Fitch Ratings has assigned a 'BB+'/'RR2' rating to Hilton Grand Vacations Borrower LLC (HGV) proposed senior secured term loan B and senior secured notes guaranteed by Hilton Grand Vacations, Inc.

Fitch has also affirmed the 'BB' Issuer Default Rating (IDR) of Hilton Grand Vacations, Inc. and Hilton Grand Vacations Borrower LLC, secured revolver and term loan at 'BB+'/'RR2', as well as unsecured notes at 'BB'/'RR4'. The Rating Outlook is Stable.

The rating assignment follows the announcement by HGV that it plans to acquire Bluegreen Vacations Holding Corporation for $1.5 billion. Fitch believes the acquisition is beneficial in terms of adding scale, increased FCF, expanded member reach, and potential cost and revenue synergies. The debt-funded transaction will increase EBITDA leverage slightly above sensitivities; however, Fitch expects it will quickly decrease over the forecast horizon.

Key Rating Drivers

Bluegreen Acquisition: HGV announced that it intends to acquire Bluegreen Vacations Holding Corporation (BVH) for $75/share, or $1.5 billion total enterprise value, in a 100% cash transaction. This implies a 6.0x multiple when run-rate cost synergies are included. The rationale for the sale includes increased size and scale that should lead to costs savings and lower cost of capital, expansion of HGV's member reach and growth profile, potential to accelerate new buyer growth by taking advantage of BVH's high quality lead flow, increased FCF from potential cost savings and revenues synergies, and the ability to rebrand BVH resorts with the HGV brand and further leverage the Hilton relationship.

HGV plans to issue secured debt to fund the acquisition, which will increase EBITDA leverage slightly above Fitch's downgrade sensitivities. Fitch expects FCF will be used to reduce debt to bring leverage within sensitivities over time. HGV deleveraged rapidly following its acquisition of Diamond Resorts.

Variation From Published Criteria: Since the September 2023 committee, Fitch has created a variation for timeshare companies. Fitch's Corporate Rating Criteria calls for deconsolidation of the company's financial services (FS) operations and assumes a hypothetical capital injection to achieve the target standalone capital structure. A variation from Fitch's Corporate Rating Criteria was made as Fitch-adjusted EBITDA now incorporates income earned from the company's FS operations.

Fitch considers the cash generated by HGV's wholly owned consumer financing subsidiary, which flows up directly to HGV, to be accessible, stable and sustainable. Therefore, its inclusion better depicts the company's true operating position as this cashflow supports HGV's ability to service debt and finance its operations.

Recovery Criteria Revision: In October 2023, Fitch released new Recovery Criteria that included a change in the definition of debt that would reduce the relative ranking of HGV's first lien secured debt. Fitch initially provided a two-notch uplift from the Issuer Default Rating (IDR) of 'BB' to 'BBB-' for HGV's senior secured debt. The new criteria revision only allows for a one-notch uplift to 'BB+'.

FCF Growth Driving Deleveraging: Strong growth in HGV's EBITDA and FCF since 2021 resulted in debt reduction and improved leverage metrics. Fitch's EBITDA leverage declined to 2.8x in 2022 from 5.3x in 2021 and is expected to remain in the low mid-3x range during the forecast horizon. Fitch's leverage calculation includes an adjustment to ensure proper capitalization of the company's captive finance operations, which is zero for 2023, given the abundant timeshare receivable assets over securitize receivable debt.

HGV has a company-defined public net adjusted EBITDA/debt target of 2.0x-3.0x. HGV's net leverage as of Sept. 30, 2023 was 2.8x.

Resiliency in Downturn: Despite a 71% drop in net sales of vacation ownership interests (VOI) in 2020, HGV generated positive FCF from recurring revenue sources, including consumer financing, club management and rental and property management fees. Recurring revenue represented 42% of total revenue in 2Q23. Low capital spending and the ability to manage inventory on a just-in-time basis provide flexibility during a downturn.

Timeshare receivables experienced a default rate of 8.9% in 2021 and 6.3% in 2020, and reached 6.0% during the global financial crisis. In a default, HGV typically retains ownership of the VOI, which it can rent or sell to another customer. Thus, loan losses are relatively low despite high default rates. In addition, the weighted average FICO score of 734 out of a potential of 850 as of Sept. 30, 2023 is considered by Fitch to be of good quality.

Well Positioned in a Competitive Industry: HGV is a top three timeshare operator based on owner families, which provides economies of scale and facilitates third-party marketing relationships. HGV is well positioned within the high-end spectrum of the timeshare industry and has a diversified portfolio of vacation ownership brands. The integration of Diamond Resorts broadens HGV's addressable market through an expanded regional network in the U.S. as well as a wider range of products and price points.

