During that time, the industry, with the exception of 2008 and 2009, has shown consistent year-over-year revenue growth. The industry has clearly had its ups and downs and definitely has its share of likes and dislikes, but no one can argue with the upward growth over an extended period of time.
Source: AIF, State of the Vacation Timeshare Industry-Shared Vacation Ownership, 2016 edition
Since the rescission, the timeshare industry has made a strong rebound and has almost regained its pre-recession revenue levels. However, if you look closely at recent public filings, it appears that this growth may have been largely on the backs of the respective company's existing owner base.
For 2015, Wyndham Worldwide Corporation reported that 68% of its sales were to existing owners. Diamond Resorts International, Inc. (NYSE: DRII) reported that 69% of its sales were to existing owners. Marriott Vacations Worldwide Corporation (NYSE: VAC) reported that 64% were to existing owners and even, soon to be public, Hilton Grand Vacations, currently a part of Hilton Worldwide Holdings (NYSE: HLT), reported that 40% of sales on average over the last 5 years were to existing owners. The American Resort Development Association (ARDA) notes that the average timeshare owner is 51 years of age with the majority in the "baby boomer" generation.
ARDA regularly points out that there are tens of millions of potential timeshare buyers out there. So, if that is the case, then why are the major timeshare companies pressing their existing owner base and not exploring this much broader prospect pool?
Actually, the answer is not surprising, especially for public timeshare companies needing to protect quarterly profit margins.
Since an existing owner is familiar and already pleased with the product, sales to existing owners are typically much easier to close. It is hard to visualize an existing owner who is totally dissatisfied with their current ownership sitting through a 90-minute sales tour. These existing owner sales bring a higher conversion rate (closing rate), lower marketing and sales costs and potentially a higher VPG (volume per guest). Many of these sales are even done through telesales call centers, and therefore the marketing and sales costs can be significantly lower.
Heavy sales into the owner base can have a number of drawbacks, as well. Eventually owners may become weary of constantly being solicited for additional purchases (so called "reloads") or "upgrades" to their current ownership into a bigger unit type or different resort. Existing owners can also potentially be "upgraded" into default as their "equity" (amount originally paid) is rolled over into bigger, less affordable loan amounts.
This high volume of sales to existing owners, most of which are an older generation, has clearly brought the industry back, but at what price for the longer term and the investment outlook of these companies.
The Next Generation
The industry clearly needs to attract new, younger buyers, especially Millennials. To be fair, timeshare companies are reporting some positive trends in this area. However, to make much deeper, faster inroads to new owners and stay ahead of an aging owner base as well as retain development (profit) margins, more dramatic steps may need to be taken.
Recently on the ARDA Insights Blog, a posting titled "What Next-Gen Wants" by Simon Jaworski and Lance Henik listed a number of "factors" to attract the next generation of timeshare owners. In their posting, they listed four factors, commitment/cost balance, sleeping capacity, exchange and exit strategies as important to these buyers.
I would argue that the first, commitment/cost balance, and the last, exit strategies, will be of primary importance and that both of these ultimately will come back to the price paid and the perceived value in ownership. In order to address these factors, timeshare companies will need to bring the price paid more in line with the actual market price. In order to do that, they will need to reduce the cost of marketing and selling their product. To accomplish that, they may need to rethink the whole approach to marketing and selling to the next generation of buyers.
This can obviously not be done all at once, but the companies that address these issues sooner than later will be the ones to watch for, have much better long-term earnings growth and be a much better investment opportunity.
Before we get into the issue of costs, price and value, let's first look at the sales process and whether or not it will attract new, younger buyers.
During the many years I have been in and around the timeshare industry, I have always heard the phase "no one wakes up wanting to buy timeshare." Well, that might be true, but what if they did?
