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Friday, 10 March 2017
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BUY, SELL or HOLD (ASX:3PL)

3P Learning Limited (3PL, formerly TNP) is a global online education company with cloud-based, software-as a-service products in numeracy, literacy and science for school students in grades K-12. The company has a presence in Australia, New Zealand, the UK and growing operations based in the US, Canada, Hong Kong, South Africa and Abu Dhabi. Key products offered by company are Mathletics, Reading Eggs, Spellodrome and IntoScience.

  • Mathletics: Mathletics is an online numeracy product for school grades K-12.
  • Reading Eggs: Reading Eggs is an online English literacy product for school grades K-6.
  • Spellodrome: Spellodrome is an online English literacy skills product for school grades K-10.
  • IntoScience: IntoScience is an online science product, which combines simulations, experiments, activities, and quests to teach science concepts.
  • Other: 3P is the creator, host and owner of the World Education Games, which is a substantial global online education event. The event consists of World Maths Day, World Literacy Day and World Science Day and involves students from around the world competing against each other in online challenges across numeracy, literacy and science.

INVESTMENT CASE

Positive

  • Strong brand, dominant market position and global footprint - Used by over 5.3 million students in over 17,000 schools across the world (as at 31 March 2016).
  • 3PL differentiates itself by providing a blend of teacher-led instruction and student-driven learning in the classroom and at home. The 3-pronged approach improves the effectiveness of the product and establishes brand loyalty.
  • As an example of this, I've just signed up my 2 high school children for the Mathletics program because I'm familiar with how it works (from our experiences in primary school). It's a cheaper alternative to a maths tutor and I can set tasks for my kids (if it's a school-sponsored program, the teacher sets the tasks) and monitor their progress.
  • Operating leverage – scalable product portfolio and scalable global operating model. There is a high degree of fixed costs and additional revenue flows largely to the bottom line.
  • Diversification across region and product offering is increasing, although the 75% contribution from Mathletics does present a bit of risk.

  • Large installed base and recurring business model means stable, annuity style revenue.

Negative

  • Technological advances – making the offering look dated and irrelevant.
  • Changes to curriculum etc which require subject revamp and additional costs.
  • New entrants with more advanced technology. Mitigating this risk is 3PL’s strong relationships with school – its programs are designed by educators and educational technologists in partnership with schools and families.
  • Illiquid – The average daily traded volume is less than $200k.

RECENT RESULTS

The most recent results was above expectations and generally well-received.

Key Points

  • 3PM gave an update of its 3 strategic priorities
    1. Strengthen product portfolio
    2. Develop a scalable sale and marketing model
    3. Globalise the operating model
  • Underlying core EBITDA up 16%.
  • Net debt of $20.3m (peaks in December) out of a total debt facility of $30m. Re-phasing of subscription billing for APAC in November (compared to January in previous years) has resulted in an increase in deferred revenue.
  • Write-down of Mathletics & Spellodrome $8.4m and IntoScience $2.9m and changes to estimated useful life of software and curriculum content.
  • Cashflow improved significantly due to revenue growth, cost containment and working capital management. Cash flow is expected to improve in 2H due to the seasonality of collection in Asia Pacific receivables.

Outlook comments:

  • 3PL will continue to deliver revenue growth greater than cost growth.
  • Asia Pacific - Released a new secondary interface in July 16 to improve retention in secondary schools which has proved successful. A new primary interface isdue to be released in June. The company is focused on growing market share and saw modest price increases above CPI.
  • Europe, Middle East and Africa - Brexit is not anticipated to have a material impact on the education sector, although GBP depreciation continues to affect FY17 performance. There is an opportunity for a scalable sales model as change in government policy sees schools transitioning to academies structure. The legacy Middle East contract renewal was not received in the half, affecting licences by 185K with a $200k revenue impact but other ME opportunities more than cover the value of this contract.
  • Americas - US operating loss will continue to narrow with planned break even in FY18.

You can view the first half results presentation here.

FUNDAMENTAL VIEW

The STOCK BOX doesn’t make a compelling argument for investing, but it does suggest keeping an eye on things. ROE is decent at 13.8% and growing, and after a big fall in earnings last year, forecasts are for accelerating growth over the next few years, assuming the company gets it act together and delivers on its strategy. 

There is no yield, so not much here for the income investors, but this is a company focused on growth so that’s not so much of an issue. From a valuation perspective, shares are trading 15% below the analysts' target prices, but there are only 2 and they both have Buys so that is to be expected. So the more important measure is the discount to historical PE, reflecting the dismal performance in the share price.

3PL is in pretty good financial shape, despite the poor ranking of the credit criteria in the STOCK BOX. It has moderate debt, strong cash flow metrics and reasonable profitability ratios.

TECHNICAL VIEW – You can draw your own downtrend on the chart – there are several possible options but wherever you draw it, shares have broken out and are officially in a recovery uptrend. They are currently resting on the support line and there are mixed signals on the future direction. On the weekly chart the MACD indicator (the blue bars) are getting less negative suggesting the uptrend may be respected, while the daily chart is about to trigger a (less reliable) MACD sell signal. Either way, you would want to see the uptrend resume before buying as the company has been prone to shock-drops on poor announcements.

 

OUR VIEW

3PL hasn’t give shareholders much to get excited about over the last few years. After the resignation of CEO Tim Powel in January last year shares fell as much as 20%, followed by further falls after the 1H16 results and then again in June last year after lowering EBITDA guidance. The 30% fall on that downgrade marked the low in the share price and they have been in (mild) recovery mode since that time.

Our interest in the company was sparked after results, as it looks like the new CEO and strategic priorities are starting to have an impact. Macquarie upgraded on this basis and both analysts who cover the company have upgraded their earnings forecasts, suggesting the downgrade cycle may be at an end.

This is a classic turnaround story and if 3PL can get it right, the growth opportunities are significant. A good product with support from thousands of schools and millions of students, combined with a scalable business model and high levels of operating leverage, topped off with a global footprint which should benefit from Australia’s well-respected ranking in educational services.

Because it’s a turnaround story, the historical fundamentals lose a bit of relevance because the worse they have been, the better the turnaround potential. So while we’re ok on that score, the technical picture suggests a bit of caution. Our other concern is the size and liquidity, which make the company a bit risky and probably not suitable as an “investment”. Overall, we’re excited about the evidence of turnaround so far and we’re putting it on MT Growth Portfolio “watch list” but we’re not prepared to add it at this stage due to the high level of investment risk and mixed technical outlook.  

BROKER VIEW

  • Deutsche Bank has a Buy recommendation with a target price of 110c. The result was well above the analyst’s expectations, mainly due to a change in the billing process which saw the company move to auto renewal. Guidance was reaffirmed for revenue to grow ahead of costs. They expect 190bps of margin expansion in FY17 and have upgraded FY17 and FY18 forecasts up by 4%.
  • Macquarie upgraded to an Outperform recommendation with a target price of 125c (from 100c). The result was ahead of the analyst’s expectations and 3PL reiterated it is on track to deliver a $2m annualised cost saving (relative to 2H of FY16) and expects to deliver revenue growth ahead of cost growth. The Macquarie analyst raised FY17 earnings forecast by 3.8% and upgraded their recommendation and target price, reflecting the improved operational outlook.
 

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