HGV has exclusive rights to the Hilton name for the timeshare business on a 100-year license and has access to 158 million members in the Hilton Honors program, one of the industry's strongest loyalty programs. Loyalty programs are crucial for chains like Hilton, as the programs drive repeat business, which translates into repeat selling opportunities in timeshares.

Derivation Summary

HGV's ratings reflect its leading position in timeshares, its strong brand affiliation and network and its robust liquidity due to limited near-term debt maturities. The discretionary and cyclical nature of timeshare sales balance the ratings.

HGV is one of the nation's largest timeshare operators, with approximately 519,000 members in its system. Travel + Leisure Co. (TNL; BB-/Stable) is the largest, with 816,000 owner families, followed by Marriott Vacations Worldwide (VAC) with 700,000. HGV generates higher EBITDA than VAC and TNL and has a stronger EBITDA-to-FCF conversion rate.

HGV's revenue is less diversified than that of TNL and VAC, which own the Resorts Condominium International and Interval International timeshare exchange networks, respectively. HGV's EBITDA leverage of 2.0x-3.0x is in line with TNL and VAC.

Under Fitch's Corporate Rating Criteria, regarding treatment for corporate issuers with captive finance subsidiaries, Fitch calculates an appropriate target debt-to-equity ratio for the finance subsidiary based on its asset quality, funding and liquidity. If the finance subsidiary's target debt-to-equity ratio, based on Fitch's calculations, is lower than the actual ratio, Fitch assumes that the parent injects additional equity into the finance subsidiary to bring the debt-to-equity ratio to the appropriate target level.

Fitch assumes that the corporate entity (HGV) funds the capital injection by an increase in gross debt, a reduction in cash, or a combination of the two. On an as-reported basis, Fitch considers the effect of this equity injection in its analysis of HGV's credit profile vis-a-vis an increase in gross debt.

For HGV's captive finance subsidiary, Fitch calculates an appropriate target debt-to-equity ratio of 1.0x, in line with the actual ratio. As a result, Fitch did not adjust its calculation of adjusted leverage for HGV.

Given HGV's strong FCF profile, Fitch expects cash will accumulate through the forecast years, despite an assumption of share buybacks. HGV has maintained strong cash and cash equivalents, which provides ample liquidity to fund working capital requirements.

Key Assumptions

Assumptions are not pro forma for the Bluegreen acquisition.

Revenue and net VOI sales pro forma for the Diamond acquisition reach approximately 100% of fiscal 2019 levels by 4Q23, with flat to low-single-digit growth in the forecast;

EBITDA margins maintained at 22%-23% through 2025;

Financing income and expense not included in EBITDA;

Base interest rates applicable to the company's outstanding variable rate debt obligations reflect SOFR forward curve;

Inventory spending of $200 million annually through 2026;

Share buybacks of $300 million annually through 2026;

No material acquisitions or dispositions through 2026.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Greater diversification by business line or scale through material increase in owner families;

Adjusted EBITDA leverage sustaining below 2.5x;

Evidence of through-the-cycle sustainability in the company's capital-light inventory sources such that it does not materially affect HGV's financial flexibility and operational strategy.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

EBITDA leverage above 3.5x;

Severe disruption in the asset-based securities markets such that HGV needs to provide material support to its captive finance subsidiary;

Material decline in profitability, leading to EBITDA margins sustaining around 15%;

Consistently negative FCF.

Liquidity and Debt Structure

Strong Liquidity, Limited Near-Term Maturities: At 3Q23, HGV had $227 million in cash and cash equivalents on hand, and $866 million of available capacity, net of letters of credits, under its $1.0 billion revolving credit facility. The strength of HGV's liquidity profile is driven by a lack of meaningful near-term debt maturities. HGV also has $308 million of restricted cash.

Because HGV relies on the asset-backed securities market to help fund its timeshare customer lending activities, Fitch notes that a significant economic downturn resulting in tightened credit markets could pressure HGV's securitization market access and potentially require it to support its finance subsidiary. This risk is mitigated by the company's $750 million receivable securitization warehouse facility, which HGV upsized from $450 million in May 2022, which had $750 million of available borrowing capacity as of Sept. 30, 2023.

HGV completed a $293 million securitization on Aug. 10, 2023 at an overall weighted average coupon of 5.94% and an advance rate of 97%. Proceeds will be used to repay debt and other general corporate purposes.

Issuer Profile

Hilton Grand Vacations, Inc. (NYSE: HGV) is a global timeshare company that develops, sells and manages timeshare resorts under the Hilton Grand Vacations brand.

Criteria Variation

Variation explained in depth in Key Ratings Drivers.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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