By Ross O'Toole, CFA :
Key Stats: Lincoln Educational Services Corp.
May 23, 2019
Market Cap: $70m
Enterprise Value: $72m
3-Month Average Volume: ~10,500
FY 2019e EBITDA (EV/EBITDA): $12.5m (5.4x)
FY 2020e EBITDA (EV/EBITDA): $17.1m (4.2x)
FY 2021e EBITDA (EV/EBITDA): $25.4m (2.8x)
Valuation range based on 8x: $4.00 - $8.25 per share or +39-185% upside
After several years of working to sustainably improve student starts ( the key leading indicator) , there is mounting evidence that Lincoln Educational Services Corp. ( LINC ) will achieve this going forward. In fact, the Company has experienced positive student starts for six straight quarters, and I expect Lincoln will report positive student starts for a seventh straight quarter when i t report s Q2 2019 results. For the past several quarters, management has maintained its expectation of turning GAAP net income positive for fiscal 2019. This outcome is well within their control, given fiscal 2019 started with a higher average student population (> 750) due to the multiple quarters in a row of positive student starts. The beauty of a business model like Lincoln's: when revenues are growing (even marginally), the inherent leverage of incremental sales to the operating line is substantial.
Justyn Putman, Talanta on Q4 2018 Conference Call
I was wondering if I could get a sense of what you think your kind of incremental contribution margin is for new students coming in now. I think we talked about that in the past, but I was just going to see what your thoughts are now.
Scott M. Shaw, CEO of Lincoln Education
Sure. I mean, again, that is where we see benefit going to the future. Historically, we've seen numbers ranging from 30% to 70% depending on where we are in the cycle and where individual campuses are. I certainly would anticipate focusing on the lower level of that range going forward, and that's kind of what we're assuming in our guidance.
Much of running schools is fixed - labor, facilities, equipment expenses. Lincoln can decide to invest more in marketing, add new programs or build new campuses, all of which would have a short-term impact on profits, but potentially intermediate-to-long term benefits to returns.
Investment decisions are about assigning probability weights to various potential outcomes and looking for those with positive expected values. The most likely outcome here - Lincoln continues to grow student starts, perhaps not every quarter, but yearly over the next several years, leading to an improving revenue profile whereby a significant portion of those incremental revenues drops to the operating line.
|Educational services and facilities||(136,742)||(142,924)|
|Impairment of goodwill|
|Gain (loss) on sale of assets|
|Total Operating Expenses||(282,212)||(292,344)|
|Income fr. continuing operations before tax||6,337||14,624|
|Provision for income taxes||(1,331)||(3,071)|
|Income from continuing operations||5,006||11,553|
|Loss from discontinued operations, net|
|EPS - continuing operations||$0.20||$0.45|
|F.D. Shares Outstanding||25,000||25,500|
|Educational services and facilities||-47.0%||-46.2%|
|Total Operating Expenses||-97.0%||-94.5%|
|Income fr. continuing operations before tax||2.2%||4.7%|
|Provision for income taxes||-21.0%||-21.0%|
|Income from continuing operations||1.7%||3.7%|
|Educational services and facilities||5.9%||4.5%|
|Total Operating Expenses||5.4%||3.6%|
|EPS - continuing operations||269.9%||126.2%|
|F.D. Shares Outstanding||1.6%||2.0%|
Let me be clear, I expect the results in the next couple of years to be different from my projections; however, I do believe the model presents a directionally accurate picture of the potential of the business model based on the high likelihood of a continuation of positive student starts.
In this scenario, the return of more consistent results will accomplish two important things. First, it will help to remove the stigma the for-profit education industry has carried for the last decade (Lincoln has never been a bad actor). Second, the stock will re-rate to a multiple more appropriate for a company with mid-teens operating margins and SaaS-light like revenue visibility.
In 2010, Lincoln reported operating margins of 16.7% and a return on equity (ROE) of 31%.
Q4 2017 provided a glimpse of Lincoln's financial potential: overall student starts increased 11.2%, with Transportation and Skilled Trades increasing 7.2% and Healthcare and Other Professions (( HOPS )) increasing 16.1%. Adjusted EBITDA increased 24% year over year, achieving a 17.2% margin. Reported net income clocked in at $9.2m.
