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Kerrisdale Partners Fund == (-1.5%) for the quarter ended September 30, 2015 net of fees, comprised of monthly returns of 2.4%, -3.8% and -0.1% for July, August, and September, respectively.

In comparison, the S&P 500 was down -6.4% for the quarter, comprised of monthly returns of 2.1%, -6.0% and -2.5%.
The Barclay Hedge Fund Index == (-4.6%) for the quarter, comprised of monthly returns of -0.6%, -2.5% and -1.6%.

Since inception, kerrisdale Fund == +1,101.8%, net of fees and expenses.
In comparison, the S&P 500 == +138.2%
Barclay Hedge Fund Index == +42.7% during that time.

Our top 5 (+)position ::
short BAVA (Bavarian Nordic A/S),
long UHAL (AMERCO),
short Undisclosed,
long LXFT (Luxoft Holding Inc),
long MRKT (Markit Ltd).

Our top 5 (-) position ::
long JLL (Jones Lang LaSalle Inc),
long BID (Sotheby’s),
long TNET (TriNet Group Inc),
long LOCK (LifeLock Inc),
long MHFI (McGraw Hill Financial Inc).

Kerrisdale Partners – Markit Ltd.

We are long shares of Markit (MRKT), a leading financial services information provider trading at 20x LTM FCF.
Markit provides critical infrastructure for the credit markets.
When Markit was founded in 2003, its key function was helping banks accurately price credit default swaps and other complex financial securities that lacked transparent prices and did not trade on traditional exchanges.
Markit developed a unique give-and-get model, a system in which banks feed their pricing data to Markit in return for access to aggregated data.
With this platform as a foundation, Markit methodically expanded in adjacent tools.

10 years later, Markit generates over $1 bil of revenue and has a broad portfolio of mission-critical products serving asset managers, hedge funds, banks and other large financial institutions.
Today, the company operates a suite of products that benefit from high barriers to entry, a highly recurring revenue base, 30% operating margins and 100% FCF conversion. The company’s valuation has been hampered by pessimism towards Markit’s processing segment: as certain, high-volume derivatives trading becomes more transparent and transitions towards swap execution facilities (as opposed to traditional bilateral arrangements), Markit is expected to lose some business in the near-term. We are confident that management will successfully navigate around this issue and that the company’s valuation will ultimately re-rate to be more in line with peers as concerns subside.

 2014, 95% of Markit’s revenue base was recurring. Discussions with Markit’s customers explain why: the portfolio of products is strong, switching costs are high, and over time customers subscribe to more products (not fewer), making it extraordinarily difficult to replace Markit with a competing vendor. Many customers claimed that even if prices increased significantly, they would find it difficult to replace Markit’s products, including its CDS/Loan pricing, WSO, and (for equity investors) the daily short interest tool product.

One of Markit’s leading offerings (~14% of total revenue) is the WSO platform.
WSO software provides a comprehensive loan portfolio platform for reporting, accounting, compliance and performance analytics for customers in the syndicated bank loan market.
Credit investors are typically invested in hundreds of loan tranches across numerous issuers, creating a sea of idiosyncratic data to maintain – each loan has hundreds of terms that can vary widely across securities.
Interest payments and calculations are calculated on a quarterly basis while CLO testing is done monthly, and sometimes the documentation between the issuer’s agent and the investor is still delivered via fax.

Markit adds value to this process by acting as the intermediary between the investor (client) and all the issuers’ agents. WSO collects all the data inputs and centralizes it in one database that is easily accessible by the investor.
This platform saves the investor significant time and resources as less time and people are needed for this manual data entry process.
We spoke to some customers who told us that, prior to WSO, they would have employees sitting by the fax machines and manually inputting this data, resulting in an extremely inefficient data input process.
Further, WSO’s close integration with middle/back office operations makes it cumbersome to replace, though few customers ever wish to.

