APOL (NASDAQ:APOL) is trading at less than book value, less than 10% of sales (net of cash), and less than 1x enterprise value-to-EBITDA. APOL is a very cheap stock, in our opinion, and we added to the position in the quarter.
Let’s discuss APOL in greater detail. APOL declined 28% in the December quarter due to reporting lower than expected new student enrollment and a non-fundamental issue. The most important items, profits and free cash flow, met expectations. Incredible as it is irresponsible, the stock partly sold off because the Chairman of the Board received a margin call on stock he had pledged as collateral for a real estate loan he assumed many years ago. Per our discussion with APOL management, the loan was for a little over $25 million and it had a condition that provided that the loan would come due immediately if APOL declined below $10 a share. This occurred on October 22, when APOL announced its earnings, lower new student enrollments, and a $110 million acquisition in Germany. Shareholders initially sold off the stock a couple of dollars and pushed the stock just below $10. Unfortunately, the Chairman did not have the proceeds immediately available that day to pay off the loan, and the margin clerk proceeded to indiscriminately sell approximately three million of the Chairman’s shares, pushing the stock down to close to $7.
Not only do we find this behavior financially irresponsible but also inconsistent with the prudent stewardship of a publicly-traded company. Subsequently, we wrote a letter to the management team and board, and had a lengthy phone call with the company’s lead- independent board member expressing our views. In summary, we suggested that the company buy back all of the remaining Chairman’s stock and eliminate the dual-class shareholder arrangement. APOL has historically generated excellent returns on capital and has some good opportunities once it completes its repositioning of the University of Phoenix (UoP). Its global business is growing very fast, its global profit margins are expanding, and the global business is expected to generate material operating cash flow this year and in the future. The stock is incredibly cheap by our metrics, at roughly 1x enterprise value-to-EBITDA, but investors are unsure of the repositioning strategy at the UoP and concerned about the heightened regulatory environment.
However, thus far, APOL has largely avoided any material penalties from the numerous investigations that seemingly never end in the for-profit education industry. For example, on January 15, 2016, the Department of Defense (DoD) removed the UoP from probationary status after a three-month review of UoP’s business practices with respect to Tuition Assistance (TA) grants. Anti-for-profit education activists last year made a number of claims about UoP and its enrollment of military personnel in its school. There were concerns that active and former military personnel would never again receive financial aid to attend UoP and APOL would have to pay a massive fine. The bottom line is that the DoD conducted a thorough investigation and within three months removed the TA probation, and APOL was not fined a penny.
Reviewing UoP’s operations, we agree with Tim Slottow, the current President of UoP and the former CFO at the University of Michigan, and his strategy and vision for UoP. President Slottow’s vision is to attract highly qualified adult students to UoP’s Baccalaureate programs and provide them an excellent education in a very efficient system that will allow these students to continue to move their careers up the corporate ladder or healthcare employment track. Retention and graduation rates are among the most significant factors President Slottow is focused on, as well as job placement for students with the hundreds of businesses that recruit from UoP.
Going forward, UoP will require prospective students to take diagnostic tests to determine their capability to complete their degree, rather than having essentially an open-enrollment policy. In the short term this means fewer students will enroll in UoP, but in the long run it is likely more students will persist all the way through to graduation. The objective is to graduate more students who are less likely to drop out and not be able to pay off their student loans.
Subsequent to year-end 2015, on January 11, APOL’s Board of Directors issued a press release indicating that the board hired two investment banks and a law firm to evaluate strategic alternatives for the company. Later that day, the Dow Jones newswire service reported that the private equity firm Apollo Global Management was rumored to have offered over $1 billion to acquire APOL.
We immediately penned another letter to APOL’s board and detailed our assessment of what APOL’s shares are worth. We are concerned that Apollo Global Management is going to offer a reasonable premium above the January 11th, 2015 closing price, but enormously below the intrinsic value of the business, and the board will capitulate and sell the company at the bottom of the cycle. If the board agrees to sell the entire company at what some of the rumors are suggesting -- $1 billion -- that would value the business at less than 2x trailing twelve-months EBITDA -- after considering the net $6 per share of cash on the balance sheet. To put that into perspective, based on Apollo Global Management’s 2015 presentation, LBO takeover EBITDA multiples averaged 9.3x over the past decade, and the lowest average multiple was 8x in 2009 during the financial crisis period.
The $1 billion valuation for APOL would be unquestionably rejected by us, and we hope every other shareholder would reject it. Furthermore, that valuation would give absolutely no consideration for APOL’s rapidly growing international business, nor the large profit improvement opportunity for UoP. Green shoots are now sprouting at UoP, with retention rates starting to turn positive and student enrollment potentially bottoming this quarter. We will update you later should any materially new information be announced with respect to APOL’s strategic review, but below we provide our estimate of what APOL is worth.
From FPA Capital Fund (Trades, Portfolio)'s fourth quarter 2015 commentary.
