Description

Almost exactly one year ago, I wrote up HMHC here (Aug 2018 Write-up). Please see that post for the full thesis.  At that time, the stock was trading at $6.00, and I saw upside to $10/sh (+70%).  HMHC jumped +23% when they reported 3Q earnings on November 8th, and by the end of that month, the stock hit my price target ($10/sh), and I exited.

The stock traded sideways for the next few months following my exit call, until in February, news hit that Florida’s governor had taken the unprecedented move to defer the state’s Math adoption from 2019 until 2022.  This was a political move regarding his professed aversion to Common Core, and it was very unusual for an adoption to be rescheduled on such short notice. The uncertainty and deferral of billings resulting from this move weighed on the stock. 

It traded down to $7/sh, before running up to $8/sh before 1Q earnings.  There was clearly fast money playing for a beat-and-raise. The quarter was fine, yet the stock fell -18% due to positioning.  Mgmt offered very positive commentary regarding the ongoing adoptions, but did not explicitly raise guidance. In fact, it would have been preemptive for them to do so, given 75% of their Education Billings hits in the 2nd and 3rd quarters.  In subsequent weeks, the stock fell to near $5/sh, and this is where I get quite interested.

Mgmt reported a beat-and-raise quarter on August 8th.  There was no run-up into the print (like in 1Q), and the stock was trading near its all-time lows.  So, I was not surprised to see the stock jump +17% when markets opened. However, I was surprised to see the stock trade off throughout the day and end DOWN -7%.  This is one of the strangest reactions I have ever seen to an earnings report, particularly given the stock is trading at multi-year lows and a deeply discounted valuation.     

I thought the stock was worth $10/sh last year (+70% versus the then current price).  Given the Florida Math deferral, I believe the stock is now worth $9/sh (+80% from the price today).  On current year, the stock trades at 5.7x Cash EBITDA and a 21% FCF yield.  Leverage is 2.9x 2019 Cash EBITDA (based on average LTM cash, given working capital cycle), and mgmt will pay down >15% of its term loan balance with FCF generated this year.  That will leave it levered below 2x at year-end (LTM), and mgmt will move to refinance its only piece of funded debt, the May 2021 term loan. 

This year is an especially strong year for the adoption cycle.  However, there are large adoptions that provide visibility for robust billings through 2022.  On 2020 numbers, the stock trades at 7x Cash EBITDA and a 14% FCF yield. Based on a 11x multiple on an average through-the-cycle FCF, I believe the stock is worth $9/sh (+80%).

HMHC is the leader in an oligopoly market, where three players consistently take >80% of billings.  HMHC is taking near 60% share of the large Texas Reading (ELA) adoption this year, and it has leading share in other large adoptions as well.  The mgmt team is the best in the industry, and they have successfully restored HMHC to its market leading position, following missteps by the prior mgmt team (in 2015-16).  There is really no reason for HMHC’s stock to be trading as poorly as it has been.  I believe this dislocation reflects an outstanding long opportunity. 

Catalyst

FCF generation in 2H

Term loan refinance

Continued strong execution