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When a company and stock underperforms peers, there are usually two explanations.

The first is that there’s a structural issue at play. A larger-scaled peer may see benefits in terms of pricing, talent acquisition and retention, and/or network effects that can’t be overcome. A competitor’s technology may be modestly, but importantly, better. End markets can move away from the existing business model, or existing end markets might be less attractive. For instance, imagine a software concern whose strongest vertical is apparel retail, while its competitor’s base focuses on healthcare.

In these kinds of scenarios, it’s dangerous to expect underperformance will reverse. “ABC is attractive because it trades at a 3-turn discount to XYZ” is only an attractive thesis if there’s a catalyst for the valuation gap to narrow. If XYZ is simply a better business and/or has entrenched, permanent or semi-permanent advantages, ABC is cheaper for good reason — and likely to stay that way.

The second possibility is that the company and stock are underperforming because of a failure of execution. And here’s where it gets a bit more interesting — and a bit more tricky.

Poor execution can be a catalyst for upside — if that execution can be fixed. That’s often quite a big ‘if’.

Sometimes, improved execution requires a massive turnaround. Turnarounds can work, with Procter & Gamble (PG) one of the better large-cap examples in recent times and Coca-Cola (KO) possibly another. More often, turnarounds disappoint, as with IBM (IBM) and General Electric (GE)1. Even for far-smaller companies, significant changes to culture, personnel, sales strategies and the like take time and resources.

In other cases, the underperformance is obvious — but unlike in a turnaround, management is either oblivious to the problems or has no coherent plan to solve them. AT&T (T) is a good example here: even a cursory look at the company shows declining market share and a fading wireline business. But the telecommunications giant has been run for 15 years by two chief executive officers whose track record suggests at least the possibility of intentional sabotage.

But, in some cases, the stars align. Management has erred; management knows it has erred; and the errors can be reversed. Meanwhile, the valuation assigned the stock doesn’t incorporate the potential improvements that can be made by relatively simple tweaks. In this case, underperformance looking backward is a positive looking forward.

Amusement park operator Six Flags SIX looks like one of these cases.

Yep, Six Flags Has Underperformed

There’s really not much argument that Six Flags the business has underperformed. Certainly, Six Flags stock has:

source: YCharts; 3-year total return chart

And that is a change from the prior decade:

source: YCharts

To be sure, the 10-year performance heading into August 2019 wasn’t spectacular. SIX did outperform pure-play peers Cedar Fair L.P. (FUN) and SeaWorld Entertainment (SEAS). But Six Flags has long had a levered balance sheet, which should have provided a tailwind in a bull market. Until Disney (DIS) announced the launch of its streaming service in April of 2019, SIX and DIS roughly kept pace. But Disney stock no doubt had a drag from rising fears surrounding the impact of cord-cutting and ESPN and other networks. SeaWorld had to deal with the negative fallout from the documentary “Blackfish”, released in 2013.

Still, SIX stock was at least moving in the right direction, and so was Six Flags revenue:

source: YCharts

But since the pandemic hit, Six Flags has lagged badly, as shown by comparing results from 2022 and 20192:

source: author

In that context, and given a still-levered balance sheet (4.7x trailing twelve-month Adjusted EBITDA), the decline in SIX stock on its face makes some sense.

SIX Stock Is Cheap

To at least some extent, SIX stock is pricing in that relative weakness. Based on trailing twelve-month results, SIX trades at 8.6x EV/EBITDA. That compares to more than 13x before the pandemic.

On the same basis, FUN, probably the best peer, is just shy of 10x. SEAS is at 8x, but that company is heavily reliant on Orlando-area attractions. That’s a risk to earnings both from a feared recession going forward and from a reversion to the mean following several quarters of insanely high travel demand. Disney and Comcast’s parks businesses are different, but generally have merited double-digit EBITDA multiples in sum-of-the-parts analyses.

In 2019, the UK’s Merlin Entertainments (admittedly not quite a perfect peer to Six Flags) went private at 12x EBITDA. Even the bull case for a since-bought-out Australian concern (Village Roadshow) cited a 10x EV/EBITDA multiple for its theme park business.

Absolute valuation works as well. Free cash flow averaged $285 million from 2017 to 2019; the current market cap of $2 billion suggests a 7x multiple to that average. Six Flags did have a lower-than-normal cash tax rate during those years, plus revenue from international licensing deals that were suspended, but the stock still trades at a single-digit multiple to normalized pre-pandemic FCF.

