|Shares Out. (in M):||224||P/E||0||0|
|Market Cap (in $M):||3,604||P/FCF||0||0|
|Net Debt (in $M):||600||EBIT||0||0|
LAUR is a leading for-profit education company, which we believe has 50% upside, and positive catalysts over the next 6-12 months to unlock its intrinsic value. Led by activist CEO Eilif Serk-Hanssen, LAUR has transformed into an under-levered and more geographically-focused education company. Yet, despite having announced nearly $2B of divestitures at approximately 13x EBITDA and cutting its pro forma net leverage from 4x to less than 1.5x, we believe the market continues to significantly undervalue LAUR’s remaining assets. The new LAUR has a meaningful opportunity to expand margins and nearly triple FCF over the next few years, driven by improved integration in its core markets and a reduction in restructuring expenses. On a sum-of-the-parts basis, LAUR could conservatively be worth $24 per share over the next 12-18 months.
A Mission-Driven Business with Underappreciated Financial Characteristics
“We have a proprietary technology platform with proprietary products and IP that gives us very meaningful scale benefits. We have strong brands in all of the core markets where we are operating, and a position that is very hard to replicate. And we have a culture of being student-centered, focusing on making our students get better jobs faster upon graduation than peer universities in the market where we're operating.” – LAUR CEO Eilif Serck-Hanssen
Founded in 1989 as a tutoring business, LAUR has evolved into a pure-play global leader in post-secondary education. The company was subsequently taken private in 2007 by a consortium of financial sponsors who completed 41 bolt-on acquisitions, expanding LAUR’s footprint to 71 institutions across 25 countries. Under the leadership of new CEO Eilif Serck-Hanssen, LAUR went public in 2017 and has since undergone a substantial transformation to simplify its business and revamp its balance sheet. The company has pared down its portfolio to 25 institutions across 7 core countries, while still retaining approximately 80% of its student base.
LAUR generates almost 75% of its revenue in Latin America, 20% of its revenue in the U.S. and the remainder mostly in Australia and New Zealand. While more than half of its students are undergraduate, LAUR also offers graduate and vocational programs as well. Importantly, LAUR places a heavy focus on Science, Technology, Engineering and Math (STEM) curricula, and provides them at an attractive average price point of $3,000-$4,000 per year.
Through the Corsair Lens, we see a high quality business with recurring revenues and high barriers to entry. This predictable revenue stream is enjoying growth due to favorable demographic trends in emerging markets and is protected by strict regulation, scarce real estate, technological infrastructure and brand equity built on decades of successful outcomes. LAUR is also benefitting from an improving mix shift towards a more asset-light, higher margin online revenue stream. LAUR’s high quality operation boasts 18 years of consecutive organic total enrollment growth with 80%+ retention rates, has #1 market shares in Chile and Mexico and has grown online teaching hours to 24% of total teaching hours. LAUR institutions are well-entrenched, growing and becoming less capital intensive.
It is also important to highlight that 71% of tuition revenue is privately paid. This high proportion of private-pay revenue reflects LAUR’s value proposition to students and also insulates the company from potential regulatory changes. Therefore, it is no surprise that private equity firms have been active buyers in the space. In December 2018, Permira acquired LAUR’s Spain/Portugal assets for 15x EBITDA. Equally notable is that KKR, part of the original consortium, upsized its ownership in LAUR and backstopped the 2017 IPO.
A Change in Strategy from Rolling Up To Paring Down
“The plan that we announced today has two critical components to it. One is to initiate the divestiture of non-core assets that are extremely accretive, we believe and expect to be extremely accretive to our current trading levels. But secondly, and equally important, the retained business will enable us to focus and further integrate around two distinct business models . . . both at scale, both with great financial attributes and both with great prospects for growth and improved free cash flow conversion.” – LAUR CEO Eilif Serck-Hanssen
LAUR’s shift from private to public ownership in 2017 was ill-received due to its levered balance sheet, geographically dispersed set of assets and lack of positive free cash flow. LAUR’s currency mismatch between the debt on its balance sheet (US dollar funded term loans) and the revenues of the company (only 20% US dollar) further complicated the story. Within just a few months of the IPO LAUR’s board undertook a portfolio review, culminating in the announcement of nearly $2B of asset sales for approximately 13x EBITDA (more than double its pro forma trading multiple). The company used the proceeds to de-lever from 4x to less than 1.5x and also addressed the debt/revenue FX mismatch by paying down its U.S. dollar-denominated term loans and issuing debt in local currencies. LAUR’s current simplified portfolio allows management to focus on integrating and scaling its core markets to drive higher margins and FCF. In fact, the remaining portfolio’s higher margins and better future growth prospects than the assets divested at 13x EBITDA on average highlights the quality and value of the business going forward.
The new LAUR is positioned as a leading campus-based operator in LatAm and a well-regarded provider of online education in the U.S. (Walden University). In our view, this shift in strategy to both monetize the public/private market valuation disparity and simplify the business to drive better margins reflects the board’s ongoing desire to create shareholder value.
Breaking Out Of the Range
While 2019 remains a transitional year for LAUR as it completes its asset sales and restructuring, we see a company with a bright future that is well positioned to hit or exceed its 2020 targets. However, the market seems distracted by subdued enrollment growth in Brazil and Mexico, relatively low near-term FCF generation and the overhang of a 45% private equity shareholder. Additionally, because $1.5B worth of divestiture cash proceeds have not yet hit LAUR’s balance sheet, the stock appears to be trading for 9x 2019 pro forma EBITDA and the company appears to be 3.6x levered. However, in reality, LAUR is trading for just 6.4x 2019 pro forma EBITDA and has less than 1.5x pro forma leverage.
