- The market assumes that the current cyclical low for Learning Tree International (LTRE) is permanent and ignores the primary catalyst in the form of a significant EBITDA rebound over the intermediate term driven by receding negative external factors, a lower cost structure and continued operational improvements.
- This mispricing is compounded by the low demand visibility and lack of analyst coverage. Moreover, the market has failed to differentiate between weaker and more visible for-profit education providers and stronger and more focused providers with unique demand drivers such as LTRE.
- The downside is limited by the high net cash balance (no debt) that represents 70% of the market cap while two secondary catalysts (e.g. another MBO attempt or special dividend) provide additional upside potential.
LTRE provides training and education to IT professionals and managers at businesses and government organizations. Courses are offered at its education centers, stand-alone AnyWare learning centers, on-site at client facilities or via the Internet using its web-based platform AnyWare.
Light at the end of the tunnel is an eventual recovery - not an oncoming train
In the mrq, revenue declined 3.8% to $32 million due to multiple headwinds including sequestration (lower bookings under its GSA contracts), weaker European growth and unfavorable weather (lower attendance at the East Coast locations). However, the focus going forward should be on the following two catalysts.
Significantly lower cost structure. In the mrq, LTRE reduced operating expenses by $4.5 million, driven by the following three factors. First, course development expense declined by $200,000, which did not affect innovation as LTRE introduced six new management course titles. Second, sales and marketing expenses declined by $1.6 million due to lower direct marketing costs and staffing levels. Third, G&A expenses declined by $2.7 million due to nonrecurring expenses incurred in the prior period related to the closure of its L.A. offices and costs incurred to evaluate a buyout offer (see below).
While there may be an incremental rise in sales and marketing as well as course development expenses after demand rebounds, overall expenses on an absolute dollar basis should remain relatively stable and decrease even further as a percentage of revenue. For example, since the peak in 2012, course development expenses (as a percentage of revenue) declined 80 basis points to 6%, sales and marketing expenses declined 800 basis points to 19.2% and G&A expenses declined 510 basis points to 17.6%.
Moreover, there is greater flexibility to respond to changes in demand due to the fact that more than half of course delivery costs are variable (e.g. dependent upon the number of course events conducted; instructors are not full-time employees) and the stand-alone AnyWare learning centers are typically located in short-term rental facilities.
Furthermore, the negative effects of the high operating leverage (due to the fixed costs for the education centers) is masking the true earnings potential. For example, in 2011 EBITDA was ~$9.9 million compared to ~-$211,000 on a ttm basis even though revenue was only ~16% higher.
This asymmetric opportunity exists because the market assumes that the current cyclical low is structural and ignores the stabilizing EBITDA and potential for a significant rebound driven by higher demand and a lower cost structure. Even assuming EBITDA only rebounds to half of this peak level, you're looking at a stock with a $12 million EV generating ~$5 million of EBITDA. Moreover, the $9.1 million of NOLs that do not begin to expire until 2032 should become increasingly relevant (there is a valuation allowance against virtually this entire gross deferred tax asset) as results improve.
Rebounding growth. While some of the previously mentioned headwinds should be resolved sooner than others (e.g. weather becomes favorable before Europe completely recovers), the fact remains that each of these are merely temporary conditions. LTRE is positioned to benefit from the eventual increase in demand due to its many competitive advantages, which do not cease to exist if the unemployment rate rises 10 basis points. Moreover, they provide more of an economic moat than is assumed given the standard risk listed in the 10-K of low barriers to entry.
LTRE has a strong reputation, built over an almost four decade long operating history, of providing vendor-independent and practical instruction in a globally consistent manner. The >90% retention rate for instructors results in lower acquisition costs and ensures high quality.
The diverse (e.g. by size, type, industry) and loyal customer base (e.g. every one of its 100 largest clients in 2008 was still a client in 2013) reduces the impact of the previously mentioned headwinds.
