ABCD - Cambium Learning Group

[KJP]

Cambium Learning Group is a ~$240 million market cap company that creates and sells educational products, primarily to K-12 schools in the United States.  It is 70% owned by funds managed by Veronis Suhler Stevenson, so the public float is only about $70 million.  There are two VIC write-ups about it, but the most recent one is 2.5 years old, and the write-ups on SeekingAlpha are almost as dated, so it doesn’t appear to be a particularly well followed company.  For the reasons explained below, the company also doesn’t screen well. 

 

Historically, most of the company’s revenue was from printed products like textbooks.  But over the last 10 years, the company has successfully transitioned to annual subscription-based online products that can provide individualized instruction and immediate feedback to students.   

 

The transition, however, is not apparent from a cursory review of the financials for two reasons.  First, overall company revenue has essentially been stagnant for the past six years, masking the underlying transition from print to online revenue.  Second, the company receives cash for its online products upfront, but records the associated revenue and profit over the term of the subscription.  (You can see the buildup of deferred revenue on the balance sheets over time.)  As a result, reported GAAP net income has understated actual cash flow as the business has grown.  (The reverse would be true if the subscription businesses began to shrink.)

 

The company has three operating segments and then reports corporate overhead separately.  I believe reported “Bookings,” rather than GAAP revenue, is the better top-line number, and “Cash Income” – which essentially adds back the changes in deferred revenue and subtracts actual CapEx – is the best measure of pre-tax, segment-level earnings.  Here are the historical segment-level bookings and cash income figures that I have pulled together:

 

Learning A-Z:  The largest segment, with a significant market share, particularly in reading.  This segment’s products are all digital.

 

Year/Bookings/Cash Income (in millions)

 

2012: 31.2/Unknown

2013: 40/20.3

2014: 52.1/23.7

2015: 65.2/28.8

2016: 73.25/32.5

 

Over the last six months, management has consistently said that this segment will grow bookings by “at least 15%,” and on the conference call last week confirmed that they were still on target to meet that through July.  If you credit them for 15% bookings growth and keep the cash income margin constant, this segment would have $84 million in bookings and $37 million in cash income this year.

 

Explore Learning:  Science-focused and all digital.  Growth in this segment largely stagnated in 2014-15, but has picked up strongly recently.  The additional scale also appears to have pushed up cash income margins:

 

Year/Bookings/Cash Income/Cash Income Margin

 

2012: 15.4/Unknown

2013: 19.6/6.5/32.6%

2014: 19.8/4.8/24%

2015: 21/5.4/25.5%

2016: 26/7.9/30%

 

This segment appears to be on track for 20% bookings growth this year.  Keeping cash income margins at 30% (they could be higher) would result in 2017 bookings of $31 million and cash income of $9.4 million.

 

Voyager Sopris Learning:  This is the problematic, legacy segment.  Historically it was print, but the company has been trying to transition it to digital, with some success.  But overall bookings have continued to decline, and management has been wrong in the past about when bookings declines will stop.

 

Year/Bookings/Cash Income

 

2012: 112/Unknown

2013: 98.4/12.7

2014: 78.7/7.9

2015: 72.9/9.4

2016: 62.5/5.9

 

During the last call, management expected an annual bookings decline of 5-10% in 2017.  They’ve been overly optimistic in the past about this segment, but assuming a 10% bookings decline and a continued decline in cash income margin to 9% would result in 2017 bookings of $56 million and cash income of about $5 million.

 

Corporate:  Shared services and company-wide management costs are reported separately.  Here are the numbers for the last four years on a “cash income” basis:

 

2013: (16.5)

2014: (13.4)

2015: (13.8 )

2016: (15.3)

 

I will use $16.5 million as the number for 2017.

 

Adding it all up, you have company-wide cash income for 2017 of $35 million (37+9.4+5-16.5), and that should continue to grow.  To put the impact of future growth in perspective, if you assume 10% growth (lower than historical rates) for Learning A-Z and Explore Learning and another 10% decline for VSL, with a slight increase in cash income margin, which the company is expecting from additional scale, then 2018 company-wide cash income would be about $40 million.

