|Shares Out. (in M):||19||P/E||14.0x||8.0x|
|Market Cap (in M):||209||P/FCF||14.0x||8.0x|
|Net Debt (in M):||-22||EBIT||19||35|
This is an updated version of my first post on EPAX. EPAX is a student travel company that earns 50% on tangible capital and trades for 5-8x normalized after-tax free cash flow.
Student travel programs are typically marketed to teachers, who serve as trip leaders and are responsible for recruiting student participants. Trips generally last 1-3 weeks, are priced in the range of $2,000 to $4,000, and can be touristy or educational in nature.
Most of the competitors in the industry are "mom and pops" that lack the scale necessary to be consistently profitable. Often they are founded by strong believers in the value of travel for young people, and as such are mission driven rather the profit driven. There are a handful of larger competitors, which travel tens of thousands of students per year. These enterprises have more of a commercial orientation and are more profitable than the rest of the industry, but their trips are in most cases undifferentiated. Student travel overall has not grown meaningfully over the past decade.
EPAX is a standout in an otherwise stagnant and unattractive industry, because it possesses a unique franchise that has allowed it to grow and take market share for the past 40 years. The franchise is based on the company's affiliation with a nonprofit organization called People to People International (PTPI). PTPI was founded in 1956 by President Dwight Eisenhower, with the mission of fostering peace through international understanding.
One of PTPI's core activities, and its primary source of revenue, is The Ambassadors Programs. These are the student travel programs administered by EPAX. PTPI's White House affiliation inspires deserved trust on the part of parents. Various connections to local politicians, activities, and attractions, which have been cultivated over a long history of operations, enable the programs to offer enriching itineraries. As a result, the trips are uniquely rewarding to participants. In many cases, students are profoundly affected by their travel experiences. Unlike other student travel programs, The Ambassadors Programs garner a meaningful amount of repeat travel. It is not uncommon for alumni who traveled decades ago to remain involved with the programs to this day, by participating in the informational meetings that EPAX conducts as part of the marketing process. The satisfaction rate for the trips is 98%.
PTPI receives a small fee for each student traveled, but EPAX captures most of the economics of the programs. These economics are highly attractive, because of the franchise's pricing power, and because little tangible capital is needed. In 2008, the average revenue per student was over $5,000. The average price of EPAX's international programs, the most important contributors to revenue, was $6,300. To my knowledge there are no competing programs that command prices as high. Historically, gross margins have been 34%, and operating margins have been 15%. In 2009, I expect the company to generate about $15 million of after-tax free cash flow (equal to $0.80 per share), compared to roughly $30 million of fixed assets on the balance sheet.
The past two years have been difficult ones. EPAX conducts its marketing campaign from May through September each year, garnering enrollments for travel in the following year. In 2007, the campaign suffered from a defective name list used in the direct mail program, which is the foundation of the marketing effort. This and a worsening economic environment negatively affected 2008 enrollments, which were down 20%. In 2008, the marketing campaign coincided with a sharp deterioration in economic activity and consumer confidence. 2009 enrollments are expected to number about 35,000, again down approximately 20% from the previous year.
One way to measure the difficulties that EPAX has faced is to calculate the cost of acquiring a student-the student acquisition cost (SAC)-by dividing the company's marketing expenditures by the enrollments produced. From 2003-2007, this number was relatively consistent and averaged $620, while in 2008 and 2009 it was about $1,000.
SAC eventually should return to its historical level, because the causes of the recent increase are temporary: the faulty name list has been replaced, and the recession will end. In fact, the challenges EPAX is facing have spurred the company to make operational improvements that could eventually push SAC below $620. It is possible that the opportunity to make these improvements resulted in part from complacency engendered by a decade of nearly uninterrupted success. The 10-year CAGRs of revenue and net income between 1997 and 2007 were 20% and 17%, respectively.
For example, prior to 2008, EPAX's marketing effort had been led by an employee without professional marketing experience prior to his time at the company (he had been a basketball coach). The new head of marketing is an experienced hire. An example of the suboptimal marketing practices of the past is that until recently, there were distinct websites for different types of trips, and the websites were graphically and technologically primitive. In November 2008, the company launched one consolidated website, and it is significantly more effective in communicating the unique value of the programs. EPAX has also consolidated the number of itineraries to 57 from an arguably unwieldy 97. The simplified product offering will generate economies of scale for the remaining itineraries, if capacity utilization is increased, as is expected.
EPAX's earnings power will increase substantially if the SAC decreases from $1,000. At the current level of marketing expenditure (about $40 million per year), I estimate that a SAC of $850 (the average of the historical level and the recent level) would produce free cash flow of $1.35 per share. A SAC of $620 would produce $2.35 of free cash flow per share.
The potential to increase enrollments is large. There are about 29 million people between the ages of 11 and 19 in the US, and a large portion of them could travel on the Ambassadors Programs. EPAX also expects to begin marketing its domestic trips to foreign students. The company aims for 15% annual unit growth, through a combination of additional marketing expenditures, increasing efficiency in lead generation, and increasing conversion rates. Fifteen percent unit growth would produce higher revenue growth, because of price increases that have in the past exceeded the rate of inflation. The growth rate of free cash flow can be expected to exceed that of revenue, because capital needs are minimal, and there is operating leverage.
In light of the long-term growth potential, the future cash flow stream is worth a high multiple of the current normalized level. I think that a private buyer would earn attractive returns purchasing EPAX for 20x free cash flow.
