Time to Give Six Flags a Ride
Our 5 STARS (strong buy) recommendation on Six Flags (SIX, recent price: $5.75) shares is predicated on a number of factors. First, we believe management's strategy of focusing on a family-oriented park is well placed, and given the team's previous experience with ESPN and Euro Disney, we have increased confidence in their ability to generate a bottom-line improvement.
Furthermore, we view Six Flags' plans to expand into broader entertainment as positive, although this initiative is still in its infancy.
Finally, we believe the company's valuation is compelling. We see an increase in admissions, as well as food and merchandise revenues, through 2008, leading to an improvement that we believe is not yet reflected in the share price.
Six Flags is the world's largest regional theme park operator engaged solely in the theme park business. At the end of 2006, the company owned or operated 27 parks, with more than 900 rides, including more than 130 roller coasters. The parks serve most of the largest metropolitan areas in the U.S., and Six Flags estimates that approximately two-thirds of the population of the continental United States lives within a 150-mile radius of one of these parks.
Operations are highly seasonal, with more than 85% of revenues normally recorded in the second and third quarters. Parks are generally open daily from Memorial Day through Labor Day. Most parks are also open on weekends prior to and following the peak season, primarily as a site for theme events. Certain parks have longer operating seasons.
The company generates revenue mainly from the sale of tickets for entrance to its parks (approximately 54% of revenues in 2006), and from the sale of food, merchandise, games, and attractions; parking at its parks; sponsorship; and other miscellaneous revenues. Approximately 33% of aggregate attendance in 2006 was from group sales and pre-sold tickets, 27% was from season pass holders, while the remaining 40% of attendance came from day-of ticket purchases. Typically, parks charge a basic daily admission price that allows unlimited use of all rides and attractions; in certain cases, special rides and attractions require additional fees.
In December, 2005, Six Flags announced that the deadline for submission of final bids in its sale process had passed without any formal bids being received. The board of directors then ended the sale process, terminated the employment of Kiernan Burke as chief executive, and hired Mark Shapiro to replace him. Shapiro had been CEO of Red Zone, a private investment firm founded by Six Flags Chairman Daniel Snyder, and previously had been executive vice-president for programming and production at ESPN. Subsequently, the board was expanded by three seats, six new directors were named, three old directors left, and a number of senior executives were brought in. In January, 2006, the company announced that it had completed its new senior executive team, including a new chief financial officer who was formerly a CFO at Euro Disney.
The new management team has begun to put into effect a series of long-term operating initiatives. Among them: expanding the family-entertainment offering of the parks by adding additional shows, parades, fireworks, and character events utilizing Warner Bros. (TWX)-licensed properties; enhancing the guest experience by improving the overall appearance and cleanliness of the parks; reviewing Six Flags' asset base to determine whether any noncore assets, including underutilized land, should be sold; redesigning the 2006 advertising campaign to emphasize the 45th anniversary of Six Flags and increasing the use of direct marketing; and increasing sponsorship and promotional revenues as well as driving increased value from admissions and in-park revenues. These initiatives were not fully completed in 2006, and will carry into the 2007 season.
We view Six Flags as highly leveraged. At of the end of March, 2007, the company had $2.1 billion in long-term debt and $202 million in stockholders' equity. We estimate the net interest expense-to-total revenue ratio at 18.6% in 2006 and 16.5% in 2007. Six Flags expects to spend approximately $100 million on capital expenditures in 2007, adding a wide array of attractions at many of the parks. We project significantly lower capital expenditure budgets going forward as the strategy shifts from thrill rides (often costing more than $10 million apiece) to more family-oriented experiences.
We believe initiatives started in 2006, when CEO and President Mark Shapiro took the helm, should start to bear fruit as Six Flags enters the peak summer season. Management has effectively negotiated a number of corporate alliances and licensing initiatives since last year, and rides and attractions this summer will include family-friendly names such as Thomas & Friends and the Wiggles. We also believe concession alliances with brands such as Johnny Rockets and Cold Stone Creamery should help to boost sales and bottom-line results.
In April the company completed the sale of seven parks with a portion of the proceeds used to reduce debt. Elimination of these underperforming sites should allow Six Flags to focus its capital improvements and marketing initiatives on the most profitable theme parks. Additionally, given the company's high debt load, the focus on family-friendly attractions and rides seems prudent to us, given their significantly lower cost compared to constructing new large-scale roller coasters.
The company has explicitly stated it hopes to become more than a theme park operator and develop into a broadly diversified entertainment company. We see the recent purchase of a stake in Dick Clark Productions as the first step in this direction. The acquisition gives Six Flags access to original content that it hopes to leverage at its parks and through other arrangements. Notable franchises include the Golden Globe Awards and the American Music Awards, American Bandstand, and So You Think You Can Dance. We see a number of opportunities coming from this deal, including events at the parks such as American Bandstand concerts and So You Think You Can Dance competitions, award-show sweepstakes that should spur park season-ticket sales, and ownership of original content for use in park attractions.
We project net revenues will advance 9.7% in 2007, to $1.04 billion, on a 6.9% rise in theme park admissions and a 13% increase in food, merchandise, and other sales. We see these increases being driven by about a 6% rise in park attendance. In 2008, we anticipate a 9.4% increase in total revenues on a 6.9% increase in admissions and about a 12% rise in food, merchandise, and other revenues.
After an operating margin decline in 2006 due to higher labor costs, we expect Six Flags to boost operating margins in 2007 by relying increasingly on higher-margin sponsorship and licensing revenues. Higher attendance numbers should also have a positive effect on margins. We project an adjusted EBITDA margin of 21.7% in 2007. Looking to 2008, we expect similar positive trends to continue, leading to a 380-basis-point improvement, to 25.5%.
We estimate a loss of $1.31 a share in 2007, compared to a $2.43 loss in 2006. In 2008, we expect a narrower loss of 91¢ a share.
Our 12-month target price of $9.00 is based on a blend of historical- and peer-based adjusted EBITDA analyses. Our historical analysis utilizes the average five-year historical enterprise value (market capitalization plus net debt)-to-EBITDA multiple of 11.0 and then applies a slight 2% premium, given the company's operation difficulties in the past few years and the relatively more attractive growth prospects we see going forward.
Applying this multiple to our 2008 adjusted EBITDA forecast of $289 million, we arrive at a value of $9.50. Our relative analysis includes competitors such as Cedar Fair (FUN), Euro Disney, and Oriental Land Company (owner of Tokyo Disney) and uses a mean peer multiple of 11.0, implying a value of $8.50. Blending these two metrics together equally, we arrive at our $9.00 target price.
We generally have a favorable view of Six Flags' corporate governance. The company has an experienced management team, including the executives mentioned earlier. We view several practices positively: The board is controlled by a majority of independent outsiders, there are no related-party transactions, and the company's option plans do not expressly permit repricing.
However, there is a poison pill in place and there is no disclosure of stock ownership guidelines for executives or outside directors. We also note that in the company's recent purchase of a 40% stake in Dick Clark Productions, Red Zone purchased the remaining 60%. Though we generally do not see a problem with this arrangement, as both parties' interests should align, it could potentially create problems in the future.
Risks to our recommendation and target price include an economic downturn that reduces spending on leisure activities, accidents occurring at Six Flags or competing parks, adverse weather conditions, and the possibility that management's strategy is unable to increase revenue, margins, and profitability.