Merlin: conjuring growth Premium

Theme park operator’s London listing promises a rewarding, if pricey, experience

Welcome to The Smiler, 1.1km of terror that will fling you upside down 14 times. The £14m rollercoaster was installed at the Alton Towers theme park this year. Now its owner, Merlin Entertainments, is to IPO in London partly to give its private equity backers (CVC and Blackstone) the chance to get off the ride.

The investment case for Merlin rests on its ability to generate growth without resorting too much to the sort of heavy capital spend that rides such as The Smiler entail. It has 12 big parks (half of which are Legolands) but they can cost up to $300m to build from scratch so the aim is to increase revenues from existing parks by adding hotels and to find outside backers for greenfield openings. But most of the growth will come from expanding its estate of 86 smaller attractions, which include aquariums and the Madame Tussauds wax displays. These units cost about $8m-$12m each to build and generate higher margins than larger parks. The plan is to send an army of waxworks and brightly coloured fish across Asia and North America.

Operating theme parks can be nicely cash generative and Merlin’s operating cash flow tends to cover both maintenance capex and growth spending. So funding the expansion should not be a problem. But Merlin will come out of the IPO with about £1bn of net debt equivalent to 2.8 times its probable 2014 earnings before interest, tax, depreciation and amortisation. Interest bills on that debt will have to be paid before Merlin can spend money on growth so in a bad year (and they can happen – just ask SeaWorld in the US, which lowered its full-year revenue guidance in August) the debt reduces the company’s flexibility.

Still, debt has been higher and times have been tougher in the past and Merlin has come through it all with decent growth. Operating cash flow grew from £220m in 2008 to £350m last year. The company is certainly pricing itself for growth. Assuming it grows moderately this year and next, the mid point of the price range would put Merlin on an enterprise value to 2014 ebitda multiple of about 11. That is above SeaWorld but below Six Flags, another US peer. Like a visit to one of its parks Merlin promises a rewarding, if pricey, experience.

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