A Stock with Hidden Assets

With soaring energy prices and the possibility of stagflation, many value investors (including hedge funds, private equity firms, corporate raiders, and mutual funds) have been scouring the marketplace to uncover companies with hidden "real" assets. These hidden assets include real estate, timber, and oil or natural gas reserves. The assets are considered hidden because they're listed on the balance sheet at cost, even though, in many cases, their market values may be much higher. Over the past couple of years, many of these asset plays have shot up in value on takeover speculation (or outright takeover bids).

Notable examples include  Toys R Us  (stock price up 53% over the past year), the St. Joe Company (JOE) (up 75% over the past year), Hallwood Group  (up 414%), ShopKo  (up 65%),  Kmart/Sears  (up 226%), and  Kerr-McGee  (up 50%). These companies have two things in common: They all have hard assets that are listed below market value on their balance sheets, and each has taken steps--either willingly or through coercion from outside investors--to unlock that value.

One company that meets both of these criteria is Intrawest , a $950 million firm that few investors are familiar with. Intrawest has extensive hidden assets (real estate) listed on its books at cost basis. At the current stock price of $20 per share, Intrawest's shares do not incorporate the value of the company's hidden real estate assets and unique competitive advantages, in my opinion. (Full disclosure: My fund owns shares of Intrawest.)

Over the next few years, I believe this stock could double as the hidden value becomes more apparent.

Overview
Intrawest is the largest developer and operator of resort villages in North America. The company owns or controls 10 mountain resorts, including Whistler/Blackcomb in Vancouver, Mammoth in central California, and Winter Park in Colorado. Intrawest also owns one warm-weather resort, Sandestin, located in the Florida Panhandle. The company is also involved in numerous other real estate and leisure travel projects. In total, Intrawest owns land that will be used to develop approximately 18,000 units over the next decade and has options to acquire land to build a further 1,800 units.

All this land is listed at cost on the balance sheet. However, the market value of the land is significantly higher than the cost basis because most of the land was acquired in the early to mid-1990s. With the stock at $20, I believe the hidden land value is being completely ignored by the stock market, resulting in an opportunity for smart value investors.

Why Now?
There are two reasons why I believe now is the time to buy the stock.

First, the stock has pulled back from its highs and is down about 13% for the year to date. Whistler/Blackcomb, the company's largest resort, experienced the mildest winter in more than 30 years, with little snow and lots of rain. This forced Intrawest to lower its earnings outlook for the fiscal year ended June 30, 2005. Bad weather is a temporary phenomenon, of course, but presents a nice short-term window to buy the stock. At an investor conference in Montreal last week, CFO John Currie said that snow finally came to Whistler in March and, as a result, there is no need to reduce 2005 guidance further.

Second, and more important, Intrawest's management team is actively taking steps to unlock the value of the real estate. The company wants to focus on what it does best: plan, design, and manage resort villages. Management would rather outsource the construction phase of resort development because this is by far the most capital intensive part of the development process. To do this, in 2003 the company formed a partnership called Leisura with JP Morgan Fleming (JPM), Ledcor, and  ManuLife (MFC). JP Morgan, Ledcor, and ManuLife provide most of the equity capital for resort construction, and they buy the land from Intrawest at current market value after the resort units have been presold. Intrawest receives the profit from the land sale, plus ongoing management and sales commissions for preselling the units before construction starts, as well as fees for overseeing the construction process. This arrangement allows Intrawest to add value in the form of intellectual capital while letting someone else do the heavy capital spending, significantly boosting Intrawest's return on invested capital.

There is little risk to Intrawest or Leisura under this arrangement because the projects are presold before construction actually begins. For example, Intrawest recently sold all 141 units available during a presale for a new resort village at Mammoth in central California. Demand for the units was far higher than supply--the units sold out in four hours. This is a common occurrence when Intrawest presells units at its resort villages.

The formation of the Leisura partnership is a great way for Intrawest to monetize its land value and pay down debt. Over the past two years, Intrawest's ratio of net debt/EBITDA has fallen dramatically, from 5.4 in 2003 to 3.7 today. The company is now a generator of cash, in marked contrast to a few years ago, when it consumed gobs of cash to build out its resorts and upgrade its ski areas.

Industry Characteristics and Economic Moat
With 10 large mountain resorts, Intrawest is the largest company in the industry, with approximately 10% market share. The ski industry is highly fragmented, and the largest 20% of resorts account for 60% of total skier visits in the U.S. In the 1980s and 1990s, the industry underwent a period of massive capital expenditures, with snow machines and high-speed lifts becoming required equipment for attracting skiers. Because these technological upgrades were quite expensive, the industry underwent a period of consolidation where only the largest and healthiest companies survived. In 1985 there were more than 1,000 ski resorts in North America; today, there are about 730. During the same period, the number of visits to North American ski resorts has remained roughly flat. This tightened supply/demand relationship means the companies that survived the 1990s shakeout are in a much better competitive position today.

In addition, the baby boom generation is entering its prime years for spending money on expensive leisure activities such as travel and skiing. This trend should provide a tailwind for the mountain resort industry over the next couple of decades.

Well-managed mountain ski resorts have a moat around them--it's very expensive to build a competing ski resort. Numerous government permits are required, and there are political and environment issues to wade through. The most attractive ski resort locations have been locked up already. For these reasons, it's safe to say that the number of ski resorts in North America will not increase in the future, providing a moat around Intrawest's business.

Intrawest's closest competitor is Vail Resorts (MTN), which is nearly the same size as Intrawest. Vail's stock is up 60% in the past year, compared with just a 15% rise for Intrawest's stock. Intrawest has lagged because of the aforementioned poor weather at Whistler this winter. Vail also carries a lot of land on its books, and was rumored to have received (and rejected) a buyout offer from KKR last year.

Further Catalysts
In addition to the Leisura partnership designed to unlock the value of the real estate and lower capital requirements, there are three other catalysts for Intrawest's stock price over the next few years.

First, the 2010 winter Olympics will be held at Whistler. This will generate loads of media attention for the resort. The Olympic organizers are paying for road improvements between Vancouver and Whistler (about 70 miles), and for other improvements to the resort. Intrawest doesn't have to spend a dime of its own money to get ready for the Olympics, yet it will receive massive media coverage and free capital improvements.

Second, new airports are being built in close vicinity to Mammoth and Sandestin. This should have a positive impact on leisure travel to these destinations.

Finally, the company is exploring partnerships as a way to attract Chinese tourists to its resorts. Chinese tourists are allowed to travel to Canada, and many of them could travel to Whistler or another Intrawest resort if the company finds the right way to market to these vacationers.

I estimate the current fair value for Intrawest's shares to be between $30 and $40. The fair value depends on how much time it takes to unlock the embedded land profits, and on the health of the leisure travel and real estate markets over the next decade. The stock would have to rise 50% from its current price to get to the lower end of that valuation range. My fair value would increase if management accelerates the pace of its land sales or strikes additional partnerships with resort hotel operators such as  Four Seasons , Westin , and  Fairmont .