2023-09-13 09:51:53 ET
Summary
- Stride acquired Tech Elevator, Medcerts, and Galvanize in 2020. I believe the market hasn't fully appreciated the value created by these acquisitions.
- Stride's Career Learning offering is in high demand with low competition and an underpenetrated market.
- I believe Stride is easily worth $70-$80/share based on DCF models and relative valuation techniques.
Stride (LRN) has performed roughly in line with the S&P following the publication of my last article on Stride. Notably, the implied equity risk premium ((ERP)) has fallen since my last valuation (I used 5.58%, whereas it is currently 4.9%). A lower equity risk premium means investors are willing to pay more for companies (and accept lower future returns), so Stride should be more valuable today. In this article, I build off my last write-up and provide an updated valuation. Currently, I believe that Stride is easily worth $70-$80/share.
Brief Business Overview
Stride offers "school-as-a-service," a comprehensive learning solution for people who prefer virtual rather than in-person learning. The business is niche, considering that Stride serves less than 1% of the students in the states where it is present. The target customers are military families (who move a lot), kids with safety concerns at school, student-athletes, etc. Stride's solution includes administrative support, information technology, learning systems, online curriculum, and academic support.
Within school-as-a-service, Stride's two segments are General Education and Career Learning. The General Education segment offers students coursework in core subjects such as math, reading, science, and social studies. The Career Learning segment offers students coursework in in-demand fields such as computer science, healthcare, and math.
Key Acquisitions
Stride acquired Galvanize (software engineering boot camp), Medcerts (healthcare and IT training), and Tech Elevator (coding boot camp) in 2020 for ~$260 million . Following these acquisitions, Stride began selling software, healthcare, and IT coursework to high schools rather than just adults.
This year, Stride generated ~$706 million in revenue and ~50,000 in net income (applying Stride's net income margin to 706 million) from new enrollments following the 2020 acquisitions. This means that Stride has generated enormous value from these acquisitions because the total acquisition cost is only ~5x current earnings. Plus, margins are still expanding, and revenue is growing rapidly (~70% TTM growth YoY).
Margins
Operating margins have grown significantly because of operating leverage and gross margin expansion. Following Stride's acquisitions in 2020, Stride's operating expenses relative to revenue fell sharply. Additionally, management has attributed some of its margin expansion to efficiency and automation initiatives in the past.
Operating margin expansion has also created significant value because Stride's return on invested capital ((ROIC)) has risen meaningfully.
Stride's average ROIC was roughly its weight average cost of capital ((WACC)) from 2009 to 2019, meaning that growth was neutral (growth adds value when ROIC > WACC but destroys value when ROIC < WACC). Given that Stride's ROIC is much higher than its WACC (I estimate it to be 7.54%) now and that the business is expected to grow, Stride is a much more valuable company.
Career Learning Segment Trends
Stride's business is well-positioned relative to other companies in the EdTech space because it sells to middle schools and high schools rather than higher education. Higher education seems to be in structural decline given that over the next decade, enrollments are expected to decline meaningfully:
People are seeking alternatives to higher education, such as online courses and micro-credentials. I see Stride's Career Learning solution as an attractive alternative to higher education because Stride is currently trying to create a solution where students earn credentials and industry certifications. Stride is also attempting to match students with job shadowing opportunities and employers.
Stride's Career Learning segment is exciting because few companies offer industry-focused coursework to high schoolers, and industry-focused coursework is in demand. In Stride's Q3 earnings call , they mentioned that in a recent survey, only 30% of respondents said their schools have satisfactorily prepared students for their careers. I see peoples' dissatisfaction with their schools' current curricula as a driver for future adoption of Stride's coursework. Also, I think the strong recent enrollment growth in Stride's Career Learning segment reflects strong demand for the product.
Growth in Homeschooled Children
Following the pandemic, the number of homeschooled children grew rapidly, creating more demand for online schools. While there isn't data on the 2023/2024 school year yet, the number of homeschooled children is expected to increase over the next few years.
Q4 Earnings
Management noted that Stride's net promoter score (NPS) score sits at 68, further supporting the narrative of product strength. Additionally, management stated that application volumes are stronger than last year, so Stride's enrollments should be up YoY. However, they didn't quantify anticipated enrollment growth.
Relative Valuation: Sum of the Parts
Career Learning Segment
I used businesses that sell career-focused courses and curricula as my peer group. I expect Stride's Career Learning segment to grow 15% or more over the next few years (it grew 60-70% annually over the last two years). However, margins for Stride's Career Learning segment are roughly the median of its peer group or slightly higher. As a result, I believe that Stride's Career Learning segment deserves a multiple between the median and 75th percentile EV/Sales ratio (of its peer group).
