Description

Adtalem (ATGE) is a mischaracterized global education franchise trading at a significant discount to intrinsic value with a clear path to value realization.

The investment community is anchored to the tumultuous past of Adtalem (fka DeVry) but the future looks bright. Over the next year, we believe that Adtalem will divest DeVry University and Carrington College, leaving investors with clean exposure to an excellent remaining business. Investors will soon see:

1)    $3.20+ per share of unleveraged earnings power

2)    Zero net debt with 1 – 2x of excess balance sheet capacity

3)    ~4% organic revenue growth

4)    20% EBITA margins

5)    A capital-light business with excellent free cash flow conversion

6)    A company that voluntarily cut their dividend to repurchase shares (how many perceived “outsider” companies have done this?)  

And yet? At ~$37 / share, ATGE trades for just 11.7x earnings.

We see upside to $65 / share, or 17x re-leveraged EPS of $3.86.

History

Investors are justified in their distaste for traditional for-profit education and right to be skeptical of the post-election rally in the operators’ share prices. Trump and the elimination of Obama-era policies will yield no panacea for these economically challenged enterprises. The brand on the degree is all that matters and the for-profit brands are tarnished. Traditional universities benefit from superior reputations, structurally lower student acquisition costs, and no profit requirement.

DeVry University (“DVU”), Adtalem’s largest business by revenue, is no exception. Prior management long held out hope that the business would turn around and viewed DVU as core to the heritage of the organization. Moreover, even if they had wanted to sell, an ongoing FTC investigation and scrutiny from the Obama administration would have made a sale borderline impossible.

The tide has shifted. The FTC investigation is resolved. Shareholders have a new, commercial CEO with no emotional attachment to DVU. She has imposed a ROIC requirement for each segment and has made it clear that if DVU cannot achieve acceptable returns (we do not believe it will), the school will be considered for strategic alternatives. I believe the company is likely already considering its options for DVU as well as the underperforming associate degree and certificate-granting Carrington College.

Removing DVU and Carrington will allow investors to focus on an excellent group of remaining businesses, unlock significant balance sheet capacity, and attract a new group of investors to the company.

Valuation

The following table outlines the run-rate earnings capacity of the pro forma business as well as a scenario in which the company utilizes 1.5x of excess balance sheet capacity to raise debt and repurchase shares. Given ~4% organic growth, 20% operating margins, and low capital intensity, we believe that 17x earnings is fair to conservative.

Quasi-peers Grand Canyon Education (LOPE), Strayer (STRA) and Capella (CPLA) trade for an average of 23x NTM P/E. We would argue that Adtalem’s business mix and long-term prospects are superior to those of the group (the possible exception being Grand Canyon). Yet even if we exclude the benefit of a re-leveraging transaction, at 11.7x earnings, Adtalem trades at just half the unleveraged P/E multiple of this peer group.

As a bonus, the strategic alternatives for DVU and Carrington may yield positive value. DVU and Carrington together contributed $639mm of revenue in the LTM period. The optimistic case would be that some portion of this revenue base is comparable to Strayer, which today trades for nearly 2x revenue. The pessimistic case would be a teach-out of the schools, in which substantial cost cuts would be implemented and net positive cash flow likely captured.

The company feels similarly. At the recent investor day, CFO Pat Unzicker noted “We, along with our board, approved a new share repurchase program in the middle of February. And that share repurchase program is tied to our conviction where we see a big gap in our intrinsic value of what we think our portfolio should trade at relative to [where] the market has us today.”

Why is the stock mispriced?

-       High quality business resident in a disliked, overlooked sector

-       Headline revenue declines due to erosion at largest segment DeVry University

-       History of regulatory issues

-       New, commercial management team

-       No obvious public comparables

-       DVU / Carrington overhang

-       Excess balance sheet capacity

-       Investors capitalizing Carrington operating losses and FTC-related legal expenses (~$23mm in total)

In lieu of providing a summary of the business segments (see investor day materials), we address a handful of the most commonly asked questions below:

Isn’t nursing going to implode?