 Markit is also widely regarded as the best source for loan, CDS pricing, and reference data.
Under a give-and-get model, Markit receives proprietary loan and CDS valuation data from the partner banks. Markit aggregates this data and returns the valuations to all of its customers.
Access to this proprietary information flow allows Markit to provide the highest quality data to its customers.
The Totem product showcases Markit’s ability to retrieve pricing data for illiquid and OTC securities.
Totem provides market prices for a broad range of derivatives (including CDS, interest rate swaps, commodity swaps) to OTC derivative market-makers (mostly sellside banks). As shown below, Totem’s coverage goes well beyond the prices available from brokers, making it indispensable for regulatory reporting and daily VaR calculations.

Markit is also widely regarded as the best source for loan, CDS pricing, and reference data. Under a give-and-get model, Markit receives proprietary loan and CDS valuation data from the partner banks. Markit aggregates this data and returns the valuations to all of its customers. Access to this proprietary information flow allows Markit to provide the highest quality data to its customers. The Totem product showcases Markit’s ability to retrieve pricing data for illiquid and OTC securities. Totem provides market prices for a broad range of derivatives (including CDS, interest rate swaps, commodity swaps) to OTC derivative market-makers (mostly sellside banks). As shown below, Totem’s coverage goes well beyond the prices available from brokers, making it indispensable for regulatory reporting and daily VaR calculations.

Management has successfully demonstrated its ability to grow the business both organically and via acquisitions. Since inception, management has made 26 acquisitions, with most achieving double-digit returns on capital. Taking a single product category, Markit’s loan franchise (includes loan pricing, WSO, Clearpar and loan indices) produced $4 million of revenue in 2004 and generated 58x more in 2014 reaching $215 million
The lack of capital intensity and high incremental margins result in substantial free cash flow: Markit generated roughly $300m of cash over the past twelve months with $200m+ of FCF in every year since 2011. Finding itself with a completely unlevered balance sheet and shares at a nadir thanks to the sellside’s ambivalence, management recently initiated a $500 million buy-back program, representing about 10% of shares, which increases leverage to a still meager 1x EBITDA. An acquisition target itself – it draws envy from even the vaunted Bloomberg for reference data, OTC, and loan pricing – Markit can continue to bolt on software platforms to further entrench itself within the global credit infrastructure. At less than 20x earnings, sustained by hard-to-replace services and products, we anticipate a high return on our investment.

Kerrisdale Partners – Parexel International

We are long shares of Parexel International (PRXL), a leading contract research organization (“CRO”) with a multi-decade track record of double-digit growth. Founder/CEO Josef von Rickenbach launched the business in 1982 and took it public in 1995. Over the past decade, von Rickenbach grew Parexel’s revenue from $545m to $2bn, EPS expanded from $0.36 to $2.70, and Parexel solidified its position as a top three CRO, all while maintaining an unlevered balance sheet and generating consistent free cash flow.
Short-term market gyrations, first caused by a guidance reduction of NTM EPS growth from 20% to 17%, then aggravated by a broad-based healthcare selloff, have left Parexel with the extremely undemanding valuation of 1.7x NTM EV/Revenue (peers are 2.5 –3.5x) and 20x FCF.
A recent hiring spree, in anticipation of a growth uptick and move towards later-stage trials, combined with a soon-to-be-remedied full tax rate (35% now; moving to 20-30% over time) result in PRXL’s below-industry margins.
Management seeks to remedy this with organic growth and a cost-reduction plan to achieve $50-60m in annualized savings within the next few years.
Management further believes margins can swell 150-200bps next year with 15-20% long-term EPS growth and sustained 20%+ ROICs. Looking at Parexel’s pristine long-term operating history, we’re apt to agree.

Parexel’s success springs from three primary growth drivers: i) global pharmaceutical R&D growth (c. 2-4%/year); ii) increased outsourced penetration (currently c. 50%); and iii) industry consolidation. Taken together, Parexel’s organic revenue growth can average 7-9% and total growth reaches 10-12% with reinvestment of FCF into bolt-on M&A. Both our primary research and a variety of public studiessupport these notions. Industry forecaster ISR predicts a 7.9% industry growth CAGR from 2014 to 2018; recent sellside surveys of pharma staff predict R&D growth of 4-7% in 2016 – a sentiment maintained through September; and both anecdotal and quantitative data from our own primary diligence speaks to the entrenchment of CROs in the global clinical research process. As one clinical director explained, CROs dampen the volatility of internal budgets by converting fixed R&D capital costs (overhead, clinical staff, reporting infrastructure) into a variable cash expense. This allows research organizations to focus on what they do best: drug discovery and/or selling and marketing. The top five CROs have about 50% share, trending towards 60% by 2017, with Parexel near 10% share. Industry leaders like PRXL can gain ~100bps of share per year from smaller firms as sub-scale organizations no longer possess the scale to satiate global research projects in a world of growing regulatory complexity.