 

In between company-wide cash income and what equityholders actually receive are (i) stock-based compensation; (ii) interest; and (iii) taxes.  SBC is about $1 million per year.  Interest is about $5.5 million per year and falling fast as the company has paid down a substantial amount of debt over the last five years and management has identified additional debt paydown as the most likely use of FCF.  Finally, the company has about $75 million in NOLs that are currently shielding it from federal taxes.  They should be largely used up over the next two years.  You can account for them and the company’s tax obligations however you wish.

 

Adding it all up, I see a company that’s trading at less than 10x FCF and growing that cash flow at a good clip.  So, I would like it even if I thought it would remain an independent company.  But I think the game plan is to sell it, and the sales price is likely to be much higher than $5/share.  I’ll explain why in a later post if there’s any interest.

 

[awindenberger]

You've piqued my interest. Why do you think it will be sold, and any thoughts on the time frame?

 

Also, do they have much competition in their newer segments?

[KJP]

You've piqued my interest. Why do you think it will be sold, and any thoughts on the time frame?

 

Here's what VSS is:  https://www.vss.com/

 

I believe Cambium was in a 2005 vintage fund that was recapped in 2016 to provide antsy LPs with liquidity:  https://www.altassets.net/private-equity-news/by-news-type/fund-news/icg-buys-out-some-lps-in-vss-communications-partners-iv.html

 

The recap gave them more time to develop Cambium, but they'll need to cash out eventually.  I think it makes sense to do that after the NOLs are used up to avoid losing them.  So, I think a sale by 2019/2020 is likely, and perhaps earlier.

 

[given2invest]

I'm the author of the most recent VIC report from 2.5 years ago.  This is my largest position (25% of my portfolio).  Happy to answer any questions as well.

 

I should add I'm also very bullish and think it could see $10 next year if Learning A-Z can grow 12-15% in 2017 and 10-12% in 2018.  That's really the main driver of the value.  But ExploreLearning is doing so well it's creating real value as well.  VSL is really just an option at this point, worth probably 50 cents a share.

[KJP]

I'm the author of the most recent VIC report from 2.5 years ago. 

 

A belated thank you for your writeup and continued thoughts in the comments.  They are very helpful.  Two questions:

 

1.  Are you aware of any additional transaction comps in the last couple of years?  Compass Learning and Think Through Learning may be similar products and were both bought by Weld North in 2016, but I don't think the terms were disclosed.  K12 bought LTS Education for $20 million (2.5x revenue) in May 2016, but the products may not be comparable.

 

2.  Is there any comparable public company to Cambium?  The competitors I'm aware of are either private or buried in larger public companies, like Lexia Learning/Rosetta Stone. 

[given2invest]

I'm the author of the most recent VIC report from 2.5 years ago. 

 

A belated thank you for your writeup and continued thoughts in the comments.  They are very helpful.  Two questions:

 

1.  Are you aware of any additional transaction comps in the last couple of years?  Compass Learning and Think Through Learning may be similar products and were both bought by Weld North in 2016, but I don't think the terms were disclosed.  K12 bought LTS Education for $20 million (2.5x revenue) in May 2016, but the products may not be comparable.

 

2.  Is there any comparable public company to Cambium?  The competitors I'm aware of are either private or buried in larger public companies, like Lexia Learning/Rosetta Stone.

 

1)  Nope.  And the high multiple paid for Archipelago resulted in a chap 11 I believe when it turned.  It's really hard to know what these are worth today to PE.  But obv the market multiple is much higher than when Archipelago and Renaissance traded last.  Renaissance is a pretty different business though. 

 

2)  Nope.

 

3)  Thanks for kind words. 

[valuedontlie]

Management/insiders own virtually no shares in this company... any thought as to why that might be? what does incentive structure look like here? if things progressing so well and a sale is likely outcome, you'd think these guys would want to go along for the ride...

[given2invest]

Management/insiders own virtually no shares in this company... any thought as to why that might be? what does incentive structure look like here? if things progressing so well and a sale is likely outcome, you'd think these guys would want to go along for the ride...

 

You actually couldn't be more aligned.

 

Private Equity controls the company and board and owns 70%.  You are basically riding along with them.  But you're even aligned at the CEO level.  The CEO is not a wealthy man and never was a CEO before this job.  He has 500k deep in the money options which are very material for him.  He has never sold a share. 

[KJP]

Management/insiders own virtually no shares in this company... any thought as to why that might be? what does incentive structure look like here? if things progressing so well and a sale is likely outcome, you'd think these guys would want to go along for the ride...