In Q3 2018, Lincoln was marginally profitable at the operating income line with the expectation that Q4 2018 will produce results similar or better than the prior year.
In Q1 2019, Lincoln reported a placement rate of 81%, an increase of 120 basis points YoY, with Transportation coming in at 83% and Healthcare and Other at 78%. The goal in the near term: reach a consolidated 85%.
Student starts for the past several quarters:
Transportation from Q1'19 - Q4'17: +0.8%, +12.9%, +10.2%, +7.5%, +0.6%, and +7.2%
Healthcare and Other Q1'19 - Q4'17: +5.9%, +21.9%, +0.7%, +21.1%, +5.5%, and +5.0%
It must be acknowledged that if the momentum in student starts, retention, and placements were to stall, or worse, reverse, then the outcome would be problematic for investors. There is a non-zero chance the equity could get whipped out under such a scenario. On the other hand, Lincoln owns $60m in real estate, according to management's estimate, against an enterprise value of $72m. The real estate secures the Company's credit facility with outstanding debt at approximately $24m. Moreover, twenty-two of the Company's twenty-three campuses are profitable; some more so than others. There are likely ways to mitigate a situation where equity investors lose their entire investment.
The other scenario that carries hard-to-handicap risk is a change in the regulatory environment. The Obama administration made numerous changes to the for-profit education regulatory framework. As a result, all companies operating in the industry were negatively affected (most of the changes date back to 2011). And, a couple of the worst actors - Corinthian Colleges and ITT Education Services, were more or less forced into bankruptcy. I believe the Government's intention was to clean up rather than destroy the industry. The current administration is unlikely to attack the industry. In two years, if an Elizabeth Warren-type administration rules in Washington, then perhaps this will change again, but the skills gap is real, and Lincoln is producing good results as validated by the mid-80s placement rates.
Here are some government statistics on the skills gap:
The market for qualified service technicians is large and growing. In the most recent data available, the United States Department of Labor (U.S. DOL) estimated that, in 2016, there were approximately 749,900 employed automotive technicians in the United States, and this number was expected to increase by 6.1% from 2016 to 2026. Other 2016 estimates provided by the U.S. DOL indicate that the number of technicians in the other industries we serve, including diesel, collision, and motorcycle is expected to increase over this ten-year period by 9.2%, 8.5%, and 0.3%, respectively. Marine repair is expected to decrease over this ten-year period by -0.5%. The need for technicians is due to a variety of factors, including technological advancement in the industries into which our graduates enter, a continued increase in the number of automobiles, trucks, motorcycles and boats in service, the increasing lifespan of late-model automobiles and light trucks and an aging workforce that has begun to retire. As a result of these factors, the U.S. DOL estimates that an average of approximately 125,200 new job openings will exist annually for new entrants from 2016 to 2026 in these fields, according to data we reviewed. In addition to the increase in demand for newly qualified technicians, manufacturers, dealer networks, transportation companies and governmental entities with large fleets are outsourcing their training functions, seeking preferred education providers who can offer high quality curricula and have a national presence to meet the employment and advanced training needs of their national dealer networks.
The U.S. DOL estimated that, in 2016, there were approximately 404,800 employed welders, cutters, solderers, and brazers in the United States, and this number was expected to increase by 5.6% from 2016 to 2026. The U.S. DOL estimates that an average of approximately 45,800 new job openings will exist annually for new entrants from 2016 to 2026 in this field, according to data we reviewed.
The U.S. DOL estimated that in 2016 there were approximately 145,700 employed computer-controlled machine tool operators in the United States, and this number was expected to increase by 1.1% from 2016 to 2026. The U.S. DOL estimates that an average of approximately 14,500 new job openings will exist annually for new entrants from 2016 to 2026 in this field, according to data we reviewed.
Management Credibility Increasing
Lincoln is at an inflection in student starts. For the past six quarters, management has communicated certain expectations to investors and consistently met or exceeded those expectations.