Within this consolidating industry, Parexel stands out for the breadth and depth of its services. Parexel has worked with all of the top 50 companies in the biopharma space, with some form of involvement on 95% of the top 200 biopharmaceutical products on the market. Further, a recent analysis of http://clinicaltrials.gov cited Parexel’s involvement in more clinical trials than all but one of its peers, the larger but slower-growth Quintiles. Our diligence discussions buttress these assertions. Paraphrased from the head of clinical research at a major pharmaceutical company about his relationship with Parexel, ‘If someone sneezes in Korea, I’ll know…if a group of patients shows side-effects, I’ll know immediately instead of two weeks. That way I’m prepared when the FDA calls.’ Another remarked, ‘Between Parexel and [a second retained clinical outsourcing partner], I expected Parexel to outperform, and they have.’ That’s not to say that Parexel is without faults. All of the top five CROs can adequately service a multi-national client, and over time the CRO group must become more cost efficient. But Parexel appears to have positioned itself ahead of these trends: it has nearly quadrupled the size of its low-cost India staff, from 200 in 2010 to roughly 900 today. We think this broad-based labor expansion, especially those in low-cost jurisdictions, may predate both near-term growth and margin improvements.

 While we’re excited about Parexel’s near-term growth prospects, we’re also encouraged by the stickiness of the current revenue book. Parexel’s backlog measures at $5.2bn versus $2bn of annual revenue. The trailing twelve months book-to-bill ratio resides at 1.2x and the historical range measures 0.9x to 1.5x. Augmenting the core CRO business, Parexel also runs a 45-50% gross margin software business – pieces of which, like the data-monitoring tool Perceptive MyTrials, are used by the top 15 pharmaceutical companies – and a consulting group that captures regulatory and commercialization business. The consulting outsourcing market is projected to grow from $2bn in 2014 to $4.5bn in 2020, a 15% CAGR – twice as fast as CRO services.

If its prior success holds, Parexel can continue to reduce industry-wide costs while helping companies innovate. With the business priced at under 2x revenue alongside recurring cash flows and an unlevered balance sheet, we expect superior shareholder returns over time.

Conclusion

We continue to be confident about the composition of the current portfolio. Regardless of how the overall market performs, we expect our portfolio to fare well over the long term.

Thank you and please don’t hesitate to contact me with any questions.

Sincerely,
Sahm Adrangi
Kerrisdale Partners
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Kerrisdale Capital: ClubCorp Holdings Inc (MYCC) == (-80%)

By Rupert Har


Sahm Adrangi’s Kerrisdale Capital, which made a name for itself and some impressive returns for investors by shorting US-listed Chinese shell companies, has singled out ClubCorp Holdings Inc (MYCC) as its next big short target.

Sahm Adrangi, Portfolio Manager, Kerrisdale Capital

Kerrisdale’s report on the company, which was released early this morning, singles out ClubCorp as a highly levered golf-course roll-up facing three profound challenges: a secularly declining end market, weak unit-level profitability, and no economies of scale.

ClubCorp Holdings Inc: Facing a number of headwinds 

The short thesis is centred around the structural changes facing the golf market within the US. Golf participation, golf rounds played, and sales of golf equipment have all trended down over the past decade, while the age of the average golfer has trended up. These issues are affecting not just ClubCorp but the whole US golf market in general. However, publicly traded ClubCorp is facing another problem in the form of not-for-profit, member-owned clubs that strive not to maximize the bottom line but merely to provide a good experience.


