Saturday, April 11, 2009

What happens when the leveraged buyout firms deleverage

The definitive users of leverage over the last 3-5 years have been the private equity funds; Blackstone, Fortress, APAX partners, KKR and the Carlyle Group to name a few. They have raised billions for leveraged buyouts, far beyond the scale of anything ever seen before. They acquired a company they felt has too much fat, trimmed it down to size - increasing profitability. This then allows them to resell, IPO or otherwise exit within a 3-5 year period with fabulous profits.

I expect many of these Private Equity Funds including Fortress, KKR and Blackstone to start to unravel within the coming months, as their short term loans (used to purchase the companies) come due. Fortress Investment Group (FIG.N) had a very public issue with Intrawest last Fall when they had to refinance a $1.7Bn loan and struggled immensely. When your facilities terms get worse you have to pay more money for the same service which is a direct hit to bottom line.  They will also be impacted as they will not be able to service the increased costs of  the debt as a result of their reduced revenues caused by the global depression, furthermore they will not be able to raise the capital needed refinance, cover shortfalls or to fuel any further growth. Thus they will be unable to hide red spots hidden within their balance sheets and we will see the beginning of a Bankruptcy season that will last throughout 2009 and well into 2010. The Private Equity funds are very well run and managed though so you can guarantee the assets are so well ring fenced that they are unaffected (bar some loss of principle) when each layer of the onion is peeled back. They will rise again to prominence in them middle of the next decade as the few assets they maintain become valuable and they are able to sell them off for a good profit. I think RailAmerica, Inc and FECI should be a great performers long term as they are cash flow businesses with incredibly high barriers to entry.

On a Micro Level looking at one of Fortresses assets that is underperforming; Intrawest. I cannot foresee them lasting the summer on heavily reduced 2009 numbers. They have frozen and rolled back salaries, lost their insurer in Liberty Mutual, seen decreased skier visits and revenue and worst of all were established using a finite model as most of their revenue and profits come form the development and sale of real estate and not the running and management of ski resorts.

Short (FIG.N).....

Intrawest's failure should spill over onto the other ski resort operators in the market and make for short term shorting opportunities and long term buying opportunities.

Thus as a small short term idea I plan to play with is:

Short Vail Resorts (MTN)

Even though their numbers are pretty reasonable, (probably a good buy at $10 at the end of 2011 season) seeing as the depression did not hit Denver till later in the season after everyone bought their season tickets (24% of revenue in 2005 to 34% in 2009). They will probably suffer immeasurably more next season.

Intrawest will probably file for the Canadian version of a CH 11 reorganization and break off the Colorado Resort in to one division, East Coast Resorts into another, maintaining Whistler Blackcomb, Tremblant and their Canadian Resorts until after the 2010 Olympics when they will hope that renewed skiing interest and revenues will save them. 

Intrawest has already divested themselves of most of their stake in Mammoth and that leaves Sandestin and Lake Las Vegas to be sold of to private investors. I would presume that the Colorado resorts would be sold off as Copper Mountain is a true "dog" and is in the Vail Resorts Epic pass stronghold of Summit County and cannot compete. They are really a great purchase for Vail resorts but the monopolies and mergers commission will probably not allow the sale.

 Steamboat will probably be sold to a private individual and will make a great destination resort and Winter Park which is 50% owned by Denver will probably be picked up by one of a few small groups of private investors; possibly including "George Gillette Jr" former owner of Vail who has been poking around in recent months. 

Intrawest as started was a short term business model which is probably why the founders sold out in 2005. It was based on ever increasing real estate sales to fuel growth but due to the finite opportunities for ski resorts this market was truly limited, which is why they did so well in it in the first place. Private Equity funds sometimes lack alot of the necessary understanding of the core and underlying business which causes them to err dramatically. The thing that makes a great ski resort is great grooming and phenomenal customer service, these do not run hand in hand with a spreadsheet in Manhattan.

Copyright Jonathan Rose 2009 - Creative Commons License

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