"Preamble"

What do 5,000 barrel per day oil spills caused by neglectful big business barons, crumbling rigs, foreign currencies and ecologically sensitive wetlands, Wall Street fat cat securities fraud perpetrators, bad mortgages, Lloyd Blankfein, moral hazards, "too big to fail" and riots atop the Acropolis all have in common?

The answer is that each of these morality deficient and socially challenged current events may make you a few dollars if you can figure out how to overlay a trade or two around their sheer madness, but executing on these ideas will not help you sleep better at night.

While the idea I will present below is a far cry from mailing a cash stuffed envelope to the nearest "Action Against Hunger" outpost, potential investors in the idea I will present can take solace in the notion of investing in the education and development of America's children.  It's the least you can do to help our poor country out of this mess as we fesat on 'Unleaded High Octane Shrimp Gumbo' from now until the day Tim Geithner is removed from his office by a slippery, sinister cadre of Goldman backed shills.

Brief Background and Overview

Cambium Learning Group Inc. (ticker: ABCD) is the (relatively) newly formed combination of Voyager Learning Company and Cambium Learning Systems, two companies that merged on December 8, 2009.  Voyager was previously a publicly traded entity listed under the symbol VLCY.  Cambium was owned and controlled by Veronis Suhler Stevenson, who now control just over 55% of ABCD.  As is always the case with my write-ups, at various times I will pull information directly from Company filings and transcripts in order to disseminate factual information. 

The Company is a "leading provider of research-based education solutions for students in Pre-K through the 12^th grade, including intervention curricula and educational technologies and services."  Put simply, Cambium Learning Group has developed industry leading intervention materials that have been statistically proven to accelerate learning and development in the areas of reading and math.  They sell these materials (including an online offering) to a ~$4.6b market supported by Federal, State and Local funds via a national sales force of in-house and contract reps. 

VIC member 'bondinvestor' delivered a good overview of Voyager Learning in his July 15, 2009 write up.  At the time, The Voyager-Cambium Merger had just been announced and the Voyager 'stub' was trading for an obscenely low valuation.  You may look back to this write-up if you choose, however it was more focused on the Merger event whereas my write-up is based on the Company as it stands today.

Having completed only the Merger and one reporting period which included a lot of pro forma and 'adjusted' numbers since the Merger occurred with only a few weeks left in 2009, the Company is set to report its first true quarter as a combined entity on Tuesday May 11^th.  This write-up is not a critical enticement to buy shares before this date.  It is however a suggestion that you tune in to the call and take a look at what is still an immensely under-followed and very interesting story.  I believe that ABCD shares offer at least 100% upside over a two year time frame, though the shares could achieve that target even more rapidly as coverage and awareness builds.  The stock offers several other catalysts as well, including ever increasing Merger synergies, debt paydown, and a shift in product mix to more scalable, higher margin offerings.

The quick snapshot...

There are many who breeze through these write-ups rather not read about the details.  For that audience I offer this 'top of the trees' perspective:

Cambium has around $200m in sales and around $50m in pro-forma EBITDA.  It is my view that EBITDA will grow as Merger synergies work their way through the P&L and margins improve based on increased digital offerings.  There was $157m in debt, and $13m in cash at the end of last year which when added to the market cap of $220m (using $5.00 per share) equates to an EV of $364m.  Thus at current levels, ABCD trades for 7.28x EV/EBITDA. 

While this is less than other public market comparables and private market transactions, I will admit it not terribly exciting when viewed in a nutshell.  So for those who do like details, please read on...

The bigger picture...

Cambium is managed in three distinct business segments, with shared services supporting all three.  The three segments are as follows:

Voyager

This is the comprehensive intervention business unit which represents 65% of sales.  Voyager offers the Company's largest product offering, including the adolescent literacy solutions, LANGUAGE! and Journeys.  Other well known brands include early literacy solutions, Passport and Read Well and the math solutions TransMath, Vmath and Inside Algebra.

Cambium Learning Technologies

This is the Company's technology-based education product unit and represents 22% of sales. This unit includes the following well recognized brands; special education tools IntelliTools and Kurzweil; web-based reading, writing, vocabulary and other resources for students and teachers from Learning A-Z; and web-based math and computer science simulations from ExploreLearning.