LTRE is not only offering new course titles but also additional distribution channels such as the 31 stand-alone AnyWare learning centers opened in 2H13. Although management said on the most recent conference call that this resulted in a slightly shorter buying cycle (and therefore lower enrollment visibility), they also noted a positive response. While in a perfect world there would be higher revenue and visibility, it is better to have higher revenue and lower visibility than the opposite.
An overlooked* yet critical shift in the course mix further supports the case for margin expansion as LTRE eliminated a heavily discounted passport program (partially responsible for the decline in the number of participants) and delivered more higher priced courses, which resulted in a 3.5% increase in average revenue per participant.
*A headline-scanning algo would almost certainly miss this underlying shift. At some point there is a diminishing marginal return to using this tool as you might as well read the entire filing yourself if you are going to code an algo to scan for an increasing number of variables.
Valuation and additional catalysts
The previously mentioned slightly negative EBITDA results in a non-meaningful absolute and relative valuation. If there is one positive aspect to this, it is that the market generally misprices stocks in this situation.
The two peers referenced below are provided to highlight the eventual multiple LTRE should receive rather than to highlight any current valuation disconnect.
While the for-profit education industry as a whole may seem like an appropriate peer group, there are two significant differences that merit a wide multiple dispersion. First, larger and more visible peers (e.g. Apollo) are heavily dependent on government student-aid or loan programs such as Title IV. However, LTRE is paid directly by employers of its participants and does not rely on these programs.
Second, LTRE offers employers (who are paying) the opportunity for significant and rapid productivity improvements as the employees use the knowledge gained in their current job, compared to students pursuing more general degrees used to get another job (with much more uncertain benefits).
While the projected EBITDA rebound is the primary catalyst, there are two secondary catalysts. The first is another MBO attempt. In September 2012, the CEO and chairman David Collins along with his wife (who currently own ~32% of the stock) offered to acquire all of the remaining shares for $5.25 per share in cash. This offer was withdrawn after they concluded that it was "causing distractions...during a period in which there should be increased focus on the operations of the Company in light of the current business environment".
However there are two factors that may encourage them to make another attempt. First, LTRE is in a much better position after the implementation of the previously mentioned operational improvements and expected intermediate term resolution of the current negative external factors.
Second, the EV is now ~26% lower compared to the previous offer. This would allow for a larger premium on a percentage basis but a lower absolute dollar cost. For example, on 9/14/12 (the day before the offer was made public) LTRE closed at $4.25, which means the offer price of $5.25 was a ~24% premium. If they made an offer of $4.00, this would be a ~34% premium to the current price but a 24% discount to the original offer price.
There is an important caveat. Long term shareholders may feel that the company is being stolen* due to the well-known anchoring effect (known to the man on the street as "living in the past"). However, shareholders should come to their senses fairly quickly this time, if for no other reason than to prevent another decline in the stock, which is what happened after the offer was withdrawn.
Second, absent a buyout, the board may return a portion of the excess cash (e.g. no debt with cash that represents ~70% of the market cap) to shareholders in the form of another special dividend (e.g. there was a $2.20 dividend declared in August 2010) or completion of the increased repurchase plan, which still has ~$2.9 million remaining.
*By definition, it is not stealing when someone offers to give you more money than you had before (e.g. $2.99 vs. $4.00).
The following are the primary risks to the investment thesis, in order of importance:
- A decline in global growth or government spending would most likely result in lower demand or at a minimum a delay in course purchases.
- The coursework and method of training delivery are constantly changing, which requires continued investment in new course titles, equipment and personnel.
- The IT and management training markets are highly competitive and fragmented.
A 30% return (at a minimum) is a reasonable target over the next 12-24 months given the previously mentioned primary and secondary catalysts. A relatively larger stop loss of 10% (placed below the recent support at ~2.70) may be used given the higher return potential, although the position size should be reduced in order to compensate. Alternatively, investors may choose to enter on strength above the 50 DMA at ~3.10.