Still, as a large, publicly traded company, it’s reasonable to assume that the economies of scale that usually come with businesses of such size allow ClubCorp to generate better returns than its smaller, local peers.

This is not the case.

Most golf-course costs are inherently local and thus difficult to centralize, as attested by ClubCorp’s own mediocre earnings and stagnant margins. As a result, ClubCorp is, if anything, suffering from diseconomies of scale as the company’s corporate structure and mountainous debt pile, built up after years of bolt-up roll-up acquisitions, eat away at margins.

At almost 10x unlevered cash flow, ClubCorp’s debt burden leaves the equity virtually no downside support.

The problem with highly leveraged roll-up businesses is that to remain solvent they need to keep expanding and profits need to be somewhat predictable. Any hiccup in operations or unforeseen adverse developments can suddenly send the whole tower of cards toppling over.

Unfortunately, with so many structural issues facing ClubCorp and the golfing industry in general it can only be a matter of time before the company finds itself facing a cash crunch. Any economic hiccup impacting consumer discretionary spending could wipe out shareholders entirely.


Undeserved valuation

Despite the dire fundamental issues facing the company, management has done an excellent job of convincing the market that ClubCorp’s shares are worth a premium valuation.

The company’s shares currently trade at a free cash flow yield of 4.2%. Capex and debt servicing currently consume 75% of EBITDA, free cash flow scarcely covers the dividend and there’s no room for genuine growth initiatives or additional acquisitions.

Further, Kerrisdale’s research shows that ClubCorp’s clubs appear to perform worse than the industry average, with member attrition three times the industry median and anecdotal evidence of lax course maintenance and bad customer service.

With this being the case, it’s clear shares in the company don’t warrant a premium valuation. In fact, based on the group’s current free cash flow and assuming an entirely benign economic backdrop, Kerrisdale values ClubCorp’s stock at just $3 per share, 77% below yesterday’s closing price of $13.27.

“Our DCF model, which assumes a completely benign economic backdrop, values ClubCorp at just [[$3]] per share, for [[77%]] downside. A simple historical analysis produces a very similar result: since ClubCorp has only generated modest, mid-single-digit returns on invested capital – at or below a realistic estimate of its cost of capital – its enterprise value should approximate its $1.2 billion of net tangible assets. While this figure covers the debt, it leaves only ~$200mm for the equity – again leading to [[77%]] downside. Whatever the analytical framework, the conclusion is clear: ClubCorp’s stock price has a long way to fall before it begins to approach fair value.”


Some more from the report below.

ClubCorp Holdings is a highly levered golf-course roll-up facing three profound challenges: a secularly declining end market, weak unit-level profitability, and no economies of scale. Founded in 1957 as a single country club in Dallas, ClubCorp now bills itself as “The World Leader in Private Clubs®,” with a portfolio of 206 locations (including two in Mexico and one in China). But as ClubCorp has grown, golf has shrunken. Golf participation, golf rounds played, and sales of golf equipment have all trended down over the past decade, while the age of the average golfer has trended up. Though these demographic pressures strain the entire industry, ClubCorp suffers further from the nature of its competition: not-for-profit, member-owned clubs that strive not to maximize the bottom line but simply to provide a good experience. As these clubs plow any efficiency gains back into additional amenities for members, ClubCorp must keep up by way of its own continuous improvements, resulting in persistently high capital expenditures and weak returns. While the premise of ClubCorp’s roll-up model is that greater scale leads to better returns, most golf-course costs are inherently local and thus difficult to centralize, as attested by ClubCorp’s own mediocre earnings and stagnant margins.

For ClubCorp shareholders, these problems are amplified by the company’s billion-dollar debt burden; at nearly 10x unlevered cash flow, it leaves the equity almost no downside support. Any economic hiccup impacting consumer discretionary spending could wipe out shareholders entirely. Yet despite its poor fundamentals and high leverage, ClubCorp shares offer investors just a [[5%]] free-cash-flow yield – appallingly slender compensation for such massive risks. ClubCorp’s valuation has remained so rich partially as a result of the dearth of similar publicly traded companies; in this informational vacuum, management has successfully directed the market’s attention to the most flattering financial metrics while glossing over the unpleasant long-term realities of the golf business.

