Description

Nobel Learning (NLCI) VIC Write-Up

Nobel Learning operates 170 Pre-schools, elementary schools, and special-needs high schools. With average tuition of $8,000 (all private pay), Nobel schools are designed to fill the gap between public schools and high priced ($15,000+) elite private schools. The students are of various backgrounds, with a heavy concentration among the children of first generation immigrant families.

INVESTMENT THESIS:

Nobel Learning has a new management team which has spent the past year stabilizing the finances of the company, and has begun to focus on turning around the business itself. Early signs are that their efforts are paying off; the education business is a high fixed-cost utilization driven model where incremental revenues generate significant profit contribution. Nobel trades at 14x current free cash flow (fiscal year ends July) and 8x my estimate of 2005 free cash flow. Should the operational initiatives prove successful, future free cash flow off the current asset base could be meaningfully higher.

HISTORY:

Nobel Learning had been woefully managed by the previous team which treated the company as its personal fiefdom. Former CEO Jack Clegg had four children on the payroll including his son who was the president, COO and heir apparent. Clegg neglected the core operations by pursuing unrelated businesses, and brought the company to the brink of insolvency.

Knowledge Universe had purchased approximately 30% of Nobel during 2002, and appeared to be making acquisition overtures. Clegg was not interested in being a KU entity (it almost certainly meant losing his job as NLCI would be merged with another educational entity) and orchestrated a deal with Gryphon as a white night taking the company private together at $7.75 a share in February 2003. Ultimately the deal unraveled, and Clegg found himself without a friendly partner for his cash strapped company that was going nowhere. Camden Partners stepped in with $6 million worth of financing in April/May 2003; Clegg was forced to step down as CEO but was allowed to remain chairman.

George Bernstein was brought in by Camden as CEO in July 2003 to clean house and turn the company around. Clegg resigned from the board shortly thereafter and the turnaround began in earnest. Bernstein had previously been president of Pearle Vision, an 840 unit chain of optical retail stores. Between October 2003 and January 2004 they changed the entire senior management team including a new COO, CFO, VP of Education, VP of Marketing, and head of HR. Every executive brought on board had previous experience at a larger multi-unit company; the head of education had previously lead a multi-unit school system.

THE TURNAROUND

From August 2003 to February 2004, the new management team worked to fix the capital structure. Their former bank lender (Fleet) was threatening to push the company into Chapter 11 if Nobel didn’t find another lender. NLCI raised $3 million by selling preferred stock to existing shareholders and lined up financing with Harris Bank, thus stabilizing the capital situation.

Only after the management team was replaced and the capital structure stabilized could management focus on operations. The key window for marketing to parents is February to April each year; that window was largely missed for 2004. Nevertheless, operational trends stabilized versus previous years. Enrollment flattened in 2004 after falling for three years; operating margins increased from 12.5% to 12.8% as NLCI benefited modestly from increased pricing and virtually flat (slightly down) utilization.

The real opportunity is for 2005. Each of the 160 schools marketed to parents differently, many not at all. There was no cohesive national strategy, no single marketing plan, no centralized purchasing, no standardized training, and no financial controls. The company has painstakingly put all of these systems into place, and importantly, NLCI will be using some basic direct marketing techniques for the first time. Additionally, the company has spent a good deal of effort on educating principals about the economics of the business as well as tying a portion of their compensation to utilization.

The market cap today is approximately $70 million. NLCI should generate a little more than $5 million in free cash flow this year. With 18,000 students, Nobel operates at around 70% utilization which is down significantly versus three years ago. It seems reasonable that they can bring utilization back to at least 75% with a marketing program which has never been in place before. Average tuition is $8,000 with incremental student margins of roughly $5,500. Five percentage points of utilization pickup would add 1,250 students and incremental operating profit of nearly $7 million and free cash flow of over $4 million. That would put NLCI at just under 8x 2005 free cash flow of $9 million. Given the increased marketing, there is no reason utilization rates shouldn’t return to the low 80s, which would create dynamic cash flow growth over current levels even without growing the current asset base. If Nobel can improve utilization and ultimately begin growing the chain, it’s reasonable to think that the stock could hit $15 a share within a couple of years.

Catalyst

-Operational improvements bearing fruit
-New marketing program
-Increased cash flow