Ambow Education Holding (AMBO) is the leading technology-enabled education company in the Greater China region. AMBO employs a combination of in-class and Internet-based training to deliver proprietary partner- and vendor-certified instruction in two of the three highest-growth segments of the Chinese education industry: post-graduate professional skill training and K-12 supplementary education. (AMBO does not teach English as a Second Language, or ESL, which is the third high-growth segment and by far the most crowded and competitive.)
AMBO's corporate motto -"better schools, better jobs, better lives"- reflects the company's ongoing relationship with its customers as they graduate from their formal schooling phase and enter the work force. The "better schools" portion of their business is focused on tutoring services as well as high school and college admission.
The "better jobs" segment is focused on technology industry professional certifications (e.g. Microsoft Certified Systems Engineer, Cisco Certified Internet Expert, Oracle Database Administrator, Baidu search engine marketer, etc.), post-graduate practical training, and post-graduate and corporate-sponsored "soft skills" training.
AMBO's results reflect its leading market position in all its segments of focus. No company certifies more Chinese in each major professional IT certification. For instance, over 60% of all of China's Cisco-certified network engineers are AMBO-trained. AMBO-trained professionals have a 95% job placement rate, and 70% of placed professionals take additional AMBO courses to enhance their careers. No company gets more Chinese students into the top local high schools and universities and into the top universities abroad, including Ivy League and "Oxbridge" schools. Competition for admission to China's "national" universities is fierce given the sheer number of applicants, but AMBO still places 97% of its students into national universities. 40% of its students elect to study abroad at a top 100 global university. Annual customer churn for AMBO is an industry low sub-5%.
As a testament to the effectiveness of AMBO's distance learning technology, the Chinese government's Ministry of Education, which regulates all aspects of the Chinese educational system, recently selected AMBO as its exclusive corporate partner in the development of the forthcoming "Chinese Education Cloud," a government-led initiative that aims to leverage Internet cloud-based technology to educate and network over 14 million government-certified Chinese teachers and over 4 million teacher candidates. This system will be used to regulate all Chinese teaching certifications and continuing education requirements. AMBO will be reimbursed by the government for the engineering costs of setting up this technology platform and will receive full operating rights once the system is implemented.
Despite the 20F filing delay that cut the stock price in half (see this post from an unaffiliated contributor on Seeking Alpha), AMBO has one of the most qualified management teams in the industry. Among the listed Chinese education companies - Ambow Education , New Oriental (EDU), Tal Education (XRS), ATA Inc. (ATAI), Chinaedu (CEDU), Xueda Education (XUE), and Noah Education (NED) - only five members of the various executive teams have advanced degrees from Beijing Normal University, the runaway top university for educators in China. Three of those five are on AMBO's management team. The founder and CEO, Jin Huang, comes from a family line of prominent Chinese educators and holds two engineering PhD degrees, one from a top local university (University of Electronic Science and Technology of China) and one from abroad (UC Berkeley). The former CEO of McGraw Hill China is one of AMBO's directors, and McGraw Hill is a corporate shareholder in AMBO. Three of AMBO's six directors have an accounting/auditing background, including the Avenue Capital partner who used to work at PWC, AMBO's auditor, and the company has never had an accounting or audit issue prior to the delay of its 20F filing this year, which has since been cleanly and completely resolved. (The 20F filing and explanatory press release can be seen here.)
The panic-driven sell-off in AMBO shares since missing the 4/30/2012 20-F filing deadline for all US-listed issuers of ADSs has created a very rare opportunity to invest in a high-growth Chinese leader of an industry with tremendous secular growth prospects at a "deep value" price ahead of multiple imminent potential catalysts that could generate a 100% return if the stock merely corrects itself to levels of just 45 days ago. I am underwriting a 200% base case return with a 12-month view.
The fundamental drivers of the investment thesis include: (i) sustained earnings growth, (ii) multiple expansion, and an (iii) increase in free cash flow generation due to the divestment of various slower-growth legacy assets and the operating leverage derived from its CapEx investments to date, which the company expects to decrease substantially in the near future.
When you consider the negative net debt (-$41 million) and therefore practically non-existent balance sheet risk as well as the accelerating cash flow profile of the business, I believe AMBO offers exceptional risk-adjusted opportunity for value investors. Most deep-value investments require a lot of patience or a lot of imagination with respect to the forward outlook of a challenged and out-of-favor business. Where this investment differs most markedly is in the quality of the business and its strong growth as well as the relatively short time-frame to realize strong returns given the event-driven nature of the opportunity and its various catalysts (discussed in the final section).
