Wyndham Hotels &Resorts, Inc. (NYSE:WH) Q3 2023 Earnings Call Transcript

Wyndham Hotels & Resorts, Inc. (NYSE:WH) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Welcome to the Wyndham Hotels & Resorts Third Quarter 2023 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode, and the floor will be opened for your questions following the presentation. [Operator Instructions] I would now like to turn the call over to Matt Capuzzi, Senior Vice President of Investor Relations.

Matt Capuzzi: Thank you, operator. Good morning and thank you for joining us. With me today are Steve Holmes, our Chairman; Geoff Ballotti, our CEO; and Michele Allen, our CFO. Before we get started, I want to remind you that our remarks today will contain forward-looking statements. These statements are subject to risk factors that may cause our actual results to differ materially from those expressed or implied. These risk factors are discussed in detail in our most recent annual report on Form 10-K, filed with the Securities and Exchange Commission, and any subsequent reports filed with the SEC. We will also be referring to a number of non-GAP measures. Corresponding GAAP measures and a reconciliation of non-GAAP measures to GAAP metrics are provided in our earnings release and investor presentation, which will be available on our investor relations website at investor.wyndhamhotels.com.

Aerial view of a luxurious resort lifestyle hotel in a gateway city.

We are providing certain measures discussing future impact on a non-GAAP basis only, because without unreasonable efforts, we are unable to provide the comparable GAAP metric. In addition, this morning we posted an investor presentation containing information with respect to our board's rejection of Choice’s unsolicited offer. We may continue to provide supplemental information on our website in the future. Accordingly, we encourage investors to monitor our website in addition to our press releases, filing submitted with the SEC, and any public conference calls or webcasts. With that, I will turn the call over to Steve.

Stephen Holmes: Thanks, Matt. As all of you are aware, last week Choice Hotels announced that they made unsolicited overtures to acquire our business. With no organic growth, a less vibrant loyalty program, and virtually no international capabilities in Choice's platform, we are frankly not surprised. Our business offers a medicine cabinet full of remedies. Our board has taken its fiduciary duties very seriously with respect to shareholders and other stakeholders, including franchisees, employees and guests. We strongly believe that Wyndham’s standalone plan and multiple levels -- levers of growth provide a more compelling proposition compared to Choice’s offered. Our board is also highly confident in our management team's capability to execute on the plan and create significant value for our stakeholders.

We have received multiple inputs from key constituents over the past week, providing us with further confidence in our decision to reject the offer. The team will be providing further insight into our decision-making rationale after we review our strong third quarter performance. I'll now hand the call over to Geoff.

Geoff Ballotti: Thanks, Steve. And thanks everyone for joining us today. We're very pleased to report another strong quarter of operating performance. Globally RevPAR grew 3% in constant currency, led by international growth of 16%. While US RevPAR declined by 1%, our economy brands continued to gain market share, outperforming their competitors by another 100 basis points this quarter, driven in part by revenue growth from our general infrastructure-related business accounts. We grew our system for the 11th consecutive quarter up 1% sequentially and 3% year-over-year on an organic basis. Our teams opened over 14,500 new rooms in the third quarter with 5,900 of those rooms opening in the US. Year-to-date through September 30, we've opened over 42,600 rooms across 326 hotels, opening more than one hotel each and every day.

We improved our retention rate by another 20 basis points from where it stood at the same time last year, as our industry leading brands maintained the highest overall franchisee retention rates in the US Economy segment. Our pipeline grew for the 13th consecutive quarter, up 4% sequentially and 12% versus prior year, including 2% sequential growth in the US and 16% year-over-year. Our teams awarded more than 230 contracts for over 26,000 rooms with 15% of our pipeline now representing our Echo Suites extended stay by Wyndham brand and an additional 7% of our pipeline now in the higher RevPAR mid-scale, upscale, upper upscale and luxury segments. Our owner first philosophy was on full display last month in Anaheim where we held the largest global conference we've ever assembled with over 6,000 registered attendees and more than 150 sponsors.

The conference provided our franchisees an opportunity to connect with their colleagues and learn firsthand how to unlock the power of recent investments we've made in next generation technologies, sales and marketing initiatives, and hotel-level operating efficiencies. Our owners have never been more engaged with our teams and the superior value proposition that our brands today deliver. Before Michele takes us through the financials, we'd like to take a moment to acknowledge our team members. The incredible success of our owner first operating philosophy would not be possible without their unwavering commitment and support. And we're thrilled about our most recent ranking at number 8, up from number 11 last year on Newsweek's Top 100 Most Loved Workplaces for 2023.

