Leisure Canada Inc. Buy. Cuba The Final Frontier (LCN V C$0.24)

Transcription

1 Leisure Canada Inc. (LCN V C$0.24) Cuba The Final Frontier! We believe that the time could finally be right for US trade/travel embargoes with Cuba to be lifted.! As the largest foreign owner of unclaimed property rights in the Country, Leisure Canada is well positioned to benefit from the anticipated upcoming paradigm shift.! We are initiating coverage with a Buy rating and $2.00 target price. Company and Industry Fundamentals Leisure Canada (LCN or the Company ) is developing 3 prime tourist and business properties in Cuba. It is a 50/50% JV partner with the Cuban government and has 75 year leases on the properties, making LCN the largest foreign land owner in Cuba. Cuba is a growing tourist destination with ~2.5 million visitors annually. Given this base of tourists, the country has an insufficient number of hotel rooms (and specifically 4 and 5-star properties) to meet its needs. If/when the United States lifts the current travel ban to Cuba and the foreseen number of Americans arrive (estimated to be 5 million/year within 5 years), the country s hotel shortage will be acute. Such a scenario would put LCN in a very favourable position with its first mover advantage and its ability to create value through partnerships with flag operators. We believe LCN s management team has the ability to execute on its plan through a combination of Cuban business experience (Chairman Walter Berukoff has operated in Cuba since the early 1990s) and hotel/resort operating experience (the management team recently joined from Intrawest). A recent $18 million financing gives the company a strong balance sheet from which to start its development. Catalysts and Risks We believe there are two primary catalysts. From a macro perspective, the lifting of the US travel ban to Cuba would be a significantly positive event for the company. We believe such a development is in the offing through bi-partisan sponsorship of The Freedom to Travel to Cuba Act, currently before the US Congress. The second catalyst would be the confirmation that LCN has obtained the debt financing needed to start construction. We believe the Company is currently in discussions with a number of potential lenders. Nevertheless, Cuba remains a Communist regime and should be considered high risk, albeit under President Raul Castro, it appears more willing to make concessions for international trade. Stock Rating: Buy 12- target (C$) 2.00 Potential ROR 733% Company Profile Sector Ticker LCN V Shares O/S, basic (m) 165 Shares O/S, diluted (m) 220 Mkt cap, basic (C$m) 39.6 Mkt cap, FD (C$m) 52.8 Key Metrics Cash (C$) 16 Debt (C$) 0 Enterprise Value (C$m) 23.6 Research Team Doug Cooper Analyst dcooper@paradigmcap.com Alisa Beach Associate abeach@paradigmcap.com Sales Toronto Calgary Paradigm Capital research is available on First Call, Reuters or at Refer to last page for official disclaimer Issued by Paradigm Capital Inc. 1-Year Stock Chart C$ Dec-08 7-Jan-09 7-Feb-09 7-Mar-09 7-Apr-09 7-May-09 7-Jun-09 7-Jul-09 7-Aug-09 12/08/09 Initiating target price ($2.00) Source: Bloomberg 7-Sep-09 7-Oct-09 7-Nov-09 7-Dec-09 Valuation and Recommendation We are initiating coverage of Leisure Canada with a Buy rating and C$2.00 target price, which is based on the average of several valuation scenarios highlighted in this report, including earnings power, EV/room, and capitalization rate. Paradigm Capital Inc, IIROC/TSX member 1

2 Investment Thesis Cuba. The final frontier. The final frontier for American tourism that is. For a country like the United States that prides itself on exporting its democratic ideals, Cuba remains the one country in the world to which Americans are forbidden to travel. Want to go to North Korea, Iran, Iraq, Syria, Somalia or any number of Axis of Evil nations? No problem. But Cuba is against the law. We believe this will change. A combination of public opinion and political will may soon open up that country once again to American tourists, who prior to the Revolution represented 85% of visitors to the island nation. A recent poll found that 70% of Americans believe they should be free to visit Cuba, while 60% of Cuban- Americans (historically the most ardent supporters of the embargo legislation) think the travel ban should be removed. Such a grass roots swelling has led to a bi-partisan bill called The Freedom to Travel to Cuba Act, which went to a hearing at the House Committee on Foreign Affairs on November 19, As of the end of September, the bill had the support of 180 members in Congress (it needs support of 218 members to pass if everyone votes) while a parallel bill in the Senate is said to have the support of 62 Senators. A PriceWaterhouse study indicated that within a few years of the travel ban being lifted, 5 million Americans would travel to Cuba. Today, Cuba welcomes ~2.5 million visitors, making tourism the largest industry in the country. The question is whether the country is prepared for the massive influx of visitors that may be coming its way. While Cuba has significant air lift potential (10 international airports) and plenty of natural beauty (558 km of beaches and the world s 2nd largest coral reef off its southern shores), it lacks sheer hotel capacity in general and 4 and 5-star hotel rooms in particular. An Ernst & Young study pegged the number of Cuban hotel rooms at 41,000, albeit with only 28,000 4 and 5-star rooms (note that Cuban 4 and 5-star product is at least 1-star lower than other international destinations). With an assumed average stay length of 7 nights (mostly all-inclusive packages currently) and 2.5 million visitors, the country is at capacity or even under capacity for its current base of tourists. If the travel ban is lifted and the foreseen level of US visitors materializes, Cuba will have to double its hotel room capacity. Leisure Canada (LCN V) has the right to build and develop 5-star properties on 3 prime Cuban locations. It is a 50-50% JV partner with the Cuban government on the properties, which will share in all of the construction costs. It is planning a hotel in the Miramar district of Havana, a luxury resort on Cayo Largo (an island off the southern coast) and an Intrawest type village in Jibacoa (a region between Havana and Varadero). Assuming the company can arrange the debt financing (it will be significantly easier if the travel ban is removed), we believe the IRR on the projects in Havana and Cayo Largo is north of 30%. Jibacoa could be the most significant cash flow generator as the company plans a resort-style community wherein it sells houses, golf memberships, and marina slips in addition to hotel accommodation. LCN s management team consists of extensive Cuban business experience with its Chairman Mr. Walter Berukoff, as well as significant hotel/development operating experience with its President and CEO, Mr. Robin Conners. Other senior managers that held prior senior posts with Intrawest bring the expertise to execute the plan. While such hotels will not be welcoming their first guests until 2013, the architectural plans are almost complete and RFP s should go out to Paradigm Capital Inc, IIROC/TSX member 2