"Given the fourth quarter results and the trends that we are seeing in the first quarter, we believe that our actions are working. We changed vendors, increased investments in strategic areas and improved our systems and processes. We currently believe that for the first time in many years, overall starts from our campuses operating as of January 1 will grow for the entire year." -CEO Scott Shaw on Q4 2017 Conference Call
" We are seeing at least four months of positive [student start] trends." -CEO Scott Shaw on Q4 2017 Conference Call
"We achieved increased student starts in both segments for the second quarter in a row. The results we reported today are ahead of our internal plan and have enabled us to reiterate the previously provided guidance for 2018. " -CEO Scott Shaw on Q1 2018 Conference Call
"We should return to profitability in 2019. And that is our goal . -CFO Brian Myers on Q1 2018 Conference Call
"It sounds like you said starts will pick up in the second quarter."
-Alex Paris, Barrington Research:"Yes, that's correct.
-Scott Shaw, Lincoln: Q1 2018 Conference Call
"Our student starts in Q2 knocked the cover off the ball. We reported student starts for the second quarter at an overall growth rate of 11.6%. This represents the third consecutive quarter of student starts growth for the company. Starts for the first six months, excluding Transitional, are up 6.8%. We have not experienced similar growth in approximately ten years." -CEO Scott Shaw on Q2 2018 Conference Call (Italics mine)
"Our high school student start plan was achieved for the second quarter and we're on track to achieve our high school start plan for the year." -CEO Scott Shaw on Q2 2018 Conference Call
"Both segments have demonstrated remarkable improvements and continue to exhibit positive start momentum" -CFO Brian Myers on Q2 2018 Conference Call
"This morning we reported that in the third quarter student starts at our continuing operations grew 7.5% and on a trailing-twelve-month basis our student starts have also grown 7.5%. That means for the last four quarters we have achieved growth in both of our segments each and every quarter." -CEO Scott Shaw on the Q3 2018 Conference Call (Italics mine)
"Our consistent student start growth has led to improved operating results from continuing operations and has positioned the company to achieve GAAP profitability in 2019." -CEO Scott Shaw on Q3 2018 Conference Call
"The real story is that student population at the end of the quarter is ahead of last year by more than 650 students and we expect to carry into 2019 with at least 400 more students." -CEO Scott Shaw on Q3 2018 Conference Call
"We are raising our guidance today. First, we now anticipate revenues to increase 3-6% compared to the prior year. Second, we anticipate student starts will increase 5-7% compared to the prior year. Third, we now expect operating income to be between $1m and $3m. Fourth, we continue to expect our 2018 year-end population to be greater than the prior year. Fifth, we expect to achieve net income in 2019." -CFO Brian Myers on Q3 2018 Conference Call
"We reported fourth quarter student starts from same-school operations grew +12.1% and for the full year our student starts grew 7.7%. More importantly, we achieved growth in both segments for the past 5 quarters and we are projecting to achieve growth in both segments for this upcoming quarter." -CEO Scott Shaw on Q4 2018 Conference Call
"…we believe [we] will deliver profitability in 2019 and position us well to capitalize on the surge in growth we expect when the economy is more favorable to our business." -CEO Scott Shaw on Q4 2018 Conference Call
"…we started 2019 with more than 750 students over the prior year. This higher population, coupled with further growth, will result in profitability for 2019." -CEO Scott Shaw on Q4 2018 Conference Call
"Our student starts continue to grow. We generated revenue growth, our student graduation rate and placement rate growth continued to increase." -CEO Scott Shaw on Q1 2019 Conference Call
"We are successfully navigating the macro headwinds and our performance to date in Q2 remains on plan" -CEO Scott Shaw on Q1 2019 Conference Call
"With a high amount of fixed costs combined with increased revenue, we are experiencing operating leverage of approximately 70%." -CFO Brian Myers on Q1 2019 Conference Call
Reasons Student Starts Will Continue to Improve:
Change is sometimes described as slow and then all at once. The six straight quarters of positive student starts at Lincoln are a result of many factors over the last couple of years. First, new sales leadership was put in place a few years ago. The new leadership has now had a couple years to work with the sales team using updated training methods and better tools. The high school field representatives numbered approximately 75 in 2016 and today is closer to 90. In 2017, the Company selected a new paid search vendor with the capability of providing enhanced analytics and improved buying efficiencies. The vendor is also an authorized Google partner agency. Moreover, the Company "goosed" spending in 2017 and then developed a new creative marketing campaign that launched in the first quarter of 2018. The Company also added 2 dedicated field reps to focus on persons leaving the military - these student starts have improved 12% recently. The call center in Denver that, a few years ago, employed approximately 10 individuals is now staffed closer to 30. The Company has plans to redo its website content for 2019, with the goal to make it easier for prospective students and parents to interact with the Company.
