Estacio Participacoes ESTC3.BZ
April 14, 2009 - 9:56pm EST by
cgnlm995
2009 2010
Price: 12.28 EPS $1.15 $1.36
Shares Out. (in M): 79 P/E 10.7x 9.1x
Market Cap (in $M): 445 P/FCF nm 10.8x
Net Debt (in $M): -101 EBIT 34 47
TEV ($): 343 TEV/EBIT 10.2x 7.3x

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Description

 

Estacio Participacoes (ESTC3.BZ - R$12)

 

Generating more than a 30% return on capital with EBITDA growth of  >20% per year, Estacio appears extremely mispriced at 8x 2009 unlevered earnings with >20% of its market value in net cash.  Estacio is the largest private Brazilian post-secondary education company.  The Company is led by an incentivized and proven management team from highly reputed operational restructuring focused private equity firm called GP Investments.  Strong double-digit EBITDA growth over the next five years, driven by clearly defined operational restructuring initiatives, highly-accretive tuck-in acquisitions and a strong secular tailwind, will reveal a significant valuation dislocation and a conservative 280% upside over the next 3 years.  Unlike US post-secondary peers, less than 2% of Estacio's students depend on credit financing to pay for the education (the balance use their own cash).  Since 2005, the company has been undergoing a transition that began with its conversion into a for-profit organization.   In May 2008, the controlling family sold a portion of its ownership to GP Investments.  GP brought in a new management team in February and expects to improve EBITDA margins by at least 1,100 basis points through a) removing excessive general and administrative costs left in place by the founding family, b) reaching below-inflation salary increase agreements with the teachers, and c) reducing the dropout rate (currently at 45%).  After spending a significant amount of time with new management and visiting six campuses in Brazil, we are confident that the cost reduction initiatives are achievable.  We expect minimal organic enrolment growth given the state of the global economy, but the Brazilian government has become increasingly focused on raising the penetration rate of post-secondary education, which may provide some support.  In fact, the Government's stated target is for 30% enrollment of young adults between 18-24 of age by 2010 versus just over 12% penetration at the end of 2008 (no chance of this happening).  After layering in operational improvements currently underway, Estacio will be able to earn well north of R$3/share once GP Investment's restructuring plan is complete (comparable margins to peer Anhanguera).  Given Estacio's strong long-term growth and return profile, we believe that Estacio should command at least an 8% yield on restructured unlevered earnings (2011/2012) yielding a R$34 fair value per share or 280% upside from current levels. 

