Student Transportation: Here's Why We Don't Use EBITDA To Evaluate This Company

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 |  About: Student Transportation Inc (STB)
by: Saibus Research

After Student Transportation Inc (NASDAQ:STB) released its Q4 2012 results, we reevaluated the company based on our 13+ month thesis that investors should avoid it because we expected it to be an underperformer relative to the S&P 500 and the NASDAQ Composite. We were intrigued by its high yield of 8% back in the fall of 2011 however we were displeased by the fact that the company was guzzling gas for acquisitions and increased capital expenditures. We were disappointed that the company continued its acquisition and CapEx spree but we are hoping that the company will focus on integrating its acquired operations and instituting discipline with regards to its capital expenditure program. STB's management and its bullish backers in the investment community are fond of quoting its adjusted EBITDA growth. We can certainly see that STB's adjusted EBITDA growth has been impressive since its 2005 IPO but we believe that EBITDA is not the most appropriate metric to value STB. While we disagree with Ben Strubel's assertion that STB is violating Regulation G because we saw that the company was quoting adjusted EBITDA, we don't believe that any EBITDA calculation is appropriate for STB and that is what we will cover in this report.

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Sources: Student Transportation's 2005-2012 Q4 Earnings Releases

EBITDA and what it is used for

As every financial professional knows, EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA is used as a shortcut to estimate the cash flow available to pay debt on long-term assets, such as equipment and other items with a lifespan measured in decades rather than years. Dividing EBITDA by the amount of required debt payments yields a debt coverage ratio. Factoring out the "ITDA" of EBITDA was designed to account for the cost of the long-term assets and provide a look at the profits that would be left after the cost of these tools was taken into consideration. The use of EBITDA also assumes that the company under evaluation has strong profitability. Unfortunately the use has evolved to include companies that don't generate profits and companies that have huge capital expense requirements, like Student Transportation.

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Source: FactSet Marquee

Breaking down STB's EBITDA

STB's management is fond of quoting its Adjusted EBITDA figures in its earnings releases in order to show that the company is "generating cash flows to pay its dividends". We will show why we disagree with STB's management and its Bloor Street analysts as to why we prefer not to use EBITDA to evaluate STB's performance. While STB's investors may be impressed with the $70.07M in Adjusted EBITDA for the company and the Adjusted EBITDA margin of 19%, we are not as impressed and we will analyze and evaluate four expense add-back categories STB uses in reconciling its Adjusted EBITDA margin from its Net Income.

Operating Lease Payments: STB reported $70.07M in Adjusted EBITDA for FY 2012. One of the adjusted expense add-back categories that STB uses in reconciling its Adjusted EBITDA margin from its Net Income was its operating lease payments. STB paid $11.65M in operating lease payments for FY 2012, up from $8.4M in FY 2011. STB uses operating leases to primarily finance its replacement capital expenditures. STB has to pay these operating lease payments in cash, the company has to make these payments whether or not it is using the vehicle and the operating leases were primarily used for replacing old buses with new buses. As such we believe that it is inappropriate for STB to add operating lease payments back to its Net Income. As such, we will deduct it from its "Adjusted EBITDA" and that results in a pro forma adjusted "Adjusted EBITDA" of $58.419M.

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Sources: Student Transportation's 2005-2012 Q4 Earnings Releases

Interest Expense Payments: STB reported $15.327M in Interest Expenses in FY 2012 and interest expense was another adjusted expense add-back categories that STB uses in reconciling its Adjusted EBITDA margin from its Net Income. STB's outstanding debt is in convertible coupon paying debt as well as its line of credit. These forms of debt financing require interest to be paid in cash rather than accrued interest like a zero-coupon bond. Plus interest expense payments are legally required expenses for the company unless it wants to go into receivership. While nearly $20M of its almost $130M in convertible debt will be called and redeemed by STB's management in November, the company would still be paying financing cash outflows either on new borrowings to replace that redeemed debt issue or it would see that debt issue converted to stock and it would have to pay dividends to the shareholders. As such, we will deduct it from STB's "Adjusted EBITDA" just like with the operating lease payments and we get a pro forma adjusted "Adjusted EBITDA" of $43.092M.

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Sources: Student Transportation's 2005-2012 Annual Reports

Non-Cash Equity Compensation Expenses: STB reported $3.62M in Non-Cash Equity Compensation Expenses for FY 2012 and this is the third adjusted expense add-back categories that STB uses in reconciling its Adjusted EBITDA margin from its Net Income that we will evaluate. While this is not a direct cash expense, it doesn't change the fact that this expense does dilute existing shareholders. Plus STB's Non-Cash Equity Compensation Expenses are paid in the form of a preferential Series B stock that allows them to regularly sell equity shares back to the company. STB's management has liberally sold millions of dollars of stock back to the company, while virtually no common shares have been repurchased under the common stock buyback program. Based on the fact that this issuance of shares results in dilution to shareholders and the fact that these shares can be sold back to the company by the management, we can see that this is a de facto cash expense and should be deducted from STB's "Adjusted EBITDA" just like with the operating lease payments and interest expenses and that leaves us with a pro forma adjusted "Adjusted EBITDA" of $39.473M.

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Sources: Student Transportation's 2005-2012 Annual Reports

Depreciation, Depletion and Amortization Expenses: This is the last category that we will be evaluating with regards to STB's "Adjusted EBITDA" is STB's Depreciation and Amortization Expenses. STB accrued $40.586M in Depreciation, Depletion and Amortization expenses in FY 2012. While Depreciation and Amortization Expenses are a non-cash expense, the company has spent a considerable sum of cash with regards to its acquisition and capital expenditure program. Because the company has spent $376M in net capital expenditures and acquisitions over the last five years yet has only generated $159M in depreciation and amortization expense accruals during this time period, we can see that this is a de facto cash expense and should be deducted from STB's "Adjusted EBITDA" just like with the operating lease payments and interest expenses and that leaves us with a pro forma adjusted "Adjusted EBITDA" of negative $1.113M.

Conclusion

In conclusion, 2013 is the year of no excuses for STB. STB needs to follow through with the management's stated guidance that the company will focus on integrating its acquisitions and rationalizing its capital expenditure program. If it manages to do so, it will ensure that shorts like Prescience Investment Group have to close out short positions held in the company as well as strengthen the company's financial position and allow it to avoid having to raise more debt and equity capital from the capital markets. We have raised our estimated fair intrinsic value of STB's common stock twice from the end of March to May before we reduced it at the end of September. We believe that the investment prospects of the company's shares are extremely bimodal. If the company manages to follow through with regards to its program of financial discipline, the company will see its share price increase and allow it to convert its remaining convertible bond issues to common stock. If the company can institute some discipline with regards to its capital expenditure and acquisition program, it can reverse the trend in which its operating lease expense and non-cash equity compensation expenses has greatly outpaced its revenue growth since 2005. If the company keeps up its mad dash of acquisitions and capital expenditures, then it is overvalued by 50-70% and will be the subject of bear raids.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.