In our view, these concerns are mostly optical, non-fundamental and transient. By year end 2019, the balance sheet should reflect all of the cash proceeds from LAUR’s divestitures, allowing investors to see a clearer picture of valuation and leverage. While it is true that economic weakness in Brazil and Mexico has slowed LAUR’s overall enrollment growth, LAUR retains its substantial margin and “distance learning” opportunities. Reduced restructuring expense, operational improvements and continued growth in asset light online hours will drive FCF to over $260MM in 2020 (~7% FCF Yield); any cyclical recovery in Brazil and Mexico represents additional upside.
Medium Term Upside to Margin and Cash Flow Target
“… I do believe that the further integration of these large four countries in Latin America will also provide for margin upside. . . we are very confident that these simplification actions will result in improved prospects in the medium and long-term for the retained franchise.” – LAUR CEO Eilif Serck-Hanssen
Beyond the targets management has put forth to investors, we believe LAUR has both operational and corporate levers it can pull to boost EBITDA margins closer to 24% in the medium term, a full 300bps improvement from its 2020 target. On the operating side, LAUR’s largest margin opportunity exists in Brazil, where its closest peer, Estacio (“ESTC3 BZ”), has nearly a 1600bps EBITDA margin advantage. We believe this margin gap is not structural and can be bridged by better integrating LAUR’s 12 Brazilian institutions. By sharing curriculum and online content and utilizing common back office systems and sales/marketing infrastructure, LAUR’s Brazilian operations should be able to reduce expenses and drive margins. In addition, LAUR’s Brazilian operations are significantly underpenetrated in “distance learning,” a form of online-driven education that can leverage LAUR’s brands and earn high incremental margins. Achieving higher “distance learning” penetration in line with Estacio would provide material revenue and margin uplifts. On the corporate side, our view is that LAUR should be able to attain a corporate cost structure in line with its pre-IPO period (adjusted for public company expenses), especially with a recently consolidated corporate footprint.
We believe there is significant room for positive earnings revisions in the coming years, a powerful catalyst for LAUR shares. Assuming 2018’s revenue base, bridging 1000bps of the margin gap with Estacio and right-sizing corporate expenses, we see a path to FCF of approximately $350MM (nearly triple 2018’s FCF), or a ~10% yield on today’s stock price.
In Good Stead with Regulators
“There are two business model attributes that mitigates our regulatory risk. Number one, we are focusing on private pay, 75% of our revenues are from private pay . . .Secondly, our positioning, we are positioned high up in the socio-economic pyramid. We are relentlessly focusing on quality and outcome that makes our interest very aligned with the regulator; that reduces regulatory exposure.” – LAUR CEO Eilif Serck-Hanssen
Fortunately for shareholders, LAUR’s focus on strong student outcomes aligns itself with regulators. In Brazil, for instance, LAUR’s ENADE exit exams were industry-leading and in Peru, LAUR’s institutions were among the first to get reaccredited under the new regulatory regime. In Mexico, LAUR has nearly 60 years of operating history and has strong ‘QS Star’ ratings. In Chile, some politicians oppose private control of traditional universities, but the proposal to ban it was deemed unconstitutional. Finally, in the U.S., Walden University has demonstrated consistent enrollment growth over the last decade with cohort default rates on student loans well below the national average. Moreover, Walden scored well on the more onerous Gainful Employment regulations set forth during the Obama administration, indicating that its students are earning a tangible return on their education.
Commitment to Value Creation and Future Catalysts
“… Let me be very, very clear. Laureate is committed to any and all value creation opportunities that unlock value for our shareholders. We have recognized that the market value of our enterprise is below the intrinsic value of the underlying assets. And management and the Board is very focused on taking steps to unlocking value to address this efficiency.” – LAUR CEO Eilif Serck-Hanssen
In short, investors can win in two ways: 1) the stock re-rates higher as LAUR’s reported leverage declines and FCF rises materially and/or 2) the board continues to liquidate the company to unlock its value. We see EBITDA growing towards $700MM in 2020 (expensing stock comp) and FCF growing to approximately $261MM as the company executes on its margin initiatives. Using a sum-of-the-parts approach, we value LAUR at a conservative 9x EBITDA multiple – a far cry from the average 13x multiple LAUR received from its recent divestitures. Through the Corsair Lens, we see the stock going to $24 over the next 12-18 months, with additional upside from the 300bps of margin upside we see beyond 2020 and the eventual cyclical recovery in Brazil/Mexico. With LAUR stock trading stubbornly near its IPO price of $14 per share, leverage well below the target range of 2.5x-3.0x and the market not pricing in any upside to margins beyond 2020, we believe the board will continue to monetize asset value and pivot towards value-creating share buybacks.
· Capital allocation to shift to share buybacks as ~$1.5bln of cash proceeds hit the balance sheet by year-end
· LAUR begins to generate more substantial FCF, proving out self-help thesis
· LAUR gives clarity on upside to margins beyond 21% EBITDA margins in 2020, potentially at an upcoming investor day
· Incremental divestitures to further arbitrage the private-public market valuation disparity