Investment Merits

  • Market leading defensive businesses with strong backdrop: Estacio is a very good business: +30% ROIC, major scale and brand advantages, high regulatory barriers to entry and a defensive end market. Estacio is the only for-profit academic institution with University status, permitting the company to offer new courses without Ministry of Education (MEC) authorization (a 2-3 year process for peers). This should permit Estacio to achieve higher organic growth than peers. The Company is expected to also grow through acquisitions, folding other schools onto its platform while management continues to pay out half of net income in dividends. The Company should also grow share as many smaller, distressed peers are currently filing for bankruptcy or looking for buyers. Enrollments should show respectable growth for the first semester of 2009 and pricing remains firm (+4-5%).
  • New best-in-class management: In May 2008, GP acquired 20% of the company's total capital directly from family owners at R$16.50/share. GP Investments, a top Latin American PE firm focused on turnaround opportunities, has brought in a strong management cadre with incentives of up to 5% ownership in Estacio if 5 year targets are met. GP's investing track record is outstanding and includes successful investments such as Gafisa (10 yr investment with 24% IRR), Logistica (11 yr investment with 17% IRR) and Equatorial Energia (3 year investment with 1,403% IRR). New CEO Eduardo Alcalay has one of the highest return track records of all professionals at GP Investments. The management option plan (5% equity dilutive) will incentivize over 300 employees by directly linking annual payouts to aggressive annual performance targets.
  • Significant scope for margin improvement: New management believes they can improve EBITDA margins from 11% to 20%+ within 4 years. Other Brazilian education companies have mid-20s margins due to more efficient cost structures. Management has already reached deals with teachers' unions across most of their territories that ensure over 200 bps of margin improvement over the next 4 years. Estacio is also implementing a new shared service center (SSC) with SAP, which will enable the company to reduce G&A employees from 280 to 70. Additionally, the Company expects to take total headcount from over 5,000 operational employees to 3,000. This can be achieved given that at the end of 2009, 78 campuses possessed their own back office with full staff (management, legal, payroll, IT, etc). The result would be savings of significantly more than R$40 million/year, increasing EBITDA margins by 820bps. Estacio's new curriculum design should enable the average number of students per class to rise from 30 to 37, improving utilization and boosting margins by an additional 200 bps. By increasing distance learning programs and through the growing wealth effects in Brazil, mgmt believes that the dropout rate can decrease by at least 5% from 45% to 40%. This could also boost margins by 100-200 bps through utilization improvement. While an improvement in the dropout rate and increased distance learning would substantially benefit the company, we do not include these potential benefits in our forecasts. Increased INSS taxes will eat into margins by about 1% per year until 2011. This is the cost of going from a non-profit to for-profit entity.
  • Attractive valuation with clear market dislocation: With EBITDA growth north of 20%, >30% ROIC and peers that trade at a significant premium, Estacio is worth a multiple of its current share price (EBITDA margins of 20%, comparable to peers). The valuation dislocation exists for three reasons: 1) the Company is largely unknown following its IPO in September 2007, 2) off-balance sheet tax-related liability could represent nearly 20% of current market cap (almost 0% chance following a recent government announcement) and 3) Estacio is a show me story - new management with aggressive cost-cutting and acquisition targets against a family-run/owned backdrop with a short track record of missing targets (pre-GP).
  • Brazilian education has a strong secular tailwind: The post-secondary education penetration rate in Brazil for students between 18-24 years old is just over 12% versus 50%+ for neighboring countries such as Argentina and Chile. The Brazilian government recently stated it intends to increase the penetration rate to 30% by 2010 through offering more student loans and providing tax incentives (such as access to retirement accounts for education purposes). IBGE data shows that post-secondary education in Brazil has grown at a compound annual rate of 11% from 1997 to 2005, with approximately 6mm enrolled students. Market share of private institutions has grown at a CAGR of 13.5% from 1997 to 2005, while public institutions' share grew at an annual rate of 5.8% in the same period (private sector market share increased from 61% to 73% from 97 to 05). In fact, post-secondary enrollments have grown every year in Brazil since I can find data (1997-2008), including the year of Brazil's latest currency crisis in 1999.

Model

(R$ in mm, FYE Dec) 2007 2008 2009 2010 2011 2012
Average Enrollments 175,000 194,000 203,500 207,570 219,681 265,665
Revenue 853,100 979,968 1,074,214 1,128,569 1,242,195 1,577,324
Growth   14.9% 9.6% 5.1% 10.1% 27.0%
             
COGS (518,900) (591,542) (644,528) (677,142) (732,895) (914,848)
Gross Profit 334,200 388,426 429,686 451,428 509,300 662,476
margin 39.2% 39.6% 40.0% 40.0% 41.0% 42.0%
             
D&A (24,400) (34,400) (37,000) (47,952) (48,390) (63,116)
SG&A (245,300) (281,200) (290,038) (282,142) (285,705) (347,011)
% of sales 28.8% 28.7% 27.0% 25.0% 23.0% 22.0%
             
EBITDA 88,900 107,226 139,648 169,285 223,595 315,465
margin 10.4% 10.9% 13.0% 15.0% 18.0% 20.0%
             
EBIT 64,500 72,826 102,648 121,333 175,205 252,349
margin 7.6% 7.4% 9.6% 10.8% 14.1% 16.0%
             