AMBO is well-positioned to continue its dominance in its target segments of education, one of the highest-growth secular trends in Chinese domestic consumption. As Chinese households have increased spending on education from single-digit percentage of overall household income to now over 25% (and growing), AMBO stands to benefit disproportionately due to its widely recognized high-end brand; its exceptional track record of delivering results; its proprietary "content engine" technology that archives, indexes, and delivers via the Internet highly customized training and self-study modules that supplement in-class training; and its rapid and to-date successful expansion into Tier 2 and lower cities which are experiencing the highest growth in GDP contribution and household income as well as the fastest ramp in education spending.
I believe AMBO will not only defend its leadership but continue to take share by leveraging its competitive moat, which it derives from a strong high-end brand, a broad network of AMBO-qualified and -trained teachers, highly differentiated content (developed in partnership with leading schools, major global education media companies, and leading global technology companies), and a proven cloud-based technology platform.
Despite the current share price of $4.15 (market cap of $301 million), I believe that fair intrinsic value for the company today is $12 per share, and I believe it will take no more than 12 months to achieve that price target. At first blush, that may seem like a real stretch, but consider the following.
Prior to the 20F deadline miss, AMBO's share price fluctuated between $7 and $8. It was then the third-largest listed Chinese education company, behind EDU ($4.2 billion market cap, 32x P/E) and XRS ($803 million market cap, 33x P/E). At the current price, AMBO trades at a 72% discount to direct Chinese US-listed comps on a P/E basis and an 81% and 82% discount to the two largest companies.
Even though the company conservatively projected and recently affirmed 28% revenue and 178% net income YoY growth rates for 2012, AMBO sold off anyway due to its 20-F filing delay and now trades at an incredible CY2012 5.6x P/E and a 2.9x EV/EBITDA. Typically, book value is a meaningless concept for high-growth companies with strong prospects for continued market penetration, but AMBO has sold off so heavily that it now trades at a 33% discount to book value.
Fundamentally, AMBO is a very attractive business, with secular 30% earnings growth, EBITDA margins of ~25%, and a FCF yield of 15% (rare in high-growth companies), especially impressive since AMBO is currently investing in CapEx to expand into Tier 2 and 3 cities, where most of the forthcoming industry growth is (>40% versus Tier 1 Cities' growth of <20%).
Merely rebounding back to pre-event levels generates half of the return I projected above. Then, any combination of the following gets you to my target price: achieving the company's financial projections for the next 12 months, modest multiple mean reversion (even if still a whopping 50% discount to comps after the multiple corrects to more normal levels), and shareholder-friendly corporate actions such as dividends or share buybacks (note insiders have been buyers lately and one third of the Board of Directors represent various activist/PE firms).
Implications of 20-F Adjustments
The aforementioned explanatory press release covers the adjustments in detail, so it is unnecessary to go into detail myself. Rather, I will highlight the following important observations:
1. The most important outcome to note from the 20-F filing is that the impact to cash and cash flows was minimal
2. The most notable impact to the P&L on a GAAP basis was the decision to recognize a minority of its revenue generated from new distributor partners without a proven payment history on a cash basis and not upon product/service delivery. As a result, 2011 revenue was revised down $14.1 million (out of a total of $279.3 million), but the cost of that revenue was kept intact. But the company has already received $12.2 million of the $14.1 million of revenue that was backed out and fully expects to get the remainder imminently.
3. Another notable accounting adjustment was the increase of bad debt provisions for accounts overdue for 90 days, which totaled only $2.2 million.
Other accounting adjustments were very minor and negligible to valuation, and I would argue that the above adjustments too have no real or sustained impact to the underlying cash performance of the business and the quality of its earnings.
PWC is a firm that, unlike its peer Deloitte, has not had any issues with fraud in China and has had the cleanest audit track record of all the large global accounting firms in China. After the intense scrutiny that followed the company due to a delay in filing, PWC was under extra pressure to ensure that the company did not misstate its financial performance. So the 20-F filing speaks for itself as proof of the company's excellent performance since its IPO in 2010. It is truly ironic and a source of great investment opportunity that AMBO's stock sold off as the investment thesis became increasingly confirmed.
AMBO has one of the smallest short bases of any Chinese ADS issuer. The company has never been involved in any controversy before the filing delay and even throughout the period when its financial status was in question due to the lack of a 20-F, the short base did not grow noticeably, if at all.