We thank all of our team members around the world who put our owners at the very center of everything it is that we do and who remain enthusiastic about the opportunities ahead for us and confident in our ability to deliver the outstanding value day in and day out to our shareholders, our guests, and our franchisees. I'll now turn the call over to Michele. Michele?

Michele Allen: Thanks, Geoff, and good morning, everyone. During the third quarter, fee-related and other revenues grew 7% reflecting global RevPAR and net room growth, as well as higher license and ancillary fees and pass-through revenues in our marketing, reservation, and loyalty funds due to our global franchisee conference in September, which was held for the first time since 2019. Adjusted EBITDA grew 5%, primarily reflecting higher fee-related and other revenues as well as marketing fund variability. Marketing fund revenues exceeded expenses by $17 million this quarter versus $12 million a year ago. Our adjusted EBITDA margin remained consistent at 83%. Third quarter adjusted diluted EPS improved 8%, reflecting our adjusted EBITDA growth, as well as benefits from our share repurchase activity and a lower effective tax rate which were partially offset by higher interest expense.

We generated $67 million of free cash flow in the third quarter and $225 million year-to-date. We remain on track to achieve our goal of converting 50% to 55% of full year adjusted EBITDA to free cash flow, which at the adjusted net income line translates to approximately 100%. We returned $134 million to our shareholders during the third quarter through $105 million of share repurchases and $29 million of common stock dividends. Year-to-date, we have repurchased 3.8 million shares of our stock for $270 million. We ended the quarter with approximately $710 million in total liquidity, and our net leverage ratio of 3.3 times was in the lower half of our target range. We are reaffirming our adjusted EBITDA guidance of $654 million to $664 million and raising our adjusted diluted EPS outlook to $3.94 to $4.08 to reflect our continued strong performance as well as our third quarter share repurchase activity.

That concludes our prepared remarks on our third quarter results. Geoff will now walk you through the rationale behind our board's rejection of Choice's unsolicited offer.

Geoff Ballotti: Thanks, Michelle. As Steve referenced in his opening remarks and consistent with its fiduciary responsibility, our board, along with its third-party advisors evaluated Choice's proposals. Our board begins from the premise that as a public company with a well distributed shareholder base, we're open to any and to all avenues to create value for our shareholders. Many of these value creation opportunities are driven from organic growth initiatives, some are from inorganic growth initiatives, and some are initiated by third parties. Our board has deep experience and has always provided oversight on our major strategic initiatives and opportunities. With respect to the offer made by Choice in August, our board determined for several specific and well-substantiated reasons focusing on both transaction risk allocation and valuation that the proposal was not in the best interest of Wyndham shareholders and rejected the offer.

We've been consistent with Choice from their initial inbound that our concerns would need to be satisfactorily addressed, something they have not done to date. In our press release last Tuesday, we provided initial rationale and insight into our board's decision to reject the offer. Today, we'll go through greater detail around that decision and walk you through our significant standalone growth prospects. This morning, we posted an investor presentation to our website, and we'll be referencing that throughout this discussion. We start by level setting who Wyndham is today on Slide 2. Not only are we the largest hotel franchisor in the world, but we're also the only public hotel company of scale that is truly asset light, generating significant free cash flow which allows us flexibility on how we choose to allocate our capital whether it be for investment in growth initiatives with attractive ROIs or whether it be returning capital directly to our shareholders.

Since our spinoff from Wyndham Worldwide we've undertaken a series of initiatives as outlined on Slide 3, that lay a strong foundation and provide a runway for sustainable organic growth going forward. Initiatives like our Echo Suites by Wyndham brand, the fastest growing brand in the underserved economy extended stay space and one we're expecting outsized economic benefits from in the coming years. Investments we've made in hotel level sales and marketing to grow our share of existing infrastructure bookings and to capture the opportunities just now emerging from the recent infrastructure bill. And investments we've made in our Windham Rewards loyalty program with over 105 million members, a program that's been voted the best hotel loyalty program by USA Today for six consecutive years.

We've also capitalized on the significant growth potential outside of the US with our direct franchising capabilities now in 95 countries. These growth initiatives and so many others support Wyndham's owner-first reputation as the franchisor preference for hotel owners in the segments we operate in, and our franchisee retention rates have correspondingly improved. While some of the benefits of these actions are already reflected in our financial performance. We believe that there will be an even greater benefit from them in the coming years, given the long tail for development, retention, and new product innovations. We're confident that these initiatives provide a significant runway for outsized growth and enhanced shareholder value. And with that background on our company, we'd now like to detail some facts surrounding the Choice offer.