3 construction companies within the next 12 months. Nevertheless, we believe that all of the major hotel chains, both American and European, are anxiously watching the political landscape unfold. Undoubtedly they have Cuban expansion plans and as such, LCN, with its first mover advantage on properties that have no prior US claims against them, would make an excellent acquisition candidate. Whether LCN were to build and operate the hotels itself or sell the properties to an existing established flag, we believe the dynamics in Cuba make this an ideal time to get into the hotel business, from both an asset appreciation and RevPAR (revenue per available room) perspective. Consequently, we are initiating coverage of Leisure Canada with a Buy recommendation and $2.00 target price. A Short History of Cuba Cuba was discovered in 1492 by Christopher Columbus, who claimed the island for the Kingdom of Spain. At the time, he described the scenery as the loveliest land ever beheld by human eyes. In our opinion, that statement continues to be true and is one of the keys that will continue to make Cuba one of the primary vacation destinations in the world. As our readers may not be overly familiar with the history of Cuba and how its current political landscape has evolved, we will endeavour to give some context. After Columbus claimed the island for Spain, the first European settlement was founded in 1511, followed soon after by the founding of Havana in This makes Havana one of the oldest European-based (and continuously inhabited) cities in the New World. As a point of reference, Quebec City was founded in 1608, New York City in 1625 and Boston in Cuba remained a Spanish colony essentially for the next 400 years (with a brief interlude in 1762 when the British captured Havana and then exchanged it for Florida less than one year later). At the time, Cuba s economy was based on agriculture, mining and the export of sugar, coffee and tobacco. The work was done primarily by African slaves. In 1892, an exiled dissident, Jose Marti (Fidel Castro s hero), founded the Cuban Revolutionary Party in New York City. In 1895, the war for Cuban independence began in earnest albeit Marti was killed in battle in that same year. (Note that he is seen as the Father of modern Cuba with many monuments and the Havana airport named after him). The tide of the war turned in 1898 when the US battleship Maine was blown up in the Havana harbour by the Spanish. This prompted the US to enter the war. At the conclusion of the Spanish-American War, the two signed the Treaty of Paris in 1898 in which Puerto Rico, the Philippines and Guam were ceded to the US for $20m. Under the same treaty, Spain relinquished all claims of sovereignty over Cuba, while the US maintained military control over the island. Given its infamous position in the news of late, it is interesting to note that under the Platt Agreement of 1902, which granted Cuba independence, the US leased the Guantanamo Bay navy base from Cuba the base that the US still holds today, and on which it continues to pay rent for which Castro claims not to have cashed one check. Over the next 50 years, Cuba was besieged by political corruption and violence, finally culminating in a military coup led by Fulgencio Batista in With the implicit backing of the United States, Batista opened up the country to gambling Paradigm Capital Inc, IIROC/TSX member 3

4 and the mafia who wanted to make it their personal fiefdom. All the while, Batista ignored the growing poverty with more than half of all Cubans being undernourished. Such an environment clearly planted the seeds of revolution. A band of young rebels attacked a military base in Santiago de Cuba on July 26, 1953, failing in its attempt but giving prominence to its young leader, Fidel Castro. Castro fled to Mexico where he organized a small group including his brother Raul (now President) and the legendary Che Guevara and landed back in Cuba in Slowly but surely, the small band of rebels grew, taking territory until they finally entered Havana early in 1959 at which time Batista fled to the Dominican Republic. The first three years of the Revolution saw thousands of people who opposed the new regime imprisoned. During this period, nearly a quarter of a million Cubans mostly professionals and wealthy landowners fled the country, mostly landing in Florida. Over the coming decades, this small group achieved a level of political clout that was clearly disproportionate to its size. Cuban Immigration to the United States Year of White Black Other Asian Number Immigration , , , , , , ,437 Total ,577 Source: Political Disaffection in Cuba s Revolution and Exodus, Silvia Pedraga Given the expropriation of American properties and Cuba s cosiness with the Soviet Union, the United States imposed a partial commercial, economic, and financial embargo on Cuba in October 1960, which was strengthened to a near total embargo in February Following the Cuban Missile Crisis in 1963, President Kennedy imposed travel restrictions in February Ironically, while the seemingly initial rationale for the trade embargo was the influence that the Soviet Union had on Cuba (which is a mere 90 miles off the US coast), once the USSR collapsed, left Cuba and therefore ceased to be a military threat, not only did the embargo stay in place, but it was strengthened. In 1992, The Cuban Liberty and Democracy Solidarity Act (also known as The Helms- Burton Act because of the its sponsors Jessie Helms, Republican from North Carolina and Don Burton, Republican from Indiana) was introduced. It attempts to penalize foreign companies that do business in Cuba by preventing them from doing business in the United States. The Title III of the law also states that any non-us company that knowingly traffics in property in Cuba confiscated without compensation from a US person can be subject to litigation and the company s leadership can be barred from entry into the United States. Paradigm Capital Inc, IIROC/TSX member 4