But our detailed industry research – including an analysis of benchmarking studies as well as conversations with more than a dozen golf-club general managers, many of whom compete directly with ClubCorp – reveals that low margins, weak membership growth, and a never-ending succession of capex projects are par for the course. Moreover, ClubCorp clubs appear to perform worse than average, with member attrition three times the industry median and anecdotal evidence of lax course maintenance and bad customer service. Informed by this bottoms-up research, our DCF model values ClubCorp equity at just [[$3]] per share, [[70%]] lower than the current price. But with such a fragile capital structure – and large contingent liabilities not captured in our base case – ClubCorp could easily be a zero. It won’t take many bogeys to lose the round, and in this game there are no mulligans.

I. Investment Highlights

ClubCorp’s free cash flow doesn’t justify its market cap. Below we summarize ClubCorp’s capital structure and run-rate free cash flow. With so much debt piled on top of so little earnings power, ClubCorp’s equity won’t get much; debt service and capital expenditures (necessary to keep club quality from rapidly decaying) together consume 75% of EBITDA, leaving little room for genuine growth initiatives or additional acquisitions. Indeed, free cash flow scarcely covers the dividend. Today, the market values ClubCorp’s equity like a safe, stable bond; in reality, with $1 billion of debt outranking it and a multitude

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 fundamental flaws in the underlying business model, it’s a highly risky asset that calls for a correspondingly high yield.


Our DCF model, which assumes a completely benign economic backdrop, values ClubCorp at just [[$3]] per share, for [[70%]] downside. A simple historical analysis produces a very similar result: since ClubCorp has only generated modest, mid-single-digit returns on invested capital – at or below a realistic estimate of its cost of capital – its enterprise value should approximate its $1.2 billion of net tangible assets. While this figure covers the debt, it leaves only ~$200mm for the equity – again leading to [[70%]] downside. Whatever the analytical framework, the conclusion is clear: ClubCorp’s stock price has a long way to fall before it begins to approach fair value.

Golf is in the midst of a long-term secular decline. According to the National Golf Foundation, the number of golf participants in the US fell 22% from 2005 to 2015; the number of golf rounds played at private clubs likewise fell 17%. Demographics ensure that this decline is just beginning: golf participation among the critical 18-to-34-year-old age group has fallen 30% over the past two decades.

Golf’s difficulties are not some passing fashion; they stem from the sport’s fundamental qualities. Golf is expensive, difficult, and time-consuming in a world with a vast array of cheap and easy recreation options. Social change is also a headwind: gone is the era when the family patriarch could cavalierly leave his wife and children behind to spend a day golfing. In keeping with these trends, ClubCorp’s revenue per club barely grew in nominal terms from 2005 to 2015 (and declined in inflation-adjusted terms), while average members per club was flat. ClubCorp’s prospects for long-term organic growth are bleak.

ClubCorp’s business model is inherently flawed. Some stagnant businesses can still generate high returns, but ClubCorp isn’t one of them. There is a basic tension in the for-profit golf-course model: shareholders would like to wring as much revenue as possible out of each 18-hole course, but member satisfaction declines precipitously with any hint of crowding, capping the productivity of the capital employed. Moreover, in any geographic region, ClubCorp’s clubs are just one choice among many, and competitors are often member-owned non-profits perfectly willing to operate at break-even. Our discussions with industry participants suggest that ClubCorp differentiates itself from the competition primarily by targeting lower-end customers and skimping on service, resulting in much higher attrition rates and greater sensitivity to economic downturns. But this strategy has not translated to strong revenue growth, margins, or returns on invested capital, all of which are consistently low.

Running private clubs is naturally capital-intensive; the golf courses, additional athletic facilities like gyms, clubhouse fixtures, parking lots, and other tangible assets all have finite life spans and require frequent renovations to maintain parity with competitors and justify even modest increases in membership fees. While ClubCorp management likes to bifurcate its capex into “maintenance” and “ROI” – implying that the latter is non-recurring and discretionary – our industry research belies this framing, showing that an annual capital budget of 7-10% of revenues – in line with ClubCorp’s historical total capex but substantially higher than its purported “maintenance” spending – is necessary just to stay in place. Intense competition and high capital intensity are headaches in any sector, but, in a shrinking market like golf, they can be deadly.