 

You actually couldn't be more aligned.

 

Private Equity controls the company and board and owns 70%.  You are basically riding along with them.  But you're even aligned at the CEO level.  The CEO is not a wealthy man and never was a CEO before this job.  He has 500k deep in the money options which are very material for him.  He has never sold a share.

 

Yes, given the VSS funds' holdings and VSS's incentives, I don't see how "insiders own virtually no shares in the company."  Stepping back, the concerns raised by a lack of insider ownership/buying would be (i) principal-agent problem, which could manifest in, for example, excessive comp, poor capital allocation or extended poor performance without consequences, or (ii) a signal the company's future is not bright. 

 

I don't think issue (i) exists here for the reasons already mentioned.  You can also look at the capital allocation over the last few years.  It's the opposite of empire building.  Any inference related to (ii) has already been addressed above. 

[KJP]

As given2invest mentioned, there aren't very many recent transaction comps and there is no real comparable public company.  If you're interested in following the EdTech industry, this is a useful website to monitor:  https://www.edsurge.com/news/edtech-business

 

Berkery Noyes also periodically publishes M&A stats on the EdTech industry, e.g., this report on the first six months of 2017:

http://www.berkerynoyes.com/publication/trends/Education1H2017.aspx

 

When looking at these sources, keep in mind that the "EdTech" category is much broader than the curriculum products subcategory in which Cambium competes.

 

These sources suggest there is continued PE interest in digital curriculum companies.  See, for example, Francisco Partners' recent purchase of myON, a Cambium competitor in reading:  https://www.edsurge.com/news/2017-02-21-capstone-sells-digital-reading-platform-myon-to-private-equity-firm

 

Weld North has also been building a portfolio of digital education companies.  See, e.g., http://www.weldnorth.com/?p=926  and  http://www.weldnorth.com/?p=923

 

 

[abitofvalue]

Nice write-up.

 

- How do you get confidence that Leaning A-Z will grow 15% this year? That's the YTD rate but Q2 had a pretty meaningful slowdown (down compared to '16). The comment about delayed bookings makes sense, but this is a company that has missed guidance in the past. how reliable / conservative do you think Mgmt is? My impression from reading last few transcripts is that they are a tad promotional and seem to focus on whatever is growing best at the time.. but that could well be wrong. have you talked to them?

 

 

[KJP]

Nice write-up.

 

- How do you get confidence that Leaning A-Z will grow 15% this year? That's the YTD rate but Q2 had a pretty meaningful slowdown (down compared to '16). The comment about delayed bookings makes sense, but this is a company that has missed guidance in the past. how reliable / conservative do you think Mgmt is? My impression from reading last few transcripts is that they are a tad promotional and seem to focus on whatever is growing best at the time.. but that could well be wrong. have you talked to them?

 

I have not spoken to management.

 

You are also correct that they over-promised last year.  Here's the 2016 outlook they provided with their Q4 2015 release (edited for conciseness):

 

Learning A-Z: Learning A-Z continues to expect strong double-digit Bookings growth in 2016, estimated at approximately 20%, with consistent Adjusted EBITDA and Cash Income margins.

 

Voyager Sopris Learning: The Company expects this segment to return to top line growth in 2016, with a slight Bookings increase — likely in the 1% to 5% range — as the growth of newer and technology-enabled solutions is expected to outpace the continued decline of legacy print-based products. 

 

ExploreLearning: The Company expects ExploreLearning Bookings growth to accelerate in 2016, as substantially the entire library of Gizmos simulations is now upgraded to HTML5 and Reflex continues to show strong momentum. The Bookings growth is expected to range between 10% and 20%. 

 

[source:  http://www.investor.cambiumlearning.com/phoenix.zhtml?c=93447&p=irol-newsArticle&ID=2145504]

 

Although EL overperformed even the high end of the range, LAZ had only 12% bookings growth and VSL bookings were down 14%.

 

I would expect the pushback they got as a result of being overly aggressive last year to chasten them a bit this year.  In addition, the transcript of Rosetta Stone's Q2 call is worth a read for the discussion of their Lexia Learning division's sales cadence, which saw the same pattern of lower relative Q2 and then big jump in July. 

