Description

Varsity Group (VSTY.ob) $1.65
Varsity books: Has a very straight forward story. Went public @ the peak of the Internet bubble with a boneheaded strategy and business model. Selling books online to students. However, management has made some incredibly brillant business/strategy decisions over the last 18 months... and found an extremely attractive niche in selling books via the internet to small private schools and I believe are now poised for considerable success. With nearly 70% of the mkt cap cash, Profitablility, and good shareholder base (including Peter Lynch).
A) EV/EPS 7x, EV/FCF 10x, B) 68.5% market cap in cash, $17.8mm Cash vs. Mkt cap $28mm C) Exceptional business (TL less than $3mm, Revs (est) $18mm, Capex $33K, 14.5% nm in best qtr of the yr) D) dominates niche 10x next competitor in terms of schools in private high school mkt (school growth up 50% yr/yr) E) growing 40% top line (bottom line should be in excess of 100%) F) Peter Lynch owns 8.5% G) market opportunity 3000+ schools in VSTY targeted market with only 140 penetrated ($129,000 per school per yr) H) clearly focused niche, less economically sensitive (selling textbooks to private school students: spending $8-19K per year tuition vs. $625-700 in books) I) Attractive operating model: high variable cost (low fixed costs), demand pulled through headmasters/school business managers(much lower customer acquisition costs) vs. students = much lower S&M cost than competitors who target students J) Schools love the service: 2-4 year exclusive contracts with retention north of 90%, when contract is up. I) $69mm NOL or about $4.05 per share.
Varsity group sells textbooks to students at private schools with base of 500+ students. Which sounds boring enough? But here is the compelling aspect of their business.

Book stores at these private schools of this size usually lose money: a) they need to come up with WC to buy books, pay a staff to unload them and put on shelves, mark up, then students rush in and buy for about 3 weeks,(then rest of the semester little happens, but fixed costs are there) then deal with returns etc.
VSTY solution:
VSTY solution is simple. VSTY targets headmasters/school business manager for their service, which dramatically cuts S&M costs vs. competitors who target students for demand. The company assigns dedicated rep to school. Who gets all of the teachers required books per class and students in those classes (and integrates into a database). Then VSTY sets up a website for the school which ties into varsity’s EduPartners system. Student goes to his/her schools web site types in name and entire course load comes up with required books, and one click of the mouse the entire book order is done for 20-33% less than the school charges, and shipped that day. Even better VSTY never touches the books, they use Baker & Taylor for all fulfillment. In some cases, VSTY will give a % of sales back to the school for a general scholarship fund. VSTY has good revenue visibility: a) know # of schools in system b) have student lists and know book list and sell through
VSTY has an outstanding reputation in this tightly knit industry, as evidenced in 90%+ retention rate, growth of schools, and value added proposition to the schools.



Varsity focus is on private schools (mainly high schools, but also private 4 year universities, also looking at going after distance learning programs)
Reasons: private schools less economically sensitive, curriculum frequently changed semester to semester (rarely reuse books yr to yr), also deal with small schools because they do not possess economies of scale to generate profit.
Competitive advantages:
Vsty niche is unique for several reasons:
First,VSTY is focused on dominanting a small market and cost structure is aligned to this focus (avg school does $129K a yr with, $10K in operating profit):
Reputation: schools are cautious about new entrants into the market, they look for a track record of success which vsty has
Strong b-sheet: Will be around, which schools focus on with 2-4 contracts
business model is built around targeting this market using market economics while most competitors are not: Lack 1) Access to capital 2) VSTY ties up with LT contracts 3) Reputation 4) Not meaningful market segment to overall revenue base. 5) VSTY is clear leader in this market, so far.
This is showing up in:
Company grew schools by 50% from 90 schools to 140 schools yr/yr (3rd qtr yr/yr)
Net income grew by over 140% yr/yr for the 3rd qtr: $2.1mm vs. $0.87mm
I estimate that the company should earn .16-.20 for 2003 and FCF should be very close to Net.
A multiple of 13x on eps = $2.34 + $1.11= $3.45 per share or 109% from current price.

Marketing expenses down significantly because they are not selling to the student (like competitors to pull traffic but selling to business manager/Headmaster of private school, much lower customer acq. costs)
Variable cost based OPEX.




B-sheet
CA
Cash $14.83mm
Short term investments $3.00mm
A/r $2.12
Other CA $0.48mm
TCA $20.42mm
Fixed Assets $0.65mm
Other assets $0.15mm
TA $20.50mm

CL
A/P $0.41mm
Accrued/Exp $0.86mm
Sales tax payable $1.61mm
TCL $2.89mm
LTL $-0-
TL $2.89mm



Major Shareholders
Peter Lynch owns 1.430 million shares about 8.5% of VSTY
Tribune Company (TRB) owns 1.654 million shares about 9.8% of VSTY
Mayfield fund owns 2.34mm or about 14%
Carlyle Group owns 2.1mm or about 12.5%
VSTY CEO owns about 2.225 or about 13.5%
Liquidity avg. daily volume is 33,000 shares.

Negatives:
seasonal qtrs
bulletin board stock
early phase of growth

Positives:
68.5% of mkt cap cash
Profitable and growing rapidly with (absolute min. capex)
clearly defined market and strategy
well managed & strong board.
NOL $69mm or $4.05 per share

Catalyst

) EV/EPS 7x, EV/FCF 10x, B) 68.5% market cap in cash, $17.8mm Cash vs. Mkt cap $28mm C) Exceptional business (TL less than $3mm, Revs (est) $18mm, Capex $33K, 14.5% nm in best qtr of the yr) D) dominates niche 10x next competitor in terms of schools in private high school mkt (school growth up 50% yr/yr) E) growing 40% top line (bottom line should be in excess of 100%) F) Peter Lynch owns 8.5% G) market opportunity 3000+ schools in VSTY targeted market with only 140 penetrated ($129,000 per school per yr) H) clearly focused niche, less economically sensitive (selling textbooks to private school students: spending $8-19K per year tuition vs. $625-700 in books) I) Attractive operating model: high variable cost (low fixed costs), demand pulled through headmasters/school business managers(much lower customer acquisition costs) vs. students = much lower S&M cost than competitors who target students J) Schools love the service: 2-4 year exclusive contracts with retention north of 90%, when contract is up. I) $69mm NOL or about $4.05 per share