GHC - Graham Holdings: Cheap Bets On The Automotive Industry And Education

2023-03-06 07:55:06 ET

Summary

• Graham runs diversified operations that include education, the entertainment industry, streaming services, manufacturing and production, home care and hospitality, and automotive businesses.
• I would also expect beneficial results from the company’s acquisitions of dealerships, higher average new and used car selling prices, and more consumer demand for used vehicles.
• I assumed that in the next ten years, Graham Holdings may be able to sell more pre-college test preparation programs, and enrollments may trend north.
• Management appears to sign many agreements with large video platforms. In my view, in the next decade, with the increase of demand for video content, we may see sales growth.

Graham Holdings Company ( GHC ) operates a diversified business conglomerate that is making, in my view, savvy transactions. With growing exposure to the automotive industry, more agreements with video content platforms, and perhaps more enrollment of students in Kaplan Education, GHC will likely report more FCF in the near future. Even considering risks from changing regulatory frameworks, I believe that Graham Holdings is quite undervalued.

Graham

With diversified operations that include education, the entertainment industry, streaming services, manufacturing and production, home care and hospitality, and automotive businesses, Graham Holdings is a US-based company with an internationally active operations facility. Through its Kaplan subsidiary, Graham offers education services including student preparation, UK education program, and general certification exam preparation. With regard to the total amount of revenue, education is quite relevant. However, Graham Holdings also reports a lot of revenue from manufacturing, healthcare, automotive, and other businesses. In my view, the company’s diversification will likely be appreciated by investors.

In its television and entertainment segment, the company has six commercial channels on television and activity on social networks through news management tools. The manufacturing segment includes the treatment and manufacture of wooden objects, the manufacture of electronic products, and the production of useful parts for electric cars. The care segment offers different types of therapies as well as home care and health care software as a service.

Kaplan has an estimated customer infrastructure of 13,000 clients, 4,500 universities, colleges, and educational establishments, students, and individual professionals. During 2022, it managed to sell more than one and a half million books related to the field of education.

The manufacturing segment is divided into its subsidiaries. Group Dekko Inc is dedicated to the manufacture of electronic products for lighting internal spaces and chargers for electrical devices. Hoover Treated Wood Products focuses on manufacturing products to be placed on wood, such as insulating materials or fire retardants, Joyce/Dayton Corp, in the manufacture of screws and products for elevators. Finally, Forney Corporation is dedicated to the production of lighters, various incinerators, and controllers for industrial applications.

Through Graham Healthcare Group, the company offers health care services through residents and medical escorts. The company also offers preparation therapies for medical interventions.

Graham Automobile segment is in charge of the automobile trade, with majority ownership of 6 car sales and distribution agencies in the United States. In addition, Graham Holdings has Clyde's Restaurant Group, in the operation and management of bars and gastronomic spaces with 11 restaurants, Frame Bridge Inc, in the production of low-cost and customizable frames, Code3 as a marketing services provider, Decile LLC, a data and information analysis software, City Cast, in publishing podcasts, Pinna LLC offering children's audio books, and The Slate Group, in publishing Slate digital magazine.

Assets

As of December 31, 2022, cash stands at $169 million with investments in marketable equity securities worth $622 million. Accounts receivable stand at $560 million with inventories and contracts in progress worth $226 million and prepaid expenses of $97 million. Total current assets stood at $1.7 billion, close to 2x the total amount of current liabilities.

With property, plant and equipment of $503 million, a lease right of use assets of $429 million, and investments in affiliates of $186 million, the company reported goodwill of $1.56 billion. Considering the total amount of goodwill, I assumed that management has a significant amount of expertise in the acquisition of target companies, which some investors will likely appreciate. It is also worth noting that goodwill appears to be distributed through many of the company’s activities, which, in my view, lowers the likelihood of large goodwill impairments.

I could also find information about the purchase price allocation paid by the company for acquisitions in 2020, 2021, and 2022. The company is really a large acquirer of targets.

The indefinite-lived intangible assets stood at $178 million with amortized intangible assets of $161 million, prepaid pension costs of $1.6 billion, and deferred income tax of $6 million. Finally, total assets stand at $6.58 billion.

Liabilities: Total Amount Of Long Term Debt Does Not Seem Large

Graham Holdings also reported accounts payable and accrued liabilities worth $563 million accompanied by a deferred revenue of $381 million, income taxes payable worth $3.766 million, and current portion of lease liabilities of $70 million. Finally, with a current portion of long term debt of $155 million, total current liabilities stand at $1.174 billion.

Non-current liabilities include accrued compensation and related benefits of $134 million accompanied by other liabilities of $37 million, deferred income taxes worth $466 million, and lease liabilities worth $393 million.

Finally, Graham also reported long term debt of $570 million and total liabilities close to $2.807 billion. With an asset/liability ratio of more than 2x and a limited amount of long term debt, I believe that the company’s financials stand at good shape.

Main Assumptions In My Model

Under my financial models, I assumed that in the next ten years, Graham Holdings may be able to sell more pre-college test preparation programs, and enrollments may trend north. I would also expect more demand for professional programs in case of an increase in the unemployment rate.

