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Friday, May 28, 1999

An Investment Opinion
by Warren Gump

The Quest for Execution

Another one bites the dust -- at least temporarily. A company about which you've probably never heard took a hefty stumble in this week's trading. ResortQuest International (NYSE: RZT), a firm that is trying to be the dominate management company for private vacation home owners, warned that earnings would fall well short of analyst estimates. For Q2, the company expects to earn $0.10-$0.14 per share, short of the $0.18 analysts were expecting, although better than the pro-forma $0.07 earned in the prior year. The stock took a free fall on the news, closing at $8 11/16 today compared to $14 3/4 last Friday.

ResortQuest came public last May at $11 per share and simultaneously merged together 13 companies to form its initial operations. The company's strategy is to consolidate many of the nation's estimated 3,000 vacation rental and property management firms into a leading enterprise with a nationally recognized name.

The logic behind this "roll-up" strategy is quite simple. Currently, most vacation rental companies serve only a single geographic entity. Consumers have to call a different property manager in each locale they patronize, and no universal standards exist to assess properties. In effect, the process of renting a private vacation home is often tedious and cumbersome. Without help from someone familiar with the location, new visitors often have a hard time knowing exactly what they're going to get. ResortQuest wants to ease this problem.

The company is trying to build up a single, nationwide brand through which people can find a rental home. You want to visit Breckenridge? Call ResortQuest. You're summer vacation is going to be in Florida? Click onto Planning a tropical interlude on Hawaii? Call or click onto ResortQuest. Beyond providing a single source for your nationwide vacation needs, the company has standardized accommodations into five classes to give you a better idea of what you're getting. No system will be perfect, but this should help give you an idea of what amenities and facilities to expect. The idea makes a lot of sense. If the company is successful at generating demand, it will be able to increase occupancy and the profitability for vacation home owners while making a bundle for its shareholders.

One of the more powerful aspects of the company's concept will be its integrated website, Through this site, vacationers will be able to get rental information, view pictures and maps, and make reservations online. While one can obviously see the profitable business prospects of such a site (remember, ResortQuest manages these properties so they get a hefty management fee instead of just a "listing fee"), the current implementation is quite clunky.

I clicked over to check out the site and was disappointed with its current incarnation. Instead of a seamless integrated system, the main page feeds you into individual sites for each of the different management companies. There was no uniform layout or design among these related sites, making it very difficult to quickly navigate the differing locations. Some sites allowed online reservations, although others did not. What about the hyped classification system for each property? I found a reference to the system (which was really vague) on some sites, but I didn't see the individual ranking for any properties. In other words, the idea sounds terrific, but the implementation has a long way to go. To be fair, the site was just launched in January and the company will undoubtedly be upgrading it over time.

ResortQuest's management team has a terrific pedigree, with a slew of former executives from Promus Hotel Corp (NYSE: PRH), the franchisor of Embassy Suites, Hampton Inns, Homewood Suites, and Doubletree. David Sullivan, ResortQuest chairman and CEO, was formerly the Executive Vice President and COO at Promus. Jeffrey Jarvis, ResortQuest's CFO, previously worked as Comptroller and Chief Accounting Officer at Promus.

While not a direct Promus Alum, ResortQuest's President and COO, David Levine, held those positions for Equity Inns (NYSE: ENN), a real estate investment trust that owns many properties flagged with Promus' brands. In addition to a strong day-to-day management team, ResortQuest's board of directors includes Michael Rose, who could be considered a "Jedi master" of the lodging industry, with his years of experience leading Promus and predecessor companies. Having such a strong group of leaders makes me really want to watch how this company progresses.

This week's warning of lower-than-expected Q2 earnings was blamed on a delay in closing new acquisitions and increased general and administrative (G&A) expenses caused by the acquisitions and rollout of the Internet site and advertising programs. Although most companies would be expected to anticipate events like a jump in G&A costs, ResortQuest is small and minor changes in spending can cause a blip on the income statement. Investors will need to watch this line closely, but I wouldn't write them off entirely because of this slip-up.

The timing of deal closings is always an issue for companies that are growing through acquisition sprees. Under normal circumstances, the long-term impact of a slip-up will not be dire since a company will jump back on track in future quarters and everyone will be happy. For ResortQuest, the impact of this shortfall could be quite significant, but it's really too early to tell. A slowdown in acquisitions caused by the dip in the stock price could cause trouble for quite a while. On the other hand, everything should be fine if the company is able to complete its acquisition plans for the year.

Many of ResortQuest's acquisitions involve equity in addition to cash. When an acquirer is using equity to fund purchases, having a high stock price is extraordinarily valuable. To understand why, let's look at a hypothetical transaction. Assume that ResortQuest is buying a local management company in a stock deal for $3 million. When ResortQuest's stock is trading at $15 a share, it must issue 200,000 shares to complete the transaction. If, on the other hand, ResortQuest is trading for $10 a share, it must trade away 300,000 shares for the same transaction. A falling share price thus causes a stock acquisition to be more expensive to ResortQuest shareholders.

Not all of ResortQuest's acquisitions are for stock; most, in fact, include stock and cash. To fund the cash portion of these transactions, the company can use cash on hand and cash generated from operations. While the company's operating cash flow is positive, it is insufficient to fund the company's aggressive expansion plans. Right now the company is attempting to raise $50 million through a private debt issuance to enable it to finance future acquisition plans. Completing this deal will be integral for the company to maintain its near-term growth plans. We should learn more on the progression of this transaction over the next month.

Combining a compelling idea and excellent management often leads to terrific investment opportunities. Despite embodying these characteristics, ResortQuest needn't be on the top of anyone's potential investment list just yet. Before taking a really serious look at the company, I want to see evidence of two things. First, the company must demonstrate that its branding campaign is working and increasing the occupancy at homes under management. Second, I need to be assured that the company's acquisition plans will not be derailed because of the recent stock price plunge. Once those concerns are alleviated, ResortQuest could prove to be an interesting investment possibility.

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