Mar 01 2021 - Strategic Education: Acquisition Raises Intrinsic Value

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 0/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 2 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 0 to ~ 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 0 million to 0 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 4 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 0 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 .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 0 to 0/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.

Some are so bullish, others so bearsish. The truth is simple though. One or two main factors typically affects most stocks in the grand scheme of things. With STRA the main factor is regulation; how much and when.