Distressed Debt Analysis - Six Flags

Six Flags (SIX) is a regional operator of theme parks across North America.  Their corporate Investor Relations website can be located here: Six Flag's IR Site

For reference, here are the current trading levels of the company's equity and debt instruments:

• Six Flag's Term Loan: 70-72
• Six Flag's 12.5% Subsidiary Notes: 54.5-56.5
• Six Flag's 8.875% Notes: 13-15
• Six Flag's 9.75% Notes: 10.5-12.5
• Six Flag's 9.625% Notes: 10.5-12.5
• Six Flag's 4.5% Convertible Notes: 7
• Six 7.25% Preferreds due 2009: $0.66
• Six's Common Equity: $0.21

And here is a simplified capital structure (with outstanding associated debt amounts listed):

The Washington Post wrote an interesting article on Six Flags and its current situation.   As the article pointed out, the company faces a liquidity shortfall with their preferreds (PIERs) coming due in August.  

As those who have participated in the high yield debt markets are aware, Six Flags has been a serial refinancer of debt over the past five plus years.  Unfortunately for Six Flag's investors and management, that option is effectively closed to them right now given the state of the credit market as well as their balance sheet and the restrictions imposed on it via the various debt indentures and credit agreements.  

Management commented on their 4th quarter 2008 conference call (transcript here) and as many press reports have announced, the company has been negotiations with its bondholders. And one bondholder (2010 bonds) looks to be holding out.  

As we have talked about in this post, Distressed Debt Terminology, Six Flags has an opco / holdco structure.  As a bondholder or bank debt holder, you want to be as close to the assets as possible.  So in a simplified waterfall structure using the above chart as a reference, the obligations of Six Flags Theme Park would be paid off first, then Six Flags Operations, and then Six Flags Inc.  This concept is called structural subordination and will be talked about constantly on this blog.  As you can see in the trading levels above, the market has reflected that subordination fairly dramatically.

Operationally, Six Flags has done fairly well.  EBITDA in 2008 was approximately $275M dollars and visitor count was better than expected.  The company drew down on its revolver in the 4th quarter and ended the year with $210M of cash.  Interest expense was $178M last year and capex was approximately $99M meaning the company was essentially break even on a free acsh flow basis.  Unfortunately for shareholders and management, the combination of a capital intensive business, with an overlevered balance sheet, in a weak economy always spells trouble.  An interesting statistic:  Including FY2001, Six Flag's has spent ~ $1.050B on capex in the last 8 years. At the end of 2001, its market cap was $1.4B and today it is $20M.  That is a substantial amount of shareholder value destruction. 

Nonetheless, that is the past and we are more concerned about the future and how to profit from this opportunity.  As Warren Buffett says, the first rule of investing is to not lose money.  In other words, you need to make sure not only do you have have a return on capital employed but also a return OF capital employed.  

I am going to go with the assumption that there is some kind of in court or out of court debt restructuring.  Press reports have stated something to the effect that 85% of the new equity will go to the holdco bonds, 10% to the preferreds and 5% to the common equity.  Now this could indeed be the case.  There currently is only one true comp: Cedar Fair (FUN), which trades for ~6.5x 2008 EBITDA and 6.3x expected 2009 EBITDA.  EBITDA for Cedar Fair in 2009 is expected to be flat year over year.

Assuming a 6.0x multiple for Six Flag's recent $275M, that would translate into a value of $1.650B, which would be enough value for the existing bank lenders and the 12.25% OpCo bonds to get their principal back.  Given that the OpCo is trading at 52 cents on the dollar, that is a very nice return from these levels.  

Unfortunately, I am going to be much more conservative that that.  We do not want to lose money.  Given how much bank debt leverage there is, a slight change in our multiple and EBITDA assumption can wipe out the 12.25% OpCo notes recoveries:

The average of that entire chart is a 50 cent recovery on the bonds.  The average if you exclude the 4.5x multiple is a 67 cent recovery and if you just include the columns in the right (5.5x-6.0x), you come up with an 82 cent recovery.  Therefore, if you are a real believe in the Six Flag's business model (unfortunately I just cannot predict the EBITDA of this company even a few years out given the volatility of EBITDA over the past 10 years) and you think a company with this kind of capital needs is worth more than 6.0x, you would be buyers of the opco bonds at these levels.  

For me though, the bank debt looks much more attractive at 72.  For a few reasons:

1. As noted in the chart above, only 4 scenarios produce a recovery less than par for the bank debt
2. If a meaningful portion of subordinated debt is converted to equity, the company should generate modest free cash flow
3. If bondholders cannot agree on a consensual solution, there is a small chance you could also receive equity in a restructuring which would could be very valuable if enough debt was extinguished
4. The bankruptcy process is a near term catalyst that could drive bank debt prices higher as lenders would be offered a higher rate to "play ball" in the restructuring process

In summation, the bank debt offers investors a substantial margin of safety with decent option value.  The bonds on the other hand, offer very juicy returns in some scenarios but little margin of safety.  We will continue to dig into the business model of Six Flags to see if we can find any diamonds in the rough to change our opinion on the opco bnds.  The equity, preferred, and holdco bonds in my opinion, at this moment in time, are speculations with fire and should thus be avoided if you are a conservative value investor.  Things may change in the interim, new facts and figures will emerge, and if they do, we will update our analysis with our most recent opinions.