Goodwill (2,300) (10,400) (14,000) (14,000) (14,000) (14,000)
Interest Income(Exp) 24,400 26,300 15,995 27,482 39,319 27,582
EBT 86,600 88,726 104,643 134,815 200,524 265,930
Normalized Taxes (4,330) (8,873) (10,464) (13,482) (20,052) (26,593)
Rate 5.0% 10.0% 10.0% 10.0% 10.0% 10.0%
             
Net Income 82,270 79,853 94,179 121,334 180,472 239,337
Average Shares Out. 79 79 79 80 81 82
Reported EPS 1.05 1.02 1.19 1.51 2.23 2.92
Cash EPS (x-amort) 1.08 1.15 1.36 1.69 2.40 3.09
             
Dividends 13,700 17,900 43,272 67,667 97,236 126,669
Dividends/share 0.17 0.23 0.54 0.84 1.20 1.55
NOPAT 61,275 65,543 92,383 109,200 157,685 227,114
Debt (229,100) (195,500) (242,407) (307,241) (309,143) (72,490)
Equity 405,400 421,100 472,007 525,674 608,910 721,579
Capital Employed 176,300 225,600 229,600 218,433 299,768 649,089
ROCE   32.6% 40.6% 48.7% 60.9% 47.9%
             
Cash Flow 2007 2008 2009 2010 2011 2012
Net Income 82,270 79,853 94,179 121,334 180,472 239,337
add: D&A 24,400 34,400 37,000 47,952 48,390 63,116
add: Goodwill Amort. 2,300 10,400 14,000 14,000 14,000 14,000
less: Organic CapEx (34,600) (65,600) (55,000) (50,786) (55,899) (70,980)
less: Acquisition CapEx (215,200) (113,800) 0 0 (87,826) (355,458)
less: CapEx (249,800) (179,400) (55,000) (50,786) (143,724) (426,437)
FCF (140,830) (54,747) 90,179 132,501 99,138 (109,984)
FCF/Share (1.79) (0.70) 1.14 1.65 1.22 (1.34)
Market Stats       Intrinsic Value  
Current Price   12.28   ROCE   32.6%
Market Cap   965,208   Growth   >20%
Net Debt (Cash)   (220,000)   Norm. NOPAT 172,671
Enterprise Value   745,208   Fair Multiple 20.0x
Dividend Yield   1.9%   Fair EV   3,453,422
Mgmt Ownership   5.0%   Fair Equity Value 3,673,422
Note: NOPAT based on 18% EBIT Margin   Fair Value per Share 46.74

 

Public Comparables
  USD P/E EV/EBITDA
Peers Mkt Cap 2009E 2010E 2009E 2010E
           
Brazil Education        
AEDU11 BZ 639 12.6x 8.4x 8.9x 6.7x
           
US Peers          
           
APOL 10,146 16.6x 13.7x 8.4x 7.2x
DV 3,097 19.4x 15.2x 11.2x 9.3x
ESI 3,961 15.3x 13.2x 8.5x 7.3x
CECO 1,870 17.3x 13.9x 6.5x 5.0x
Average   17.2x 14.0x 8.6x 7.2x
           
Estacio          
           
Estimate 461 9.0x 7.3x 5.3x 4.4x
Premium to Brazil -28% -13% -40% -35%
Premium to US -47% -48% -38% -39%
           
           
           
           
Enrollments 2008 2009 2010 2011 2012
Beginning 178,206 207,006 207,006 207,006 232,356
+ Organic 8,800 0   10,350 11,618
+ Acquired 20,000 0 0 15,000 55,000
Ending 207,006 207,006 207,006 232,356 298,974
growth 16.2% 0.0% 0.0% 12.2% 28.7%

 

Investment Risks

  • Unemployment rate in Brazil: If unemployment increases significantly in Brazil, both the drop-out and rate and new admissions will be adversely impacted. Company management believes that organic enrollment growth for the industry will be roughly in-line with GDP absent major involvement from the Government. Estacio recently hired the head of marketing for Anhanguera who led his team to industry leading growth and retention rates. The Company also believes they will gain share from failing schools without cutting tuition.
  • Execution risk: Turnaround could prove difficult if new curriculum is boycotted by faculty or if employees resist the new reporting structure. 70% of the faculty (100% of certain unions/geographies) have agreed to the new compensation scheme proposed by Estacio.
  • Brazil/LatAm/Liquidity/Technical risks

