No one even reads the ESI board anymore. Used to get alot of traffic - particularly when the shorts were active. Short interest is still 9.7 million shares (against an estimated 23 million shares outstanding currently - that includes the 925,000 shares repurchased from April 1 - 24, 2012). Where did the shorts go? They are still out there, but don't bother showing up here. Maybe there are not enough longs on this board to have any impact.
Core Long Term Holders:
Providence Equity 1,483,161 6%
Argyll Res. 1,338,000 5.4%
Acadian 1,128,000 4.5%
Blum Partners 4,145,500 16.8%
Wellington 3,730,000 15.0%
Select Equity 3,121,000 12.7%
and Index Funds...
Vanguard Growth 664,999 2.7%
Other Vanguard 252,600 1.0%
These shares total to roughly 15,900,000, or 66% of shares.
That leaves an adjusted float of 8,100,000 shares.
The short interest is thus 121% of the adjusted free float.
Another way to look at it is that the short interest has created an additional bunch of long shareholders to the tune of 9.8 million shares. And there is the above referenced existing adjusted float of 8.1 million shares. So, longs are at 9.8 mill and 8.1 million shares, or 17.9 million. Against this figure, the short interest is still a stunning 51%.
These figures are "off the charts". ESI must have the largest short interest figures in the market. I can think of no other company, with the exception of Diamond Foods, that has figures like this. And Diamond Foods is a nightmare (bad earnings, accounting problems, management terminated, terrible balance sheet, no cash, etc.). And none of these things that taint Diamond Foods appear even remotely with ESI.
thanks for the clarification. It helps greatly to understand how you got to your numbers. Clearly the keys here are new student enrollments (which converts to total student enrollment), tuition rates (unit pricing), and operating margins (ie cost structure). ESI's financial model has enormous "operating" leverage (no financial leverage as there is nominal debt outstanding). As such, cash flow and earnings are highly sensitive to the above factors. One interesting thing along these lines with ESI is that student enrollment has fallen from 88,000 students (revenues were $410 million and op profits $162 million, op margin 39.6%) to 71,123 students (revenues $340 million and op profits 100 million, op margin 29.4%). These are meaningful declines, of course, but the margin decline is far less than I would have expected. Earnings per share have dropped from $2.82 per quarter to $2.38 per quarter, a decline of only 15%. Earnings per share numbers have fallen significantly less than the other numbers as the company has repurchased stock with its free cash flow.
The question is at what level of student enrollment will the company's business stabilize, if at all. Ten years ago ESI had lower operating margins, but a much much smaller student enrollment. In late 2007 and early 2008 ESI had a student enrollment of 53,000 - 54,000 and reported operating margins of 21% to 29%. It will be interesting to see how margins turn out going forward.
My analysis of ESI correctly figured out the the ESI per share earnings decline was going to be far far less than what the shorts were projecting several years ago. Nonetheless, the market environment and valuation metrics have changed over the past several years. I remember when bombed out stocks would trade to 8-10 times their peak earnings levels. At those valuations, people would start to look seriously at the stock. A stock that had earned $2 per share and traded at $38/share would generate interest at a price of $16 - $20 per share, even if current earnings had dropped to $1.40/share. Now, in the current environment, that $1.40 in earnings per share gets a p/e of 5-6, or a share price of $7-$8. ESI is in this boat.
Right now, all of this analysis is of little consequence as the stock market has no "value" buyers. Any stock that has an actual or perceived earnings issue is automatically delegated to the mid single digit p/e level, regardless of the quality of the balance sheet, stock buybacks or other. All one has to do is look at Lexmark, HPQ, ESI, and RIMM among a host of others to see this. On the other hand, those companies where earnings are rising at the present time achieve huge multiples, Starbucks, Whole Foods, Sherwin Williams, a variety of high flying tech names, and so on. In the meantime, there are absolutely no "value" buyers in the market. What ever happened to all the value oriented mutual funds? I know that they used to get so excited to be able to buy a stock at ten times earnings. Now no one hears a peep out of these funds. They must have been crushed in the 2008/2009 market collapse when they bought declining stocks too soon. The market participants are not willing to buy things bombed out a wait for improvement. These stocks drop and then go a whole notch lower generally, scaring everyone to death, as we have seen with ESI.
1) I'm not factoring in any buybacks past 2013.
2) While you use a constant operating margin, I have it declining at an average of 8% YOY rate, down to about 15% in 5 years. FWIW, 10 years ago their operating margins were 12.9% - an indication of the leverage of their business model. In total, I'm modeling about a 10% average year over year decline in earnings.
Obviously this is the crux of our disagreement.
Thanks for the numbers, I thought that you were never going to produce a figure.
I used your 60,000 student enrollment number, $4550 in revenue per quarter per student (assuming no increases going forward), and 22.5% operating margin (well below the 28% currently). With those figures ESI will generate $166 million per year in net income. With that income, assuming the p/e stays at 6.9 times (ie the share price rises as more and more stock is repurchased), ESI share count will drop to 11.6 million in 2016 (in four years) against a short interest of 9.8 million. This is clearly not possible as the short shares will be called in creating huge demand in a less and less liquid stock. Your numbers may seem fine to you, but they pose a serious question as to the resolution of the massive short interest. I also took you numbers and did a discounted cash flow at 10% and came up with a much higher number than $54. You analysis also may not account for the fact that ESI's cash flow accumulates to shareholder's, yet earns zero compounded interest. As such, the company is deploying all its free cash flow to stock buybacks. Unless you fully put the free cash flow back into the numbers through a stock buyback, you are not doing the math correctly. Doing this with your numbers generated a net present value for 9 years of earnings of $70 per share and a terminal value of an additional $97, for a total of $167 per share in net present value. All you have to do is take the $166 million and buyback stock each year to that amount. The share count falls and free cash flow per share rises. With your numbers, ESI generates $25.11 per share of free cash flow on a base of 5.8 million shares after 9 years. Then that $25 per share annual terminal value is worth at least $97 per share to stockholders ($25 annual perpetuity divided 10% discount rate then discounted back 9 years at 10%).