In other words, to at least some extent the market is pricing in continued underperformance. And so, particularly given the leverage on the balance sheet, there’s a clear path to upside if Six Flags can change the trend.

The “Premiumization” Strategy

From a broad perspective, there’s one simple reason to believe that Six Flags can change the trend: there’s almost no reason to believe otherwise. If that doesn’t quite make sense, please read on.

Six Flags has 27 parks in its portfolio, 24 of them in the U.S. None of those parks have truly direct competition. A family in Jefferson City, Missouri might choose Cedar Fair’s Worlds of Fun in Kansas City over Six Flags St. Louis, given that the two parks are roughly equidistant. But there is significant geographic exclusivity to Six Flags locations; for most potential customers, direct competition doesn’t really exist.

In other words, returning to the original discussion, there almost can’t be a permanent, structural problem with the business. External factors matter, of course, but those external factors — notably the macroeconomic cycle — should affect regional theme parks in roughly the same manner.

Indeed, for Six Flags, the wound seems to be self-inflicted. Before the pandemic, Six Flags aggressively pushed customers to a monthly membership plan for park access, even setting up kiosks at front gates to push the product. The company took a similar stack with concessions, launching an unlimited dining pass.

For a while, the strategy worked. On his last conference call after third quarter earnings in October 2019, former chief executive officer Jim Reid-Anderson took a victory lap:

We are developing a sustainable business model that delivers consistent recurring revenue and cash flow, enhances customer loyalty and protects against both bad weather and an economic downturn.

After Reid-Anderson retired, the conference call following Q4 earnings four months later sounded quite different. New CEO Mike Spanos noted that full-year Adjusted EBITDA had declined year-over-year, in large part because single-day visitors had declined. The same record revenue Reid-Anderson had cited for some time suddenly became a long-term trend of weakening margins. Six Flags cut its dividend, and walked back a previously-disclosed, long-term, target of $750 million in 2020 Adjusted EBITDA (due to performance, not the pandemic).

Since then (with an obvious interruption due to the pandemic), Six Flags has been trying to recalibrate its pricing strategy. Spanos was given less than two years to improve operations before he surprisingly left in late 2021. New CEO Selim Bassoul summed up the new approach in his first call in February:

Our guest surveys and our guest interviews have both indicated that customers are willing to pay more for better quality of service.

However, we have historically ignored this data. And instead, we prioritized filling our parks to maximum capacity at the expense of the guest experience. Data shows that guests who came on heavily discounted or free tickets pre-pandemic did not match -- spend much time -- much money in the parks, yet they used up our park capacity.

So, based on our analysis, our historical reliance on heavy discounting was not the right strategy. Through premiumization, we are focused on guests who are willing to pay more for a premium experience which will lessen the crowding of our parks, reducing pressure on operations and elevating the guest experience.

In other words, the focus on monthly subscriptions was wrong. (In retrospect, it certainly looks like Six Flags management was trying to ride the wave of investor optimism toward recurring revenue, particularly given how often the company’s executives used that exact phrasing during the second half of the 2010s.)

That focus led to overcrowded parks, as management noted on Bassoul’s first call. Foodservice lines were so long that food was cold by the time customers received it. One reason for the long lines is that TikTokers literally figured out how to game the Six Flags dining pass, leading the company to abandon the plan earlier this year.

The strategy appears to have pushed away families. And the benefits in terms of attendance simply didn’t drive enough growth in either revenue or profits. (Poking around various sites for Six Flags reviews seems to confirm the complaints about lines and crowding from both Spanos and Bassoul; the company has said reviews on both Facebook and Twitter have improved markedly and quickly.)

Beyond the change in pricing strategy, Six Flags also planned to focus more on tech — where even Spanos admitted the company had lagged, and another common complaint online — and less on investing capital expenditures in thrill rides. Bassoul also noted plans to improve SEO (search engine optimization) and (on the Q1 call) the installation of single-rider lanes to keep coasters from leaving with empty seats.

To some extent, this commentary seems like it suggests a larger turnaround rather than a process of simply fixing a few unforced errors. Certainly, Bassoul in particular had a laundry list of targets.