Education is Countercyclical
Education tends to be somewhat countercyclical. When the economy is strong and unemployment low, employers become more desperate to find workers, wages increase. The benefits of forgoing a working wage in favor of taking out loans to develop a new skill decreases, especially in Lincoln's Transportation and Skilled Trades segment (approximately 65% of students). This has been the economic backdrop now for ~115 months. It's possible the industry has simply reached a new equilibrium from which it can slowly begin to grow (in the current economic environment) and grow considerably faster (in a weakening economic environment). For example, in 2010, Lincoln had 39 campuses and almost 30,000 students, compared to today's 23 campuses and approximately 10,000 students. Lincoln's management has executed a successful reorganization of its campuses and programs over the past several years and now is ready to reap the rewards of such efforts.
It's possible the low unemployment rate is leading employers to work more closely with Lincoln to encourage students to learn auto tech, CNC machining, or welding because the jobs are going unfilled at higher and higher rates with an aging workforce.
"As I've mentioned on past calls, increasingly, companies are looking to us to help them solve their workforce needs whether that is helping them recruit new trained technicians or upskilling their existing workforce." - CEO Scott Shaw on Q2 2018 Conference Call
"Advanced discussions with other corporate partners continue and importantly we are also having numerous conversations with a variety of corporate partners regarding the expansion of their current programs to additional campuses." - CEO Scott Shaw on Q1 2019 Conference Call
New programs have also been a driver to improving student starts. In a number of conversations with management, I've learned:
- Added a welding program at South Plainfield (sold out)
- Expanded welding program at Nashville
- Added a welding program at Indianapolis
- Had a new CNC program in place for the full year
- Brought back a collision program
- In fact, except for the CNC machining program, the others only place for half of 2018
Lincoln successfully moved seven campuses accreditation to ACCSC during Q2 2018, which will allow the Company to submit new programs and program modifications starting in Q4 2018 and into 2019. Management acknowledged as much on the Q3 2018 conference call:
"You should definitely expect some new ones [in 2019]. " -CEO Scott Shaw on Q3 2018 Conference Call
Investors can look for Lincoln to add welding and electrical to one or two more campuses each and a new registered nurse program to another sometime during 2019. These program additions will support continued positive student starts into 2020 and beyond. A welding program can add as many as 100-120 new students at full capacity per school.
