Summary thesis: La Quinta’s (LQ; disclosure: long) upcoming spin of their owned hotels (in combination with the sale of their franchised business) into a REIT presents investors with all the hallmarks of a classic undervalued / underestimated spin: the spun-off business will be completely different than the current one, management is going to the spinco, the trailing financials are messy, a quirk in the deal structure incentivizes management to sandbag numbers / valuation heading into the spin, and the spinco will be a juicy acquisition target for a variety of strategic acquirers. I believe the entire company is worth more than $23/share today, which presents solid upside from today’s price of $18.60/share. However, I also think that upside undersells the opportunity, as $8.40/share will be returned in cash in the near term (sometime in Q2). Looking through that cash distribution, you’re creating the REIT business (CorePoint) for ~$10 against my valuation of >$15, presenting over 50% upside. La Quinta today consists of two businesses: the La Quinta brand / franchise and the ownership of 317 La Quinta hotels. In early 2017 the company announced a plan to pursue a taxable spin that would split off the owned real estate into a REIT and leave behind the high margin franchise / brand management business. In early 2018, the plan changed slightly: the company announced they were selling the La Quinta franchise / management business to Wyndham, and concurrent with the sale they would spin off the REIT as a company known as CorePoint Lodging. The whole transaction should close in Q2 2018. The terms of the Wyndham agreement call for Wyndham to pay LQ shareholders $8.40/share in cash in addition to paying off some debt and covering taxes associated with spinning CorePoint off in a taxable spin. So, at today’s price of ~$18.60, LQ shareholders are paying for the right to receive ~$8.40 when the Wyndham transaction closes in the next few months plus the remaining CorePoint business, which I believe is worth >$15/share. On a PF basis (with a fully loaded standalone cost structure and adjusted for the new external management contract), CorePoint earned ~$207m in Adj. EBITDA in 2017. While CorePoint will be unique in its focus (it’ll focus on midscale and upper-midscale select service hotels; most peers are higher-end and tend to be full-service focused), both peer multiples (CLDT, HT, INN, and RLJ are the best peers) and individual La Quinta hotel transactions suggest CorePoint should be worth at least 11x EBITDA. With 118m shares out and the company taking out a $1,035m CMBS loan as part of the transaction, we can come up with a loose valuation. Add that to the $8.40 payment from Wyndham and you get a combined company value of ~$19, which gives a little upside from today’s prices, but it would basically be a rounding error of upside. Here’s where things start to get interesting: I think both the debt and earnings number I used in that valuation will prove much too conservative. I’ll discuss why in a second, but let me start by discussing why the company would intentionally obfuscate its value. After all, most managers know that spinoffs have trouble finding an investor base and are constantly out pitching what a great deal the stock is leading up to a spin, particularly in a spin that’s part of a deal shareholders have to vote on / approve. I think the answer to that question lies in a hidden tax provision in their Wyndham deal. The press release on the La Quinta sale contains a near throwaway line that Wyndham will “set aside a reserve of $240 million for estimated taxes expected to be incurred in connection with the taxable spin-off of La Quinta’s owned real estate assets into CorePoint Lodging Inc.” However, if you dig through the proxy and the merger agreement, you can see that the tax reserve amount was not a throwaway amount; in fact, it was the subject of a good deal of negotiation. But what’s really interesting is that the tax reserve is just an estimate of how much tax the spin will incur, and, to the extent the tax incurred is less than $240m, CorePoint gets to keep the difference (if it’s more than $240m, CorePoint has to pay La Quinta the difference, but as I’ll show in a second that’d be a happy problem for investors at today’s prices to have). NEWSLETTER SIGN-UP You can probably see where I’m going with this: the CorePoint / Wyndham agreement calls for a fixed tax payment. If the taxes are lower than that payment, CorePoint keeps the proceeds. If the taxes are higher, CorePoint covers the excess. The ultimate tax payment is based on the difference between CorePoint’s tax basis in their hotel assets and the enterprise value at the time of the spin, so a lower share price at spin time results in a lower tax liability. Because the tax payment is based on CorePoint’s share price at the time of spin, CorePoint is actually incentivized to try to keep their share price as low as possible heading into the spin, as doing so results in more cash coming on to their balance sheet / less going to Uncle Sam (Wyndham doesn’t really care what happens here; they’re on the hook for $240m no matter what). Note that this is not a completely unique situation: Disney / Fox have a somewhat similar issue with their taxable spin of the remaining Fox assets, though they use an increase in Disney shares to FOX holders to resolve the “lower than expected” tax “problem”. With the incentive for management to keep the share price low discussed, let’s turn to the two key sources of upside to my valuation: the net debt number and the EBITDA number. I’ll start with the debt number. In my valuation, you’ll notice that I used the gross CMBS debt number, which I think will end up being much too punitive. The reasoning lies in the details of the merger agreement. While the press release highlights that Wyndham will “repay $715m of La Quinta debt net of cash” as part of the acquisition, the deal is actually structured so that CorePoint will take out the $1,035m CMBS loan to pay a $983.95m dividend to LQ Parent (the franchise business Wyndham is buying) as part of the spin off. This dividend is subject to adjustment up or down to the extent “estimated existing net indebtedness” is different than the target net debt of $1.665B (see page E-4 and E-23); the difference between those two numbers is how they arrive at that $715m debt paydown number. La Quinta had net debt of ~$1.55B at 12/31/17, so they’re already >$100m below the net debt target before any cash build between 12/31/17 and the spin. Given CorePoint’s raising $1,035m in debt to pay a ~$984m dividend (so ~$50m excess there) and they are already >$100m below their net debt target, CorePoint should spin with at least $120m in excess cash on their balance sheet, good for ~$1/share in value.