Did you factor ongoing stock buybacks into your calculation? If so, in what year did your share count drop below the level of short interest? What was the number of shares outstanding in you model after 5 and 10 years.
I appreciate you posting your numbers. I am sure it is not a problem to post these additional numbers as you have clearly put them all into a handy spreadsheet, as have I.
Using my 5-year growth model with a 10-years of terminal growth and a 10% discount rate, I come out to a fair value of $54, but that assumes student enrollment stabalizes around 60K which may be too optimistic. But as you pointed out, that there is so much overhang on this stock and no positive catalysts in site, that it will likely go lower. Models are only so useful when the extent of the decay of the company is so uncertain.
Of course, the shorts are betting on draconian action by the US government on the for-profit education sector and a resulting drop in enrollment numbers and thus cash flow. The stock market players are current scared of the uncertainty and I have no great crystal ball on how it will all end up. The company continues to buy back stock hand over fist every quarter, ESI remains very profitable, and people need educations (there are only so many jobs flipping hamburgers at McDonalds).
My interest in ESI is based in its focus on vocational training. I am not invested in any of the conventional for-profit, general education colleges (I am actually short APOL). It is my belief that we need more schools like ESI that teach students how to become nurses and other industry specific professionals, as opposed to getting majors in South African history. My opinion is of little consequence. ESI, at $1.4 billion, is one of the largest market cap publicly traded education companies and its size makes it a target for the short sellers. ESI's profit margins also make it a target as the argument goes that no one should make a "profit" from education. Yet, anyone that thinks Harvard, or other colleges do not have huge built in profit margins is grossly mistaken. These profits are simply consumed by wasted spending, inflated salaries, physical plant expansion, massive overhead and administrative costs, and unnecessary student luxuries that are targeted at levels to consume these excess profits. The for profit schools do not burden themselves with these ridiculous costs. ESI's services are priced well below what a general education costs and they still generate significant margins. Not everyone automatically gets a job in life, regardless of your training or education. I never went to an interview where I expected to automatically be given a job, regardless of my qualifications. Not being able to get a job is frustrating, but not getting an education is a one way ticket to palookaville.
For the moment, this is all of little consequence as the education sector has the monkey on its back, so to speak.
Anyway, please provide your cash flow projections and dcf figures. Thanks.
No problem. Use whatever method you wish to for valuation. What valuation do you get to based on what numbers using what method? I am interested in what you think. Is that so hard to answer?
Basically, ESI generates about the same amount of depreciation as it spends on capital expenditures, so free cash flow each year is the same as earnings.
Since 12/31/07 quarter, ESI has generated $49.14 in per share earnings (total free cash flow). The company is generating roughly $2.35 per quarter in free cash flow now. That is a $9.40 annual rate. Any discounted cash flow analysis requires an estimate of on the order of 15 years of forward annual cash flows projected and an assumed discount rate. One can almost make up any number they wish for valuation using various assumptions. Furthermore, who know where ESI's earnings and cash flow will be 15 years from now. Despite this, I would very much like to see what your numbers are.
The other factor involved is that each year ESI's free cash flow generates no ongoing compounded return since bond yields are so low. A quarterly operating income (then take out taxes) stream of $86 million allows the retirement of 3.9 million shares each year at the current $58 share price. If this rate continues than the share count will collapse and that same quarterly operating income will generate not $9 per share in free cash flow, but a figure much higher. Here is my cash flow analysis.
To be specific, under the current state of annual earnings (assuming no meaningful drop off), ESI will eliminate all shares outstanding by 2018, or in 5 1/2 years. During that time (2012 to 2018)the cash flow per share will be $9.00, $10.55, $13.02, $16.99, $24.44, $43.53, $198.94 (only 1 million shares will be left outstanding that final year). This discounted cash flow stream equals $200 per share at a 7.5% discount rate and attaches no value to the full terminal value of the company at the end of year 2018 (this terminal value on $213 million in annual after tax free cash flow itself could be worth another $53 per share in net present value today by my calculation). Under this scenario, ESI is currently worth $250 per share (which is about 25 times current earnings). I did not make adjustments in my analysis for a rapidly rising stock price over this time and assumed that all share repurchases were made at the current $58 price (this is clearly not realistic, but for practical purposes I did not have time to make that adjustment to my model yet).
I didn't give my opinion on what P/E ESI should have - and won't, because NCF is better to use for comapany in rapid decline. The P/E ratio is almost irrelevant since it is based either for the past year or just the next year, which are both near all-time peak earnings for ESI, versus the longer term trajectory.
Step 1: Re-read where I wrote "WEIGHTED" average shares.
Step 2: Go pull up your high school financial text book and read how "WEIGHTED" avergae shares are calculated and how it differs from "OUTSTANDING" shares.
You of course pose a most interesting question (which I asked you previously and you failed dot again answer).
"The key is what multiple you put on a company whose enrollment/revenue is decaying and has negative growth?"
Regarding you question, I would also ask...
"What multiple you put on a company whose enrollment/revenue has stabilized, has huge free cash flow, and is buying back enormous quantities of stock?"
These questions are clearly the bear and bull scenarios. Anyone with either a long or short position in ESI must have evaluated both. It is the correct and prudent thing to do from an investment perspective.
So what is you answer to each question? Is the answer a p/e of 3,4,5,7, 9, 12, 15, 20....?