 

Catalyst

  • Step change in earnings: we believe that Estacio will generate materially higher earnings than current expectations. Through industry channel checks and discussions with management, we developed the view that overly bearish expectations are priced into immediate and longer-term forecasts.
  • Government announcements regarding new programs to stimulate greater education participation
  • Acquisitions of other schools at distressed prices to fold into the Estacio system (cheap way to acquire new students)
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    Description

     

    Estacio Participacoes (ESTC3.BZ - R$12)

     

    Generating more than a 30% return on capital with EBITDA growth of  >20% per year, Estacio appears extremely mispriced at 8x 2009 unlevered earnings with >20% of its market value in net cash.  Estacio is the largest private Brazilian post-secondary education company.  The Company is led by an incentivized and proven management team from highly reputed operational restructuring focused private equity firm called GP Investments.  Strong double-digit EBITDA growth over the next five years, driven by clearly defined operational restructuring initiatives, highly-accretive tuck-in acquisitions and a strong secular tailwind, will reveal a significant valuation dislocation and a conservative 280% upside over the next 3 years.  Unlike US post-secondary peers, less than 2% of Estacio's students depend on credit financing to pay for the education (the balance use their own cash).  Since 2005, the company has been undergoing a transition that began with its conversion into a for-profit organization.   In May 2008, the controlling family sold a portion of its ownership to GP Investments.  GP brought in a new management team in February and expects to improve EBITDA margins by at least 1,100 basis points through a) removing excessive general and administrative costs left in place by the founding family, b) reaching below-inflation salary increase agreements with the teachers, and c) reducing the dropout rate (currently at 45%).  After spending a significant amount of time with new management and visiting six campuses in Brazil, we are confident that the cost reduction initiatives are achievable.  We expect minimal organic enrolment growth given the state of the global economy, but the Brazilian government has become increasingly focused on raising the penetration rate of post-secondary education, which may provide some support.  In fact, the Government's stated target is for 30% enrollment of young adults between 18-24 of age by 2010 versus just over 12% penetration at the end of 2008 (no chance of this happening).  After layering in operational improvements currently underway, Estacio will be able to earn well north of R$3/share once GP Investment's restructuring plan is complete (comparable margins to peer Anhanguera).  Given Estacio's strong long-term growth and return profile, we believe that Estacio should command at least an 8% yield on restructured unlevered earnings (2011/2012) yielding a R$34 fair value per share or 280% upside from current levels. 

    Investment Merits

    Model

    (R$ in mm, FYE Dec) 2007 2008 2009 2010 2011 2012
    Average Enrollments 175,000 194,000 203,500 207,570 219,681 265,665
    Revenue 853,100 979,968 1,074,214 1,128,569 1,242,195 1,577,324
    Growth   14.9% 9.6% 5.1% 10.1% 27.0%
                 
    COGS (518,900) (591,542) (644,528) (677,142) (732,895) (914,848)
    Gross Profit 334,200 388,426 429,686 451,428 509,300 662,476
    margin 39.2% 39.6% 40.0% 40.0% 41.0% 42.0%
                 
    D&A (24,400) (34,400) (37,000) (47,952) (48,390) (63,116)
    SG&A (245,300) (281,200) (290,038) (282,142) (285,705) (347,011)
    % of sales 28.8% 28.7% 27.0% 25.0% 23.0% 22.0%
                 
    EBITDA 88,900 107,226 139,648 169,285 223,595 315,465
    margin 10.4% 10.9% 13.0% 15.0% 18.0% 20.0%
                 
    EBIT 64,500 72,826 102,648 121,333 175,205 252,349
    margin 7.6% 7.4% 9.6% 10.8% 14.1% 16.0%
                 
