Loyalist Group Limited ("Loyalist" or "the Company") (TSX Venture: LOY) owns and operates private English as a Second Language (NYSE:ESL) schools across Canada, with a focus on Vancouver and Toronto. The Company offers ESL for international students, training programs for teaching ESL (TESL), career training courses, and corporate English for professionals. The Company has commenced a strategic initiative to become the premiere consolidator of independent, privately owned and operated schools, in what is considered to be a large and extremely fragmented market. Substantial revenue and cost synergies can be realized quickly, thus making acquisitions highly accretive to earnings. We believe that Loyalist is in a good position to continue executing its growth strategy given its experienced management team and the economies of scale gained over time.
CANADIAN LANGUAGE TRAINING MARKET
· ESL training is important to both international students and landed immigrants in accelerating their settlement in Canada, and/or their career progression
· Canada is one of the top 5 most popular host countries for international students, and Ontario and British Columbia are the most chosen destinations.
· Languages Canada reported that ~150K students attended its member institutions in 2012, generating ~$592M in tuition revenue and ~$1.9B in annual revenue for the country.
An overwhelming majority of students are from a country where English is not the first language, which creates a large marketplace for Loyalist to pursue:
An attractive characteristic of the ESL market is its recession-proof nature. While data specifically regarding foreign students studying under short-term language programs is limited, according to Citizenship and Immigration Canada, the total number of long-term international students in Canada(across all levels of education) has consistently trended upwards, growing by a 10-year CAGR of 6.7%
A recent report by the Advisory Panel on Canada's International Strategy recommended that Canada should aim to have more than 450,000 full-time international students enrolled by 2022. Here's an interesting fact, education services is Canada's 11th largest export globally, and its single-largest export to China. A 2011 report commissioned by Foreign Affairs and International Canada indicated that in 2010 international students in Canada spent in excess of $7.7B on tuition, accommodation, and discretionary spending. This translates roughly into 86,570 jobs and $455M in government tax revenue. Part of Canada's brand is based on a relatively higher-quality education system and a reputation for excellence across the education spectrum. As such, Canada's government has undertaken efforts to increase Canada's positioning as one of the top-ranked ESL student destinations, which currently include the U.S., the U.K., Australia, and New Zealand. With applicants facing an increased amount of difficulty pursuing studies within the U.S., and the U.K., Canada is expected to be the net beneficiary. These factors all bode very well for Loyalist to continue to grow and attract new students, as well as the Canadian industry in general.
The Canadian ESL market is extremely fragmented with no large incumbent provider, characterized by a large number of schools in B.C. and Ontario, generating a relatively small amount of revenue and likely constrained by capital with no clear exit strategy. According to Languages Canada, there are ~185 accredited member programs across the country, with ~35% of these programs in the public sector (ex., universities and colleges) and ~65% in the private sector (ex. Private and not-for-profit schools).
The majority of private sector programs are represented by 'mom-and-pop' owner/operators. The lack of another aggressive consolidator and the upcoming retirement of the baby boomer generation that have created well-run but small scale ESL businesses, has created the perfect storm for the Company to gain significant market share through highly accretive acquisitions. Since going public, Loyalist has acquired 8 ESL schools and 6 career colleges, representing an expected annual revenue run rate of ~32M In 2013. This figure represents less than 10% of the total market share. The Company's acquisitions have largely been concentrated in British Columbia and Ontario (~42% and ~37%, respectively) where the majority of international students reside.
MERGERS & ACQUISITIONS
Loyalist is primarily a growth by acquisition play. The Company's strategic initiative to date has been to acquire schools, consolidate operations, and build its brand in the market. As previously mentioned, Loyalist has acquired 8 ESL schools and 6 career colleges, operating primarily in the highly fragmented Vancouver and Toronto markets.
Most of the ~185 Language Canada accredited vendors consist primarily of independently owned private businesses with annual revenues ranging from $0.5M to $1M. Given the current market environment, access to deal flow for Loyalist should not be a problem over the next few years.