5 A Repeal of the US Travel Ban Seems Very Probable We believe there remains little appetite amongst the US populace for the continuation of this seemingly archaic (and quite frankly hypocritical) congressional act. Four times since 2000, the US House of Representatives has adopted language lifting the travel ban and in 2003, the US Senate followed suit for the first time. However, each time then President George W. Bush threatened to veto the bill, which stopped such legislation in its tracks. Despite this, the embargo has been continually watered down in practice. In response to pressure from American farmers, the embargo was relaxed under The Trade Sanctions Reform and Export Enhancement Act, which allowed the sale of agricultural good and medicines to Cuba for humanitarian reasons. In fact, in 2007, the US was the largest food supplier to Cuba and was its 5th largest trading partner. The election of President Barack Obama last year has brought new hope that the embargoes, both travel and business, will soon be overturned. While campaigning, Obama expressed his opposition to the repressive Cuban policies of the Bush Administration. That was reiterated early in his presidency when he spoke at the Summit of the Americas in Trinidad and Tobago in April 2009 and said that the US seeks a new beginning with Cuba. Shortly before, on April 13, 2009, President Obama had lifted all restrictions on the ability of individuals to visit relatives in Cuba, as well as to send them remittances. However, travel restrictions for Americans of non-cuban descent remain in place. So what keeps the travel ban in place? It certainly is not public opinion. According to a survey done in April 2009, the majority of US respondents felt that the US embargo has neither weakened nor strengthened (ie. no effect) on the Castro government, with 59% (47% Republican, 71% Democrats) believing it is time for a new approach to Cuba. Such attitudes reflect the opinion that only 7% of respondents view Cuba as a serious threat to the US with only an additional 27% viewing it as moderate threat. More specifically, 69% of respondents favour reestablishing relations with Cuba with 70% believing that all Americans (62% Republican, 77% Democrats and 66% Independents) should be free to visit Cuba. In fact, 71% of respondents believe that increasing travel and trade between Cuba and the United States will lead Cuba in a more open and democratic direction (see Appendix 2 for full survey results). Nevertheless, it has really been the Cuban-American lobby that has kept the embargoes in place. Recall that President Bush won the 2000 election on the back of Florida, whose Cuban-American population has long seen the embargo as a way to weaken the Castro regime. Time seems to be healing those wounds as well. A November 2009 Time Magazine article ( Could the US-Cuba Travel Ban End Soon? ) referred to a recent poll that found 59% of all Cuban-Americans think the 46 year-old ban on all US travel to Cuba should be removed. Remarkably, the survey by Miami-based Bendixen & Associates, the largest Hispanic polling firm, found that 48% of older and more conservative Cuban exiles known as historicos support lifting the prohibition, up from 32% in Paradigm Capital Inc, IIROC/TSX member 5

6 Bi-Partisan Freedom to Travel to Cuba Act Went to House Committee on Nov 19 With that backdrop in mind (ie. President who believes in policy change and a public opinion that favours change), it should be no surprise that there is proposed legislation to end the travel ban. A bipartisan bill known as The Freedom to Travel to Cuba Act was introduced by Senator Byron Dorgan (ND D) and Senator Michael Enzi (Wy R). According to Sam Farr, a Californian Democrat, the bill had support from 181 members of the House and needs 218 votes to pass. That was as of the end of September In a recent statement, Indiana Senator Richard Lugar, a Republican and co-sponsor of the bill called this a very good time for public diplomacy with Cuba, while former US Secretary of State George Shultz has called the travel ban lunacy. Even Human Rights Watch, which recently published a very critical report on the human rights track record under Raul Castro, sent a letter to Howard Berman, Chairman of the US House Committee on Foreign Affairs, indicating its full support of The Freedom to Travel to Cuba Act. The US House Committee on Foreign Affairs held a meeting on November 19, 2009 on the travel ban, an initial step to what we see as an inevitable repeal of the legislation. On top of the pending legislation, there have been trips by US State Governors this year (Bill Richardson (D) New Mexico and Mike Beebe (D) Arkansas) to discuss trade issues. Finally, the US and Cuba have recently held high level talks about restarting normalized postal service between the two countries for the first time in five decades and under a policy change announced in April, US telecommunication providers will be able to establish fiber-optic and satellite telecommunication facilities linking the US and Cuba as well as license to enter into and operate under roaming service agreements with Cuba s telecommunication providers. In summary, therefore, we believe there is good reason to assume that the US travel ban to Cuba will soon be repealed. There seems to be political will, public opinion, and the de facto end of the trade embargo through increased agricultural trade and the licensing to US telecommunication companies to do business in Cuba. As we will see, LCN seems very well positioned to benefit from Cuba s growth as a tourist (and business) destination. Cuba A Growing Tourist Destination Even Without the US What is Cuba s potential as a tourist destination with or without US travelers? The first thing to note is that Cuba is already a significant tourist destination (note that tourism is now the #1 industry in Cuba, surpassing sugar cane). In the first six months of 2009, Cuba welcomed 1,375,907 visitors, up 2.7% y-o-y, and it was the only destination in the Caribbean that showed a y-o-y increase during the most severe recession since the 1930s. In June, Cuba received 164,904 visitors, translating into a 7.3% increase v/s June 2008 and +22.1% compared with June For the year, the Cuban government anticipates 2.35m visitors. In terms of its physical capacity to grow its tourism industry, Cuba is 1200 km long and covers 111,000km². To put that in perspective, Cuba is 40% the size of Italy, 80% the size of Florida and 10x larger than Jamaica. Those destinations receive 43.7m, 8.1m and 2.7m (including cruise ship visitors) international visitors respectively. Paradigm Capital Inc, IIROC/TSX member 6

