TEXT-Fitch rates Wyndham's proposed notes 'BBB-'
Feb 19 - Fitch Ratings has assigned an initial 'BBB-' Issuer Default Rating (IDR) to Wyndham Worldwide Corp. (Wyndham). Fitch has also assigned a rating of 'BBB-' to Wyndham's proposed issuance of senior unsecured notes. The Rating Outlook is Stable. A full list of rating actions follows at the end of the release. Wyndham has announced that it will be issuing five- and 10-year senior unsecured notes that rank pari passu with all existing notes and credit facility. The proceeds will be used to repurchase existing debt and for general corporate purposes. On Feb. 6, 2013, the company announced an any and all tender offer of its 5.75% notes due 2018 and 7.375% notes due 2020. Fitch expects today's issuance will be leverage neutral to Wyndham. The ratings reflect Wyndham's strong free cash flow (FCF) profile, its focus on an asset-light/fee-driven business model, strong market position in all of its businesses, and management's public commitment to maintaining investment-grade credit metrics. Rating concerns include the company's high exposure to the more capital intensive timeshare industry, cyclicality in the lodging and timeshare businesses, material working capital swings, and leverage being managed at the high-end of Fitch's target level for the given rating and business risks. STRONG FREE CASH FLOW GENERATION Since rightsizing its timeshare business in 2008, the company has generated strong annual FCF. At year-end 2012, the company generated FCF (after dividends) in the amount of $662 million, or roughly 25% of its total core debt balance (excludes securitized debt). Fitch expects FCF/debt will remain between 15% and 20% over the next few years, with most of the deterioration coming from dividend increases. ASSET-LIGHT/FEE-DRIVEN FOCUS Most of Wyndham's business is asset-light and fee-driven, with the exception of vacation interval sales. Approximately 60% of total revenues are fee-driven. Fitch's expectation is that management will continue to focus on asset-light alternatives in the timeshare segment (e.g., Wyndham Asset Affiliation Model and management fee revenue) in addition to maintaining its current asset-light, fee-driven lodging and vacation exchange and rentals models. The ratings reflect the addition of owned properties, which will be used for Wyndham's mixed use (lodging and timeshare) concept. Fitch expects the company's main focus to be on the franchising of its hotel brands with the mixed use concept comprising a small component of its overall strategy. POSITIVE LODGING FUNDAMENTALS Wyndham is primarily a franchisor of midscale and economy hotel brands in the U.S. (roughly 80% of current room count is in the U.S.). U.S. demand trends remain strong, although growth is moderating as the current lodging cycle matures. Fitch expects weaker growth in 2013 with a conservative U.S. RevPAR base case scenario of +4.5%. U.S. RevPAR grew 6.8% in 2012 and 8.2% in 2011, according to Smith Travel. Fitch expects Wyndham's RevPAR performance to be slightly below the industry average at this stage of the lodging cycle, as hotels in the mid-to-lower end segments generally have less pricing power than ones in the upper-scale segments. The industry is currently benefitting from high occupancy rates and low supply growth, which is leading to greater pricing power. Fitch believes that supply growth has reached a trough, with supply growing at only 0.5% in 2012. However, Fitch expects U.S. supply growth will remain below 1% in 2013 and well below its long-term historical average of 2% in 2014. DIFFERENTIATED SEGMENT: EXCHANGE & RENTALS The vacation exchange and rentals segment differs from the traditional businesses of other high-profile lodging companies. Fitch views them as a modest positive contributor to Wyndham's business profile risk. Vacation exchange and rentals comprises roughly 30% of the company's revenue and EBITDA and is almost entirely fee-driven, with the exception of a small portion of owned/leased properties on the rentals side. This segment provides stability to the business profile as it had less severe declines during the past recession (-8.5%) compared to both the lodging and timeshare segments. In addition, it has a fairly flexible cost structure allowing for easier cost reductions during a downturn. Scale is a significant barrier to entry in the vacation exchange industry because a large amount of resorts are needed to make it an attractive exchange. The industry is essentially a duopoly. Wyndham's vacation exchange, RCI, has over 4,000 vacation ownership resorts and competes mostly with Interval Leisure Group, Inc., which has approximately 2,700 resorts. Near-term business risk is slightly elevated in Wyndham's rentals business due to its exposure to Europe and its small ownership position in several assets. However, it remains largely an attractive fee-for-service business that complements its other business lines well. Wyndham maintains a strong and growing competitive position, which should enable it to capitalize on opportunities in the fragmented rentals industry. This may present some M&A risk, but Fitch believes most acquisitions would be bolt-on rather than transformative and asset heavy. HIGH EXPOSURE TO TIMESHARE Fitch generally views the timeshare industry less favorably than lodging. Fitch estimates that roughly half of Wyndham's revenues and slightly less than half of its EBITDA comes from timeshare operations. The industry is currently in a stage where development spending is low compared to historical levels due to the high supply growth and demand slowdown that occurred prior to and during the past recession. Longer-term, cash flows for timeshare companies will eventually become more volatile as higher development spending will be needed to build new