EPAX shares trade for $11.21. Adjusting for excess cash of $1.16 per share, the enterprise value (EV) is $10.05 per share. The following are the current trading multiples:
Free cash flow (FCF) EV / FCF
Estimated 2009 $0.80 14x
Normalized, SAC = $850 $1.35 8x
Normalized, SAC = $620 $2.35 5x
At a valuation of 20x FCF, the stock would trade for between $28 and $48 per share, before considering two additional sources of value.
The first is the float generated as a result of the trips being paid entirely in advance. The balance of travelers' deposits averaged $66 million over the past year, and was invested conservatively in low-yielding fixed income securities. Assuming a 2% after-tax yield, the float generates $1.3 million of income annually. Because the float will increase as a function of revenue, the earnings of the float will grow at a rate similar to that of the business, justifying a similarly high multiple. A multiple of 20 yields a float value $26 million, which is equal to $1.41 per share. If interest rates rise, it is possible that the float could be worth substantially more.
The second additional source of value can be thought of as a free option. Earlier this year EPAX announced an agreement with Discovery Education to market a new travel program called Discovery Student Adventures. I believe the economic structure of the relationship is similar to that of the relationship with PTPI. Discovery Education is one of the most well-known and well-liked brands among young people in the US. Through its educational content, Discovery has a presence in 1 million US classrooms, representing 35 million students. Even a small penetration of the market opportunity could be meaningful to EPAX. The investment EPAX is making to launch the new initiative is only about $3 million (16 cents per share). The first trips are slated to occur in the summer of 2010.
In October, EPAX will report preliminary 2010 enrollments along with third quarter earnings. I believe there is a good chance that enrollments will show year-over-year growth. An end to the declines of the past two years could serve as a catalyst for the stock.
Preliminary 2010 enrollments to be accounced in October.
|Entry||06/28/2009 06:43 PM|
Duff--Thank you very much for raising these issues. Let me try to tackle them one at a time.
1) Consumer spending. It is true that EPAX would be worth more if it were to make more money over the next, say, 3 years, which it would if consumer spending recovers in that timeframe, which may not happen. However, a large majority of the value of the enterprise is derived from the cash flows earned after the next 3 years. If the direction of the cash flows over time is up, which I believe will be the case, then the near-term cash flows do not comprise enough of the total value of the company for me to worry whether the level of free cash flow will be X or 2X.
Another concern related to consumer spending is that there will be a permanent shift in the behavior of American consumers. This is in part why I think it is important to think about what EPAX's earnings power would be if SAC were $850, not the historical $600. But I also do not believe that wanton consumerism is what fueled demand for the trips over the past decade. The trips are for most travelers a once-in-a-lifetime purchase and are considered an investment in the future of the student, not a vacation.
Of course, part of the investment thesis is that the stock will go up, and for that to happen the negative operational trends will probably have to reverse, and economy might have to recover. But I think the company is worth $30-50 per share, and if it takes 5 years to get to $30, the return will be decent
Another thing to note is that the operational results could be positive as soon as this October. There are at least 3 reasons that 2010 enrollments might be higher than 2009 enrollments: 1) The general level of fear and uncertainty is arguably lower now than it was a year ago. 2) The operational improvements EPAX has undertaken will, if successful, manifest themselves in the 2010 numbers. 3) I believe that a portion, perhaps a significant portion, of the families who decided not to travel in 2009 didn't forget about the option but rather deferred the decision. In that case there would be pent up demand that might materialize in this marketing season. Students have had a year to save up for the trips and to raise money for them. (Something I didnt include in the write up is that some travelers hold fundraisers for themselves. The company says that 40% of students raise 40% of the cost). EPAX always makes efforts to stay in touch with families who don't end up traveling.
These three factors will of course be offset to the extent that the economic reality for potential travelers' families is worse now than it was last year.
2) Everybody hates us (1). I think there is some truth to this statement, too. But I do not see a strong connection between that and the interest a teenager might have in taking an organized trip to another country to learn about it. Nor do I think the value of doing so is diminished. In fact, perhaps it is enhanced.
3) Everybody hates us (2). If the Bush administration impaired EPAX, then one would expect this to be noticeable in the company's performance during the Bush administration. Yet, SAC was basically constant between 2000 and 2007, except for 2002, which was hurt by 9/11. The marketing campaign that took place in 2006 was the company's most successful ever. There are readily identifiable causes of the poor performance in 2008 and 2009 (namely, the faulty name list and the recession).
4) A weak dollar would be a headwind. I agree with this. It will be interesting to see if EPAX is successful in its efforts to market domestic programs to students located outside the US, for which the weak dollar would be a tailwind. The concern that everybody hates us is probably more relevant here.
|Entry||12/31/2011 08:58 PM|
I looked at this recently. I dont think you can annualize YTD FCF as the business is massively seasonal. I concluded they will be cash flow negative or thereabouts in 2012. still very interesting, but also potentially a value trap. would be interested in some other opinions as well.
|Subject||new EPAX writeup|
|Entry||01/07/2013 10:26 AM|
I posted an EPAX writeup on seekingalpha pro, I guess I can't post it here but it can be viewed free by anyone today only. Basically I lay out how a proxy contest in mid 2012 resulted in several activist value investors winning seats on the Board. The company is now embarking on aggressive cost cuts, if SG&A can return to more reasonable levels consistent with historic margins, the impact on earnings and cash flow could be phenomenal. They continue to return cash to shareholders through special dividends and buybacks, the 130,000 square foot corporate campus in Washington state is now listed for sale, and they may also eventually be able to sell their non-core internet assets for significant additional cash. It will take time but I think a lot of value could be unlocked here over the next several years.