7 Looking at the attributes that make a country a popular tourist destination, we believe Cuba scores high in many of the categories: a) Weather: The average temperature in Havana is 22 degrees Celsius in the winter (November April) with a high-low range of 29 to 16. b) Beaches: Cuba has more coastline than the rest of the Caribbean islands combined. It has over 200 beaches (588 kms). On Cuba s southern shoreline lies the 2nd largest coral reef in the world (ie. the same reef that passes the Cayman Islands and Cozumel, Mexico). c) History and Culture: As mentioned, Cuba was discovered by Christopher Columbus and Havana is one of the oldest cities in the Americas. Its historic old city centre became a UNESCO Heritage site in Cuba has vibrant culture and has given the world such musical gifts as salsa, rumba and mambo, as well as the ever popular daiquiri and mojito. d) Safety: According to Frommer s Travel Guide, Cuba is an extremely safe country. Street crime is relatively rare. In addition, Cuba has the potential for significant air lift. It has 10 international airports, including 3 that are conveniently located near Leisure Canada s three proposed hotel/resort developments in Havana, Jibacoa and Cayo Largo. Having concluded that Cuba is today a growing tourist destination with ~2.5m annual visitors and that the US travel against Cuba may end, we now must examine the supply of product to feed that growing demand. We would note that in addition to the number of arrivals quoted above, a PriceWaterhouse study done indicated that if the US travel were to be lifted, up to 5 million Americans per year would travel to Cuba. Such a number seems to make intuitive sense as Americans in the 1950s (ie. prior to the Revolution) made up 85% of all tourist visits to Cuba. Hotel Capacity is an Issue and Will be Especially Acute When Americans Arrive Looking at Cuban hotel capacity, an Ernst & Young study done in 2006 ( A Business Guide to Cuba ) indicated there were 41,000 hotel rooms on the island with only 28,500 listed as 4-star (20,000) and 5-star (8,500). Note that in our experience, Cuban 4 and 5-star properties are at least 1-star lower in reality. Nevertheless, assuming 41,000 hotel rooms and 15 million room nights (ie. 41,000 x 365 days) against 2.5 million visitors staying an average of 7 nights who would need 17.5 million room nights, it is clear there is a shortage to support continued growth even without the potentially massive influx of US visitors. The table below not only illustrates the potentially significant shortage of Cuban hotel rooms today, but especially if/when US visitors come to the island. We have used as comparison Las Vegas (probably one of the most densely populated hotel regions in the world). Mexico, and the island of Martinique (where 3 new hotels were recently opened). Paradigm Capital Inc, IIROC/TSX member 7

8 Hotel capacity comparison Destination Las Vegas Mexico Martinique Cuba Cuba** Available Rooms 141, ,000 6,000 41,000 41,000 Annual Room Nights 51,654, ,950,000 2,190,000 14,965,000 14,965,000 Annual Visitors (overnight) 12,000,000 22,000, ,000 2,500,000 7,500,000 Avg Nights Available per Visitor Avg Stay (Days) ** Assumes US travel ban is lifted and 5 million Americans travel to Cuba, some of whom go for 2-3 days stays thus reducing the average stay (days) Source: Paradigm Capital, Travelmole In our view, if the last row (average stay in days) is higher than the average nights available per visitor, it is an indication of a shortage of rooms. Note that Las Vegas, Mexico and Martinique have a slightly better supply of rooms than demand, while Cuba today is in disequilibrium. We believe the shortage is even more acute than indicated given the lack of 4 and 5 star product. Furthermore, if the Americans do come, Cuba will need to double the number of hotel rooms. Interestingly, according to a recent article in Travel Weekly (November 19, 2009), there are 129 hotels totalling 18,715 rooms that are scheduled to open in the Caribbean in the next two years, including 10,615 in Mexico, which would increase its room availability by 2.5%. Among the hotel chains building there, the upperupscale segment has the largest portion of rooms planned or under construction, followed by mid-market, while economy had the smallest portion. We find this interesting as, despite the current economic downturn, hoteliers are planning in advance and clearly believe the Caribbean will continue to be a very popular tourist destination. We believe Cuba will participate in the next round of growth, regardless of US policies. The shortage of hotel rooms becomes even clearer when compared to other Caribbean destinations: Cuba s Hotel Potential Versus Caribbean Average Cuba Caribbean Average Number of rooms per thousand of population Less than 1 31 Arrivals per square km Tourist arrivals per thousand of population 150 2,502 Tourist arrivals per km of coastline 475 1,560 Source: Ernst & Young Given the importance that the Cuban government now places on tourism, it has taken on a very high profile within the government. According to the Ministry of Tourism, Cuba aims to open 10,000 more hotel rooms in the next 10 years. While Cuba does have 3 separate tourism companies that own and operate the majority of hotels currently on the island, we believe the new properties will most likely take the form of joint-ventures (JVs) because: a) Cuba is capital constrained b) Foreign developers bring expertise in planning and operations that is required when dealing with a more discerning clientele, such as Americans. Paradigm Capital Inc, IIROC/TSX member 8