A boutique analyst in Canada with good success in for-profit education shorts has attracted a high short interest (~17%) in Adtalem based on the belief that profits from the Chamberlain School of Nursing will implode. The short pitch is that the RN-BSN degree offered by Chamberlain will see increased competition and lower profitability. This will result in “misses” versus street estimates and a lower stock price. The fundamental microeconomic proposition of RN-BSN degrees is likely correct – margins will eventually decline. That said, the discount in the shares is simply too wide for this to matter given that multiples of the potential negative impact are already priced in. Chamberlain generated LTM EBITA of ~$95mm. Based on significant primary research, I believe that the RN-BSN degree generated ~$46mm of EBITA. This represents <20% of consolidated EBITA and <15% of NOPAT. The remaining nursing profitability benefits from high growth, high returns on capital, strong moats, and significant brand value.

The RN-BSN degree offers few barriers to entry. Margins will compress as the current supply / demand imbalance eases over time, but they are not likely to simply implode. Chamberlain has many advantages compared to myriad operators in the space. In particular, Chamberlain benefits from an advantaged student acquisition pipeline via hospital relationships and its large pre-licensure degree offering. Conversations with the company indicate that approximately 72% of RN-BSN students come through corporate partnerships, up from 50% three years ago. Moreover, approximately 38% of RN-BSN students are sourced within 50 miles of an existing Chamberlain campus.

On the current share count, the RN-BSN degree represents $0.47 / share of earnings. While it is possible that profitability could be cut in half over some medium-term horizon to $0.23 / share of earnings, this drag would likely be compensated for by a variety of existing growth and margin expansion opportunities including: (1) Family Nurse Practitioner (FNP) program growth; (2) Ramp of the new Masters in Public Health (MPH) offering; and (3) Seasoning / margin maturation of the existing base of physical pre-licensure campuses. Even if you are an uber-bear on RN-BSN and decide that you want to write off its earnings contribution in full (which is especially punitive given that it would continue to generate FCF for some time), you are left with $2.75 / share of unleveraged earnings power and $3.18 / share of re-leveraged earnings power. Even on those figures, Adtalem would still be a very cheap stock.

Why is DMI performing so poorly?

DeVry Medical International, which houses the medical schools in the Caribbean, represents the crown jewel of the organization. These organizations offer secure competitive positioning, ~27% operating margins, and pay virtually no taxes. In recent years, enrollment has suffered due to mismanagement and late entry into social and digital marketing. My primary research indicates that chief competitor St. George’s University has seen no such slowdown in operating trends. New management has been adamant that the issues are fixable and at the most recent investor day both the CEO and divisional leader for DMI noted that enrollment growth is expected to be back on track based on acceptances and deposits received for the upcoming school year. In other words, the company is telling investors based on private information that they are highly confident enrollment growth (and thus revenue growth) is imminent.

Hasn’t this company made questionable capital allocation decisions?

Yes – in the past. The company likely overpaid for a handful of acquisitions in Brazil and definitely overpaid for ACAMS. That said, it is a new day and investors now benefit from obtaining these prior acquisitions at a discount. New management and the board have taken considerable flak from investors for these decisions and their thoughtful consideration of investor concerns led to the appointment of Michael Malafronte from International Value Advisors to the board of directors. At the recent investor day, CEO Lisa Wardell referred to shareholders as “owners” nine times and used the phrase “intrinsic value” four times. Case in point: the company voluntarily eliminated its dividend to repurchase shares based on the belief that it was a better use of funds. We kindly ask VIC to mention any other companies that have made this difficult but rational decision.

Why is the short interest so high?

As discussed above, the shorts we have encountered in Adtalem appear to be playing for weakness in the RN-BSN sub-segment of Chamberlain. Some market participants believe that the RN-BSN degree constitutes 100% of Chamberlain profitability. Based on numerous conversations with the company, we strongly believe this to be incorrect. Moreover, we believe some analysts may underestimate the growth opportunities and barriers to entry present in the Master of Science in Nursing (MSN) / FNP programs (which together contribute ~24% of nursing EBITA) due to the requirement of physical clinicals. Finally, few analysts have discussed the natural profit uplift from the pre-licensure program as the existing base of physical campuses season enrollments.

Catalyst

• Divestiture of DVU / Carrington

• Share repurchases

• Releveraging of balance sheet

• 22+ days to cover for misplaced short thesis