But while the list is long, the items on the list are basic. Stop selling monthly memberships (which Six Flags announced it would do after Q1). Implement an SEO strategy (which companies one-hundredth Six Flags’ size have). Don’t send off coasters that are three-quarters full when there is a 45-minute line of waiting customers. Quit letting people in for free (free customers at one point accounted for ~10% of total attendance).

Maybe not all of these initiatives will work immediately, or necessarily at all — but there’s clearly a lot of low-hanging fruit here.

“Indefensible” Earnings

First quarter results seemed to show some early progress. Revenue increased 8% against Q1 2019. Attendance declined 22%, but per capita admissions rose 54% and in-park spending 58%. On the call, Bassoul seemed optimistic, though he did ask one analyst for “a few quarters” of patience.

Q2 earnings, however, were far more disappointing. Keybanc called the quarter “indefensible.” Not only were results weaker than Q2 2019, but Six Flags posted declines on both lines (revenue -5%, EBITDA -9%) relative to the year-prior period. As noted above, other theme park operators posted far stronger results.

But with all due respect to Keybanc, there are some puts and takes here. Per the Q2 call, across the entire first half, and adjusted for a modest fiscal calendar shift and the loss of international revenue, Adjusted EBITDA actually increased 5%.

And that’s with a pretty big whiff. Six Flags wanted attendance to decline — but it overshot. Year-to-date attendance through July was down 35%, against a target of 20% to 25%.

Keybanc raised the question of whether the attendance decline in fact suggests Six Flags’ pricing power is far less than management believes. The tone of the Q&A on the Q2 call suggests that many other analysts have similar concerns.

But Bassoul said that Six Flags ticket prices still lag those of competitors. He noted on the call that the season ticket price for the Six Flags in New Jersey didn’t increase for 25 years. And it will take time for Six Flags to communicate the improvements to its operations, the lower attendance and shorter lines, and perhaps the fact that the parks no longer are, as Bassoul put it on the call, “cheap day care center[s] for teenagers.” One attendance miss, however large, in a single quarter doesn’t destroy the longer-term case for improvement.

The quarter isn’t good news, certainly. But some patience is warranted here. Indeed, investors already are taking that view. SIX dropped 18% on Thursday after the report; it gained 13% on Friday.

The Long View And The Risks

It seems more likely that Six Flags is lagging competitors because of years of missteps (and the time needed to repair those missteps) than because there is something structurally and permanently wrong with the company’s parks. These are good locations; competition is limited; new supply simply isn’t coming online. Bassoul had a hugely successful run at cooking equipment manufacturer Middleby; he deserves some time to get the work done at Six Flags.

And where the case here seems attractive is that valuation is reasonable now. SIX isn’t undervalued only if Adjusted EBITDA margins rise 500 basis points, or if the company hits or nears its attendance or profit targets. Price to free cash flow based on 2022 results is in the range of 11x. As noted, the EV/EBITDA multiple is well below the company’s historical range and below peers.

To be sure, this is a highly-levered company posting minimal growth. That alone shows there’s real risk here. But the upside is tremendous. Bassoul’s compensation is based on an EBITDA range going up to $710 million. Hit that bogey and re-rate valuation to 12x EV/EBITDA and the stock more than triples. That’s not a base case, obviously, but it highlights how the risk/reward seems heavily skewed in the bulls’ favor, even after Friday’s bounce.

So what goes wrong here, beyond the broad problem of low growth and high debt? Inflation obviously is one concern, in terms of both pressuring demand and increasing costs. But at least on the cost side, the lower attendance should ameliorate labor inflation; Bassoul after Q2 in fact admitted the company had done a poor job on that front and should do better going forward.

Macro concerns present another risk. Six Flags in fact filed for bankruptcy in June 2009 amid the worst of the financial crisis. But the company was 7.8x net leveraged at the end of 2008. Its debt now yields 5.5% to 6.6% (the latter with a 2027 maturity); the bond market is pricing in an exceedingly small chance of history repeating.

Even in 2009, amid that bankruptcy, Six Flags revenue declined only 11%. Cedar Fair’s revenue dropped 6%; Adjusted EBITDA during the worst year in a generation fell 16%. A more modest recession should be manageable, particularly (as has been the case for many consumer-facing companies so far) the impacts on higher-end consumers are more muted.

There are external risks, yes, but there’s still clear room for internal improvement. SIX stock is pricing in much of the former, but very little of the latter.

As of this writing, Vince Martin is long shares of Six Flags.

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