Daekyo 019680 KS
March 30, 2005 - 7:16am EST by
abra399
2005 2006
Price: 74,600.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 775 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Daekyo (Bloomberg ticker - 019680 KS Equity) is one of the leading for profit education companies in South Korea. The company trades under 11x 2005 earnings and under 5x 2005 EV/EBIT with a return on capital exceeding 40%. Additionally the company has cash and realty assets exceeding half the market cap and pays a modest dividend. Aside from a cheap price and increasing investor community recognition, there are not clear catalysts.

Daekyo has the #1 brand in for profit elementary school education in Korea. The private education market on Korea is about 20 trillion KRW (about $20 billion USD). This is comprised of home tutoring, on-line education, and for profit educational institutions. Daekyo is a branded home tutoring service with learning centers and learning guidebooks for elementary school students. I recommend watching the Daekyo public relations movie as it will give you a great understanding of the different business lines. This movie is available at www.daekyo.co.kr/eng.

The weekly home tutoring market is dominated by four companies – Daekyo with 20+% share and 2.4 million subs. The other competitors are Woongin.com, Kumon and Jaenung, along with a lot of mom & pops. The growth rate is slow in this business due to a shrinking birth rate and market maturity with 70% penetration of the market between kids age 8-13. The company is addressing the market maturity by expanding into other adjacent markets and selling customers more services.

Daekyo has 17,500 part time tutors and sales agents. About 13,000 of these individuals are Noonnoppi tutors (weekly home tutors for elementary students), with the remainder mostly door-to-door sales agents selling tutoring worksheets and educational supplements. The company charges about 31,000 KRW (about $31 USD) per month per student. Monthly membership fees for students are paid in advance. About 45% of the fees are paid to teachers as commission/compensation to visit the students at home. Typically teachers visit 1 time per week. 13 different subjects are offered, with the typical student taking 1.85 subjects in 2004. There is some growth in the # of subjects taken per student, and the company is focused on increasing the # over time.

Regarding financials, the company has 10.4 million shares outstanding trading at 71,700 KRW for a market cap of 775Bn KRW. On the balance sheet there is 170Bn KRW of cash and cash equivalents. Also there’s 123.5 bn of financial assets which include 69 bn of publicly traded securities (57bn of Shinhan Financial Services, some KT, some Hyundai motors, etc.), 39bn of stock in unlisted Shinhan Life insurance, 9bn of unit trusts and 13.6bn of bond. There is no debt. Total enterprise value (market cap less these financial non-core assets) is about 480Bn KRW. The company has 90Bn worth of building assets and land with a book value of 38bn KRW and a market value according to the company of 64 bn KRW for a total of 154bn of real estate assets. I suspect a lot of this real estate is excess but it’s unlikely any of the realty will be sold.

Other key financial highlights are below:

2003 2004 2005e
Sales 805 839 865
EBITDA 106 111 117
EBITDA margin 13.20% 13.20% 13.50%
EBIT 71 90 95
EBIT margin 8.80% 10.70% 11%
Net profit 61 65 73
EPS 5,856 6,508 6,994
P/E 11.5x 10.7x
EV/EBIT 5x

Capex was 30bn KRW in 2004 and 51bn is forecast for 2005. Of the 51bn forecast, 18bn is for information systems, 20bn is for R&D of new products and 28bn is for potential M&A. A lot of this is expansionary capex to tap into new markets. Maintenance capex is under 15bn KRW. I estimate normalized FCF of about 80 bn KRW.

The company plans to increase the dividend annually via an increased dividend payout ratio. Over time the company targets a 30% dividend payout but it’s currently at 20% payout with a target of 1500-1600 KRW in 2005 for a 2% yield. The company paid a 650 dividend on 7/30/04 and pays an 850 dividend on 3/31/05 (record date 12/31/04). In 2003 the company paid a 1250 dividend.

Korea has been in a consumer crunch due to a slow economy and high consumer credit card debt. The sales and EBIT performance indicate that the business is resilient in a weak economy. The company has historically had pricing power and raised prices 11% in December 2003.

The company is expanding into preschool and high school markets. New businesses include a program for pre-schoolers called Sobics (penetration is 20% in this market relative to 70% in elementary shool) and also a Gcamp program for middle school students, as well as Edupia – an internet education business and English/reading tutoring. A premium service called Soluny which costs 80,000 KRW/month is being launched as well. New business sales were 80bn KRW in 2004 and are targeted to be 100bn KRW in 2005. It’s important to note that the new business lines are losing money on an EBIT basis though the company projects BEV in 2006. The Noonoppi business earns 110bn KRW of EBIT and the new businesses lose in aggregate about 20bn KRW of EBIT. If the new businesses earn 10% EBIT margins, then EBIT would increase by over 30%. I think it’s realistic to see this happen over the next 3-5 years.

The company would like to expand internationally (in Japan, Malasia, the US & China). They’ll do so prudently, without making wildly overpriced acquisitions. They’re targeting domestic & overseas acquisitions and both online and offline but focused entirely on education.

The chairman of the company is Mr. Song, age 68. Mr. Kang (the founder) is not involved in operating activities -- a positive in my view. The company is owned 54% by a holding company of Mr. Kang (of which he owns 80%), 25% of the shares are owned by foreigners, 7.5% by relatives of management and 4% by the ESOP with the remaining 9.5% by locals. Foreign ownership has increased consistently since the IPO in Feb 2003.

A few key risks:

There are a number of well capitalized education companies in Korea and the competition is likely to intensify as the market is relatively mature. Population under the age of 18 is declining due to a low birthrate (20.1 million pops under age of 18 in 2003 to 18.7mm projected under age 18 in 2010). Moreover, Koreans spend the most per education per capita in the world and the government may attempt to reduce this cost through subsidized programs. It will admittedly be hard to monitor competitive dynamics in the educational market from halfway around the globe.

Corporate governance is an issue in Korea and Daekyo is no exception. The company went public in early 2004 but did not have a very good explanation for doing an IPO. As you can tell from the financials, the company does not have a need for external financing. Based on my experience, there is a great deal of pride which comes from running and working for a public company in Korea. When I asked management why they went public they said “we wanted to be a worldwide company and we wanted to fund the ESOP to meet the promise of equity management for employees.” Employees have been sellers of their stock holdings.

Another key risk is fund flows. There’s a good chance that all this money flowing into Korea will flow out just as quickly if there’s political, economic, currency, etc. turbulence in the world. Foreigners have recently been net sellers as there is concern that the KRW currency is too high relative to the USD & high oil prices may cause Korea to dip back into a recession (among other things).

I met with management in New York yesterday and they get points for coming to NYC to meet with investors. I asked them many times about returning the excess capital to shareholders and it just doesn’t look like this will happen. They may buy back stock and they may pay a higher dividend over time, but they aren’t likely to sell their financial holdings anytime soon. They’d rather keep the funds for small M&A and a safety cushion. I think this may change over time as the company has more western shareholders. However, balance sheets such as Daekyo’s are typical in Korea and for the time being I just consider it a big margin of safety.

Catalyst

No clear catalyst other than a cheap price for a good business
Possibly an increasing dividend over time
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