    Goodwill (2,300) (10,400) (14,000) (14,000) (14,000) (14,000)
    Interest Income(Exp) 24,400 26,300 15,995 27,482 39,319 27,582
    EBT 86,600 88,726 104,643 134,815 200,524 265,930
    Normalized Taxes (4,330) (8,873) (10,464) (13,482) (20,052) (26,593)
    Rate 5.0% 10.0% 10.0% 10.0% 10.0% 10.0%
                 
    Net Income 82,270 79,853 94,179 121,334 180,472 239,337
    Average Shares Out. 79 79 79 80 81 82
    Reported EPS 1.05 1.02 1.19 1.51 2.23 2.92
    Cash EPS (x-amort) 1.08 1.15 1.36 1.69 2.40 3.09
                 
    Dividends 13,700 17,900 43,272 67,667 97,236 126,669
    Dividends/share 0.17 0.23 0.54 0.84 1.20 1.55
    NOPAT 61,275 65,543 92,383 109,200 157,685 227,114
    Debt (229,100) (195,500) (242,407) (307,241) (309,143) (72,490)
    Equity 405,400 421,100 472,007 525,674 608,910 721,579
    Capital Employed 176,300 225,600 229,600 218,433 299,768 649,089
    ROCE   32.6% 40.6% 48.7% 60.9% 47.9%
                 
    Cash Flow 2007 2008 2009 2010 2011 2012
    Net Income 82,270 79,853 94,179 121,334 180,472 239,337
    add: D&A 24,400 34,400 37,000 47,952 48,390 63,116
    add: Goodwill Amort. 2,300 10,400 14,000 14,000 14,000 14,000
    less: Organic CapEx (34,600) (65,600) (55,000) (50,786) (55,899) (70,980)
    less: Acquisition CapEx (215,200) (113,800) 0 0 (87,826) (355,458)
    less: CapEx (249,800) (179,400) (55,000) (50,786) (143,724) (426,437)
    FCF (140,830) (54,747) 90,179 132,501 99,138 (109,984)
    FCF/Share (1.79) (0.70) 1.14 1.65 1.22 (1.34)
    Market Stats       Intrinsic Value  
    Current Price   12.28   ROCE   32.6%
    Market Cap   965,208   Growth   >20%
    Net Debt (Cash)   (220,000)   Norm. NOPAT 172,671
    Enterprise Value   745,208   Fair Multiple 20.0x
    Dividend Yield   1.9%   Fair EV   3,453,422
    Mgmt Ownership   5.0%   Fair Equity Value 3,673,422
    Note: NOPAT based on 18% EBIT Margin   Fair Value per Share 46.74

     

    Public Comparables
      USD P/E EV/EBITDA
    Peers Mkt Cap 2009E 2010E 2009E 2010E
               
    Brazil Education        
    AEDU11 BZ 639 12.6x 8.4x 8.9x 6.7x
               
    US Peers          
               
    APOL 10,146 16.6x 13.7x 8.4x 7.2x
    DV 3,097 19.4x 15.2x 11.2x 9.3x
    ESI 3,961 15.3x 13.2x 8.5x 7.3x
    CECO 1,870 17.3x 13.9x 6.5x 5.0x
    Average   17.2x 14.0x 8.6x 7.2x
               
    Estacio          
               
    Estimate 461 9.0x 7.3x 5.3x 4.4x
    Premium to Brazil -28% -13% -40% -35%
    Premium to US -47% -48% -38% -39%
               
               
               
               
    Enrollments 2008 2009 2010 2011 2012
    Beginning 178,206 207,006 207,006 207,006 232,356
    + Organic 8,800 0   10,350 11,618
    + Acquired 20,000 0 0 15,000 55,000
    Ending 207,006 207,006 207,006 232,356 298,974
    growth 16.2% 0.0% 0.0% 12.2% 28.7%

     

    Investment Risks

     

    Catalyst

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