FrontFour Letter On ILG And Marriott Vacations Merger
Thank you for taking the time to meet with us last week. As discussed, FrontFour Capital Group, LLC (together with its affiliates, "FrontFour") is currently a significant shareholder of ILG Inc. ("ILG" or the "Company") with total shareholdings and equivalents of approximately 2.65 million shares; representing over 2.0% of ILG's total shares outstanding. As we discussed, we believe that the publicly traded timeshare companies have been one of the most misunderstood opportunities in the leisure industry despite strong fundamentals, growth prospects and the favorable secular shifts in leisure travel. We were particularly attracted to ILG given its valuation, growth profile and free cash flow opportunity. In addition, there is a significant opportunity to unlock value for shareholders at ILG through the pursuit of a strategic combination with Marriott Vacations Worldwide Corporation ("Marriott Vacations").
We appreciate the recent dialogue that we have had with you and certain members of the Board of Directors (the "Board"). However, we continue to have significant concerns related to:
(i) The cumbersome size of the Company's 13-member Board, which is sub-optimal;
(ii) Your stated appetite for incremental acquisitions, despite not yet having fully integrated the Vistana acquisition from Starwood Hotels and Resorts ("Starwood") from May 2016;
(iii) The Company's questionable capital allocation policy and the Board's view of ILG's intrinsic value in light of only $3 million in repurchases during the first quarter of 2017 despite highly accretive trading levels;
(iv) The Company's position that Safe Harbor in a Reverse Morris Trust transaction ("RMT") requires that total share repurchases are limited to 10% of total outstanding for a period of two years in contrast to the opinion held by leading tax experts;
(v) The general perception held by many investors that the Company is using the Tax Matters Agreement associated with the Reverse Morris Trust transaction as a poison pill.
Despite ILG's strong stand-alone prospects, we believe that significant shareholder value can be created through the exploration and completion of a business combination with Marriott Vacations. There is tremendous industrial logic for ILG and Marriott Vacations to merge. At a meaningful premium to the current stock price, the transaction would still be highly financially accretive, while also yielding a number of qualitative synergies through the integration of the Vistana and Marriott Vacations sales & marketing functions given Marriott International's ("Marriott") ownership of the respective hotel flags, as well as the elimination of duplicative corporate G&A. As we discussed, we have a long history investing in the timeshare industry. We were a significant holder of Diamond Resorts International ("Diamond") and in October 2015, sent a public letter to Diamond asking them to seek strategic alternatives prior to their sale in 2016. Given our experience in studying Diamond's successful strategy of executing on a number of acquisitions of non-hotel affiliated properties, the opportunity to significantly reduce corporate G&A and sales & marketing expenses is not lost on us. The opportunity here is even more compelling on the back of the merger between Marriott and Starwood given the strength of both loyalty programs and the ability to seamlessly work with the pro forma Marriott to expand and grow the timeshare business as one.
While we write this letter to you and the Board, we have also made this letter public as we believe that our views are shared by the broader investor and analyst community. We are confident that a financially accretive transaction would be well received not only by ILG shareholders but also Marriott Vacations shareholders. We believe this to be the case as Marriott Vacations stock has appreciated subsequent to public comments during their recent 1Q2017 earnings conference call where they indicated a desire to not be investment-grade rated and their readiness to take financial leverage to approximately 3x debt / EBITDA for the right transaction. From our perspective it is crystal clear that this is the "right transaction". Accordingly, we urge the Board to immediately retain both legal and financial advisors to assist in the evaluation of a transaction with Marriott Vacations. Moreover, we were happy to hear from both yourself as well as other directors that you are not afraid of and would consider a deal at the right price.
We believe that a strategic combination with Marriott Vacations would result in:
(i) A significant premium to ILG shareholders while maintaining equity upside exposure in the pro forma Company as the consideration would be a mix of cash/stock;
(ii) The creation of the preeminent and global leading timeshare operator of upper-upscale vacation ownership brands with access to Marriott's consolidated loyalty rewards program;
(iii) Significant cost savings due to duplicative finance, IT, legal and sales & marketing functions amongst the Vistana and Marriott Vacations vacation ownership businesses;
(iv) The ability to leverage the newly opened sales centers in pulling forward the monetization of both ILG and Marriott Vacations' extensive completed and in-process inventory;
(v) The extinguishment of potential conflicts associated with Marriott's intention to combine the Marriott Rewards Program with Starwood's Preferred Guest Loyalty Program ("SPG") by the end of 2018;
(vi) The creation of a complementary and unparalleled product portfolio enhancing the value proposition to existing timeshare owners;
(vii) Lastly, a key part of theILG business model is the Exchange and Rental segment which offers alternative vacation accommodations and options to its 1.8 million exchange members, who are either associated with private developers or other larger timeshare operators. Through a monthly fee, either paid individually or through annual maintenance fees, individuals can effectively trade in their points/weeks to access this exchange network, called Interval International, which encompasses over 3,000 resorts. In this segment, ILG has approximately 40% corporate exchange members whose annual fees are paid by their respective timeshare operator from their annual dues. This is lower margin, as ILG has less direct customer contact and therefore less of an ability to control the process and upsell. Over the years, this corporate exchange portion has experienced headwinds due to industry consolidation as well as the larger timeshare operators trying to reduce the annual fees paid, so they can capture a larger spread. Through the Vistana acquisition, ILG was able to bring approximately 25% of its corporate exchange members in-house, which effectively provides insulation against potential future headwinds. A combination with Marriott Vacations, would significantly further increase in-house corporate exchange members, providing additional stability to this business.
We believe that a transaction with Marriott Vacations can be structured through a combination of cash and stock that delivers a sizeable premium to ILG shareholders while allowing all remaining shareholders to participate in the equity upside of the pro forma entity. Below is an illustrative and conservative analysis assuming that ILG enters into a transaction between $33 – $39 per share. Such a premium would represent close to 100% upside at the midpoint of the range from where ILG stock traded during the first quarter of 2017. Additionally, we note that over the last year there has been virtually no insider buying despite the stock trading at significantly lower levels.
Our conservative analysis below assumes total cost synergies of $150 million, no revenue synergies, assumes only $100mm of synergies included in the leverage calculation and excludes non-recourse securitized debt, a 6% cost of debt financing, $60 million in cash transaction expenses and is derived using current 2018 consensus street estimates for revenue and EBITDA. As shown in the table below, and assuming the midpoint of the offer range and leverage range, and further taking into account our conservative assumptions as discussed above, a transaction is nearly 20% accretive to Marriott Vacations shareholders based on current 2018 EPS estimates.