And, from recent conference calls, investors have learned that Company has been adding and expanding partnerships :
- Hussmann TechX program graduated its 2 nd class (Q3 2018)
- Johnson Controls ( JCI ): ceremonies at 2 of 10 campuses (Q3 2018)
- New VW ( VWAGY ) training program at Mahwah, NJ campus (Q3 2018)
- Negotiation with another OEM for a new advanced level program (Q3 2018)
"Our placement rates increased 400 basis points compared to the prior year." - CEO Scott Shaw on Q4 2017 Conference Call
"Our placement rates are also improving and we hope to achieve 80% placement overall for 2018, which will be the first time in over a decade that such levels have been achieved. " -CEO Scott Shaw on Q3 2018 Conference Call (Italics mine)
"In March, we reported that our placement rate for the full year 2018 increased to 120 basis points to more than 81% with an 83% rate in transportation skilled trades and a 78% rate in healthcare and other professionals' segment." - CEO Scott Shaw on Q1 2019 Conference Call
"We have created new reports that allows us to quickly assess teacher performance and student engagement. And by continuously monitoring these reports and taking corrective action, we are able to increase retention." - CEO Scott Shaw on Q3 2018 Conference Call
Cost Savings and Cash Flow Improvements
"We have identified additional lease savings, which will further help lower our fixed costs over the next twelve months and beyond." - CEO Scott Shaw on Q3 2018 Conference Call
"We also expect to achieve approximately $1.7m in annualized cost savings through the closure and teach-out of LCNE." - CEO Scott Shaw on Q3 2018 Conference Call | This teach-out costs Lincoln about $4m in additional expenses in 2018 that will not repeat in 2019
"If you remember last year our cash flow from operations was a negative $11m. This year we're expecting to be slightly positive. Our capital expenditures are going to be around $6m so our cash position will be down about $1 million from last year." - CFO Brian Myers on Q2 2018 Conference Call
"We will generate cash from operations and even add to the cash position [in 2019]. WE anticipate we'll be in a positive net debt position." - CFO Brian Myers on Q3 2018 Conference Call
"We have some dorms in the Hartford area that will be expiring. I believe, around September of this year, and we basically carry a negative $1m a year on those dorms. So that will definitely [be] going away, but we also see some other opportunities as well for lease savings." - CEO Scott Shaw on Q4 2018 Conference Call
Cohort Default Rates
Lincoln's 90/10 cohort default rate was 79% at year-end 2017 - 200 basis points below the national average. And, on the Q3 2018 call, management indicated cohort default rates improving for the fifth year in a row in 2018.
Lincoln's management team should be applauded for reconfiguring the asset base of the Company (shutting down underperforming, i.e. money-losing campuses and selling non-core real estate) to improve the P&L and the balance sheet over the past few years. The current balance sheet has approximately $23m in cash and $24m in debt. Lincoln is likely to generate free cash flow in fiscal 2019; in fact, management has said as much on conference calls. However, more work needs to be done to position Lincoln for long-term success. More work needs to be done to remove the non-zero chance of permanent equity impairment. For example, for-profit educator, Education Corporation of America, recently filed for bankruptcy, which could lead to a similar situation as Corinthian a few years ago, where thousands of students' education became stranded. It is situations like this that can lead to unwanted attention from Washington. In addition, state regulators could require more bonding. Lincoln would like a stronger balance sheet to ensure the recent success it is experiencing does not get undone. A stronger balance sheet would not just be defensive but offensive as well. Lincoln could roll out new programs faster, relocate outdated campuses in favor of more modern ones, or even build new campuses or pursue appropriate M&A.
Management believes if it can achieve its goal of reaching positive GAAP net income and generate free cash flow in 2019 that the Company's negotiating position with its bank group will improve. It's possible a favorable refinancing is in the future. If less collateral is required, the Company could pursue a sale-leaseback with its real estate. The Company has a beauty school (non-core) in the Las Vegas area generating approximately $1.7m in EBITDA. This asset could be sold for perhaps 5-6x and raise $8-10m in cash. Or Lincoln with its longstanding and highly concentrated shareholder base could pursue a rights offering at the appropriate time.
Lincoln's student starts are positively inflecting with management, indicating the Company started with a 2019 average student population approximately 750 (~$17m in highly EBIT incremental annual revenue) ahead of 2018. Even so, 2019 will be a transition year, and investors may not see the typical 40%+ incremental margins immediately. The Company offers programs that provide a valuable service to an underserved student population in areas of study where there is a skill shortage - auto tech, diesel tech, CNC machining, welding, electrical, nursing. The Washington Monthly named Lincoln its number 24 best vocational school - the Company has a history that dates back to the mid-1940s. The Company is producing graduation rates and placement rates that revive and sometimes exceed those of traditional schools. Yes, there is always the risk of further negative regulatory actions. Yes, the student starts, retention, and placement progress could fail to be sustainable. However, these potential outcomes are less likely, in my opinion. Further, the real estate value, the value of most campuses, and industry partnerships provide a measure of downside protection. The equity has as much 185% upside over the next several years if the company continues to report positive student starts and can convert the incremental revenues into operating income as it has done historically.
|Lincoln Education Services Corp.|
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