Since the industry began, timeshare has basically been sold the same way. First, a prospect is identified through some type of marketing channel (i.e., tourist booth, tele-marketing, direct mail, etc.). Then, the prospect is promised some type of premium (i.e., discount room nights, gift, ticket discount, etc.) if they attend a sales presentation or "tour." Finally, the prospect takes a tour of the timeshare resort, is informed of the benefits of ownership and pitched the purchase of a timeshare property. Timeshare is clearly a "sold" product with arguable some of the most talented sales people out there. For many years, this process has served the industry well.
Typically, each time a resort is developed, a timeshare company opens a sales center at that site to conduct tours and the process begins again. Many timeshare companies now operate off-site sales centers as well, but the overall approach is basically the same, just given a little more "virtually."
Because of this sales methodology, timeshare companies have extensive networks of sales associates and managers, multiple sales centers, call centers, marketing departments, sales models, etc. The most significant cost on any timeshare company's income statement is the cost of marketing and selling the product, which can be as much as two to three times the cost of actually building or acquiring the product itself. Think about that for a second.
One might easily question if this type of direct, high cost, face-to-face selling is going to attract a newer, younger buyer. A buyer that turns to Uber (UBER) for transportation and Airbnb (AIRB) for lodging and keeps up with everything through their smartphone. Is this next generation of buyers going to want to put their vacation on "hold" while they take a sales tour? The answer is not completely clear, but generations that appear to be desiring freedom, flexibility, ease of use, and value are probably going to be looking for something more exciting and up to date.
I mean, think about it. In the not-too-distant future, a potential buyer should be able to strap on a VR headset and walk through the resort accommodations room by room. They can then experience sitting on the beach, enjoying the balcony view or even playing a hole on the championship golf course from their couch. Will the need for a "tour" of the property really be necessary? Apart from feeling the warmth of the sun and smelling the freshly cut grass, they can experience it from the comforts of their home, and along with the internet make a more informed decision by researching the company, reading reviews, exploring options and comparing financing. When the time comes to purchase, they will be able to access paperwork on-line and complete their purchase.
The pieces of this high tech sales, vision of the future are already out there and getting better every day. Moving towards this type of transaction would put the sales process more in-line with how the next generation buys. It would also have a huge benefit in reducing marketing and selling costs and thereby lowering the sales price without sacrificing margin.
Costs, Sales Price and Value
For many people, one of the major complaints of timeshare ownership is that it is overpriced and there is no appreciated value in the real estate. In addition, when it no longer fits their lifestyle, it cannot be sold for anything less than pennies on the dollar.
Timeshare is definitely not a real estate investment and apart from the occasional overzealous sales associate, timeshare companies long ago stopped pitching it as such an investment. Yet, its lack of being a real estate investment may make it less attractive to newer, younger buyers who are wanting value and the ability to sell it when they no longer want or need it.
To increase the real estate value, first and foremost, the sales price of timeshare has to come down. However, timeshare companies need to retain their development margins. There are two components to a timeshare company's development margin. They are cost of goods sold (cost of the product) and costs to market and sell the product.
The American Resort Development Association (ARDA) reported that the average price of a timeshare in 2013 was $20,460, which was up 9% over the prior year's number of $18,720. The typical unit is a two-bedroom unit. The highest average sales price was in Hawaii at $27,712. That would mean for all 52 weeks of an average unit, the average price would be approximately $1,063,920.
As a general rule, approximately 50% or more of the price paid for a timeshare is absorbed by the marketing and sales costs. These costs are primarily the commissions paid to the sales associations, managers, directors and on up as well as the costs of any gifts (premiums) given such as tickets, the cost of prospecting (tele-marketing, etc.) and the cost of fulfilling any accommodations promised (mini-vacations or "mini-vacs").
If, on average, 50% of the sales price is absorbed my marketing and sales costs and a large portion of current sales are to existing owners that would indicate that the average cost to market and sell to new owners would be pushing well above 50%. Therefore, if all things remain the same, as timeshare companies change their focus toward newer owners, the percentage associated with marketing and selling may rise. This is definitely in the wrong direction.
