Friday Fishing: A Navitas education

Private education provider Navitas, which listed as IBT Education in 2004 at $1.00 a share, has found a very profitable niche as a bridge between international students and Australian universities. Students want the prestige of studying at an Australian university; universities want full-fee paying international students to help with funding pressures. Navitas brings them together, at a cost.

The company’s main division, University Programs, operates flexible colleges with small class sizes, preparing international students for Australian university life. It then feeds them into follow-on degrees at its partner universities.

This division accounts for about 75% of Navitas’ earnings. In the first half of 2012, it produced earnings before interest, tax, depreciation and amortisation (EBITDA) of $49m on revenues of $182m, an impressive margin of 27%. If the students are being fleeced, they appear not to mind.

The success of the model has led to international expansion. Navitas has signed deals with universities in the UK, USA, Canada and Singapore to deliver similar services. Smaller or less prestigious universities are especially keen; they love the fact that Navitas pays them royalties (amounting to 21% of revenue in 2011) and feeds them lucrative students.

After a period of phenomenal growth (the company’s share price rose to a high of $5.50 six years after listing) Navitas has hit a speed bump. Changes to local immigration and student visa policies, the high Australian dollar and the effect of violence against Indian students have hit the company hard. The international education sector contracted by 15% in 2011.

Red flag

This is partly why Navitas has been reducing its reliance on existing businesses. In February 2011, the company tried to accelerate its diversification program with the $294m acquisition of SAE, a media technology training business. Whilst also a high-margin education operation, SAE otherwise seems a slightly unusual fit and earnings have since disappointed. It’s a potential red flag.

Together, University Programs and SAE generate around 95% of Navitas’ earnings. While the company has several other divisions accounting for 30% of total revenue, none of them produce much profit. So Navitas is a bet on the continued success of its main division.

How might it fare?

Increasing demand for tertiary education, growing wealth in developing countries and funding pressure at Western universities suggests a prosperous future. That’s certainly what the market thinks: Navitas has traditionally traded on a hefty PER—up to 38 in 2009—a reflection of its growth potential.

But profit will flat-line in 2012 and, while a full year of earnings from SAE will help this year, it will be offset by a decline in the profit of University Programs (see Chart 1). Earnings per share are expected to decline from 22 cents to around 20 cents this financial year due to last year’s capital raising to fund the SAE purchase. At the current price of $3.42, the stock is trading on a prospective PER of 17.

Ritzy price

That means a decent profit recovery is already priced in. With long lead times for student decision-making and the fact Australia is currently an expensive place for international students (and everyone else—Ed), it might pay to be cautious.

There are other more fundamental risks. Questions have been raised over the academic standards of students emerging from Navitas courses. Some universities have also chosen not to proceed with agreements with the company, despite the financial benefits. If there’s a backlash over academic standards, it could seriously affect Navitas. It’s the epitome of a reputation-based business.

Offsetting that are the numbers in Table 1. Navitas enjoys high margins, high return on equity and generates lots of cash. There’s a lot to like and, with favourable long-term industry tailwinds, this company is likely to be more than a flash in the pan.

Closer look?

Given the risks, what is most unappealing about the stock is the price at which it trades. It may have fallen 38% since early 2010 but it remains premium-priced. Another upset—such as a failure to achieve growth in 2013—could see the share price tumble. Below $2.75 we’ll take a closer look.

Navitas is one for the watchlist but determining whether any downturn is cyclical, or related to more fundamental problems with the model, won’t be easy. While universities have chased the money thus far, academic standards will win out in the end. If Navitas can’t help them achieve that, it will struggle. But if those problems prove temporary, this would be an attractive business at the right price.