Description

DeVry Education Group (DV) $25.60

Summary

DeVry Education Group runs higher education systems primarily in the US and Brazil offering associate’s, bachelor’s and master’s degree programs primarily in business & technology and healthcare. Educational services are provided both on campus and online.

The for-profit educational services sector has been operating under a cloud since 2010, when Front Point’s Steve Eisman delivered a scathing presentation on the industry at the Ira Sohn conference which accused many firms of existing primarily to defraud the government’s Title IV student loan program. The fallout has been that many bad actors have been identified and punished, but lingering investigations have left the industry out of favor with investors.

DeVry is several years into a turnaround program and should experience trough earnings in F2016. The company is getting little credit for it’s efforts and investors are underestimating the earnings power that could be released in the next few years. With a clean balance sheet, a depressed price and a commitment to return capital via dividends and share repurchase, investors are being well compensated to wait for the turn. Upside potential of 34% - 90% is likely within the next 12-18 months with limited downside risk.

The Opportunity

DeVry operates in three segments: Medical & Healthcare, International & Professional and Business, Technology and Management.

Medical & Healthcare consists of two medical schools and a veterinary school in the Caribbean, Chamberlain College of Nursing & Carrington College. The two medical schools are stable and growing and have just finished a period of capital investment. They are also subject to favorable international tax rates The veterinary school represents just under $80MM revenues and is vulnerable to regulatory compliance issues that may curtail the availability of Title IV loans for students. Note, these issues relate to program limits such as the 90/10 rule and gainful employment and are not related to any punishable offenses of the company. Chamberlain is growing and adding campuses. Carrington is performing.

Segment revenue breakdown and margins are shown in the table below along with Management’s guidance for F16E – F20E issued at the Investor Day in September. This segment offers moderate growth with low capital requirements.

International & Professional consists of DeVry Brasil and Becker. DeVry Brasil offers post-secondary education and test preparation services in Brasil. This is the primary growth engine for DeVry. While it has grown – and will continue to grow – via acquisition, this is more than just a roll-up story. The company is investing to standardize the educational experience across the acquired businesses and drive organic growth. In addition to favorable international tax rates, the platform growth allows the company to reinvest its internationally generated cash at favorable returns. The IRR on capital invested in DeVry Brasil to date is above 20%

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The country of Brasil is facing significant challenges. The Brazilian Real is off -30% versus the US Dollar in 2015. There are political challenges and talk of impeachment following years of political corruption and incompetence. The country’s oil revenues have fallen with the price of oil. However, the difficulties that the country is facing now, make positive change more probable going forward. Brasil is a large economy with a young population and an emerging middle class. Like all emerging economies, there is a productivity problem which can only be solved through educating the populace. DeVry Brasil is well positioned to serve this need as the return on investment for students is exceptionally high.

I have no forecasting ability of exchange rates, but given that the company is investing cash generated in Brasil back into the country, the exchange rate volatility (and trajectory) is perhaps more detrimental to reported results than to a real economic impact.

Becker is a gem of a business providing non-accredited professional training – primarily CPA test prep. They have a market leading position in a business which requires minimal capital and generates significant cash flow. Expansion will be driven by entering adjacent verticals like CFA test prep.

Business, Technology & Management is primarily the legacy DeVry University business which has been exceptionally challenged over the last few years due to market weakness, regulatory issues and a tired product. From 2011 through 2016 the business will have shrunk around -54%. Unlike some competitors that offer general degrees, DeVry is more focused on providing targeted functional job training. Programs are now balanced between business (accounting) and technology.

The good news is that the business should bottom in F2016 at around $670MM in revenues, down about -16% y/y. Management has done an admirable job of flexing costs down aggressively in order to maintain profitability at this point in the transformation. Looking forward, the residual business should start growing revenues around 6% y/y in 2017 through 2020, which will drive strong cash flow growth driven by strong operating leverage on the smaller campus footprint and minimal capital needs.

There is the potential for additional upside if demand increases as the economy recovers further or if regulatory issues reduce industry capacity and DeVry can capture additional market share.

The resulting financial profile using Management’s midpoint guidance as a base case does not look like a distressed firm.

DeVry should throw off enough cash over the next several years to provide for a significant return of capital to shareholders after investing in the business. The company just announced a $100MM renewal of their share repurchase program. While they have been repurchasing shares over the last few years during the turnaround, they have not been particularly aggressive, repurchasing mostly to offset dilution. Once the turnaround recedes in the rear view mirror, there should be no excuse not to aggressively repurchase shares if the valuation continues to remain depressed.

Once the market gains confidence that the turnaround has been successful (likely late calendar 2016 – early 2017, there should be a re-rating on the stock price.

DeVry’s balance sheet is debt-free with significant excess cash – about two-thirds of which represent international balances. The business needs about $100MM of cash on hand for operations. Options and stock appreciation rights (SARs) representing about 6% dilution are currently out of the money.

Current market cap is $1.7b and enterprise value is $1.4b which equates to 4.7x F15 EBITDA and 3.8x F17E EBITDA which I view as normalized. As the end of the turnaround nears, DeVry has a pre-tax free cash flow (EBITDA – Maintenance Capex)/EV yield of 21% for F16E and 24% for the normalized year of F17E.

I believe that as the turnaround completes the market will re-rate the stock price to reflect a company that is no longer shrinking – and is showing moderate growth along with excellent cash generation ability. This should happen towards the end of calendar 2016 (F16 ends on 6/30/16). A modest rerating at a 15% PTFCF yield on F17E would deliver a share price of $34 on a fully diluted share count of 68MM, representing upside of 34% from the current quote.

A re-rating at 8x F17E EBITDA would equate to a price of $48 or 90% above the current quote.

The risk of permanent capital impairment at the current quote is minimal. The balance sheet is clean and the company generates significant cash. There is a dividend yield of about 1.4% which provides further support.

While a regulatory cloud still hangs over the industry, I believe that the damage remaining is minimal. The investigations are all several years old and new regulations will be eased in over a few years giving the company ample time to adjust.

DeVry offers a highly assymetric reward-to-risk profile at the current quote with reasonable upside of 34% to 90% within the next 12-18 months with limited risk of permanent capital impairment.

Catalyst

turnaround completes in next 12 months and the company resumes growth

strong cash flow and clean balance sheet will be rerated once the company stops shrinking

regulatory concerns will dissipate