Strategic Education: Acquisition Raises Intrinsic Value, Strong Buy

Mar. 01, 2021 5:31 AM ETStrategic Education, Inc. (STRA)46 Comments

2.98K Followers

Summary

Strategic Education made an acquisition that will inherently boost ROIC, which will significantly benefit long-term shareholder value.
Shift from physical locations to virtual education should buoy margins.
Capital structure should maintain relatively low leverage and free cash flows should accelerate to record highs by next year.
STRA could reasonably be worth $150/share within the next few years.

Investors lost their minds when Strategic Education (NASDAQ:STRA) announced that it would be acquiring Laureate Education, Inc.'s Australian college assets for $642 million, which represented essentially all of the company's accumulated cash and equivalents, as some believed such a build-up would be used for capital return to shareholders. As a result, the stock sold off from about $160 to ~$90 within the span of a couple months, or a 44% share decline. Fortunately, however, management made the inherently right decision for long-term shareholders by acquiring high-quality assets, which have higher education curriculums within job markets that have secular growth and longevity, particularly outside the U.S. which diversifies their asset portfolio and currency risk, as well as provides more stability to quarterly cash flow.

On the surface, investors and Wall Street analysts thought that the acquisition multiple ran well beyond what their own business was valued for, but management disclosed that claim was baseless. When digging deeper, it turns out that STRA bought these assets for only 14.5x 2020 pro forma adjusted EBIT, but when factoring the growth potential and the opportunity to create cost synergies as have been done for Strayer and Capella University, I think what we'll find is that these assets were likely acquired for much less, perhaps even for a high-single-digit multiple when considering the exit cash flow potential. The company disclosed access to its credit revolver:

"The Company has received commitments from SunTrust and Bank of America to expand the Company’s existing revolving credit facility from $250 million to $350 million coinciding with the close of the transaction."

But frankly, I believe that management will stick with its historical playbook and keep debt close to zero as there's no need to carry the interest burden.

That said, I firmly believe management bought these assets with the intention of not only diversifying and growing cash flow, but it also likely did so at a level that would be highly accretive for shareholders simply given its operating and M&A track record. In 2020 alone, consolidated adjusted EBT approached $214 million. For its 2021 outlook, management expects 15% growth for the ANZ and alternative learning assets, partially offset by U.S. Higher Education, resulting in adjusted EBITDA to be flat versus 2020.

While that may not sound very exciting at first, think about the 3-5 year potential. Management already disclosed in its modeling that new enrollment at Strayer University will remain soft in H1 2021 but should trend positive by the back half of the year, i.e. flat, and net enrollment growth by 2022. Combining that with stronger enrollment trends at Capella and its Australian/New Zealand assets, we're effectively looking at very solid, sustained revenue growth starting within the next two to three quarters.

Then if you factor in expense control for its newly acquired assets, management is effectively setting up FY22 to be a really exciting year from an EBITDA and free cash flow perspective, which should be music to shareholders' ears. For context, Strayer has already printed record free cash flow, and when factoring in these tailwinds, the company will likely be pushing close to $200 million plus the incremental consolidated revenue growth.

Also, think about what these means from a return on invested capital perspective. Remember the days when Strayer was generating double-digit ROICs? Well, those are coming back once by this time next year as these new assets' operating performance figures roll in against their capital base.

Then consider what was contained in Q4... a myriad of one-time expenses that are non-recurring, such as severance and right-of-use lease asset charges, amortization expenses, merger expenses, etc. all of which totaled $32.3 million against net income. Surely, management accounted for that in its statements, but investors may have scrutinized such adjustments when comparing against bottom line expectations. For what it's worth, the company at least from my perspective did quite well on both the top and bottom line.

Another important factor that might be understated from a profit-driver viewpoint is the expiration of operating leases associated with its schools, as the company continues to leverage its virtual assets. We can argue the long-term implications from an economic-value-added perspective, but I believe that this plays right into the desire of lower tuition costs and more convivence for students while equally reducing the company's operating costs.

Keep in mind that STRA's long-term goal has been to increase tuition cost transparency, affordability, improve graduation rates, and most importantly, help students land jobs post-graduation. While the degree of its success can be debated, it has made significant progress on this front in recent years which has underpinned its enrollment trends, and that will continue for the foreseeable future. This matters because it ultimately provides a competitive edge versus other education institutions that continue to feed into the ongoing crisis for graduates, finding gainful employment and avoiding the student debt crisis.