9 Leisure Canada Building Cuba s Next Wave of Hotels Mr. Wally Berukoff, Chairman of Leisure Canada, has been operating in Cuba since shortly after the Russians pulled out of the country. Starting in the mining industry, Mr. Berukoff developed a close relationship with senior members of the Cuban government, including Mr. Castro, who needed his experience to generate much needed hard currency during the time known in Cuba as the Special Period. In the mid 1990s, the Cuban government approached Mr. Berukoff with the idea of partnering with him on a number of hotel developments. Understanding that the greatest IRR of such developments would occur under a scenario whereby the US travel ban would be lifted, Mr. Berukoff limited the property choices to those that had no prior US claims against them. To confirm such details, the company engaged in extensive legal due diligence with US lawyers. At the end of the negotiations and due diligence, LCN became a 50%-50% JV partner with Gran Caribe (the Cuban government-owned luxury hotel property owners) on three properties: a) Monte Barreto in the Miramar district of Havana b) Cayo Largo c) Jibacoa (half way between Havana and Veradero) LCN s Property Locations Source: Leisure Canada Investor Presentation The company has 75-year leases on those properties, which do not start until construction is completed. This is important given the company has had the rights to the properties since the late 1990s, but did not advance on any of them during the years of the Bush Administration and its repressive Cuban policies. Clearly the advent of the Obama Administration, the growth of Cuba as a tourist destination and the changing attitudes of Cuban-Americans towards the travel ban, has re-initiated the economic viability of the projects. Below we highlight the attributes of each of the properties as well as the key upcoming milestones and their projected earnings power. Paradigm Capital Inc, IIROC/TSX member 9

10 Hotel Income Statement Metrics Prior to a discussion as to our revenue and cash flow projections on each of LCN s properties, we thought it would be instructive to take a look at the Common Size Income Statement of Host Hotels & Resorts (HST N). Host owns a multibranded portfolio of luxury and upper-upscale hotels under such premium brands as Marriott, Ritz-Carlton, Westin, Sheraton, W, St. Regis, Hyatt, Fairmont, Four Seasons, Hilton and Swissotel. It is the owner of the real estate and generally sells the management of the property to one of the aforementioned flag companies for ~5% of total revenue plus a performance bonus. Such a strategic plan is one that LCN may follow as it builds out its properties and then brings in a recognizable brand to manage them. In 2007, revenue generated within the hotel represented 98% of Host s revenues. They broke down as follows: a) Room revenue 61% b) Food and beverage 30% c) Other (spa, parking, etc) 7% In terms of expenses, hotel operating expenses represented 99% of total costs: a) Room expenses (housekeeping, reservation systems, supplies, laundry, front desk,etc) 17% b) Food and beverage 26% c) Other (parking, golf course, spas) 29% d) Management fees 5% e) Other (tax, insurance) 9% f) Amortization & depreciation 13% We can conclude from the above that food and beverage revenue is typically 50% of room revenue while other amenities may be 12-15% of room revenue. On the expense side, it is clear that many of the costs are variable, ie. labour related. In fact, one of the key differences that separate a 3-star hotel from a 5-star hotel is the level of service. As Host operates primarily in the United States and Europe, its variable cost structure is significantly higher than LCN s will be. This should lend the profit profile of LCN to be much higher than Host. Leisure s Properties: Monte Barreto a) Location: Leisure Canada s Monte Barreto project is located on a 34,500m² ocean-front site in the Miramar district of Havana. The property is adjacent to both the Russian Embassy and the proposed site of the Brazilian embassy, next to the new National Aquarium, and two blocks from the Miramar Trade Centre (a JV with an Israeli entity). Paradigm Capital Inc, IIROC/TSX member 10

11 Monte Barreto Location in Havana Source: Leisure Canada Investor Presentation b) Structure of JV: Leisure Canada and the Cuban government, through Gran Caribe, are 50-50% partners in this venture. In simplistic terms, the Cuban s put the land into the JV, which is valued at ~US$10m. LCN must put matching capital in (of which it has thus far spent ~US$2m). Once even, both LCN and the Cubans must put equal amounts of capital into the project. If for whatever reason, LCN funds the entire project (ie. it may be easier for one entity to arrange for the entire debt package), it will retain the entire cash flow of the project until the debt and associated interest attached to the Cuban portion is repaid. c) Capacity: The current site plans call for 538 rooms in addition to 200 fractional ownership rooms 1. There is also to be such amenities as restaurants, spa, conference, retail and parking. d) Capital Budget: While the company has not yet issued an RFP to construction companies, we have assumed total capital costs of US$170m. We believe this is a very conservative estimate as labour costs should be substantially lower than when compared to those in developed countries. The obvious question is where will the company access the capital? Looking for ~US$100m+ of debt financing in Cuba limits the 1 While time-shares, or fractionals are a common structure in the tourism industry, they do not yet exist in Cuba. The fundamental concept is approved by the Cuban government, however, the mechanics of how the system will operate or function still need to be finalized. Paradigm Capital Inc, IIROC/TSX member 11

