SeaWorld Entertainment (SEAS) : Outlook

• SeaWorld Entertainment (NYSE:SEAS) operates a diversified portfolio of 11 destination and regional theme parks that are grouped in key markets across the United States.
• SeaWorld offers a very good customer experience, where, according to the company's Q3 2014 filing, TripAdvisor ranked 9 out of its 11 parks among the best 25 attractions in North America, and Discovery Cove was voted Number 1 amusement park in the world for 2 years in a row.
• The company has spent more than $500mm, or a third of its market cap, on capex over the last three years to ensure new attractions and state-of-the-art facilities support higher attendance.
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• The stock trades 48% below its IPO price, on the back of a wide range of factors of temporary nature, where things can be fixed with a bandage.
• Announced restructuring program should generate nearly $50mil cost savings by the end of 2015.
• SEAS instituted a buyback program for 16% of its outstanding stock given the current pricing, which should help shares close at a sizable discount to peers.
• Replacement of the CEO should help fixing the prior ticket pricing mistakes that exacerbated the decline in revenues and margins.

Why has the stock underperformed?

A string of unfavorable events led to a 5% YoY drop in attendance at SEAS's theme parks for Q3 2014. The developments include a documentary promoting a negative image of the company, widely anticipated attractions at competing parks and poor decisions on ticket pricing on the part of the company's management. Given the high fixed operating cost leverage, lower attendance led to a sharp drop in EBITDA and created uncertainty around the prospects of the company.

Source: Company data

• Ticket pricing missteps led to a significant fall in revenues. The company offered discounted tickets on the premise that this would drive higher attendance, which in turn, would compensate with increasing in-park spending. In the end, this simply resulted in a drop in revenues.
• The documentary "Black Fish" has generated significant negative publicity for SEAS and contributed to the decline in visitors. Additionally, the proposed legislation for banning captive orcas in California added to the earnings uncertainty, where, fortunately for the company, the legislation eventually failed in the April of 2014.
• Launch of attractions at competing parks led to attendance eroding further, with the Harry Porter anniversary celebrations at Universal being a particular detractor.

But all of the negative developments are of a temporary and reversible nature, and poor pricing decisions are possible to fix in quick order. As a result, I believe the current stock price offers a highly attractive entry point for long-term investors, with multiple catalysts to support a rebound.

Long-term growth

• SEAS intends to institute an asset-light international expansion program. The company has the capacity to attract a park partner to build the physical asset and then operate it based on a management contract plus royalties. Wildlife is an area which is universal and attracts interest on a global basis, which opens a wide range of attractive opportunities with negotiations for new park in India, Russia and the Middle East.
• The company implemented an extensive reinvestment program, spending $580mil on capex over the past 3 years, and will bring additional attractions in the coming years. The Blue World Project would bring new killer whale environments to 3 SeaWorld parks, with the first to open in San Diego in 2018.

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Source: Company data

Catalysts for change

Improvement in management. In December, the board removed the long-standing CEO, Jim Atchison, on the back of the company's underperformance and management missteps. Chairman David F. D'Alessandro will serve as the company's interim CEO until the board selects a permanent successor over the next 6-9 months. Fortunately, Blackstone still maintains 16.8% interest in SeaWorld and controls the board. Blackstone acquired the business in the dark days of 2009, and the company trades in line with those valuations.

I believe the expertise and significant control by the private equity sponsor would ensure normalization of the operating performance in a short period of time and the more skillful management stepping in place. Management has already announced that it is reviewing its marketing plans and performing in-depth research to better understand guest needs and preferences, and hence, should avoid previous marketing mistakes.

Improving free cash flows. High capex over the recent years provided a major drag on the firm's FCF. Normalized maintenance capex was guided by management at 10% of revenues, which would imply just $140mil a year, significantly below the recent $170-220mil. Normalization of the company's operating results by 2016 would offer significant improvement in Free Cash Flows, hence making the real earnings of the business more evident.

Restructuring. SeaWorld announced the elimination of 300 positions across its eleven theme parks and its headquarters as part of the restructuring program announced in December 2014. The company-wide cost initiatives are projected to deliver $50mil in annual cost savings by the end of 2015. It expects to record approximately $12mil in restructuring charges for Q4 2014 on the back of those initiatives.

Benefit from cheaper gasoline. Cheaper oil would translate into much cheaper gasoline for consumers, which in turn, effectively translates into cheaper entry tickets for visitors, since they would be making significant savings on the costs of transportation to get to the parks. Currently, gasoline futures for June-August period are approximately 47% below the corresponding period prices in 2014.

Refinancing. SEAS intends to execute refinancing of the expensive $260mil 11% senior notes, which would generate sizable interest expense savings, since those notes are callable from December 2014. Given the secured SEAS's debt financed at Libor +225bps, we can conservatively assume 4% interest upon the refinancing of the 11% notes, which would translate into around $18mil annual savings.

Buyback. SEAS earlier instituted a $250mil share buyback program, which represents 16% of outstanding equity value. This program was commenced in December 2014, and should serve as a further significant catalyst for a rebound, given its large relative size.

Potential for REIT conversion. Management openly spoke about the possible REIT conversion, which would eliminate taxes on the corporate level and create opportunity for further upside on the back of valuation multiple expansion. Given the long and time-consuming process of such conversion, I would project this to be achieved only in 2016, which may lead to EV/EBITDA multiple increasing to 13x-15x and in line with Six Flags valuations.

Valuation and great upside

SEAS stock represents a highly asymmetric situation from the risk/reward perspective. Theme parks are a stable and high cash flow-generating business, which makes a further decline in EBITDA highly unlikely. At the same time, SEAS trades at close to 30% discount to its peer median EV/EBITDA, which would be hard to justify for prolonged periods of time, where stable YoY revenue for the second quarter may act as a strong catalyst by dissipating the prevailing uncertainty. Second- and third-quarter data would be especially significant because SEAS operates a highly seasonal business, with summer months representing the peak of activity.

The expected attendance for 2014 is nearly 10% below the levels reached just in 2012, and there is a high chance of this decline being reversed over the next 2 years as negative audience reaction to the killer whale documentary subsides and management corrects its earlier missteps. Stable visitor numbers over the next 6 months would be a good indication of a business turnaround.We expect SEAS to trade around $20 by second quarter and around $24 by end of this year.