Elie Rosenberg is a value investor based out of Dallas, Texas. He is the founder and editor of valueslant.com, a site dedicated to value investing research and analysis.
Ambassadors Group (EPAX) is a travel company that markets and runs educational trips for middle school and high school students. The business is a good one, with high margins and little tangible capital required. And the company may even possess a small moat with their brand. But it has fallen on hard times with the dip in consumer discretionary spending over the past few years.
The flagship product of EPAX is the Student Ambassadors trips, where students travel to foreign countries as “delegates” to spread goodwill and learn about other cultures. EPAX also operates four other lines:
- Sports Ambassadors- students participate in athletic tournaments in foreign countries
- Leadership Programs- educational domestic trips
- Citizen Ambassadors- international trips for professionals to meet others in similar professions
- Discovery Student Adventures- Discovery Education branded international trips with a science and adventure focus
(EPAX also operates Bookrags.com, an education website, which for now is fairly immaterial.)
A Presidential Moat
EPAX markets their Ambassadors trips under the People to People brand, which constitutes a meaningful competitive advantage. Other student travel providers do not possess a strong branded image and generally market themselves to teachers with the hope that they will recruit students to join the trips. EPAX leverages the strong PTP brand and markets directly to students and their parents, primarily in the form of direct mail campaigns. People to People is a not-for-profit organization founded in 1956 by Dwight Eisenhower to promote world peace. PTP is a well respected organization, with the last 8 U.S. presidents serving as honorary chairman. EPAX leverages the PTP name and presidential affiliation in their marketing. They pay PTP a small royalty per delegate (probably in the range of $100) for the right to use their name.
EPAX also tries to create an air of prestige for the trips through direct mailers that claim that students have been specially “invited” to participate in these trips as “ambassadors” for their country. While it is true that school teachers can nominate students for invitations, most of their marketing is based on mailing lists used by college recruiters. EPAX has toned down this marketing angle after getting continuous heat for it over the years, but based on responses on their Facebook page from potential travelers it still seems to be effective.
Beyond the marketing gimmicks, there does seem to be a genuine focus on the educational and cultural aspects of these trips that differentiates PTP and EPAX from other student travel operators. One example of this emphasis is the ability for students to earn high school or college credit for many of the trips. This is also reflected in the fact that students are typically able to raise about half of the trip cost through donations because people believe in these trips as educational initiatives.
These advantages enable EPAX to play in the higher end of the market, with trips at a 4-6 k price point versus competitors who cater to the lower end of the market. Looking at EF Tours, the largest competitor for EPAX in international trips, reveals the niche that EPAX occupies. EF Tours markets mainly towards teachers organizing the trips, focuses on trips with a 2-3 k price point, and has a tourist oriented focus.
In better times for consumer spending, EPAX was a remarkable business that earned 30-40% ROE with no leverage. EPAX requires very little fixed capital, and operates with negative working capital (if you strip out excess cash) due to receiving deposits and payment in advance of the trips.
The recession has decimated EPAX’s business, with delegates traveled falling from a peak of 52,661 in 2007 to 26,657 in 2010. EPAX has been able to raise revenue per delegate over the past few years due to price increases and a skewing of the travel mix towards the more expensive international trips. Gross margins have also risen from the 35% range to 41% in 2010 due to the increased revenue per delegate and better management of travel costs. But marketing costs have gone up since 2007, with the cost to acquire a delegate (marketing cost/delegates) increasing from $739 in 07 to $1,602 last year. The net impact has been a decline in operating income from $41.8 million in 2007 to $10.1 million in 2010.
2011 has not been much better for EPAX. Delegates traveled is down 4% year over year. Total enrolled revenue for the year, which also takes into account bookings for future trips, is down 5% year over year. On top of those declines, gross margin has fallen from 41% to 38% YTD due to increased air travel costs that EPAX could not pass on. The one bright spot is that enrolled revenue for the core Student Ambassadors product line is up 5%. Management is guiding for 2011 net income between $4.5 and 6.5 million versus $8.1 million last year.
The major weakness has been in the domestic trips, which are more price sensitive and where EPAX does not possess the same competitive advantage that they do in international. EPAX has installed new management in those lines, but for the 2012 marketing season they intend to devote more resources to international which is trending well. They have also been more proactive in their social media marketing efforts. But it is uncertain how much those changes will help boost revenues in light of the continued weak environment for consumer spending.
At $8 a share, EPAX trades at a $142 million market cap. They have no debt and $90 million in cash and equivalents. The cash balance is not all excess cash as much of it consists of $62 million in customer deposits for future trips, which will need to be used to pay for travel costs. One way to come up with excess cash is to take out the projected gross margin from customer deposits and subtract the rest of the deposits from the cash line. Using a 38% gross margin would yield $52 million in excess cash. That would get us to a $90 million cash adjusted enterprise value.
Normalized earnings power is the big question here. I don’t think the EPAX brand is permanently impaired. Travelers still love the program and EPAX is the leader in the space. The question is if and when consumer spending on expensive student trips will recover to anything near prior levels. The upward trend in the core Student Ambassadors program is an encouraging sign, and management appears to be making a smart move by concentrating their marketing efforts there. I would be surprised if delegates traveled was down again in 2012, but whether we will see a material increase is uncertain.
SG&A expense does not appear to fluctuate with the number of delegates traveled, giving EPAX tremendous operating leverage. That has hurt it in the last few years on the downside, but could provide significant upside if EPAX can start to grow the delegate count even modestly. The gross margin of any increases in delegates will flow directly to the bottom line.
Since the key driver of net income is the number of delegates traveled, it might be helpful to look at how different levels of delegates traveled will impact net income and the equity value. This sensitivity analysis takes the predicted net income per share at each level of delegates traveled and multiplies by a PE multiple to get intrinsic value per share:
Assumptions in the model:
- Annualize Book Rags revenue through 2 quarters- $3.8 million run rate
- Revenue per delegate of $6,200, between the $5,961 in 2010 and $6,408 thus far in 2011. I assume it will have to come down some to drive the higher volumes of delegates.
- 38% gross margin – rate through Q2 2011 and low end of management guidance for the full year
- Selling expense up 5% to $44.8 million and G&A expense flat
- 34% tax rate in line with historical
- Add back $52 million in excess cash to equity value
- Depreciation and amortization is roughly in line with cap ex and working capital is stable, so net income should be a decent proxy for free cash flow
Disclosure: No position