General Education Segment
I used businesses that sell curriculum to middle/high schools as my peer group (unfortunately, very few are publicly traded). I averaged the EV/Revenue multiple of Pearson and Cengage and then reduced that by 33% to get to my expected EV/Revenue ratio. The 33% reduction is because Stride's current operating margins are roughly 1/3 lower than Pearson's and Cengage's operating margins. For my pessimistic case, I used the EV/Revenue ratio for Stride right now (1x).
Sum of the Parts Valuation
After applying my expected EV/Revenue ratios to each segment's sales, I predicted that Stride is worth 10.2% to 63.5% more. The price/share was calculated by taking (total enterprise value (TEV) + Cash - Debt)/(Shares Outstanding).
2014-2019 EV/EBITDA
Stride is trading at a significant discount to its 2014-2019 historical EV/EBITDA ratio despite having a much better ROIC and strong future growth prospects. If Stride were trading at its average 2014-2019 EV/EBITDA ratio of 9.94x (current: 7.9x), the stock would be worth $55.61/share. I believe that Stride is a better business today than in 2014-2019, so I believe that Stride should be worth more than 9.94x EBITDA (or $55.61/share).
Discounted Cash Flow
Bearish Case
General Education Revenue: I estimate this will grow at the economy's growth rate (10-year rate, which is a proxy for the economy's growth rate). This part of Stride's business is mature, given its limited TAM and historical growth.
Career Learning Revenue: I have this growing at 12% until year 5, and then revenue growth moves linearly toward the risk-free rate. I chose 12% because 12% causes the Career Learning segment's revenue to converge with Stride's General Education segment's revenue. I assume that Stride can cross-sell its Career Learning offering to its existing customers over the next ten years.
EBIT Margin: I have this flat at 9.01% to be conservative. I assume that margin expansion from efficiency gains and operating leverage is offset by increased competition in the future.
Effective Tax Rate: Worldwide average corporate tax rate.
WACC: Aswath Damodaran's implied ERP of 4.9%; AAA credit spread added to the risk-free rate to get the cost of debt; beta of 0.899 (5-year weekly beta with two standard errors added to it. Adding and subtracting two standard errors generates the 95% confidence interval (.267-0.899). I chose the highest beta to be the most conservative).
Reinvestment: (Increase in revenue YoY)/(Sales/(Invested Capital (IC)).
Sales/(Invested Capital) Ratio: I keep this at one (well below what it has historically been). I chose one because it causes the ROIC to decline and begin to converge with Stride's WACC. The assumption is that Stride is forced to reinvest aggressively to maintain their market share.
Bullish Case
Note: Stride's equity is worth $85.53/share when using 7.54% as the WACC
General Education Revenue: Same as the bearish case.
Career Learning Revenue: Revenue converges with the General Education segment's revenue by year five rather than year 10. Given the historical growth of the Career Learning segment, I believe this assumption is reasonable.
EBIT Margin: EBIT margins reach 11.74% in year 2 (in line with analyst estimates). This seems reasonable, given that management expects gross margins to be between 36% and 39% in the future. Using the midpoint of this range (37.5%) and Stride's TTM gross margin of 35.2%, Stride theoretically will grow margins by 2.3%. TTM operating margins were 9.01%, so adding 2.3% to TTM operating margins yields an operating margin of 11.31%. If Stride continues to benefit from operating leverage and efficiency gains, Stride's operating margins will likely reach or surpass 11.74%.
Effective Tax Rate: Worldwide average tax rate.
WACC: Same as bearish case, except I used the actual 5-year weekly regression beta rather than the upper end of the range.
Reinvestment: (Increase in revenue)/(Sales/IC)
Sales/IC: I used the historical Sales/IC ratio. This assumes that Stride will generate high returns on the capital it invests, which seems possible given management's acquisitions in 2020 (technically, acquisitions aren't a CapEx, but I'm considering them a CapEx).
Risks
1. Connections Academy recently launched Career Pathways, which competes with Stride's Career Learning offering. Analysts seem worried, given the number of questions about Connections Academy in Stride's recent earnings calls. However, I believe this risk is manageable because the market looks underpenetrated. Plus, Stride is differentiating its offering by trying to match students with job shadows and employers through their platform Tallo. If Tallo succeeds, it could provide Stride with a long-term competitive advantage.
2. Revenue per enrollment could theoretically revert to historical levels. However, management predicts that gross margins will expand, indicating that revenue per enrollment will increase. Plus, some of the revenue per enrollment expansion is due to inflation.
Conclusion
I believe that Stride is attractive at current levels, given that it looks undervalued in my bearish case (which I think is far too pessimistic). In my view, the Career Learning business is well-positioned to benefit from trends in education, so I expect long-term shareholder value creation from this part of the business. Over the next five years, I see enrollment growth, revenue growth, and operating margin expansion as catalysts to drive Stride's share price up to $70-$80/share.
For further details see:
Stride: Still My Favorite EdTech Play