, ILG is getting both the management team and the game plan to drive that growth.

What makes the timeshare development business economically attractive is that recent timeshare demand driven sales growth has been in the mid to high single digits while supply growth has been relatively tepid. Historically, timeshare demand has been resilient with sales volumes growing in 28 out of the last 30 years. From a financial perspective, the timeshare business is attractive considering the number of fee streams a new owner provides. Specifically, VO developers can earn:

• Development margin on a sale

• Interest spread if a purchase is financed

• Management fees for property upkeep and maintenance

• Rental fees for unsold inventory

• Higher-margin on an upgrade sale

Yet despite these various fee streams, timeshare stocks appear relatively under-owned and under-followed. A few potential reasons:

• Investors see the timeshare industry as predatory and offering limited value to customers

• Timeshare companies are an ‘odd lot’ in the lodging space:

     o They are neither ‘fee for service’ hospitality C-Corps nor asset heavy REITs

• Timeshare stocks have been spun off from larger parent companies

• Timeshare stocks have relatively small market caps with limited sell-side coverage

In our view, continued industry growth and greater visibility of ‘branded’ timeshare players should sway market opinion over time. While the industry still needs to address certain issues, today’s timeshare product is more heavily regulated and consumer-oriented. Timeshare companies generally need internally sourced capital in order to grow most effectively and that typically did not fit with the ‘capital light’ business models of their parent companies. This doesn’t make these businesses ‘bad’, per se, they just need to be examined through a different lens. Private equity, for instance, has viewed this business through a more positive lens. In recent years, PE has committed capital to develop timeshares in conjunction with external operators and even purchased some operators outright. Most recently, Diamond Resorts International ("DRII"), our biggest winner in 2016, was acquired by Apollo Global Management ("APO").

In assessing the combination of the exchange and VO businesses, we believe investors underrate their highly synergistic nature. The growth of the VO business will bring new customers into ILG’s exchange while the exchange’s cash flows will effectively self-fund all of its development pipeline. In addition, ILG’s exchange and Vistana’s management fee businesses provide a very stable base of recurring cash flow. We estimate that roughly 60% of ILG’s EBITDA has >90% recurrence and low economic sensitivity, which compares very favorably to peers. This base of cash flow should enable ILG to sustainably reinvest in its business throughout the cycle.

Given the heavy focus on the Vistana development pipeline, we also believe the market is missing the benefits the deal will have on ILG’s Hyatt VO business. Historically, Hyatt’s footprint has been built out through joint ventures where third parties contribute capital/land, thereby limiting the required outlay of capital. We believe that the integration of the Vistana sales platform will be a catalyst for incremental third-party capital interest. We believe Hyatt’s modest footprint, gives the company substantial opportunity to grow the business in a capital efficient manner, which could generate incremental fee streams not contemplated in the current guidance.

We believe that with an expected ramp in contract sales, ILG should see double digit EBITDA growth and even stronger FCF growth. ILG’s growth trajectory, low leverage, and recurring base of EBITDA warrants a 10x EBITDA multiple on 2018 EBITDA or a $30 stock. Historically, ILG has traded between 8-10x EBITDA and with the merger improving the quality of the business, we are comfortable that ILG can trade at the higher end of the range. We also view management’s decision to quickly buy back 5% of the float after the deal closed as a strong signal, which reflects their own bullish view on the stock.

We think there are multiple catalysts for a rerating: 1) a ramp in VO sales, 2) a new JV project for Hyatt, 3) an increase in FCF as ILG completes a heavy spend year in 2017, 4) a May Investor Day, and 5) increased investor awareness of the timeshare space as a result of Hilton’s ("HLT") recent spinoff of Hilton Grand Vacations ("HGV"). In addition, we believeany potential corporate/consumer tax reform would yield substantial benefits to ILG: ILG pays a full U.S. cash tax rate and has little corporate debt and its consumers would benefit from the increase in discretionary income.

Finally, much has been made of the fact that Marriott ("MAR") will likely combine the Starwood and legacy Marriott Rewards programs together, which could force ILG to sell itself to Marriott Vacations Worldwide ("VAC"). While we disagree that ILG will be somehow disadvantaged by the combination of the two loyalty programs, we do believe that future industry consolidation is likely. Given the substantial corporate and marketing costs associated with running a timeshare business, we do believe a combination could drive an even higher stock price.

Catalyst

As described above:

• a ramp in VO Sales
• a new JV project for Hyatt
• an increase in FCF as ILG completes heavy spend year in 2017
• a May 2017 Investor Day
• increased investor awareness of timeshare industry