ClubCorp’s acquisition-driven growth strategy is a value-destroying failure. Like the retailer in the old joke, ClubCorp hopes to make it up on volume – transforming the golf-course business from dud to winner by simply buying and operating many courses. But, as industry benchmarkingstudies confirm, back-office and other readily centralizable costs represent a small fraction of the typical golf-course budget, while key line items like on-premise labor, facility maintenance, and local marketing are difficult to buy in bulk. There’s no good reason to expect compelling synergies from a golf-course roll-up. Sure enough, ClubCorp’s profit margins – whether measured using the company’s own liberally adjusted version of EBITDA or more standard metrics – have been flat or down over the past five years, even as the number of clubs in its portfolio has grown almost 40%.

Given that ClubCorp generates mid-single-digit returns on tangible capital, paying a premium to net assets – as it has typically done in its acquisitions, resulting in $348 million of goodwill and other intangibles on its balance sheet – destroys economic value. A recent example is ClubCorp’s large purchase of Sequoia Golf in 2014. We estimate that this deal generated a 7.7% pre-tax return on invested capital (including goodwill). Yet ClubCorp’s last unsecured debt issuance priced at 8.25%, and credit spreads have widened further since then. This is a new twist on the proverbial 3-6-3 rule of old-fashioned banking (borrow at 3%, lend at 6%, and be on the golf course by 3 p.m.): borrow at 8%, invest at 8%, and own an extra golf course or three. Such a strategy expands ClubCorp’s empire but destroys shareholder value.

Overlooked liabilities could wipe out ClubCorp’s equity. In lieu of straightforward fees, some of ClubCorp’s clubs have required refundable “membership initiation deposits”; after a long but limited time period, usually 30 years, members are entitled to get these funds back. Today such deposits exceed $700 million and are carried on ClubCorp’s balance sheet at their present value of $357 million, of which $153 million is classified as current and could, in principle, come due at any moment.

Yet the market (as well as most of our own analysis) completely neglects this material liability ([[50%]] of ClubCorp’s market cap and [[170%]] of our base-case estimate of equity fair value) on the theory that few members have asked for their money back so far. Over time, however, something has to give. Either

• members do ask for their deposits back, resulting in a cash outflow large enough to significantly impair or even completely destroy ClubCorp’s equity; or

• they don’t ask for their deposits back, leading them to be classified as unclaimed property and remitted to the relevant state governments under escheatment laws, again draining cash; or

• they don’t ask for their deposits back but ClubCorp somehow manages to evade the rules governing unclaimed property, thereby converting the deposits into taxable income and resulting in a multi-hundred-million-dollar tax bill over time – again, quite material relative to the magnitude of ClubCorp’s equity.

While investors may give ClubCorp the benefit of the doubt as long as this liability remains largely hypothetical, any bad news could quickly alter perceptions. The long-term fate of ClubCorp’s membership initiation deposits is just one more downside risk for a dangerously levered company with weak fundamentals trading at a high multiple of free cash flow.

………………..

VI. ClubCorp’s Large Contingent Liabilities Pose Serious Risks

For the most part, the problem with ClubCorp is simply that the company’s high leverage and structurally poor fundamentals make its equity free-cash-flow yield absurdly inadequate. However, there is a plausible scenario in which the outcome for ClubCorp shareholders is even worse. The issue is membership initiation deposits. In lieu of straightforward fees, some of ClubCorp’s clubs have required long-term refundable deposits whenever new members join. Members are entitled to eventually get every dollar of these

 deposits back, but only after a long period, usually 30 years after the membership starts. At the end of 2015, ClubCorp held a staggering $717 million in deposit liabilities owed to its members, which it carried on its balance sheet at a discounted present value of $357 million. These liabilities are so large that ClubCorp actually has negative tangible book value after taking them into account.