While the offer may have had an initial headline of $90 per share, the proposal is currently worth less and may continue to fluctuate in value over time, as it includes a significant amount of stock consideration. Just last week, within a few days of Choice's public announcement, Choice's stock had decreased by over 9%, and the implied value of the offer was already $4 lower at $86 per share. And it's important to note that Choice has not offered our shareholders any protection against potential continued downward volatility. Furthermore, the fixed value of the cash portion offered to our shareholders would not be realized until the conclusion of an extended regulatory process which our advisors estimate could take 12 to 18 months. When we consider all of this, one point is clear, the actual offer is worth materially less to our shareholders if and when they receive it.

At its core, there are three primary reasons why our board has rejected Choice’s offer, which you could find on Slide 4. First, there is asymmetrical risk to Wyndham shareholders associated with an uncertain regulatory timeline and outcome without commensurate protections and compensation provided to our shareholders for taking on these risks. Second, Choice's proposal does not provide appropriate value for Wyndham's standalone growth prospects and exploits short-term volatility in Wyndham's stock price without a consideration of a broader view of Wyndham's trading levels. And third, the consideration mix includes a heavy portion of Choice stock. Our board has concerns over Choice's organic growth prospects, and those concerns are exacerbated if the pro forma company will be left with an over-levered balance sheet that constrains its capital allocation strategy in a material way, further limiting its growth opportunities.

We'll delve into each of these points in more detail, and we'll start on Slide 6. Upon Choice's initial approach, our board immediately engaged subject matter experts to assess the proposed combination. Our extensive diligence confirmed that the transaction would be subject to an uncertain prolonged approval process of 12 months to 18 months. A particular concern is that, US antitrust investigations are at historic highs. There have been more second request issues by the Biden administration in their first fiscal year than in the preceding 20 years combined. The party's advisors met on multiple occasions and Choice eventually acknowledged the probability of an extended regulatory review period of at least 12 months. Our business would be uniquely exposed to deterioration risk during a long regulatory review period as our business is built on relationships.

Our franchisees typically sign 10 year to 20 year contracts with us. They care very much about who they are doing business with. And we believe we offer a differentiated service through the relationships we had fostered over not years, but over decades, relationships that underpin our new business development activity and our improving franchisee retention rates. As depicted on Slide 9, we open more than 450 hotels annually. If this uncertainty were to persist for an extended period of time, some portion of our development and openings may not materialize, which compounds over time. Additionally, developers of our Echo Suites brand have expressed significant reservations about deploying such large sums of capital with a brand steward other than Wyndham, jeopardizing the brand's future.

Moreover, our considerable momentum in improving franchisee retention rates could also be impacted the longer this drags on as competitors capitalize on franchisee concerns around a potential combination. There are significant business disruption risks that our board believes have potential for irreparable damage to our business and erosion to Wyndham's shareholder value. We've made it clear to Choice from the very outset that we would need creative and appropriately scoped protections to address these asymmetrical risks to Wyndham's shareholders. Choice, however, dismissed our concerns as unfounded. As our advisors reviewed high regulatory risk transaction precedents more broadly, there was a clear theme of buyers compensating sellers with materially higher offer premiums and significant protections in compensation.

We have been offered neither. Moving on to our second concern, our board strong belief that choices offer undervalues Wyndham’s standalone growth prospects and the opportunistic nature of the offer, which does not at all stand up well when looking at our share price more holistically. As you'll see on Slide 11, their initial offer came at a time when the exchange ratio was the most in their favor over the past 24 months. The premium offer is unacceptable for a change in control transaction with the level of asymmetrical risks that we just discussed. Industry research analysts recognize our strong, sustained momentum and overwhelmingly believe Wyndham is undervalued and has significant upside as evidenced by their price targets and buy ratings on our stock.

Our management team has consistently been able to execute on our near-term goals, while also reinforcing the foundation for long-term value creation. As shown on Slide 13, we've delivered organic room growth and beat consensus EPS estimates for 11 consecutive quarters. And as we've outlined on Slide 14, we have multiple levers to accelerate net room growth from the current 2% to 4% to 3% to 5%, including building on the success of our new Echo Suites brand, leveraging our best-in-class international direct franchising capabilities, and continuing to enhance our franchisee retention rates, which have already improved 200 basis points since our spinoff. Beyond system growth and market-driven RevPAR gains, we're pursuing several initiatives that will significantly enhance shareholder value, including those that we've previously discussed with you and others that are taking shape out of the spotlight.

Combined, these opportunities set up an achievable path to accelerate organic EBITDA growth to a 7% to 10% compounded annual growth rate through 2026. In addition, the ability to deploy significant incremental capital through excess free cash flow and leverage capacity will amplify earnings growth for our shareholders. And you can see this roadmap on Slides 15 and Slide 16. Today we're introducing the first step on this path with our 2024 adjusted EBITDA outlook of $690 million to $700 million, reflecting year-over-year organic growth of 7% to 8%. This outlook concludes only a partial earnings benefit from our initiatives with full realization over a longer time horizon and represents our growth potential before capital deployment. In 2024 alone, we estimate our capital allocation capacity at the midpoint of our target leverage range to be between $700 million and $750 million, which translates to approximately $8.50 per share.