inventory. Wyndham has reduced its cash flow volatility exposure by focusing on recurring management fees as evidenced by its acquisition of Shell Vacations, which mostly consists of already sold inventory. Wyndham also has implemented alternative models that are less capital-intensive, such as WAAM. The WAAM models allow Wyndham to either sell other developers' inventory into Wyndham's timeshare network for a fee or buy inventory on nearly a just-in-time basis once Wyndham has a subsequent buyer in place. Fitch does not expect a significant ramp up in development spending over the next few years. Rather, Fitch expects the company will continue to seek asset-light alternatives in addition to modest inventory spending of roughly $150 million annually as it works through existing inventory. Longer-term, the ratings incorporate Fitch's assumption that inventory spending will ramp up modestly, resulting in a continued solid FCF profile. INCREASED CONTINGENT LIABILITIES The ratings reflect increased contingent liabilities from its recent management agreements with FelCor and Hospitality Properties Trust (HPT). Fitch does not expect the company to deviate materially from its lodging franchisor business model. However, Fitch recognizes the company may need to enter into management agreements, which may increase contingencies through performance guarantees, in order to grow its hotel supply and bolster the competitive position of its more upscale hotel brands. Such contingencies are factored into the ratings through an analysis of Wyndham's liquidity position and the potential impact to increased leverage as a result of having to fund some, or all, of the contingency amount. LBO RISK Fitch recognizes the company has some common characteristics of an LBO candidate, particularly a strong FCF profile, a historical valuation discount to peers, and the potential perception of a misunderstood business model. This risk is heightened in the current accommodative credit environment. However, there are several mitigants, including change of control provisions in its bond indentures, the company's competitors are largely investment grade issuers, and there is limited leveragability on some of its businesses. LIQUIDITY PROFILE Wyndham's ample liquidity position is supported by $195 million of cash, $631 million of availability (less commercial paper and letters of credit) under its corporate revolving credit facility, and $460 million of availability under its two-year vacation ownership conduit facility as of Dec. 31, 2012. Wyndham has a sizable and well-established consumer financing business related to its timeshare business. Term securitization transactions of timeshare receivables provide an additional source of liquidity and recent transaction terms have been favorable. Market accessibility was better than Fitch's expectations through the recent recession, although transaction terms were much less favorable than the current financing environment. The company's maturity schedule is favorable with no major maturities coming due over the next four years. The company had $273 million in commercial paper outstanding, as of Dec. 31, 2012. The company will continue to have a negative drain on working capital from its timeshare contract receivables. Fitch expects future changes in working capital to be roughly negative $200-$250 million, with a slight uptick coming from increased development spending on timeshare inventory. SENSITIVITY/KEY RATING DRIVERS --Fitch calculates year-end 2012 core lease-adjusted leverage of 3.35x. Fitch believes this is at the higher-end of the range it expects Wyndham to manage its balance sheet, though we expect leverage will remain around current levels in the near term. Fitch's core lease-adjusted leverage target (excludes securitized debt and consumer financial profit) for an IDR of 'BBB-/Stable Outlook' is 3.25x, with a cap of 3.5x. There is little tolerance in the current rating/outlook for leverage at or above 3.5x. Fitch allows for leverage to be slightly above its target level at 'BBB-' due to its strong FCF profile. --Wyndham's current FCF/Debt ratio is 25%, which is very strong for the rating category. If the company's FCF/debt deteriorated to below 15% without the company reducing leverage to within 3.25x there would be negative pressure on the rating/Outlook. --Negative rating pressure could result if Fitch's outlook for development spending and the capital intensity of the company's businesses were to increase materially. --There could be positive ratings momentum if the company reduced its leverage and adopted more conservative financial policies. Fitch does not expect this to occur in the near term, but upward rating momentum could ensue if core lease-adjusted leverage were reduced to around 2.75x while maintaining a solid FCF profile, and management instituted the policy to maintain leverage around that level. Fitch has assigned Wyndham the following ratings: --IDR 'BBB-'; --Short-term IDR 'F3'; --Commercial paper 'F3'; --$1 billion senior unsecured credit facility 'BBB-'; --Senior unsecured notes 'BBB-'. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable Criteria and Related Research: --'Inn the Footnotes: Comparison of Adjusted Credit Metrics and Contingency Risk for U.S. Lodging C-Corps' (Jan. 7, 2011); --'2013 Outlook: Cross-Sector Lodging & Timeshare - The Penthouse View' (Dec. 18, 2012); --'Corporate Rating Methodology' (Aug. 8, 2012); --'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 8, 2012). Applicable Criteria and Related Research: Inn the Footnotes: Comparison of Adjusted Credit Metrics and Contingency Risk for U.S. Lodging C-Corps 2013 Outlook: Cross-Sector Lodging & Timeshare - The Penthouse View Corporate Rating Methodology Short-Term Ratings Criteria for Non-Financial Corporates