Australia | Jul 10 2014
-Will other universities follow?
-Loss reduces growth profile
-Yet macro drivers still favourable
By Eva Brocklehurst
Education program provider Navitas ((NVT)) has been dealt a blow. Macquarie University has decided, come 2016, it will take a major partnership program in-house. This represents a large loss of income for the company and there is an earnings gap that needs to be filled from 2016. Will Navitas be able to meet the challenge? Most brokers believe the outlook is favourable but the announcement does elicit a few questions.
The contract, via Sydney Institute of Business and Technology (SIBT) at the Ryde campus, is one of the company's longest standing and most profitable. Macquarie University is the company's highest ranked Australian university partner. The decision to terminate the contract coincides with a new vice chancellor being appointed at the university. Navitas has, in the past, signalled royalty payments to its university partners typically represent 25% of the student fees. There is a replacement contract, as a CBD-based visa processing partner which could supply international students to Macquarie University, but volumes are likely to be lower than under current arrangements.
Will other partners try to take programs in house? Several brokers field this question. CIMB wonders, too, whether other universities may also try to bargain on price. Navitas will likely try to place students into other campuses and this may provide some offset. The upside for Navitas is that it requires scale and brand power for other universities to move programs in-house. The bear case scenario, whereby Navitas loses all the the SIBT students, reduces FY16 earnings by 23%. Still, CIMB does not think the bear case is likely. CIMB reduces earnings forecasts for FY16 by 7% and for FY17 by 16%. The broker sticks with a Hold recommendation but other brokers have seen fit to change their ratings on the back of the announcement. Not all of them are more bearish.
Citi upgrades to Buy from Neutral. The broker concedes the loss of Macquarie University is a significant issue and the university probably decided the move would help lift its ranking. Outsourced first-year pathway programs are rare among Australia's top eight universities. The broker doubts the cancellation was for financial reasons, as Macquarie University could have easily coaxed a higher royalty payment or renegotiated terms. Moreover, Citi thinks Navitas can compensate for the loss, as its model remains attractive for universities, students and investors. The broker believes earnings are yet to fully recover from depressed enrolments caused by visa changes. Also, little success is being factored in for new contracts in North America. Longer term, strong returns are also likely because the company is exposed to Asia's emerging middle class.
The contract loss highlights a risk that the market previously ignored. Hence the sudden drop in the share price yesterday, which is an over-reaction in Citi's opinion. UBS thinks so too, adjusting valuation methodology but noting a 31% fall in the share price is excessive. Now the stock is trading at a slight discount to its revised price target, UBS raises its recommendation to Neutral from Sell. UBS estimates that SIBT paid Macquarie University $18m in 2013, which means it generated $72m in revenue. Applying a 35% margin delivers an estimate of $25m in earnings generated from the agreement with the university and UBS has reduced FY16 earnings estimates by 5.9% and FY17 by 13.0%.
UBS thinks the company's model may fall under further scrutiny. In the past eight years university programs have been affected by regulatory change, and while all agreements have been renewed under materially similar terms and conditions, the broker does wonder whether the balance of power has shifted such that terms will need to become more favourable to the universities as they are re-signed in the future. Such as shift would ultimately lower the value placed on further cash-flow from partner agreements. Credit Suisse cites a preference for being on the sidelines until the long-term impact of Macquarie University's decision is better understood, even though the macro environment for international tertiary education is unchanged and Navitas is well positioned. Credit Suisse downgrades to Neutral from Outperform.
Key pathway contracts that are up for renewal in the next 18 months include University of Massachusetts, Edith Cowan University and Curtin University. While some universities have extension options, terms must be agreed by both parties and, hence, there is some increased risk of cancellations, in Macquarie's (the unrelated investment bank, not the university) view. Macquarie also downgraded the recommendation to Neutral from Outperform because of the earnings hit that will apply in FY16/17 and also because this was a key relationship, now lost. The broker adjusts forecasts, assuming some of the core student numbers are retained, envisaging a loss of 2,400 students. With average revenue per student of $30,000, and assuming incremental margin around 40%, this implies an earnings hit of around $31m. Macquarie reduces earnings forecasts for FY16 by 7.6% and FY17 by 13.1%.
BA-Merrill Lynch believes the macro drivers are favourable for Navitas, with rising income in emerging economies and growth in internationally mobile students. Australia could receive an incremental 50,000 students by 2020 and Navitas is well positioned to benefit from such an environment. Nevertheless, as Morgan Stanley sums up, at the very least the significant premium the stock enjoyed in recent times will be compressed back to market levels as investors assess the sustainability and quantum of earnings growth in the year ahead.
There are one Buy and five Hold ratings on FNArena's database, whereas the day before there were two Buy, three Hold and one Sell. The consensus target is $5.27, suggesting 3.7% upside to the last share price. This target compares with $7.40 ahead of the announcement.
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