 

At the end of the day, I don't think the investment case hinges on whether LAZ growth this year is 15% versus 12% or 10%.  Even if you model in only 10% bookings growth this year and 5% bookings growth next year and add in (i) a reasonable expectation for ExploreLearning, (ii) continued decline in VSL, (iii) a bit of cash income margin expansion (VSL just went through a big CapEx phase), (iv) and additional debt paydown from 2017-18 cash flow (I think they'll have $25 million or less of debt by the end of 2018, assuming no M&A) I think you end up with a company that still looks cheap at current prices.  [With those assumptions I get company-wide cash income of ~$36 million in 2018] 

 

EDIT:  I should also add that as of the Q2 release last year, they were still saying 20% bookings growth for LAZ.  [source: http://www.investor.cambiumlearning.com/phoenix.zhtml?c=93447&p=irol-newsArticle&ID=2194873]  So, again, no guarantees about 15% for this year.

[abitofvalue]

thanks for the comprehensive response. some more reading / learning for me to do on this one. appreciate it. cheers.

[given2invest]

The really short pitch is this:

 

Nobody believes LAZ will grow 15% this year after the big miss and deceleration last year.  The stock is priced for this to not happen.  If it happens, the stock works big.  If it doesn't happen, but LAZ continues to grow and grows in 2018, the stock still works, just not as big.

 

I wouldn't worry too much about Q1 and Q2 #'s.  Go back the last few years and you will see some odd stuff happen in these quarters.  Every year it seems Q3 gets more and more of the business.

[educatedidiot]

Thanks for sharing your research on this company, this looks interesting. 

 

The Learning A-Z business has been absolutely incredible.  I counted 18 consecutive quarters of at least 15%+ growth:

http://www.rocketfinancial.com/Financials.aspx?fID=125339&p=1&i=0&pw=4136145&rID=8&tID=1&stID=-1&segID=88237

 

And the contribution margins are obviously extremely high in this business.  I'm sure the growth will eventually slow further, but the deceleration to date if you look at the numbers has actually been rather modest.

 

Do you know who their primary competitors are in the Learning A-Z segment?

[KJP]

 

Do you know who their primary competitors are in the Learning A-Z segment?

 

Past company presentations identify specific competitors.  More generally, LAZ is primarily a reading tool.  So any product or service that helps teach reading is an actual or potential competitor, and a software program that offers individualized instruction and assessment is a direct competitor.  Here's an example:  https://www.lexialearning.com/

 

Because it's part of a public company, Lexia's financials are publicly available.  It's also had very healthy growth.

 

 

 

 

[educatedidiot]

Thanks KJP!

 

Yeah, Rosetta Stone even breaks out Lexia as their "Literacy" segment I believe.  A little more than half the size of LAZ:

http://www.rocketfinancial.com/Financials.aspx?fID=19205&pw=633723&rID=8&p=1&segID=123513&stID=1

 

It's historically had strong growth as you said, but I noticed that the sequential growth has slowed significantly over the past couple of quarters.  Perhaps their products are finding it tougher to compete with LAZ.

[KJP]

Q3:  http://www.investor.cambiumlearning.com/news-releases/news-release-details/cambium-learning-group-reports-third-quarter-2017-financial

 

As abitofvalue suggested might happen, they didn't hit 15% booking growth for LAZ.  Instead, it's now "at least 10%" for LAZ and "at least 17%" for ExploreLearning.  VSL also continues its journey downhill.  I suspect the stock will be hit hard today, but underneath the failure to meet guidance you still have a nicely growing business that generates a lot of tax-sheltered cash flow.

[KJP]

Regarding continued PE interest in EdTech companies generally and curriculum companies in particular, see:  https://www.edsurge.com/news/2018-01-04-silver-lake-acquires-majority-stake-in-weld-north-s-digital-curriculum-business

 

I continue to believe that Cambium will be sold once its NOLs are used up.  In the meantime, you're getting a very lightly levered, highly cash generative business and growing business at less than 10x FCF.

[misterkrusty]

any idea why the slowing momentum at Learning A-Z?  they hired more salespeople a while back, now they just replaced the long-time head of that biz.  is the problem with the marketing/sales or with the product?  any idea how Reading 360 and other competition are doing?

[KJP]

any idea why the slowing momentum at Learning A-Z? 