12 number of potential participants. Most likely, the loan will be against future cash flows to be held off-shore. The company is in the midst of conversations with a myriad of potential lenders. We would note one potential lender could be Ceiba Investments, a finance company based in Guernsey. It has experience lending to Cuban projects, including the Miramar Trade Centre. e) Revenue, Cash Flow and IRR Projections: Revenue, cash flow and IRR projections are clearly all very sensitive to the assumptions one makes, as well as the price at which the company sells the fractional units. We have assumed the hotel construction is started in 2011 and completed at the end of 2012, with the hotel opening in January We have further made the following assumptions: 1) Occupancy rate in Year 1 is 75% rising to 85% over the next 5 years 2) Average room rate (RevPAR) in year 1 is US$160/night rising to US$220 in year 5. While we are clearly discounting some probability of the removal of the US travel ban, we believe the rate could be much higher if/when the ban is actually removed. 3) Fractional sales (tenth of a year) start in year 1 with 50 unit sales per year (ie. 500 tenth units) for 4 years. Assumed selling price per tenth is US$85,000. Total proceeds for fractional sales of US$170m or roughly equivalent to the entire construction costs of the project. 4) Food and beverage revenue is equivalent to ~50% of occupancy revenue. 5) Excluding fractional sales, EBITDA margin in year 1 grows from the mid 30% to 50%, primarily driven by the low operating costs (ie. labour) and improving economies of scale. Under the aforementioned scenario, we believe the IRR of the Monte Barreto project would be north of 30%. Even under a more conservative assumption where RevPAR is US$140/night and excludes the impact of the US travel embargo lifting, we believe the project would produce an IRR of 21%. Summary of Milestones for Monte Barreto: March 2010 finish architectural drawings for all 3 phases of the project March/April 2010 tender for bids for construction project June 2010 have debt financing in place July/August 2010 award construction project January 2011 first shovel in the ground December 2012 finish construction January 2013 open doors Cayo Largo a) Location: Cayo Largo is a small resort island off the southern coast of Cuba. The island is ~25km long and 3km wide. Leisure Canada s property is 300,000m². Its beach front is protected by a coral reef directly in front of the property. Paradigm Capital Inc, IIROC/TSX member 12

13 Cayo Largo - Source: Leisure Canada Investor Presentation (image 1), aircanadavacations (image 2) b) Structure of the JV: Like the structure of the Monte Barreto deal, the Cayo Largo JV is a 50-50% relationship with Gran Caribe. In this case, the value of the property has been estimated at ~US$3m. c) Capacity: We have modeled that the company will construct a resort with 130 rooms. In addition, the company will build 160 fractional units to be sold in tenth shares. The Cuban government has limited the capacity on the island to 2000 rooms. Today, there are four resorts on the island, only one of which is classified as a 4-star (3-star in reality), which is 100%- Cuban owned but operated by Sol Melia (a Spanish hotel chain). As such, there are no 4 or 5-star properties on the island. In addition to the proposed Leisure Canada property, a group out of Qatar is planning on constructing a resort. On May 7, 2009, the Qatar Diar Real Estate Investment Company announced that it would build a 5-star Gran Paraiso hotel on the island with up to 450 rooms and 60 luxury villas. Total construction costs were estimated at that time to be US$75m. Part of that cost is to include infrastructure costs (sewage treatment, roads, electrical, etc) on which LCN will also benefit (note that the Qatar property is right next to LCN s), thus reducing LCN s costs. d) Capital Budget: To construct a 5-star hotel of the aforementioned size, we have assumed construction costs of US$40m. On top of that would be ~US$3m of offsite infrastructure costs, albeit that figure is lower than normal given LCN s ability to leverage off the Qatari s infrastructure investments. Given the significantly lower cap-ex budget than the level needed for Monte Barreto, we believe the financing options are greater and could include a number of Canadian banks that have lent to Cuban projects in the past. e) Revenue, Cash Flow and IRR Projections: We have assumed that LCN builds and sells the 160 fractional units and runs the other 130 rooms on an all-inclusive basis. The pricing for the fractional (tenths) is assumed to be US$40,000 indicating a total potential revenue and cash flow stream of US$64m. Like the Monte Barreto project, a successful selling program of Paradigm Capital Inc, IIROC/TSX member 13

14 the fractional units would make the project entirely self funding (albeit with timing differences). For the all-inclusive component, we have assumed US$250/night per room in year 1, increasing to US$325/night in year 5. In terms of corresponding occupancy rates, we have assumed 70% in year 1 increasing to 80% in year 5. Note that our conversation with the general manager of the Sol Melia in Cayo Largo indicated its occupancy rate is 80%. Under such a scenario, the Cayo Largo resort would generate 30% margins in year 1, growing to 50% in year 5, not including the impact of the fractional sales. Again, margin enhancement is driven by low labour costs and economies of scale. These cash flow numbers in our scenario would generate an IRR of 38%. Summary of Milestones for Cayo Largo Spring 2010 have all architectural drawings done Summer 2010 put out tender to construction companies Fall 2010 have debt financing in place January 2011 first shovel in the ground December 2012 finish construction January 2013 open doors Jibacoa Jibacoa is located approximately half way between Havana and the beach resort of Veradero. It is an approximate 45 minute drive from Havana. The property is enormous at 5.5km², 5,500,000 m² or approximately 1,500 acres. The property at Jibacoa represents a huge opportunity for the company to develop an Intrawesttype of village. It is in the early stages of development and the company has not yet solidified its plans in terms of concrete drawings. Conceptually, the company would develop the project in phases that would take 10 years to completely unfold. Rough Design for a Potential Jibacoa Village Source: Leisure Canada Investor Presentation (image 1), aircanadavacations (image 2) Paradigm Capital Inc, IIROC/TSX member 14