In addition to the typical mom-and-pop school, Loyalist has identified five to six independent operators with annual revenue in excess of $10M, which if acquired would certainly propel Loyalist's growth prospects and timeframe. The King George International College (KGIC)/KGIC Business College (KGIBC) acquisition in September was by far the Company's largest to date. "This acquisition almost doubles our revenue and EBITDA," commented Loyalist CEO Andrew Ryu. "It also offers organic growth as it allows us to attract significantly more student business from Asia and strengthens the Loyalist brand as a dominant ESL player in Canada." More of these large educational institutions may be acquired over time in order to reach management's stated 5-year goal of achieving $200M+ in revenue.
Example of Synergy Generation
Mr. Ryu has outlined a very straight-forward strategy: acquire ESL and ESL-related schools primarily located within Toronto and Vancouver to create geographic clusters. Once a sizeable cluster/hub has been established, acquisitions are made immediately accretive by eliminating duplicate operating expenses such as back-office administration, non-essential staff, and optimization of physical space.
While the qualitative aspects of the consolidation strategy are intriguing, the following quantitative example highlights the accretive aspect of the strategy: In 2011, Loyalist acquired Pacific Gateway International College (PGIC) for ~$1M and Western Town College for ~$1M, which were generating a combined revenue of ~$10.4M. Since the acquisition, a reduction of unnecessary staff has resulted in savings of ~$1.2M on an annualized basis in fiscal 2011 alone. In fiscal 2012, the addition of six new schools resulted in additional cost synergies of ~$1.2M. Combined, this represents about 5% of the top line in fiscal 2013 (with the synergistic effects of the KGIC/KGIBC acquisition yet to be realized). Extrapolating on these metrics, it's possible that Loyalist can increase its EBITDA margin to the 25%-30% level through further acquisitions as well as organic growth.
Loyalist's acquisition strategy is well supported given the geographic congruence of potential clientele to congregate to particular city centres and areas. As Loyalist continues to scale its operations, standardization of practices, and enhanced brand value will lead to a higher influx of students into its programs.
Attractive Prices Paid To Date
As highlighted in Figure 3, Loyalist has been able to acquire its targets for very reasonable prices; consider the valuation metrics: average ~0.6x revenue multiple. This ability to negotiate favourable deals reflects the Company's consolidator status within the industry.
The success of any growth by acquisition strategy is best measured by the number of future opportunities, along with the extent of potential revenue and cost synergies.
From a cost perspective, synergies have been realized by reducing operating expenses. Overlapping staff (ex. finance/general and administrative), consolidating excess space and converting non-revenue generating space (ex. for G&A purposes) into revenue generating classrooms.
Furthermore, as the scale of the business increases, the Company should be able to mitigate the single largest expenditure for any ESL school, which research has shown is the commissions paid to foreign, third-party recruitment agents. Agents typically earn a fee equal to 20-30% of the tuition paid by the student.
Loyalist can mitigate these fees in a couple of ways. The Company can use its increased purchasing power, through increased economies of scale, to negotiate lower rates. The Company can also open recruitment offices abroad, run internally. In fact, the Company has already moved forward with this and already has 5 offices - Brazil, Japan, South Korea, Taiwan, and Saudi Arabia. When the Company starts to realize a decline in commission fees as a percentage of revenue it will start to see a significant increase in its EBITDA margin, and will be a significant step in achieving the 25%-30% margin level.
The Company's acquisition this past summer of Urban International School (NYSE:UIS), a high school, represents an interesting opportunity - UIS has a permit to directly recruit Chinese students, which is expected to open cross-marketing opportunities. Loyalist can feed existing UIS students into its university and college programs, while also being able to directly target the enormous Chinese market for the first time.
