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On August 8th, SeaWorld reported 2Q17 adjusted net income of $16.8 million, or $0.20/share, down 5% from the year-ago adjusted net income of $17.8 million, or $0.21/share. An adjustment of $269 million reflected the write-off of all goodwill associated with the company’s Orlando theme park. The write-off does not affect operations, taxes or cash flow. The full release can be viewed here.
Adjusted Ebitda, or earnings before interest, taxes, depreciation and amortization, was $104 million, up 24% from a year ago, based on the company’s definition of Adjusted Ebitda. Free cash flow, which can be affected by the timing of working capital changes and other somewhat discretionary items, was $36 million, up from $24 million a year ago.
Revenues of $374 million increased 1% from a year ago, with a boost from Easter occurring in 2Q this year but in 1Q last year. For the first half of 2017, which includes Easter in both years (obviously), revenues were down about 5% from last year’s first half. Revenues were about 5% below analysts’ consensus estimate of $394.4 million and earnings were 38% below the $0.32 consensus. Adjusted Ebitda was a tad better than consensus.
Due to a weaker revenue outlook, higher nation-wide advertising spending needed to encourage attendance, and competitive pressures, the company reduced its full-year 2017 Adjusted Ebitda guidance to $295 million (mid-point), down 14% from its previous guidance of $345 million (mid-point), clearly disappointing investors. SEAS shares fell just over 6% in trading on the day, and had been down as much as 18% at one point.
Park attendance continues to struggle to remain flat. While 2Q17 attendance was up about 138,000 guests, the improvement was due to the Easter effect. For the first half, attendance was down about 353,000 guests, or 3.8%.
Most of the weaker attendance was from weakness in guest counts from Southern California and from guests who live more than 300 miles from the Orlando and San Diego parks. Management had pulled back on its ‘reputation marketing’ and nationwide advertising in prior quarters, and said that this has led to a re-emergence of brand perception issues and generally lower interest in visiting SeaWorld. The company is confident that restoring its previous advertising spending level will reverse these issues, with increases in ad spending underway now.
Attendance increased from guests who live within 300 miles, partly driven by the growing success of the new season pass offering. SeaWorld has clearly struggled to offset the negative publicity of its killer whale shows, and then ironically the resulting lower attendance from the closing of the shows. Competition in Orlando also continues to be particularly sharp. We find it encouraging that local attendance (inside a 300-mile radius) is generally strong and that attendance by longer-distance travelers is fairly sensitive to advertising. While we’ll leave it to the management team to decide the profit trade-off between higher advertising costs and higher attendance revenues, the fact that the relationship exists gives the company a lever to adjust and offers a solution to a difficult problem. The boost in advertising costs hurts the company’s near-term profits and won’t likely be fully offset by lower costs elsewhere.
Some attendance weakness is outside of the company’s ability to influence. Attendance from U.K. travelers will apparently be down 20% this year, which alone could remove 1% from total revenues. The U.K. currency has weakened from a year ago relative to the dollar, making travel to the U.S. more expensive. Also, uncertainty about Britain’s upcoming departure from the European Union and its effect on their economy could also be contributing to weaker attendance. Lower attendance from Brazilian visitors seems to be improving some.
The company’s debt remains relatively high and the lower Ebitda guidance could result in a ratings downgrade. Management is confident that no covenant violations would occur in 2017 or 2018. Fortunately, there are no maturities until May 2020 and its committed borrowing capacity provides considerable liquidity. However, significantly weaker Ebitda than guided could trigger debt covenant violations. We would expect these covenants to be renegotiated but this could raise SeaWorld’s costs. Management sounded like they were being conservative for the 2017 guidance, so this bears watching.
In essence, the risks to the SeaWorld story have increased, as lower profits could pressure capital spending (which would weaken the parks’ competitive positioning), advertising spending and their credit rating (further pressuring their finances). This higher risk is pushing the stock to its lows.
Overall, we think SeaWorld is much better managed than under its prior leadership. The new team has addressed head-on the killer whale issue, modernized its pricing and revenue management systems, upgraded the parks including adding new rides and attractions, streamlined much of the operations and is pursuing new growth opportunities including potential Asian and Middle East expansion, domestic Sesame Street/Place expansion and possibly a new resort. Much of the weaker revenues so far this year have been offset by trimming unnecessary costs and processes. Management appears to have a handle on their problems.
An activist fund, Hill Path Capital, holds a 13% stake. While unlikely near-term, they could enlist the interest from other investors in more aggressive changes, including perhaps a sale or breakup. Chinese strategic investor Zhonghong holds a 21.5% stake, and is likely but not guaranteed to favor the status quo.
The turnaround, which is heavily driven by higher attendance and higher margins, will take longer than we expected, but we remain confident that it will be successful. Most of the problems are at their San Diego and Orlando parks (admittedly a large part of the business). The San Antonio park and their other parks (Williamsburg, Sesame Place, Busch Gardens, etc) are doing well.
As frustrating as it is to see a stock decline 40% from our recommendation, turnarounds like SeaWorld can produce a highly volatile stock price. Valuation is still low, at 9x the depressed 2017 Ebitda guidance mid-point, reflecting low investor expectations. We continue to rate SEAS shares a BUY up to 27.