Since 2011, a fundamental shift has transpired, whereby the major hotel brands like Marriott International, Hyatt, Starwood Hotels and Resorts and most recently Hilton and Wyndham have been divesting their vacation ownership units from their core hospitality and leisure platforms. In this article we will look at a historical perspective of why the hotel companies entered the Vacation Ownership space and now, what is driving the divestiture of these business units from the conventional hotel brands.

A Historical Perspective

In 1984, Marriott became the first of the major brands to enter the VO industry by acquiring American Resorts and its 122 units in Hilton Head Island, which eventually was re-branded as Marriott’s Monarch at Sea Pines[1]. Disney was another major hospitality/theme park company who entered into the business in 1991 at Walt Disney World in Orlando. Hilton was the next player when it entered a joint venture with Grand Vacations Limited in 1992[2]. What the brands were evidencing was that their well-known consumer hotel brands both attracted new customers and added strong credibility, which helped allay reputational issues associated with vacation ownership or timeshares. Hyatt, Starwood and Wyndham entered the industry as well. Today, approximately 80% of timeshare sales originate from the major brands and independents, and with the help of the American Resort Development Association (“ARDA”), most of the high pressure reputational issues abated as the major hotel companies realized how important their brand name was.

So what happened? Where did the business model fall apart? In our opinion there are four key factors that were critical to a pending disassociation and subsequent divestitures;

1)   The capital intensive nature of VO products to acquire, entitle, develop, build, sell and manage[3];

2)   The Returns On Capital were not matching the needed returns that the management and branding operations were supplying;

3)    There were cultural issues between the core hotel company and the VO division, in how executives were compensated, the needs of the VO company in “purchasing” inventory from their sister company and its constant consumption of capital.

4)   The associated financial risk of the VO divisions during stressful economic times

The Capital Intensive Nature of VO Products

By their very nature and certainly in comparison with their traditional counterparts in the transient hospitality divisions, the VO divisions consumed a tremendous amount of corporate capital. Interval Leisure Group (“ILG”) was traditionally an almost pure asset light company, acquired both Hyatt’s VO division and should be closing on Starwood’s VO division sometime in the 2nd quarter of 2016. ILG who initially projected a combined capital investment inclusive of Hyatt’s timeshare development, of $141 million for the period of 2016-2018 will likely see the same capital investment increase by an additional $770 million in acquiring Starwood’s VO group renamed Vistana Experience[4]. ILG appears to be substantially increasing capital investment with the hopes of dramatically increasing earnings, securing their member base and capitalize off of the top tier brands in the Vacation Ownership space. Not only do these VO divisions require substantial capital to develop and build, substantial additional working capital is required due to the negative cash flow from operations during the initial years of sales at each individual resorts.

Returns On Capital

 Not only were the VO divisions requiring substantial capital, their returns were less than spectacular. Some of this was driven by allocated centralized G&A (from the branded hotel companies) but much of it was a simply the lower returns on larger capital investment. Historically, Marriott International’s hotel division has largely been a fee driven, asset light business model. While some capital was needed to acquire management contracts and brand agreements, much of this was related to “key” money or small slices of capital to get the management contract. Often, this capital was returned in one to five years with ROI in the high teens and low 20’s percent. Some VO divisions were only returning a paltry 10%-12% on a fully allocated G&A basis. While Marriott did invest capital to develop, it was largely to launch brands or secure long-term management contracts and then divest the hard asset (i.e. Edition Hotels).

Cultural Issues

By its very nature, the VO divisions were led by their sales and marketing associates and executives who were focused on commissions. Commissions and over-rides often ran at 15% to 20% of each sale. The way their overall compensation was structured was very different than their transient divisions. Executives in the VO division could earn substantially more than their more senior counter parts in the hotel division. Divestitures could help the hotel companies more closely align compensation with unique corporate cultures of these synergistic but different divisions.

There are core differences between the traditional transient hotel/resort model and the VO business model. In fact, maintenance fees have escalated sharply as many VO companies restructure their business into Club based points programs in contrast to deeded interests at resorts. In a number of cases, we are seeing maintenance fees rising to as much as $2000 per one-week interval or almost an additional $300 per night. When you take into account the lower end VO companies the average is about half that amount.  Millennials are simply not buying this product in any volume. It is also substantially more complex in its accounting and treasury functions. On top of these issues, it is highly regulated and management contracts can typically only be written for 3 to 10 years varying from jurisdiction to jurisdiction in contrast to 40, 60 and even 100-year management contracts in the hotel divisions. In sum, while there are excellent synergies between the two product classes, the VO model simply presents substantially more human resource, treasury and management issues as compared with traditional brand and management operations.