Aside from cost synergies, there are numerous potential revenue synergies through consolidation. As a larger and publicly traded educational organization, Loyalist has a lot of potential to develop a stronger brand, thereby helping it win market share away from smaller, mom-and-pop competitors. At the same time, improving the Loyalist brand can help strengthen relationships with government agencies, universities, corporations, and agents, all of whom refer students to Loyalist's schools.
This is perhaps the most exciting opportunity, the Company could complement tuition revenue with additional offerings such as student housing. Management has stated its intention to "investigate ways in which to monetize student lodging opportunities." While the details are not known, so the metrics don't yet factor into our valuation, it is known that there are currently pilot projects in operation at a handful of Loyalist schools. This expansion into the student housing market could represent an important second phase to growing the Company, and could be a crucial driver of long-term growth. Hopefully we'll hear more about this at the upcoming AGM.
Another interesting possibility would be to offer online correspondence courses, integrating live chat via an application like Skype to offer personalized tutoring, or classroom-like services to students. This would be an excellent low cost, high margin opportunity since the curriculum has already been developed, and software is already being developed.
Other potentially complimentary businesses include travel tours or SAT/GMAT/MCAT/LSAT/GRE, etc. coaching/testing.
As highlighted in Figure 4, Loyalist has experienced very swift and increasingly profitable growth. This reflects the Company's aggressive acquisition strategy, along with the benefits of initial cost synergies generated from greater economies of scale.
The Company is currently operating a >20% EBITDA margin. As the business scales, increases its brand, and generates a greater proportion of business from its own recruitment agencies, it's very feasible to reach an EBITDA margin ~25-30%. Even being conservative, one would have to project minimal growth given recent results.
The slight hiccup during Q2 2013 was a direct result of the Professional Association of Foreign Service Officers strike, which caused a backlog in processing visas of all types including those required for international students attending schools in Canada. This revenue should be reflected in the coming quarters as Loyalist accommodates these students.
It will be very interesting to see how the Company consolidates its most recent and largest acquisition to date, KGIC & KGIBC. The acquisition adds revenues of ~$25M, with EBITDA margins at the time of acquisition around 10%, and at a cost of only 0.54x revenue (lower than the average of the Company's previous acquisitions). The enormity of this deal can act as a catalyst for the Company going forward and accelerate its 5-year $200M+ revenue plan.
We believe that the Company could exit 2013 with a revenue run rate of ~$32.4M, EBITDA of ~$6.6M, cash of ~5M (pending the closing of the announced financing) and fully diluted shares of ~132M. Given management's track record to cut costs, it's really a matter of when we're going to see the results from the KGIC acquisition. As more acquisitions take place there will be a standard of practices in place to efficiently and effectively consolidate new growth.
We believe that the Company could exit 2014 with a revenue run rate of ~$60M, EBITDA of ~$15M, and no need for further dilution (see Figure 5). Debt can be used to supplement cash in acquisitions, and organic growth will improve the bottom line as well as the EBITDA margins.
This results in a valuation of ~$1.54 per fully diluted share, as outlined in the figure above.
**The financial section is pending accurate completion with updated financial numbers from Company filings. Margin assumptions will be re-visited then.
We believe that Loyalist Group Limited represents a unique investment opportunity for small-cap investors that are looking for an interesting consolidation story, with limited downside risk and the potential for significant capital appreciation. The Company's current operations are highly profitable and we expect Loyalist to continue its accretive acquisition pace towards becoming the premiere provider of ESL training in Canada. We believe that the Company remains undervalued at its current market capitalization. Our $1.54 price target is aggressive, but well within the abilities of management given their track record. We believe that there is significant potential for a higher re-rating with each subsequent acquisition by the Company.
Key investment highlights include:
· The market for short-term language training in Canada is large and extremely fragmented
· The ESL market is recession-proof by nature, during hard economic times people go back to school to re-train
· Loyalist has the experience and capital required to consolidate this industry (large insider holding and institutional support)
· There are considerable synergies to consolidation (many options to decrease opex and capex while increasing revenues)
· Long-term upside potential exists through expansion into the student housing market (pilot projects are currently running)
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