Ambassadors Group, Inc. (NASDAQ: EPAX) is engaged in organizing and promoting international educational travel programs for students, athletes and professionals via “People to People Ambassador Programs” which aim to inspire intellectual and cultural exchange. The company has been in operation since 1967 and has arranged for approximately 500,000 individual ambassadors to travel to more than 90 different countries on all seven continents. In addition to the company’s travel business, in 2008 it also purchased BookRags.com, which is a source for online book summaries and notes, lesson plans, and biographies.
The company trades (as of 11/7) for a market cap just shy of $80 million, down 62% this year. Yet the company is profitable, has zero debt and $53 million in cash and securities! Furthermore the company appears to be a cash flow machine, generating free cash flow averaging $16 million over the last three years, and the company has historically returned much of this to shareholders in the form of both a healthy dividend and share repurchases. What gives?
Let’s look for clues in the company’s past performance. First, we’ll look at the company’s historical returns.
Ambassadors Group, Inc. - Historical Returns, 2000 - 2Q 2011
Here we see a rather alarming decline in returns over the last few years, but given the highly discretionary nature of the company’s business, I am less surprised by the decline than I am by the fact that the company remained profitable throughout the recession. However, having noted the decline, when reviewing the company’s filings we’ll definitely have to stay on the lookout for red flags that suggest a secular decline in the company’s business rather than cyclical.
Let’s turn to revenues and margins. We first have to understand the company’s sources of income. The company has two segments: “Ambassador Programs and Other” and “BookRags.” Within the Ambassador segment, the company categorizes revenues in two manners: directly delivered for the sale of travel programs that the company also organizes and carries the risk of execution, and non-directly delivered for the sale of travel programs whereby a third party takes the execution risk and EPAX receives a commission for the sale. The accounting for each is different. From the company’s 10-K (emphasis mine):
Within our Ambassador Programs and Other segment, revenue is categorized as non-directly and directly delivered. For non-directly delivered programs, we do not actively manage the operations of each program, and our remaining performance obligation for these programs after they convene is perfunctory. Therefore, revenue from these programs is presented as net revenues and recognized as the program convenes. For directly delivered programs, however, we organize and operate all activities. As such, we recognize the gross revenue and cost of sales of these directly delivered programs over the period the programs are operated.
Ambassadors Group, Inc. - Revenues and Margins, 2000 - 2Q 2011
There are a few things to note from this graph. First, the company introduced its direct programs only in 2005. These programs are riskier, in that the company is on the hook for the costs of execution, and so we see that the company’s margins declined beginning in 2005 despite a significant uptick in revenues (this usually tends not to be the case due to economics of scale). Unfortunately, this business also suffered the most dramatic decline in demand over the last two years, shrinking by 46%, as compared to just 14% for its traditional indirect programs and 64% growth in its internet revenue.
Another thing worth noting is that the company’s revenues are largely concentrated in Q2 and Q3. This will be important momentarily.
Let’s turn to the company’s cash flow.
Ambassadors Group, Inc. - Cash Flows, 2000 - 2Q 2011
Here we see the best feature of EPAX: its cash flow. Except for a momentary dip in 2007, the company has had exceptional cash flows throughout its history as a public company. Combined with its low capital demands, the company generates strong free cash flows. As noted above, the three year average is about $16 million, which is a whopping 20% yield at the current market cap!
This strong free cash flow has contributed to the company’s exceptional cash and securities balance (which currently exceeds the company’s market cap). Now, recall that the company’s revenues are recognized almost entirely in just Q2 and Q3. Here’s what the company says about that (emphasis added):
As further discussed below, our operating results depend primarily on the revenue we earn from our travel programs and costs associated with providing these programs. Our business is highly cyclical. The majority of our sales and marketing expenses are incurred during the third and fourth quarter of the current year in order to acquire customers that result in revenue recognized in the subsequent second and third quarters of the next fiscal year. More specifically, we will not recognize the majority of the revenue generated by our 2010 sales and marketing efforts until the second and third quarters of 2011. …
We bill travelers in advance of travel, payments of which are recorded as participants’ deposits. We also pay for certain program costs in advance of travel, including, but not limited to, airfare, hotel and other program costs, which are recorded as prepaid program costs and expenses. Under our cancellation policy, a program traveler may be entitled to a refund of a portion of his or her payments, less certain fees, depending on the time of cancellation. We recognize all cancellation fees concurrent with the revenue recognition from the related programs.
So here’s what happens: the company incurs expenses in one year in order to market its travel programs for the next year. As customers sign up, they make deposits which boost the company’s cash balance. But since the bulk of these deposits are refundable, it would be inappropriate to treat this cash balance as freely distributable.
The company uses a metric called “Deployable Cash“
Deployable cash is a non-GAAP liquidity measure. Deployable cash is calculated as the sum of cash, cash equivalents, short-term available-for-sale securities and prepaid program costs and expenses less the sum of accounts payable, accrued expenses and other short-term liabilities (excluding deferred taxes), and participant deposits and the current portion of long-term capital lease. We believe the deployable cash measurement is useful in understanding cash available to deploy for current and future business opportunities.
The company’s deployable cash in the most recent quarter was $46 million which constitutes more than 58% of the company’s market capitalization. The following chart depicts the company’s cash balance and deployable cash over time.
Ambassadors Group, Inc. - Capital Structure, 2000 - 2Q 2011
Here we see that the company has historically eschewed debt and maintains a healthy level of deployable cash. One concern is that the company may waste this on an acquisition. As the company notes in its 10-K (emphasis added)
We continue to consider acquisitions of educational and travel businesses. An acquisition may require the use of cash and cash equivalents. Currently, there are no pending acquisitions and no assurance can be given that definitive agreements for any such acquisitions will be entered into, or, if they are entered into, that they will be on terms favorable to us.
Another thing to note about the company’s business structure is that, since revenues for its direct programs are recognized only when the travel programs are operated (up to a year after deposits have been received), we can get a feeling for the how this area will perform in the future by keeping an eye on the company’s Net Enrollments metric, which shows the net number of customers who have signed up for the following year.
Ambassadors Group, Inc. - Net Enrollments, 2006 - 2Q 2011
This chart shows net enrollments each year since the company began direct programs. Unfortunately, this does not paint a positive picture, with declines each year. Additionally, enrollments this year (for next year’s revenues) are weak, suggesting that this segment will not be turning around anytime soon.
In valuing EPAX, it is important to take into account this ongoing weakness when developing possible scenarios for the company’s future revenues. I looked at the historical average revenue per lagged enrollment (since enrollments are for the following year) and worked up some scenarios for continued enrollment decline. I then added an estimate of revenue for each of the other divisions and and considered historical margins. The result of my analysis is that EPAX looks to be significantly undervalued.
What do you think of EPAX?
Disclosure: No position.