Investors could be forgiven for running a mile from listed education stocks. Vocation has been a disaster and Ashley Services Group has disappointed. But education software provider 3P Learning looks more attractive after recent price falls.
To recap, about five million children, through 17,000 schools in more than 200 countries, use its products. More students in the UK now use Mathletics than in Australia and 3PL has strong growth prospects in the US, a market where it is expected to make more investments or acquisitions. About a third of its revenue is earned offshore.
3PL’s flagship program, Mathletics, is used by more than 3 million students worldwide. The company distributes Reading Eggs, the popular online literacy product for younger children. Another literacy program, Spellodrome, and the latest release, IntoScience, complete its main education offering for schools and students.
A decade in the making, 3PL listed on ASX through a $282 million Initial Public Offering, at $2.50 a share in July 2014. It was part of an impressive group of tech IPOs that year, and in 2013 that included Freelancer, iSentia Group, Vista Group International and Rewardle.
3PL ticked plenty of boxes for fund managers. It had a large user base, a genuine global footprint, recurring licence revenue, high margins and a capital-light business model. It could expand without huge extra investment and should have high return on equity.
These are characteristics of exceptional companies and attributes this column looks for when choosing companies to analyse. When they it get right, software companies have these traits in droves, but usually come with a pricey valuation to match.
Unlike several other tech IPOs, 3P Learning’s share price has fallen since listing. It has mostly traded below the $2.50 offer price, despite beating key prospectus forecasts, exceeding market expectations with its earnings results, and making astute acquisitions.
3PL slumped to $1.80 this month, amid concerns from some fund managers that it was having to discount software licences heavily in the US to gain traction. It jumped to $2.06 after heavy fund buying and favourable analyst commentary on its latest investment.
Chart1: 3P Learning
Source: The Bull
3PL acquired in September a 23.07 per cent shareholding in Learnosity Holdings, a Dublin-based provider of software-as-a-service assessment tools for US$19.4 million. There is an option to move to 40 per cent within eight months.
It seems unusual that 3pL would agree to be a minority shareholder, but probably did so because of the deal’s strong strategic rationale. Learnosity gives 3PL access to state-of-the-art online assessment tools and can be leveraged across its product suite and geographic markets. It takes 3PL into an interesting space in online education.
The Learnosity tools should make 3PL products stickier within schools and, in time, improve its pricing power. Learnosity is growing rapidly, has an excellent customer base, and looks like a strong investment on its own, regardless of synergies with 3PL.
Moreover, the assessment technology strengthens 3PL’s offering in the key US market and should help it grow faster there. As more assessments in schools and universities move online, 3PL looks well positioned to benefit in the examinations market.
The Learnosity deal followed 3pL’s US$5 million investment in March for a 17 per cent stake in Desmos Inc, a US graphic calculator application business. 3PL is clearly comfortable being a minority investor if it means getting a foothold in fast-growing education ventures.
I favour companies such as 3PL that have a strong balance sheet and can fund acquisitions through surplus cash flow. Less debt is required and there are fewer equity share issuances that dilute shareholders and constrain return on equity. Small, low-risk, bolt-on acquisitions can be quickly added to the main platforms and strategic investments can be lifted.
Longer term, 3PL has a remarkable opportunity as the convergence of technology and education redefines how children learn. Textbooks and printed workbooks are migrating to online resources, technology is supplementing traditional classroom learning, and rising internet penetration and a rapidly growing middle-class in Asia are boosting demand for online learning.
The K-12 global online education market is estimated to quadruple to US$69 billion by 2017, from US$16.6 billion in 2012, according to a 2013 IBIS Capital report, referenced in the 3P prospectus. Technology in the global education sector is coming of age.
3PL’s return on equity should exceed 35 per cent this year, its cash balance exceeds its debt (there are barely any borrowings), and it has excellent cash-flow growth. The company is also well run and innovative: parents who have watched their kids use Reading Eggs know the power of the product and the potential of online education at school and university.
The key question, of course, is valuation. At $1.89, 3PL is on a forecast Price Earnings (PE) multiple of 18 times 2015-16 earnings, consensus analyst estimates show. That is not excessive for a high-growth software company with strong offshore exposure. Macquarie Equities Research has a 12-month price target of $2.92. Deutsche Bank reportedly has a $2.90 target – about 50 per cent higher than the current price.
3PL looks undervalued at the current price, but finding a short-term re-rating catalyst is hard. Further acquisitions or investments, at least for now, seem unlikely given the company has chewed up much of its $30 million of cash to the end of FY15 on the Learnosity investment. A large share placement at the current price, to raise funds, doesn’t make sense.
A favourable trading update in the annual general meeting later this year, and more signs of growth in the US, could spark greater interest in 3PL. Either way, it has a strong market position and business model in an online education sector with unprecedented opportunity.
As a small-cap company, 3PL suits experienced investors who can tolerate volatily.
– Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at Oct 6, 2015.