15 In Phase 1, it is envisioned that Leisure Canada would build a golf course, a hotel and a number of bungalows that it would then sell. Phase 2 would encompass a smaller hotel and more bungalows along the golf course. Phase 3 would entail a 9-hole golf course and another hotel. Finally, the company would build a 2nd 18- hole gold course. In addition, a marina is planned for the site. Of the 3 properties, in our opinion, this vision for the Jibacoa property is most dependent on a lifting of the US travel ban. If the change does come, we believe the development of Jibacoa would mirror the Casa de Campo development in the Dominican Republic. Casa de Campo is a 7,000 acre hotel resort and residential community that encompasses hotels, golf courses, marinas and for-sale houses. In total, the company s license enables it to build 1300 hotel rooms, 600 bungalows, 45 holes of golf, a marina, tennis club, spas and retail. Much like the other properties, it is hoped that a good portion of the financing could eventually be recouped through sales of houses, golf memberships, the marina, etc. It is interesting to note that as of today, there is only one 18-hole golf course on the island of Cuba and that Jibacoa represents the closest port of entry from the United States, which would certainly make the marina attractive if the political situation is improved. While still early, it is estimated that the entire project would have a capital budget of ~US$250m. Summary of LCN s Properties Monte Baretto Cayo Largo Jibacoa Geographic Footprint (m 2 ) 34, ,000 5,500,000 JV Structure 50-50% 50-50% 50-50% Capacity (rooms) ,300 Proposed Fractional Sales Capital Budget US$170m US$43m US$250m Estimated IRR 35% 38% n/a Construction Start Jan-11 Jan-11 n/a First Guests Jan-13 Jan-13 n/a Source: Company, Paradigm Experienced Management Team We believe Leisure Canada brings two distinct managerial strengths, both of which are extremely important to the success of the company: a) Cuban Experience and Government Relations: Mr. Walter Berukoff is the founder and Executive Chairman of the company. As mentioned earlier, Mr. Berukoff brings extensive Cuban experience as well as excellent relations with the Cuban government. b) Real Estate Development Experience: From an operational perspective, a group led by Mr. Robin Conners, joined Leisure Canada in May Each of these senior members worked together at Intrawest. In particular, Mr. Conners (President and CEO) held senior positions at Intrawest as well as the St. Joe Company (JOE N), a $2.5b market cap real estate developer in Florida. Colin Yee (CFO) was VP Finance for Intrawest Paradigm Capital Inc, IIROC/TSX member 15

16 Placemaking. Robert Jerome (Senior VP Strategic Planning) is a member of the Order of Architects of Quebec. Mr. Jerome joined Intrawest in 1996 and held many senior positions including President of Intrawest Europe, where he led the development team. Strong Balance Sheet after $20m Financing As of its latest quarterly report (June 30, 2009), LCN had $0.5m in cash. Subsequent to quarter-end, the company completed two private placements. On July 20, 2009, it completed a small placement of 2.7m shares at $0.20 with a half warrant at $0.25. On August 17, 2009, LCN completed an offering of 91.1m shares at $0.20 with a half warrant at $0.25. As of today, therefore, we believe the company has ~$16m in cash. Post the financings, Leisure Canada has 165m basic shares outstanding and 220m on a fully diluted basis. Conversion of the warrants would yield the company an additional $12m in cash. At a current price of $0.24, the company has a market capitalization of $39.6m or an Enterprise Value (EV) of $23.6m. Put another way, its current cash position represents ~40% of its current market cap. Valuation We have looked at a couple of different metrics to triangulate value. We have made the following assumptions for all of our methods: a) The company will need to raise additional upfront capital to fund the construction of its projects. We assume it will be able to raise 70% of its requirements through debt. b) The shortfall between capital required and debt financing secured will be financed through equity. We have assumed an equity raise of $0.75 (capital raise assumed to be undertaken after positive news regarding US travel ban) resulting in an additional 40 million shares. Including such a financing, its current cash balance of $16m and the conversion of its outstanding warrants, LCN would have pro-forma cash of $60m. On a pro-forma fully diluted basis, LCN would have 260 million shares outstanding. c) Through sales of fractional ownership units, LCN is able to fully pay off its construction debt. Earnings Power We like to look at the earnings power of a given company s asset base. As we indicated in our above analysis, we believe the earnings power of Cayo Largo could be US$6.5m while Monte Barreto could be US$40m. Understanding that half the profits are reserved for the Cuban partners, LCN shareholders would be entitled to US$23.25m. The earnings power of the 2 projects would therefore be ~$0.10/share. At a 20x P/E, discounted by 25% would imply a target price of $1.50. Note that this earnings power does not take into account any potential earnings from Jibacoa, which would therefore represent a free option under this scenario. Paradigm Capital Inc, IIROC/TSX member 16