The timeshare companies may find themselves in a situation where they are unable to significantly raise prices without damaging the perceived benefit of timeshare ownership as a "hedge" against future vacation costs. Higher initial costs coupled with annual maintenance cost and club membership and exchange fees may cause some potential buyers to favor holding onto their future vacation dollars.
To examine the value issue a little further, let us do a little math.
According to the recent quarterly filing by Marriott Vacations Worldwide , their development margin for the twenty-four months ended June 17, 2016 was 20.4%, which represented 24.4% cost of goods sold (inventory cost) and 55.2% marketing and sales expenses. These amounts were similar to their year-end balances for 2015, which were a development margin of 20.8%, cost of goods sold of 30.3% and marketing and sales expenses of 48.9%.
So using these numbers as an example, assuming approximately 52% costs to sell the product and 28% costs acquire the product, let us apply these percentages to the average sales price per ARDA.
That would mean that of the $20,460 paid by the buyer, it cost $5,729 to acquire or construct the interval and $10,639 to market and sell the interval. Knowing that the true market price of the interval is actually closer to the cost amount, one can already see that it would take years of appreciation for the current value to recover to the amount paid. Assuming a 4% annual appreciation rate, it could take approximately 30 years for the appreciated value to equal the amount paid.
Now, assume these numbers were slightly different. Let us continue to assume that the company wants to generate at least a 20% development margin, but what if the marketing and sales costs were only 10%. That would mean that the price paid would be $8,184, the cost of goods sold would be $5,729 and the cost to market and sell would be $818. The actual sales price would actually be more in line with the market value of the product. This lower amount would be 40% of the current sales price. Even at 15% marketing and sales costs, a sales price of $8,814 would not be far off the true current market.
I would content that placing the selling price more in line with current market would now add the real estate investment advantage back to ownership. Even when coupled with the annual maintenance fees it would bring down the total cost of ownership to a level that would be a greater hedge against future vacation costs, improving the overall value proposition. If the sale price is more in line with market, then a secondary resale market could flourish wherein owners could actually sell their ownership at or above what they paid for it. Entry in and out of ownership would be much more fluid.
So it really comes down to reducing marketing and sales costs in order to improve owner value. More than likely, the cost to construct cannot be dramatically reduced with all the value engineering in the world. If developers just turn a resort into another hotel with hotel-size room, they have lost a significant selling point.
The question now is can timeshare companies actually do this?
For many in the industry, the ideas presented here are clearly "out there" in a utopian dream world of development and sales. Such a dramatic and immediate about-face in operations would be extremely difficult for timeshare companies given the investment in large sales forces, call centers and sales centers. Not to mention their current pricing levels with existing owners.
Staffing models, sales and marketing strategies, etc. are all built upon the "prospect to tour" sales cycle that has severed the industry for many years. Such a change may actually require new entrants into the market. But with some of the new capital efficient inventory acquisition strategies being utilized this might be easier than in years past and may create investment opportunities.
For existing timeshare companies, they appear to be headed into a period of time when they need to reduce their operating costs to drive down the price of ownership and create more perceived value for the next generation.
Ultimately, tapping into existing owners has a limit, if not simply age.
In the near term, investors interested in timeshare companies should look to companies that are clearly focused on ways of bringing in new and younger buyers, cutting marketing and sales costs and keeping prices low. Hilton may be a company to watch based on the fact that it has a lower percentage of sales into its existing owner base. Marriott has indicated a desire to get its sales into "an equal mix of new buyers and existing buyers." Wyndham has shown a decrease in sales percentage to existing owners, down from 70% in 2013.
In the longer term, investors should look for companies that are applying new technology in innovative ways, that are moving outside the traditional marketing and sales model and bringing real estate value back into ownership. These are the companies that will be sustainable and bring the most shareholder value.
Disclosure: I am/we are long HLT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.