Select Equity Group Opposes Management-Led Buyout of Laureate Education (LAUR)
In the letter, Select Equity states that the Proposed Transaction is grossly inadequate and that the process by which the deal was proposed and evaluated was flawed by clear conflicts of interest.
In the letter the firm said, "Using the $5.00 per share figure projected for 2010 and applying the 24 times forward multiple currently placed on Strayer Education (Nasdaq: STRA), Laureate, by the summer of 2009, would trade at almost double the proposed transaction value. Using a conservative discount rate of 15%, Laureate is worth substantially more than $60.50 per share."
The firm changed their filing status from 13G to 13D, indicating their more active stance with the investment.
A Copy of the Letter:
Dear Independent Member of the Board:
Select Equity Group, Inc. and its affiliates are significant and long-term shareholders of Laureate Education, Inc. ("Laureate," or the "Company"). We began investing in the Company in 2003 and currently own over 3.6 million shares of common stock, making us the Company's third largest outsides shareholder.
We have admired the management of the Company over the last four years, but we have significant reservations about the proposed management-led buyout transaction at $60.50 per share. This offer is grossly inadequate and the process by which the deal was proposed and evaluated was flawed by clear conflicts of interest.
If the terms of the Merger Agreement are not amended to better reflect the true value of the Company, Select Equity will not support the transaction.
A. PEER ANALYSIS. Currently, Laureate's US peers - as defined in the Company's 2006 Proxy Statement - trade at an average of 21 times 2008 estimated earnings. Three of the six companies you compare Laureate to, however, have FLAT TO DECLINING EARNINGS, and the only company with revenue and earnings growth rate consistently approaching Laureate's, Strayer Education, trades at 24 times 2008 estimated earnings. The current deal, at $60.50, values Laureate at 19.5 times 2008 estimated earnings, nearly 10% BELOW that of its under performing peers and19% BELOW Strayer.
We think there is a clear argument to be made, however, that LAUR should trade at a premium to the US-based education companies. CEO Doug Becker has explained publicly the superior qualities of Laureate's business model versus its American peers, including: (i) International higher education markets are growing two to four times faster than the US market; (ii) A four to six year average length of stay per enrolled international student versus one to two years in the US; (iii)A lower attrition rate for international students; (iv) The absence of Title IV funding/regulatory issues internationally; (v) A two to three times wage premium for college graduates internationally versus domestically; (vi) Greater tuition pricing power internationally at one and a half to two times the rate of inflation; (vii) Virtually no online competitors internationally; (viii) Public higher education systems abroad that cannot afford to expand; and (ix) An untapped international adult education market.
Additionally, there is, as described by Mr. Becker, tremendous franchise value as the largest (and arguably the only) international network of universities. Laureate spent nearly a decade acquiring and integrating best-in-class universities in 15 countries, creating a network that would be extremely difficult--if not impossible--to replicate.
B. EARNINGS ANALYSIS. CFO Rosemarie Mecca said at a recent investor conference:"Our vision for 2010 has remained unchanged for the last several years. By 2010, it's our expectation that we have at least $2 billion in revenue and operating margin[s] somewhere around 20%, and EPS of about $5.00 per share. We're generally going to see between 15% and 20% earnings growth beyond 2010 to 2015.And I can tell you that Doug and I spend a lot of our time thinking about and working on the path beyond 2010."
Using the $5.00 per share figure projected for 2010 and applying the 24 times forward multiple currently placed on Strayer Education, Laureate, by the summer of 2009, would trade at almost double the proposed transaction value. Using a conservative discount rate of 15%, Laureate is worth substantially more than$60.50 per share. And there's upside to our forecast, as Mr. Becker has discussed the possibility of achieving that $5.00 EPS benchmark earlier than2010 if even a reasonable number of the accretive acquisitions currently in the pipeline in China and Brazil are completed.
C. ANALYSIS OF THE EDMC TRANSACTION. Some have undoubtedly tried to persuade you that the $60.50 per share price compares favorably to the valuation multiple at which Education Management Corporation (EDMC) was taken private in June 2006.But comparing EDMC to Laureate is inappropriate. First, the comparison does not accurately reflect the life cycle of capital deployment and harvest for each franchise. EDMC was a more mature business at the time of its acquisition; its capital expenditures had actually fallen by nearly 20% from fiscal years 2003 to2006. As evidenced by repayment of debt, significant cash accumulation on the balance sheet, capital spending declines, and public discussion of stock buybacks and/or dividends, we can infer that either returns on additional capital deployed had become less attractive or fewer opportunities were present for EDMC.
By contrast, Laureate sees, in the words of Mr. Becker, "an almost inexhaustible array of investment opportunities" with internal rates of return in the 40%range in Latin America and mid-20% range in Europe, as well as numerous high return opportunities in Asia. As evidence, Laureate's capital expenditures approximately doubled from 2003-2006, contrasting sharply with EDMC's spending trends.
Second, should your advisors encourage you to compare multiples of EBITDA, remember that Laureate's EBITDA is significantly understated, as the Company has been rapidly investing over the past few years to build its global platform. Mr.Becker has publicly discussed "lots of advanced investment in infrastructure, product development, new country entry, management additions," and other investments needed "to grow the business at a 15%-20% earnings growth rate"after 2010. For example, of Laureate's 58 campuses, only 25 are considered mature, 25 are developing, and eight are less than two years old. Company management has discussed how the operating margins of fully performing campuses can reach 40%, yet the existing campus network has operating margins of 18%. It should be noted that EDMC did not have such a high proportion of newer campuses(nor did it maintain a full-time M&A team in countries without campuses, as Laureate does). Additionally, Laureate's online business has undergone significant investment since the purchase of Walden, and management has told the investment community to expect online operating margins to reach the mid-20%range in a few years, up from current 19% margins. All told, Laureate is "in the early days of growing [the] business," according to Mr. Becker, pressuring EBITDA margins near-term while creating significant earnings power down the road.
Finally, if you are forced to compare the EDMC transaction with the proposal of the investment group led by Mr. Becker, a P/E multiple is a better valuation metric. After all, the Company pays minimal taxes today in most of the international markets in which it operates. The buyout of EDMC valued that company at 21.5 times calendar 2007 estimated earnings on June 1, 2006. The Laureate deal, expected to close in the summer of 2007, values Laureate at 19.5times calendar 2008 estimated earnings, or 9% LESS THAN the EDMC multiple. For the reasons discussed above, Laureate demands a higher multiple than EDMC.
Our reservations about this transaction extend beyond price to the process by which the deal was proposed and evaluated. There is an inherent conflict of interest in a management-led buyout that arises from interested management, in their role as part of the buying group, trying to get the lowest price for the company and a greater stake in the equity of the acquisition vehicle. Thus, in dealing with private equity suitors, interested members of management, by definition, act against the interests of the Company's other shareholders, who are seeking the highest price possible in order to maximize the value of their investment. In this case, the Special Committee's appointment of an interested member of management (Mr. Becker) to solicit offers from other potential suitors created an obvious conflict of interest between public shareholders and the buyout group.
We are concerned that the evident conflicts in this case have resulted in a deal that is unfair to long-term shareholders and we urge the Board to reconsider. As stated above, if the terms of the Merger Agreement are not amended to better reflect the true value of the Company, Select Equity will not support the transaction.
John D. Britton/Principal
James R. Berman/General Counsel