Nord Anglia Education (NORD) operates 42 K-12 schools across 15 different countries and is the world’s leading premium schools organization.
The business model of a school operator is fairly straightforward and attractive. Enrollment and tuition determine revenue, and the relatively fixed costs of rent and teacher salaries allow for significant operating leverage. NORD’s schools have typically raised prices 1.5-2x inflation, received 50% of their revenue at the start of the school year, retained 72% of students per year, and secured long-term leases with their landlords. As of January 24, 2016, Nord Anglia had 34,784 full-time equivalent students and capacity of 48,998 seats, which implies a capacity utilization of 71%. The low end of NORD’s fiscal 2016 guidance implies revenue of $850mm and an Adjusted EBITDA margin of 25.2%.
Industry checks indicate that schools with capacity utilization rates of 80% achieve EBITDA margins near 32%. Our checks indicate that schools acquired by NORD before 2014 and not pursuing capacity expansions had utilization of 80% in December 2014; these schools have 19,000 seats. In our view, it’s not unreasonable to believe that if NORD did not pursue another acquisition or capacity expansion, its company-wide capacity utilization would reach 80% in 3-4 years. Assuming 32% EBITDA margins and today’s revenue per student of $24,700 rises 2% per year implies 2020 revenue of $1.05bn and EBITDA of $335mm. Assuming maintenance capex of $900 per student and a 27% tax rate produces 2020 NOPAT of $220mm. Using a 10% discount rate and a TEV of $3.1b implies a 2017 FCF yield of 5%. Assuming 2% growth in perpetuity from price increases, this gives rise to a 7% private-market IRR in a state of the world where NORD does not add to capacity.
Growth scenarios should consider that most K-12 schools are independently owned non-profits, but NORD’s business focus and scale allow for differentiation in two important ways.
First, the company can use its scale to build a global brand. Branding plays an important role in attracting outstanding students, parents, and teachers. NORD entered into a partnership with Julliard to enrich its music, dance, and drama programs and to setup school-based engagements with traveling Julliard artists. NORD encourages its students to consider themselves part of a global network by bringing them together online through the Global Classroom and in-person through Global Orchestra events and expeditions to Tanzania. NORD reported that 92% of parents would recommend NORD’s schools to others. Teachers are evaluated rigorously and encouraged to improve their skills via guest lectures and Nord Anglia University, a global learning platform. A partnership with King’s College London, announced in November 2015, will allow for 50 teachers per year to pursue graduate education degrees part-time; this should allow for NORD to attract and retain outstanding teachers. In December 2015, NORD received 11,600 applications for 300 teaching vacancies across its 42 schools; this is a year over year increase in applicants per teaching vacancy of 30%. Student results have also been strong. In 2015, the International Baccalaureate Program pass rate of Nord Anglia’s students was 90.9% while the global average was 79.3%. One out of every three 2015 graduates of a Nord Anglia school matriculated to one of the top 100 universities per the QS World University Rankings. NORD appears to be improving the educational experience as it adds schools, which bodes well for future expansion opportunities.
Second, the NORD management team possesses the operating history to pursue growth initiatives. Our checks indicate that NORD has a good reputation with real estate developers, banks, independent school owners, and regulators. My own experience assisting a private school in its expansion plan taught me that the competing visions of donors, parents, and faculty often lead to higher costs and delays. Furthermore, these stakeholders are reluctant to consider leverage, sale/leasebacks, or acquisitions, and they typically only consider capacity expansions every 5 years, causing their relationships and knowledge to atrophy. Conversely, NORD adds to its capacity annually and actively maintains relationships with builders and private school owners.
NORD has stated that in fiscal 2016, it could spend $225mm on acquisitions. Let’s assume that over the next 3 years, NORD spends $500mm. A review of pre-2014 acquisitions suggests that NORD has paid 7-10x EBITDA and that EBITDA has doubled in four years. We don’t have reason to believe that 2015 acquisitions deviate from this thinking, which if it occurs again, adds $118mm to EBITDA in 2022. Prior assumptions that maintenance capex is 10% of EBITDA and tax is 27% produce 2022 NOPAT of $77mm. This becomes $48mm in 2017 with a 10% discount rate and adds 1.5% to the previously calculated 2017 FCF yield, for a total yield of 8.5%.
These capital deployment assumptions are likely too conservative. NORD has stated that it plans to acquire schools almost immediately after completing a $170mm sale/leaseback, which occurred in April 2016. A modest upside scenario assumes that acquisitions cease in three years: NORD has indicated a desire to continue acquiring schools and notes that the value of the global K-12 private school market is around $60bn.
Risks include the fact that 30-35% of EBITDA comes from China and leverage. I estimate that 97% of NORD’s current students in China are expats, so an economic slow-down causing expats to flee could be problematic. However, industry experts indicate that it would take NORD no more than 1-2 years to reposition its schools to serve the local population. NORD estimates that the Chinese private school market is worth $20bn and, with its planned September 2016 opening of a 2,250 seat Shanghai school for the local population, NORD is the first truly international operator with the ability to educate local Chinese students. The other concern is leverage, and NORD estimated that its pro forma 4.9x net debt to EBITDA on November 30, 2015 would decline to 4.0x by November 2016. A review of the credit documents suggests that the company enjoys covenant-lite loans, and that the most onerous requirement is that the company stay below 5.75x net debt to EBITDA if it wishes to use more than 30% of its revolver.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
Acquisitions or capacity expansions. Enrollment updates.