- Career Education is trading at an Enterprise Value that is one-sixth of the company's Book Value.
- We look at how the market arrives at such a low valuation using price to sales as our launching point.
- Should CECO's new management deliver improved future enrollment trends while lowering costs, then the current share price is a gift to those that can stand the inherently large risks.
Valuations like what Career Education (NASDAQ:CECO) currently is tagged with, as highlighted in the recent article on Seeking Alpha, are rare. Instead of rehashing why many will undoubtedly come to the conclusion that today's pricing is a gift, taking a look at how the market may be placing such a low existing valuation on these shares seems a better starting point. We can do this with some reverse engineering starting with its existing market capitalization of ~$333 million, which is a fraction of the company's LTM revenue.
The obvious factor that drives any valuation is the perceived future growth of the firm in question. In the case of CECO, the company reported that its revenue declined in conjunction with lower enrollments during the first quarter of 2014. Specifically, the company stated in its 1Q14 press release that, "Total revenue was $243.1 million for the first quarter of 2014, a 14.5 percent decrease from $284.5 million for the first quarter of 2013. The decline is largely due to approximately 4,400 fewer total student enrollments in its ongoing institutions, which excludes Transitional Schools, in the first quarter of 2014 compared to the first quarter of 2013. In addition, the Transitional Schools segment accounted for 4.1 percent of the decrease in revenue."
Breaking this down into its components we see that:
- The average revenue per student per quarter declined by 2% from 1Q13 to 1Q14 ($4457 vs. $4364 per student per quarter, respectively).
- The students that dropped out or graduated had tuitions that were roughly double the company's average revenue per student or $8,805 per quarter (change in quarterly revenue minus transitional schools' contribution divided change in Career School Enrollments).
- Student enrollments are declining by 12%, from 1Q14 release.
Interestingly, if you use both the declining revenue per student (2%) and declining enrollments (12%) as trends for modeling future revenues in five years and apply them to full-year results for 2013, then this implies the company's revenues would shrink to ~500mn by 2018. If you then discount the revenue back to current dollars using 7% as your discount rate, then this revenue for 2018 equates to $361 in today's dollars. So, the conclusion is CECO shares are trading at 0.9x 2018 sales estimates. Other education companies are trading around 1x annual revenues, just not so far out into the future with revenue estimates to reach this conclusion.
2013 Enrollments 53,700 times decline trend of 87.6% raised to fifth power implies 27,667 students in 2018.
2013 Average Revenue Per Student $19,683 times decline trend of 97.9% raised to fifth power implies 17,712 ARPS in 2018.
Multiplying these results together implies annual revenue of $490 million in 2018.
The compelling component of CECO's valuation story is found when you look at its enterprise value (i.e. the all in cost of acquiring the company or Market Cap plus Debt less Cash). Right now, CECO has an enterprise value of $68 million or roughly one-fifth of the companies book value. If CECO's new management is effective over the next few years at producing a reasonable level of Free Cash Flow, then an investor today has the potential to own a company that delivers an annual FCF yield that is the equivalent of their original investment. Opportunities like this are rare and as would be expected are mirrored by a rather large amount of risk, including regulatory, legal, and the usual competitive pressures.
Comparison of Book Value to Enterprise Value
Share Price $4.95
Outstanding Shares 67.2 million
Market Cap $332.64 million
Cash $264.19 million
Enterprise Value $68.45 million
Book Value $398.13 million