Sopris

This is the supplemental solutions business and represents 13% of sales. It's materials form a content treasure chest of work by some of most respected and foremost educational authors (the Company names Dr. Louisa Moats, Anita Archer, and Roland Good) and serves as a collection of research-based supplemental education materials.  The materials are marketed via direct sales, the Web and catalogs.

Size of the market / proof that the product works

Cambium pegs the size of their target market at $4.6b out of a total of ~$16b spent by K-12 schools on all textbooks and additional materials and claims that they are "the only provider focused solely on the intervention market and covering the spectrum of at risk needs."  There are very few, if any, direct competitors that have the scale to compete with Cambiums 122 Field and Inside Reps across all business units.  While Voyager had been focused on more urban areas, Cambium's strengths lay more in regions with smaller footprints and the combination of the two should prove to be powerful.

More than 40% of the 52m K-12 students attending pubic and private schools are deemed 'challenged' learners and this is where your ethically responsible investment really starts to matter.  Since Cambium targets many Title I ie economically challenged school districts, you are not only helping the most challenged learners, you are helping students who reside in some of the most disadvantaged and neglected corners of America.

I won't go into specifics on the effectiveness of the product in this write-up.  Instead, I  encourage you to visit the 'Evidence of Effectiveness' section of the Cambium Web site.

http://bit.ly/a2p77A

Funding for the Product Offering

Cambium's customers are funded from Federal, State, and Local funds (in that order of importance).  The Company believes that more than half of its revenues are supported via Federal programs, with state and local coming in at 25% each.  As of the beginning of 2010, Federal stimulus funding to states totaled almost $70b, of which $34b or so has been estimated to have gone towards broken education budgets.  The Literacy Education for All, Results for the Nation (LEARN) Act, which was recently introduced into the House and Senate, is a comprehensive literacy bill promoting reading and writing across the K-12 levels and in all disciplines.  The Company believes that LEARN could have a value of $2.3b but more importantly, it is a step in the right direction from its predecessor program which only covered K - Grade 3.  Are Federal, State and Local budgets challenged having bailed out everybody in sight?  You bet.  However, I get around this point by noting that Cambium's small revenue base is only a fraction of the budget money that is out there and market share gains can and will offsett the poor condition of our nation's education maked purse-strings.

From a concentration perspective, the Company is most active in Florida, Texas and California, though no customer accounts for more than 5% of total sales.

Who sits on the Board?

As a general rule, I like to know that the interests of the Board are aligned with shareholders.  However, it is even more important in this case as a Private Equity investor (VSS) is the control shareholder.  While I have little to add about the track record or ability of VSS, I am generally skeptical when a Private Equity firm sits in the drivers seat.  This seems to be a bit different.  As a Voyager shareholder pre Merger, I will admit that the deal VSS struck was extremely favorable and generous to existing stockholders, offering both cash, shares, and a contingent distribution based on future tax matters.  VSS also put up an additional $25m in capital to get the deal done and invited former large Voyager holders on to the Board.  Rounding out President Dave Cappellucci and CEO Ron Klausner is one VSS partner and "under-the-radar" activist Neil Weiner, whose Foxhill Opportunity Fund is the second largest holder after VSS.  Foxhill not only didn't complain about the price paid for Voyager, it seems as if they have not sold a single share of the former Voyager or the new Cambium to date.

Upside drivers:  Synergies, NOLs, Higher Margin Offering

Synergies

The merger between Voyager and Cambium is one of the few Mergers I have observed that actually made 100% sense.  By leveraging the depth, reach and offering of a national sales and rep organization, the Voyager/Cambium combination is akin to say Pfizer adding a new drug to the repertoire of its salesforce or Oracle being able to offer 3 more software products to the customers it already interacts with.

On the expense side of the equation, Management has identified the following areas for synergies:

-          Headcount reduction

-          Facilities

-          Outsourced development

-          Professional services

-          IT related expenses

Adding up what Management has put forth, you arrive at $10.5m in EBITDA synergies in 2010 and $12.5m in 2011.  This is a significant figure on a $200m sales / $51m EBITDA revenue / cash flow base which Management may have even underestimated based on the speed at which post-merger some of this has already been achieved.