 

is there actually any real "problem," marketing, product or otherwise, with LAZ?  I'd be concerned if they were losing market share or being replaced in classrooms they're already in, but I haven't seen evidence of that yet. 

 

You're right that LAZ revenue growth is slowing, but I believe part of the issue is that it's just harder to keep the same growth rate due to the increasing penetration rate of the existing business.  The vast majority of LAZ is reading.  According to the company, LAZ's reading products already have 17% penetration in the US.  (See slide 60 of the May 2017 presentation.)  This isn't a network effects business, so increasing penetration makes it harder to keep growing.

 

Also, I think you need to take the "slowing momentum" in perspective.  If I gave you just the cash-generating capacity of the existing business and its current multiple, you'd probably think it's a low-single-digit grower at best.  But LAZ is still growing 10+% and Explore Learning is growing faster than that (albeit off a smaller base, both in terms of revenue and penetration). 

 

Many competitors are private.  But you can see the revenue growth of a competing product by looking at the Lexia Learning segment of Rosetta Stone. 

 

EDIT:  Also, the former head of LAZ was 74. 

 

[misterkrusty]

yeah, 10% ain't bad.  and maybe someday EL will grow so large we don't have to worry much about LAZ.

 

But I wonder - what is the "right" market share for LAZ?  Is this like soft drinks where there are regional preferences?  Are there many teachers / school districts that haven't heard of LAZ?  Is product awareness enough to drive sales or is this one of those products that has to be pushed by constant marketing (like soft drinks)?

 

I have so many questions, given this is my first ed-tech/ ed-pub investment.

 

How

[KJP]

 

But I wonder - what is the "right" market share for LAZ?  Is this like soft drinks where there are regional preferences?  Are there many teachers / school districts that haven't heard of LAZ?  Is product awareness enough to drive sales or is this one of those products that has to be pushed by constant marketing (like soft drinks)?

 

 

Good questions to which I don't have sure answers. 

 

Cambium has audio of old investor conference presentations from the CEO (Campbell) on its website.  In many of them, he emphasizes that Cambium is trying to partner with a teacher, not replace them.  He's very careful never to bad mouth teachers or blame them for poor performance.  That makes sense when you hear his explanation of how Cambium's product works its way into a school system.  According to Campbell, it'll often be one teacher paying out of pocket, finding that it works, causing it to spread to other teachers in the school, then to other schools in the system.  Eventually, the whole system buys it.  If that actually happens fairly often, I think it's a great sign that the product actually works, as opposed to being a fad or a boondoggle funded by appropriately schmoozed Board of Education members and superintendents.

 

I also believe the industry is likely in something of a land-grab mode.  Once a digital product is embedded in a school or school system, teachers are familiar with it, and it works (or people believe it works), there is little reason to bear the risks of moving to a different product, unless there were substantial cost savings.  (Cheap open source content is a looming threat to traditional textbook suppliers, but I don't think it's as big a risk to the types of digital products Cambium makes.) But once again, you're not seeing this business valued as if it's a high-recurring-revenue subscription business.

[KJP]

Q3:  http://www.investor.cambiumlearning.com/news-releases/news-release-details/cambium-learning-group-reports-third-quarter-2017-financial

 

As abitofvalue suggested might happen, they didn't hit 15% booking growth for LAZ.  Instead, it's now "at least 10%" for LAZ and "at least 17%" for ExploreLearning.  VSL also continues its journey downhill.  I suspect the stock will be hit hard today, but underneath the failure to meet guidance you still have a nicely growing business that generates a lot of tax-sheltered cash flow.

 

The stock price was hit hard, but it's come all the way back and then some.  This is now up over 50% since the write up 6 months ago.  Not bad considering the only real development is that management admitted it won't meet its own exuberant guidance for 2017. 

 

Going a bit from memory, I believe the enterprise is now trading at about 12x 2017 EBIT, without subtracting the present value of NOLs from enterprise value.  I'm not aware of any recent comparable transactions that have disclosed their terms, so it's hard to say what the private market value of this company is today.

[misterkrusty]

per an article in mergermarket on 12/15/17, Renaissance Learning expected to sell for a high teens multiple of cash net income.  a similar biz - Frontline Education - sold to thoma bravo in august for a 19x multiple.

 

I'd say the M&A market implies more upside for the shares.