But despite ClubCorp’s contractual requirement to refund these deposits after the allotted time period, and despite their presence on the company’s balance sheet, investors tend to ignore them, as we have in all of our foregoing financial analysis. After all, so far, few members have actually asked for their money back, as the summary below shows – despite the steady increase in the portion of the liability classified as current, i.e. due within 12 months:


If ClubCorp only ever has to pay out a few million dollars on a several-hundred-million-dollar liability, then it doesn’t make much of a difference. But what about taxes? We believe that IRS rules generally treat the receipt of refundable membership deposits as a non-taxable cash inflow, on the theory that the deposits essentially remain the property of the members. (We sought clarity on this and related points from ClubCorp management months ago but never received any answers.) At some point, however, this theory becomes ridiculous. If ClubCorp gets to do what it wants with millions of dollars for decades and never really expects to pay anything back, then those amounts must ultimately be treated as taxable income, and ClubCorp will be on the hook for a material tax bill. (35% of a $352 million deposit present value equals $123 million.) If ClubCorp does actually refund a large portion of its deposits, the tax bill goes away, but investors should then regard the liability as just as real as ClubCorp’s other borrowings, yet senior to ClubCorp’s equity. Using our base-case valuation of $206 million for ClubCorp’s equity, which does not contemplate the payout of its membership deposits, the present value of even a fraction of those deposits is so large that it would completely wipe out the equity and potentially even impair the debt.

While ClubCorp will likely try to ignore this problem for as long as possible, it might run into trouble with escheatment laws. These laws govern the status of unclaimed private property, like 30-year-old membership deposits. In Texas, for example – the home of more than 20% of ClubCorp’s clubs –

The unclaimed property law requires financial institutions, businesses, and government entities to report to the state personal property they are holding that is considered abandoned or unclaimed. … Property is turned over to the Comptroller’s office annually when the owner’s whereabouts are unknown and the property has been inactive on the books of the reporting company after the appropriate abandonment period has expired.

Despite this statutory requirement, ClubCorp contends in its risk-factor disclosures that it can somehow evade the escheatment laws via “complex” legal analysis (emphasis added): [W]e may be subject to various states’ escheatment laws with respect to initiation deposits that have not been refunded to members.

All states have escheatment laws and generally require companies to remit to the state cash in an amount equal to unclaimed and abandoned property after a specified period of dormancy, which is typically 3 to 5 years.
We currently do not remit to states any amounts relating to initiation deposits that are eligible to be refunded to members based upon our interpretation of the applicability of such laws to initiation deposits.
The analysis of the potential application of escheatment laws to our initiation deposits is complex, involving an analysis of constitutional and statutory provisions and contractual and factual issues. While we do not believe that initiation deposits must be escheated, we may be forced to remit such amounts if we are challenged and fail to prevail in our position.

It’s difficult to take comfort in this vague and thoroughly hedged pronouncement, especially when ClubCorp goes on to note that the relevant authorities are already making inquiries:

…[M]ost of the states in which we conduct business have hired third-party auditors to conduct unclaimed and abandoned property audits of our operations…[T]he audits have not been terminated.

Whether ClubCorp ends up refunding old membership deposits, escheating them to government agencies, or treating them as income and paying tax on them, any outcome has the potential to take a serious toll on the company’s financial resources and do significant damage to its equity value. These risks may take years to materialize, but ClubCorp shareholders are receiving no compensation for taking them.

VII. Conclusion

There’s a good reason that the overwhelming majority of golf courses in the United States are owned and operated by non-profit entities: golf is a bad business. It’s extremely capitalintensive, and its unit-level growth is inherently limited. It’s also in the midst of a decade-long decline that, based on demographic trends, will likely get much worse before it gets better. ClubCorp keeps doubling down (and levering up) on golf, but its mediocre returns barely cover its cost of capital, and its massive debt load puts it in a precarious position, especially when its low-loyalty, high-churn model is acutely susceptible to economic downturns. At some point, it will also have to face reality and crystallize its thus-far unrealized deposit liability. To those standing in the way of these fearsome risks in return for a bond-like [[5%]] free-cash-flow yield, we offer the traditional golfer’s warning: fore!
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