NOLs

At year end, the Company had ~$61 million of federal net operating losses, or NOLs.  At a tax rate of 35%, these NOLs will reduce future cash taxes due on taxable income by approximately $21 million.  Additionally, Cambium has $7 million in available tax credits, which have no expiration period.  However, it should be noted that $38 million of the NOLs and all of the $7 million in tax credits came from the acquisition of Voyager and therefore restricted their annual utilization.

The Company does not expect to be a federal taxpayer until at least 2012, and thereafter, their tax attributes would reduce federal taxes otherwise due on taxable income of $6.6 million a year.

Offering

I should first begin by stating that roughly half of Cambium's revenues are deemed to be 'recurring in nature' by Management.  Even though customers do not enter into multi year contracts, it is unusual for a school to invest time and resources to switch out of an existing offering if they are happy with it.  Think back to your days in grade school where "Phonics" was used year after year after year.

Web based subscription products represent $30m per year in revenue and Management has stated on multiple occasions that they are committed to growing this figure rapidly as it provides much higher margin potential.  It is worth noting that Cambium's online early literacy program, Ticket to Read, has more than a quarter of a million students logging on weekly.

Valuation and Upside?

Here is a recap of the cap structure:

Cambium Learning Group Inc.

Shares out: 43.859m

Price 5.6.10: $5.00 per share

Market Cap: $219.3

Debt: $157 (see below for description)

Cash: $13m (does not include restricted cash)

Enterprise Value: $363.3m

EBITDA (adjusted for Merger) 2009 actual: $51m

Description of Debt:

$97m Senior Secured Loan (LIBOR + 500bps, LIBOR floor 3%, matures in 2013)

$55m Mezz Loan (Fixed at 10% cash + 3.75% PIK added to principal periodically, matures in 2014)

$5m Revolver

- - - - - - - - - - -

$157m total

Combined (blended) effective rate on debt: ~10%

I expect that this year, Cambium can generate free cash flow in the range of $25-$28m calculated as follows:

FY 2010e

EBITDA:  $55-58m

Interest Expense: $18m

Capex: $12m

Free Cash: $25-$28m (11.4-12.7% yield)

If the Company were to pay down debt with free cash, total leverage would drop to under 2.4x Debt to EBITDA at which time a refinancing at better rates would not be out of the question.  Ignoring the refinancing costs, a new average interest rate of say 7.5% on new remainig debt of ~$132m would take interest expense down to the $10m neighborhood.  That's where Free Cash really gets interesting.

FY 2011e

EBITDA:  $60-63m

Interest Expense: $10m (assumes 7% rate on $132 in debt after $25m of debt is paid down in 2010)

Capex: $12m

Free Cash: $38-$41m

Under these assumptions, you are paying only $220m today for a business that will throw off a total of $63-$69 in free cash flow over the next two years.

Using normalized taxes in 2012 and beyond, and not taking into account the 2011e Free Cash which could be used to further pay down debt (or buybacks), Cambium shares could command the following valuation:

FY 2012e

EBITDA:  $65-68m

Interest Expense: $10m

Capex: $12m

Free Cash: $43-$46m

Value per share on 2012e projections at the following multiples of Free Cash (using the midpoint of the Free Cash estimate):

10x:  $10.14

11x:  $11.16

12x:  $12.17

13x:  $13.19

14x:  $14.20

What if your horizon doesn't go this far out, and you don't want to guess about refinancing and debt paydown.  Here is another way to look at the valuation...

8x projected EBITDA after synergies ($60m): $480m

NPV of the NOL (using a ~10% discount rate):  $43m

Cash: $13m

Less Debt: $157m

Value per share: $8.65 (upside of over 70%)

In summary, I don't think a lot has to go right for Cambium to demonstrate results, gain coverage and execute on its plan.  Better yet, with VSS at the helm, so to speak, you can be sure that this stock will not be around forever as PE firms have their harvest periods (5 years on average I would say) and a a carefully managed exit down the road is probably being discussed in some oak paneled Board room as I type the final lines of this write-up.

Risks

Synergies do not materialize as anticipated

Funding programs reverse course and the Company's customers are challenged

Company fails to gain attention / coverage

Investors continue to gravitate towards less responsible areas such as Casinos, Fast Food, or the guy in Omaha who between sips of Coca Cola, basically just talks his own book.