Overall, demand for graduate and pre-college test preparation programs has declined due to the strength of U.S. employment markets and the decline in test takers, while demand for professional programs remained stable. Operating results declined in 2022 and the fourth quarter of 2022 due to lower revenues and increased advertising and product development costs. Source: Quarterly Press Release

I would also expect beneficial results from the company’s acquisitions of dealerships, higher average new and used car selling prices, and more consumer demand for used vehicles. In the last quarterly report, the company explained the rationale behind these revenue drivers.

Revenues for 2022 increased significantly due to the acquisitions of the Ford ( F ), Toyota ( TM ) and CDJR dealerships; sales growth at the Jeep dealership due to an increase in new vehicle inventory provided by the manufacturer and a growing market presence; and higher average new and used car selling prices at the Lexus, Honda and Jeep dealerships as a result of strong customer demand and new vehicle inventory shortages related to supply chain disruptions and production delays at vehicle manufacturers. Source: Quarterly Press Release

I am quite optimistic about the future of the company’s television business segment. Management appears to sign many agreements with large platforms. In my view, in the next decade, with the increase of demand for video content, we may see sales growth.

Movies and other video programming increasingly are available on an on-demand basis through a variety of online platforms, which include free access on the websites and apps of the major TV networks, ad-supported viewing on platforms such as Hulu, and subscription-based access through services such as Netflix ( NFLX ). The Company has entered into agreements for some of its stations to be distributed via certain of these services, typically through opt-in agreements negotiated by the stations’ affiliated networks. Participation in these services has given the Company’s stations access to new distribution platforms. Source: 10-k

My Cash Flow Model Implied A Valuation Of $647 Per Share

My results for 2033 include a net income of $556 million, depreciation and amortization close to $830.134 million, and an amortization of lease right of use of -$53 million. I also included net pension benefit expenses of close to -$859.147 million and loss on marketable securities close to -$24.573 million. I believe that my numbers are quite conservative. Some of these adjustments were positive in the past.

I also included 2033 credit loss expense of -$39.446 million, 2033 stock based compensation of $5.100 million, and 2033 gain on disposal and write downs close to $980.718 million with an equity in earnings of affiliates of close to $53.544 million.

Also, with changes in accounts receivable of -$22.829 million and inventories of -$452.712 million, I also assumed accounts payable and accrued liabilities close to -$139.907 million.

Finally, with changes in deferred revenue of $352.460 million and changes in other assets and other liabilities of -$199.119 million, I obtained 2033 cash flow from operations of $311 million. With a capex of -$100 million, 2033 free cash flow would stand at $211.276 million. Note that I assumed a decline in FCF from more than $400 million in 2023 to less than $230 million in 2033.

By assuming WACC of 7.90% and EV/FCF of 9x, the residual value would stand at $1.90 billion, and the enterprise value would be close to $3.033 billion. Adding cash of $169 million, market securities of $622 million, short term debt of -$155.81 million, and a long term debt of -$570 million, equity would stand at $3.09 billion. Finally, I obtained a fair price of $647 per share and an internal rate of return of 3.06%.

My Sum Of The Parts Model Implied A Valuation Of $741 Per Share

Using the income from operations before D&A, impairments of goodwill, and intangibles would imply a valuation of close to $741 per share. I tried to use conservative multiplies that other financial analysts use in the United States. My results include an enterprise valuation close to $3.4 billion and an equity valuation of $3.54 billion.

Risks

The company’s operating risks vary by business segment in terms of its operational level. Possible risks due to regulations or legislation in the education and health segments exist. The national and international level of education and the state legislation for health are exposed to variations and sudden changes that could affect current operations. Radical changes may force Graham Holdings to make meaningful investments, which may lower future FCF generation.

I would also be a bit worried about foreign jurisdictions changing their laws. Graham Holdings operates in a number of countries, which may change their laws following political movements or economic events. As a result, Graham Holdings could be forced to sell its interests in the country, and the group may lose money.

Operating in foreign countries and regions presents a number of inherent risks, including the difficulties of complying with unfamiliar laws and regulations, effectively managing and staffing foreign operations, successfully navigating local customs and practices, preparing for potential political and economic instability and adapting to currency exchange rate fluctuations. Source: 10-k

I would also be afraid of the company’s transactions not being successful. If Graham Holdings expects a lot of synergies from the acquisitions, and they are not obtained, the market may lose its faith in the company’s ability to sign beneficial deals. As a result, the demand for the stock may decline, which would lead to stock price declines.

Finally, I believe that a generalized increase in wages could significantly affect the manufacturing business segment as well as other business divisions. If hiring becomes more costly, I believe that the company’s valuation would most likely decline.

If staffing cannot be hired at a cost-efficient wage rate relative to product pricing, volume will be impacted. Source: 10-k

Conclusion

Graham Holdings operates a diversified business model with many business segments, and operates in many jurisdictions. I believe that enrollment of students could increase if unemployment increases in the coming years. Besides, further investments in vehicle dealerships and more agreements with video content platforms will likely bring sustainable free cash flow in the future. Even assuming certain risks from changing regulatory frameworks, I believe that the company is quite undervalued.

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