Description
Company Overview
The company is a spin-off (middle school / high school on + offline education) from Megastudy. It generates 83% of rev from high school division, 16% from elementary~middle school division and 1% from real estate lease. The demand for company’s business was hit with a triple whammy of increasing regulatory threats; 1) government trying to lower private tutoring expense by producing college entrance exams from EBS, the education channel, which is basically free and widely accessible 2) elimination of paper exams to enter special purpose high schools (foreign language school and science school, which is reserved for academically strong kids) 3) Moreover, the loss of star professor Shin, lowered the demand for Megastudyedu’s products. Most recent development has been the 1) spin-off of Megastudy Education from its parent to operate the core business (elementary to high school education), 2) insider buying and 3) rising popularity of math star professor Hyun Woo Jin.
MSE thesis
Situation: Due to heightened competition and loss of MSE’s top math teacher (Shin), the company has suffered from significant market share loss throughout the years since 2014 end. Due to high level of fixed costs associated with Mr. Shin, MSE faced significant drop in earnings in 2015 and stock price also moved downwards. During July 2016, I first looked into the company and was interested as the company was low P/B, strong brand name but unfortunately stuck in a very mature industry with heavy competition between incumbents. H&Q Korea which had second largest stake had to exit MSE due to closure of their fund and MSE being a spin off, created more short term selling pressures.
Why I thought the stock was mispriced in July 16? (similar to current price). Initially, I liked the extremely high property value vs market cap (more than 2x) providing strong downside protection and that for 2017, the company will turn around to a more normalized earnings after huge offs in 2016, Hyun (new math teacher) ramping up sales, op leverage, and competition easing. I also liked the insider buying activities. However 2016 2H numbers were much worse than the guidance, creating more short term selling pressures in the near term. Also 1Q17 will be still weaker than that of 1Q16 due to product mix change and operating deleverage. YoY earning trends will only start recovering starting in 2Q17, which is more delayed recovery than I initially thought. After recent weakness, what is the thesis now?
Thesis: Why I expect a turnaround starting in 2Q
1. MSE to gain share leads to op leverage effect: MSE is currently recording market share gains as it is recovering very strongly in the online segment as it launched rebate + free pass for this year’s CSAT students / Hyun + synergy ramping up between different professors. MSE is thus gaining m/s share this year with the unearned revenue growing 20~30% YoY. Our checks on google / naver / blogs suggests that Hyun is no. 1 in math segment now and other teachers are benefitting from this trend. Given contribution margins for online is very high at 50%~60%, OP for online can contribute significantly.
2. One off add back in 2017: MSE will gain back the 6B worth of one offs (litigation of 2B / pension new recognition of 4B)
3. Competition easing potential: Pricing for freepass has gone up while Skyedu is having a severe financial difficulty to continue on its aggressive marketing behavior. E-toos is also under a lawsuit case involving 10B penalty if E-toos loses – so it may be hard for Sky/E-toos to be more aggressive.
4. Valuation: After getting higher OP for online vs, 2016 and one off cost add back, the company is expected to achieve 15B in 17E and it should be trading at 6x EV/EBIT multiple or 2.1x EV/EBIT (if investable real estate is included as mkt value) / and even cheaper if 29B of real estate deposit is included as cash vs peers trading at 6.5x~ 9.2x (all adjusted for real estate, cash, debt).
5. Downside protection: While I think many different scenarios can happen in the upside potential, I still think it is quite cheap (P/B 0.6x / 97B market cap vs. 200B real estate value + 5B net cash + 29B rental deposit) with couple of free options stock could go up this year.
Risk is that the top management may continue to get into low ROIC potential businesses while paying huge premiums. This not only crushes the company ROIC but also increases discount to their asset market value. Competition between incumbents can also can get worse, continuing to pressure the marketing costs. Lastly, you may see a risk when Hyun is going for a new contract during FY17 end. But likely that the signing bonus amount is pro-rated evenly in his new contract years, so not much cash pressure.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
MSE to gain share leads to op leverage effect: MSE is currently recording market share gains as it is recovering very strongly in the online segment as it launched rebate + free pass for this year’s CSAT students / Hyun + synergy ramping up between different professors. MSE is thus gaining m/s share this year with the unearned revenue growing 20~30% YoY. Our checks on google / naver / blogs suggests that Hyun is no. 1 in math segment now and other teachers are benefitting from this trend. Given contribution margins for online is very high at 50%~60%, OP for online can contribute significantly.
2. One off add back in 2017: MSE will gain back the 6B worth of one offs (litigation of 2B / pension new recognition of 4B)
3. Competition easing potential: Pricing for freepass has gone up while Skyedu is having a severe financial difficulty to continue on its aggressive marketing behavior. E-toos is also under a lawsuit case involving 10B penalty if E-toos loses – so it may be hard for Sky/E-toos to be more aggressive.
4. Valuation: After getting higher OP for online vs, 2016 and one off cost add back, the company is expected to achieve 15B in 17E and it should be trading at 6x EV/EBIT multiple or 2.1x EV/EBIT (if investable real estate is included as mkt value) / and even cheaper if 29B of real estate deposit is included as cash vs peers trading at 6.5x~ 9.2x (all adjusted for real estate, cash, debt).
5. Downside protection: While I think many different scenarios can happen in the upside potential, I still think it is quite cheap (P/B 0.6x / 97B market cap vs. 200B real estate value + 5B net cash + 29B rental deposit) with couple of free options stock could go up this year.
Risk is that the top management may continue to get into low ROIC potential businesses while paying huge premiums. This not only crushes the company ROIC but also increases discount to their asset market value. Competition between incumbents can also can get worse, continuing to pressure the marketing costs. Lastly, you may see a risk when Hyun is going for a new contract during FY17 end. But likely that the signing bonus amount is pro-rated evenly in his new contract years, so not much cash pressure.