Description

Summary

I believe Abril Educacao (ABRE11), a leading provider of educational materials in Brazil, is an interesting growth investment. The company, currently trading at 11x 2013 consensus EBITDA and 21x 2013 consensus earnings, does not appear cheap.  However, the combination of organic growth opportunities; margin expansion from business mix improvements; integration of recent acquisitions; a rich pipeline of acquisition prospects; and a strong management team with a successful record of value creation, will lead to, I believe, a doubling of EBITDA in the next three years.

History

Grupo Abril, the parent company of Abril Educacao, is a privately held company controlled by the Civita family. It is the second largest media group in Brazil, and it has a long history of value creation.  In the 1960’s Grupo Abril entered the education space by pioneering  teaching materials targeted towards Brazil’s illiterate adult population. The education segment grew via product innovation and acquisitions over the next decades. In 1999, the group did a transformational acquisition of Brazil’s two leading k-12 educational publishers, Editora Atica and Editora Scipione. In 2008, Grupo Abril  introduced the SER  “learning system” in order to leverage its established client base of public and private K-12 schools.  In 2010 Grupo Abril acquired Anglo, the largest and most prominent  provider of learning systems in Brazil. That same year BR Educacional, a private equity fund founded by Paulo Guedes, acquired a24.7% interest in the recently carved out education division of Grupo Abril, a precursor to a subsequent IPO. In April 2011 Grupo Abril acquired two schools and their respective learning systems, ETB and pH.  In July 2011,  Grupo Abril completed the IPO of Abril Educacao. Abril Educacao  did a primary offering at R$20 per share resulting in a 28% float and providing funds for additional acquisitions. Since the IPO, the company has consummated another eight acquisitions and recently announced two more, further consolidating the learning systems market in Brazil. More recently the company has entered the language training field through the acquisitions of Red Balloon and Wise Up.

Business Segments

With the exception of a small minority investment, Abril Educacao is 100% focused on Brazil. It reports in three segments, Publishers, Learning Systems, and Schools and Preparatory Courses. Given the size and importance of the newly acquired languages business, I have chosen to discuss language as a separate division even though it resides within Schools and Preparatory Courses. Given the mature, cash cow, nature of the textbook publishing business within Publishers, I have chosen below to discuss the textbook business separately from the smaller, higher growth businesses within the Publisher’s segment.

Textbook Publishing Segment

Textbook publishing accounts for 45% of revenues. This is a mature, highly cash generative business for which management has guided towards mid single digit top line growth and mid 30’s% EBITDA margins. This seems reasonable given my analysis of the industry.   Abril Educacao sells printed content through its two brands, Atica and Scipione to the k-12 market. The k-12 textbook market in Brazil is roughly a R$2 billion market. Sixty percent of sales are to public school students and 40% of  sales are to private school students. Abril Educacao is the largest player with a 34% market share in the public sector and 24% in the private sector. Abril has grown market share, from 16% in 2006 to a current 34% within the PNLD program (public sector).

Learning System

Learning systems account for 22% of revenues. Learning systems consist of a suite standardized products and services offered as a package to public and private schools. Learning systems encompass curricula, supporting printed and multimedia pedagogical material, testing, consulting, and teacher training.  Abril Educacao leverages the brands and content of its proprietary schools to provide learning systems under four different brands targeted at different regions and price points.  The company is aggressively pursuing regional consolidation of the industry with two recently announced acquisitions pending closing.  Learning systems is a high growth, high return on capital, high margin business, with a 95% renewal rate. As of 1Q2013 Abril Educacao worked with 1,800 schools in Brazil accounting for a combined 580,000 subscribing students, 519k in private schools and 62k in public schools. Abril Educacao charges on a per student basis. Maxiprint, the most economical solution, has an average ticket of R$218 per student per year. pH, the most prestigious learning system affiliated with the pH schools in Rio de Janeiro, charge on average R$530 per student per year.

Currently Abril Educacao, with 17% market share, is the second largest player in the learning systems market, a market that is both growing organically and consolidating. Abril Educacao continues to gain market share both organically and through acquisitions.  EBITDA margins in this business are currently 50% and growing given the very high operating leverage (80% incremental margins). Learning systems have a 38% penetration rate in private schools but only a 2% penetration rate in public sector schools.  

Language Courses

Brazil has one of the lowest English literacy penetration rates in Latin America, estimated at 2-3% versus 5% for Mexico and 24% for Chile. AE management entered the language space through the R$30 million acquisition of Red Balloon in July 2012  and more recently the R$877 million acquisition of Wise Up in February 2013. Red Balloon is a network of 23 schools targeting children 3-15 years old. Wise Up is a network of 338 franchised schools concentrated in three states, Sao Paulo, Rio de Janeiro, and Curitiba and focused on working adults. Wise Up has grown revenues at a 40% cagr rate over the past three years while maintaining a 50% EBITDA margin. Wise UP charges on average R$587 per month per student. AE keeps about 30% of the revenue and the franchisee keeps the rest. Eighty percent of the revenue is to AE is derived from material sales and 20% from franchise fees. Proforma for the two acquisitions, the Languages segment will account for 15% of 2013 revenues.

Proprietary Schools, Preparatory Courses, and Other

Proprietary schools, preparatory courses, and other, represent 16% of revenues. The vast majority of the revenues in this category are derived from the ownership and operation of proprietary nameplate schools which form the backbone of the learning systems franchise, these are high quality schools analogous to  Horace Mann, Philips Academy Andover, etc, etc,  in the United States. The rest are franchises around preparatory courses for university entrance exams and other early stage businesses.

Investment Thesis

As the higher growth, higher margin businesses (learning systems and language) become a larger part of the company, Abril Educacao will experience the combination of top line growth and margin expansion. If management executes as it has in the past on the organic growth opportunities available within its current set of businesses, the combination of top line growth and margin expansion should lead to EBITDA of R$650 to R$700 million in fiscal year 2016, nearly double my estimate of R$350 for 2013. Based on my projections, and management’s guidance, the company should be able to generate R$ 1 billion in FCF cumulatively excluding any additional acquisitions during this period. Management will most likely deploy that cash flow for deleveraging and to do additional accretive acquisitions like it has successfully in the past. Given that these are high return on tangible capital businesses with a high degree of recurring revenue and high free cash flow conversion, the current multiple should remain relatively constant.

Estimates

Below are some estimates which are based partially on management’s long term strategic goals and my understanding of the end markets in which they operate.

1Q2013 Results

The first quarter 2013 was disappointing relative to very high expectations. Organic revenue growth of  Learning Systems was 10%. This has led to some analyst downgrades and a 20% sell off from recent highs.

Main Risks

Currency weakness.

Execution.

This is a roll up. It is highly dependent on management’s ability to continue to execute accretive acquisitions.  A study of previous acquisitions going back to the origins of Abril Educacao within Grupo Abril is very encouraging. However, one must continue to monitor the integration of recent acquisitions.

Disappointment in Public Sector Learning Systems Opportunity

The disappointment in first quarter was related to growth of learning systems within public schools. Management is confident that it can continue to grow in this area, but I think this will pose a near term risk.

Reliance on Key Management

CEO Manuel Amorim has built a very competent team. So far they seem to be attracting key talent from competitors.

Earnings disappointments and a multiple derating.

Like with most growth stocks, there is some degree of expectations built into the current multiples.

Catalyst

Catalysts

Continued growth and execution of business plan as outlined in the thesis. Earnings upgrades in the out years.