Economic Risks Associated with Specific Adverse Economic Conditions

The VO industry was historically thought of being recession proof (see graphs below). But the specifics of the 2008-2009 “great” recession shook the industry to its core. Historically, recessions were judged on the amount of unemployment and successive quarters or months of negative GDP growth. However, the “great recession” of 2007-2009 had a third component which proved to be highly destructive to the entire capital markets and the VO divisions in particular. In short, there was a complete collapse of the ABS market and an almost complete evaporation of liquidity in the market place. While their sister transient divisions fell in EBITDA and earnings as management and brand fees fell, due to RevPAR declines, they still made fees and had asset light balance sheets. However, on the VO division side, whole projects had to be shelved and in many cases they had to intentionally stop or slow down sales. They were forced to revalue and write-off large sums of capital and charge such write-offs to corporate earnings. Additionally, the industry was devastated and a multitude of bankruptcies which followed[5]. This proved the fallacy that the industry was “recession proof”. And while the traditional hotel industry has prospered since 2009, setting records in virtually all metrics, the VO industry is still down approximately 10% to 15% (8.6 billion in 2015 and an expected $9.0+ billion in 2016) from its highpoint with the factional and PRC businesses struggling at levels one-sixth from their high point in 2007 (See graphs below). The value of the private and public timeshare companies fell precipitously in 2015 and early 2016, have since rallied from mid-2016 to present.

Summary

The major hotel brands are divesting their VO divisions for capital, cultural and economic risks as contrasted to the traditional hotel industry. Hilton, recently announced its decision to divest its VO division. Wyndham has just recently announced the separation of their hotel and VO platforms. , Upon closer review, Wyndham is much more of a traditional VO company with over 80% of its total revenues coming from VO related divisions including traditional VOI sales, financing revenue, fees from managing the resorts and its rental and exchange divisions[6]. It now seeks to completely separate its hotel “brands” from the VO company to provide for a pure play hotel stock and a pure play VO stock. Upon conclusion of its separation of the company in 2018, Wyndham’s VO company will look strikingly similar to ILG in-terms of its core offerings and divisions.

Publically traded Vacation Ownership companies had seen dramatic falls in their stock prices in 2015 into 2016. However, since July of 2016, Most of the VO companies have rallied on news of share buy backs, increased dividends and a stock market that has been surging in many sectors. Presently the leading VO stocks are trading in the 25-32 PE multiples. Even the lower valued public companies are trading in the high teens.  While there has indeed been earnings growth there is generally less room for revenue growth until the major VO companies find new sources of sales instead of a high reliance on existing customer base. A re-alignment of investors is currently taking place along with management looking for ways to lessen capital exposure. Further, we believe there will be additional rounds of consolidation, which should provide some downstream savings in corporate G&A where duplicative platforms can be eliminated for cost savings. However, we believe that a pure asset/capital light VO company either will not be able to survive or will do so with substantially lower growth prospects. Rather, they will need to combine more capital intensive asset strategies[7], including ground up development and acquisitions to survive and grow. In the end analysis, these companies will require substantial capital as contrasted with their hospitality counterparts, in order to regain their historic revenue and earning levels.

[1] Wikipedia – The history of Marriott Vacations as well as Company filed S-4’s prior to divestiture in an IPO.

[2] A History of Hilton Grand Vacations – Wikipedia

[3] Asset Light and Capital Light Strategies for the Vacation Ownership Industry – Published in Hotel News Network, March of 2015, by Jon R. Simon, ISHC

[4] ILG S-4, Filed 12/15/2016, pages 94-95.

[5] 2014 ARDA-AIF State of the Vacation Timeshare Industry, page 13, prepared by Ernst and Young

[6] Wyndham Worldwide – 2014 Form 10-K

[7] See “Capital and Asset Light Strategies for the Vacation Ownership Industry”, Published in Hotel News Network in 2015.

July 7, 2018

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