17 Enterprise Value per Room Another valuation metric we believe is relevant is EV per key or EV per number of rooms. Through this metric, one can quickly compare the relative value of similar star properties. Given that most of the publically traded hotel companies are in fact management companies, such a metric is not particularly meaningful. However, we have looked at Host Hotels & Resorts (HST N). Host owns hotels that encompass 62,000 rooms. At a recent price of US$10.70, the company has a market capitalization of US$6.6b. Together with US$6b in debt, HST has an EV of US$12.6b. With 62,000 rooms, this would imply a valuation of US$204,000/room. While clearly very early in its development, Leisure Canada has plans for ~3,000 rooms plus amenities (738 at Monte Barreto, 290 at Cayo Largo and 2000 at Jibacoa). At a current EV of $20m, this put an EV/room value of $6,600. Clearly, the company has to raise additional capital to fund the build of the rooms but the plan would be to sell the fractional units that would completely offset those capital costs. Therefore, excluding the fractional units, the company plans to have ~2,000 hotel rooms. At a similar valuation to HST s current level, that would imply an EV of $410m or $205m for LCN s share. On a per share basis, this would imply $0.80/share or $0.60/share after a 25% discount. However, we would argue that under better economic conditions, HST traded as high as US$405,000/room. We would further note that we would anticipate the level of profitability of LCN could be significantly higher than HST. In 2007, HST recorded an EBITDA margin of 27%. Most of the variable costs are labour related. Given the advantage that LCN would have on this front, we believe it could garner an EBITDA margin of closer to 50% at a 75% occupancy rate. Finally, we would note that Host Hotels purchased the 270 room Crowne Plaza Amsterdam City Centre for ~US$115m in August This implies a price/room valuation of US$420,000. At that valuation, LCN would be worth $420m (US$420,000 x 2,000 / 2) or $1.62 per share. Discounting that by 25% would imply a value of $1.22. At a US$500,000 per room value to reflect the better profitability profile, LCN would be worth $1.92 or $1.44 after the 25% discount. Capitalization Rate Capitalization rates are typically used in real estate transactions to ascertain selling prices for properties. The variables are operating cash flow and the cap rate. Above, we have attempted to gauge the operating incomes for Monte Barreto and Cayo Largo. As for the cap rate, we have attempted to ascertain the rate used for Host Hotels purchase of The Crowne Plaza Amsterdam. Knowing it paid US$115m and assuming the cash flow from that hotel was ~US$6.5m, we arrive at a cap rate of 5.5%. Understanding that there is a higher degree of risk involved in Cuba, at least until the travel ban and/or trade embargo is lifted, we have used a 10% cap rate for the projects. Monte Barreto s cash flow is assumed to be US$40m. At a 10% cap rate, that would imply a valuation of US$400m or US$200m to LCN. Cayo s Largo s assumed cash flow is US$6.5m. At a 10% cap rate, that would imply a valuation of US$65m or $33m to LCN. Together, that would indicate US$233m to LCN or $0.90/share. Again, such an analysis sees Jibacoa as a free option. Paradigm Capital Inc, IIROC/TSX member 17

18 Jibacoa as Free Option What s It Worth? Jibacoa is the largest piece of LCN s properties and as such, should offer the greatest potential return. While we have assumed it will be the last to be developed, a change in the political environment could quickly change that assumption. With a more village-style development planned, we believe there is a lot of potential to generate returns. A quick back of the envelopment would indicate to us that there is potentially at least $1.00 of value per share. That calculation is derived from 1300 potential 5-star hotel rooms valued at US$500,000 per room discounted at 25%. Summary of Valuation Scenario Earnings Power EV/Room Cap Rate Monte Barreto/Cayo Largo $1.50 $0.50 $0.90 Jibacoa n/a $1.00 n/a Total $2.50 $1.50 $1.90 Source: Paradigm *The totals for Earnings Power and Cap Rate include the $1.00/share Jibacoa EV/Room calculation Initiating Coverage with Buy and $2.00 Target Price We believe there is an excellent risk-return opportunity in the shares of Leisure Canada, driven by the following: a) Cuba is a growing tourist destination with ~2.5m visitors annually; b) The country has an insufficient amount of quality hotel rooms to service its current tourist industry; c) There seems to be great momentum, both grass roots and political, to repeal the US travel ban against Cuba, which could increase visitors to the island 3-fold; d) If there is a shortage of hotel rooms in Cuba today, the shortage with the onslaught of American visitors would be acute; e) Leisure Canada has first mover advantage with 3 prime Cuban hotel/resort properties. Construction should commence in the next 12 months. Its positioning could allow for significant value creation upon partnership with a US flag hotel operator. f) Current market capitalization is $40m with an EV of $22m. In our view, this clearly does not properly reflect the changing political landscape nor the significant cash flow that could accrue from the properties. We are consequently initiating coverage with a Buy recommendation and $2.00 target price based on an average of the above valuation scenarios. Paradigm Capital Inc, IIROC/TSX member 18

19 Appendix 1: Text of H.R. 874: Freedom to Travel to Cuba Act Feb 4, Introduced in House. This is the original text of the bill as it was written by its sponsor and submitted to the House for consideration. This is the latest version of the bill currently available on GovTrack. HR 874 IH, 111th CONGRESS, 1st Session To allow travel between the United States and Cuba. IN THE HOUSE OF REPRESENTATIVES February 4, 2009 Mr. DELAHUNT (for himself, Mr. FLAKE, Ms. DELAURO, Mrs. EMERSON, Mr. MCGOVERN, Mr. MORAN of Kansas, Ms. EDWARDS of Maryland, Mr. PAUL, and Mr. FARR) introduced the following bill; which was referred to the Committee on Foreign Affairs A BILL To allow travel between the United States and Cuba. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SECTION 1. SHORT TITLE. This Act may be cited as the Freedom to Travel to Cuba Act. SEC. 2. TRAVEL TO CUBA. On and after the date of the enactment of this Act, and subject to section 3-- (1) the President may not regulate or prohibit, directly or indirectly, travel to or from Cuba by United States citizens or legal residents, or any of the transactions incident to such travel; and (2) any regulation in effect on such date of enactment that regulates or prohibits travel to or from Cuba by United States citizens or legal residents or transactions incident to such travel shall cease to have any force or effect. SEC. 3. EXCEPTIONS. Section 2 shall not apply in a case in which the United States is at war with Cuba, armed hostilities between the two countries are in progress, or there is imminent danger to the public health or the physical safety of United States travelers. SEC. 4. APPLICABILITY. This Act applies to actions taken by the President before the date of the enactment of this Act that are in effect on such date of enactment, and to actions taken on or after such date. SEC. 5. INAPPLICABILITY OF OTHER PROVISIONS. The provisions of this Act apply notwithstanding section 102(h) of the Cuban Liberty and Democratic Solidarity (LIBERTAD) Act of 1996 (22 U.S.C. 6032(h)) and section 910(b) of the Trade Sanctions Reform and Export Enhancement Act of 2000 (22 U.S.C. 7210(b)). Paradigm Capital Inc, IIROC/TSX member 19