This is a material amount of capital that can be deployed to accelerate growth above our current outlook. Our proven track record, capabilities, and embedded value drivers give our board confidence that our standalone plan will deliver superior risk-adjusted returns compared to Choice's proposal. Finally, the third concern our board has is the substantial equity consideration. We've consistently made it clear to Choice the stock portion of their offer poses significant risk to our shareholders. Our concerns are focused on several areas, and they're presented on Slides 18 through 22. We'll first address the recent performance of the core business and financials of Wyndham versus Choice. We highlight these metrics as investors take them into account for helping to understand the appropriate valuations ascribed by the public markets.

In the first half of 2023, Wyndham grew net rooms 3% organically, whereas Choice's system declined 2% organically. Wyndham grew first half 2023 EBITDA 9% organically, while Choice's organic EBITDA growth was 1%. Choice's future growth prospects are equally challenged given their declining pipeline as shown on Slide 19. In particular, their revenue-intense pipeline has declined 38% between year-end 2019 and year-end 2022. And while that level of detail is not available on an interim basis, we can see that their total pipeline is contracted by 12% year-to-date through June. These adverse movements raise serious concerns for our board around Choice's ability to organically grow their system, along with their ability to execute their stated revenue intent strategy.

Choice' multiple premium historically benefited from organic growth. However, its more recent performance, including seven consecutive quarters of negative organic growth combined with its declining pipeline, have reduced that premium as depicted on Slide 20 and make it susceptible to further valuation multiple contraction in the future. This challenging growth profile will only be exacerbated should Choice be required to operate within the proposed excessive leverage profile that this transaction would require. Prudent leverage and balance sheet flexibility are core tenants of how Wyndham operates and is a position shared by many hospitality peers as shown on Slide 21. We estimate choice would need to secure approximately $6 billion of debt to fund this transaction, including over $4 billion of incremental debt and the remainder to replace Wyndham's existing debt.

Our financial advisors estimate this leverage level would take 3 years to 4 years to be levered from, even if the company were to allocate nearly all of its excess cash flow towards paying down the debt and potentially longer, depending on the macro environment. Choice has historically been heavily reliant on its balance sheet to grow its system. From 2017 through 2019, Choice deployed $0.5 billion to grow their system organically at a 3% CAGR. Conversely, from 2020 through the second quarter of this year, Choice has deployed less than $150 million and their system has declined organically at a 1% CAGR. Choice has used M&A to mask its lack of organic growth through the $675 million acquisition of the rights to use the Radisson brand in the Americas, which is accounted for the entirety of their reported system growth since the transaction closed of August of 2022.

And Choice’s declining organic growth will only be exacerbated when it cannot use its balance sheet to generate net room growth as it's done in the past. The higher leverage contemplated for the transaction would drastically shift the pro forma company's focus to deleveraging, preventing meaningful investment in growth for multiple years, which could significantly impact the pro forma companies trading multiple. In addition, the cost of debt required to fund this transaction is materially higher than historical levels. Servicing the debt stack for the proposed transaction would require over $200 million of incremental interest cash outflows compared to just 2 years ago. This higher cost of financing would further diminish the cash available to invest in the business.

And while synergies could help deliver, we note they take multiple years to achieve and have an initial upfront cost to secure them. The lack of availability of growth capital is a concern for our board, given how reliant Choice has been on their balance sheet historically to grow their system. And given the significant momentum and success [Wyndham] (ph) has joined today, which may be impaired in a constrained capital environment. In conclusion, our board remains open to risk-adjusted valuation creation alternatives, whether those are driven from internal initiatives, from external capital deployment, or from third party opportunities. And whenever reviewing any of these alternatives, our board believes that it is imperative to consider the impacts to our shareholders, our franchisees, and our team members.

And so, after considerable review with our financial and legal advisors, our board believes that the Choice proposal is inadequate on multiple fronts, including its unmitigated asymmetrical risk allocation, the confidence our board has in our standalone growth strategy that is not being considered by Choice in its opportunistically timed offer, and the heavy portion of Choice stock in the consideration mix that we believe has potential for additional downside risk. We will continue to execute our business model, drive growth, allocate excess capital appropriately, and maintain strong partnerships with our franchisees to drive shareholder value. And with that, we'd be happy to take your questions. Operator, you could please open up the line.

Operator: The floor is now open for questions. [Operator Instructions] Thank you. Our first question comes from Joe Greff of JP Morgan.

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