Finally, perhaps the best third-party indication other than PWC itself that AMBO's performance is real is the fact that Baring Private Equity Partners Asia ("Baring"), one of the largest Asia-focused PE firms in the world with approximately $5 billion of AUM, had access to full insider and financial information before they invested, and with the benefit of that level of access, they conducted the rigorous due diligence that is standard in PE but found no issues.
Private Equity Investors
Throughout AMBO's history, the company has received PE sponsorship. Although PE investment is in and of itself not necessarily a bullish sign, repeated rounds of PE investment throughout the company's history at prices between 25% to over 100% of today's share price are undeniably a very positive sign.
Two rounds of private equity investing preceded its IPO in 2010. The first round was done over four years ago at $5, with Avenue Capital Group (~15% holder) leading the round. Another round was done by Actis Capital at $7.50 (~9% holder). Macquarie Asset Management (~8% holder) and strategic investor CID (~4% holder) also participated in those rounds. Then, after the IPO, late last year, Baring invested through an entity named Campus Holdings (~8% holder) and has been accumulating shares in the open market consistently within their insider trading windows. It is telling that the latest investor, Baring, has continued to accumulate shares after executing a series of structured PIPE transactions starting in late Q4 2011 as the stock price has weakened. The average buy-in price for all of Baring's holdings, a total consideration of approximately $50 million, is $8.36/ADS, or a 101% premium to today's share price.
This level of PE activity is not surprising. AMBO exhibits many of the qualities that attract PE investors: industry leadership, predictable and steady business with easily manageable growth and cost levers, strong cash generation, substantial headroom in operating leverage, excessively oversold valuations, and a Board of Directors receptive to PE involvement.
The most imminent catalyst is technical in nature. The following factors contributed to the stock's near 50% fall last month:
1. Panicked selling after the announcement of a filing delay.
2. Further panic as AMBO was included in various articles about the "Chinese fraud problem" even though the company has never had an issue with any allegations of fraud and was not ever subject to attack by short sellers (one such article can be found here).
3. The drop in share price to sub-$5 levels made the stock uninvestable by larger funds such as mutual funds who have restricted ability to invest in "penny stocks" (often, the $5 share price level is the level below which a stock is considered too small-e.g. brokers will not issue any leverage to funds for stock they hold priced under $5).
4. The fact that the stock is relatively illiquid and traded less than $500,000 in value per day until the spike in volume as larger holders sold the seemingly bad news.
The sudden spike in volume has subsided, which tells us that the large institutional sellers are done selling and any substantial buying will start to drive the stock back up to where it was. Illiquidity, after all, works both ways.
The company delayed their 1Q12 reporting to complete their 20-F filing. The company reiterated their forward guidance in their press release announcing a delay in filing, so we should expect another strong quarter of growth. Further, the accounting adjustments that hurt 2011's GAAP figures should actually help in 2012 since some revenue (from new distributors) was pushed forward, and we should start to see that flow through to 1Q12 figures.
I believe the company has not bought back any shares at this distressed price level because they cannot: being insiders, they are not within their insider trading window until after they release their 1Q12 earnings, when a new window opens up. Not only could the company then buy back shares, which it should given its substantial net cash position and no imminent plans of increasing CapEx this year, but a new window would also free Baring up to continue buying in the open market. As detailed in two 13D filings that show consistent purchases throughout their trading windows, Baring has accumulated shares at over a 75% premium to today's price levels and I believe they will be aggressive buyers at today's distressed levels.
Finally, a more speculative catalyst is the potential for the company to become the target of an MBO or an LBO. The period starting from the "summer crisis" of 2011 to now has seen the most take-privates of Chinese listed companies in history. Several of these (e.g. SNDA, Alibaba.com) have been led by insiders or founders. This is not surprising, given the negative public sentiment towards China and the resultant deep discounts associated with Chinese companies, which as a group are now trading at multiples substantially below 2008 trough levels. AMBO's PE-friendly board, various existing PE holders, and the addition of Baring as a new, deep-pocketed PE sponsor who has been buying aggressively within their insider trading limits at prices 75% above current levels (their entire equity stake acquired to date was done at over 100% premium to current levels) all imply to me that PE activity may be imminent. If not PE, it would not surprise me to see an offer from a strategic (e.g. YOKU/TUDO industry consolidation), perhaps someone like McGraw Hill, already an investor, or a strategic such as New Oriental , which could see AMBO as an opportunity to expand into complementary high-growth segments of the Chinese education sector that it does not currently service directly.