Valuation

STRA is misunderstood by the investors who follow it, or at the very least, it's mispriced to the point where its inherent ability to compound intrinsic value is not being accounted for. If you take the most bearish assumption by assuming flat or even declining earnings through 2021, then the business remains within a reasonably fair value price range. However, if you actually believe the story that management has laid out that consolidated growth and enhanced margins will improve over the next year, and likely beyond that, then shares are inherently undervalued and considerably so.

My view is that the company is actually going to perform considerably better by the time 2022 and 2023 come around with its newly acquired assets and cost reduction initiatives. At the end of the day, I think the company could be worth anywhere from $140 to $160/share within the next few years, which would conservatively result in double-digit annualized returns. Granted that's not even factoring in an acceleration of enrollment growth trends or cost benefit surprises, which could lead to materially higher returns.

Many investors think that you need to own exciting stories, growth narratives, or catalyst-driven events, but some of the best returns result from buying inexpensively valued businesses. That's how I've generated most of the alpha in my investment career anyway. What do you think? Let me know in the comments section below.

As always, thank you for reading.

This article was written by

Equanimity Investing

2.98K Followers

Equanimity Research helps you focus on protecting your principal and thinking long-term with your investments. I'm long treasuries, select high-quality companies, and will never use margin. As a generalist, I cover multiple sectors with a dividend and non-dividend long-only stock strategy over a 5-10+ year investment horizon. I also cover macroeconomics regarding monetary policy and excessive debt levels globally.All articles/blogs are for informational and entertainment purposes only. Under no circumstances should any of these articles/blogs or any published information be interpreted as investment advice, or as an offer to buy/sell any financial security. Perform your own due diligence. I welcome comments and corrections of all kinds.

Analyst’s Disclosure: I am/we are long STRA. 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.

I may purchase additional shares in $STRA in the coming days/weeks.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Possible Points for STRA’s Approximate 104 Stockholders to Raise with Management:
1. What is the reason behind the continuous segment reorganisations and classifications that have taken place in recent years? (Be honest please).
2. With regards to CEC, following the segment reorganisation and considering the overall net loss for the year ended December 31, 2018, how is it that the timing of the operations allocated to STRA actually turned into income (not a loss) from operations, and if so how was this achieved?
3. Where are the depreciation and amortization expenses accounted for in the income statement?
4. What are the ‘other’ assets included in the ‘other current assets’ and ‘other assets’ portion of the balance sheet?
5. Can the exact estimated useful lifetimes of all asset classes be provided? Why are they not currently provided?
6. Why were the capital expenditure projections changed from absolute values to percentages of revenue?
7. The amount deferred for estimated redemptions earned under the Graduation Fund increases every year, why is it constantly increasing and at what point does this become a concern?
8. Can any information be provided on the industry regulations in Australia and New Zealand?
9. Why were the payments for the assets supporting the operations of the Jack Welch Management Institute deferred for so long?
10. Can the Company explain their commitments to invest in certain partnerships through 2027?
11. Prior to the Company’s acquisition of Capella Education Company the line “there are no pending material legal proceedings to which the Company is subject or to which the Company’s property is subject” [11, 13, 15, 17, 19], had existed since the 2013 10-K filing. Is this still currently the case?
12. Can the Company explain the change in course fees over the last fiscal decade?
13. Is the Company planning a big share purchase operation anytime soon?
14. Why have advertising costs been consistently rising and does Management think they are seeing a good return on this investment?
15. The Company continually mention their ability to have detect fraudulent activity in the past and the occurrences isolation, but exactly what instances are they referring to? Can full details be provided?
16. In what year was Capella University founded and why do different reports cite different years?
17. Can the Company provide any kind of update on their previously mentioned initiatives such as Strayer@Work and the SEI Venture and can they do so going forward for all other initiatives they are going to mention in the 10-K filings?
18. Why has there been committee re-shuffling in the last few years?
19. “Mr. Wargo was not nominated for re-election at the 2019 Annual Meeting of Stockholders” [6]. Why?
20. Why did the Vice Chairman, resign as an executive of the Company but remain as a non-employee Director on August 1, 2019?