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Morningstar | No Surprises in Navitas’ Messy 1H Result as BGH Acquisition Approaches

No-moat Navitas’ first-half result was in line with our expectations and management guidance and we have maintained our fair value estimate at the BGH consortium offer price of AUD 5.83 per share. Our fair value implies the BGH acquisition is highly likely to proceed and the first-half result only strengthens this view. The reported result was muddied by the ongoing reorganisation of the company, which began last year following the appointment of David Buckingham as CEO. We’re not particularly surprised no interim dividend was declared as a special dividend is likely to be paid prior to the completion of the acquisition by BGH. This is partly to distribute franking credits, but the value of the offer will be reduced by the value of the special dividend.

At the current price of AUD 5.62, Navitas shares are slightly undervalued but our fair value is dependent upon the takeover offer proceeding. We do not expect a higher bid which means risk is skewed to the downside due to the small probability the BGH offer will be reduced, withdrawn, or will fail to receive sufficient shareholder support at the scheme meeting to proceed. Despite the 4% difference between the offer price and share price, shareholders may prefer to sell on market to remove the small risk of the acquisition not proceeding and the opportunity cost of remaining invested in the stock until acquisition funds are received, which is likely to be in the second half of the year.

We intend to provide a formal recommendation on the BGH offer following the release of the scheme of arrangement booklet, which we expect in April or May 2019. We expect the scheme meeting to be held in mid-2019 although a timetable is yet to be provided. At this stage, the BGH offer looks attractive considering it’s 34% above the pre-offer share price, 14% above our standalone fair value, and the all-cash nature creates value certainty.

The BGH offer allows BGH consortium members, including Navitas founder and ex-managing director Rod Jones and AustralianSuper, to vote in favour of an alternative superior proposal should it materialise. This creates the potential for a bidding war, although we doubt an alternative bidder will emerge considering no other offers have been made since the process began in October 2018. The BGH offer also has an exclusivity period which restricts Navitas from seeking other bids or allowing due diligence access to other bidders until BGH’s due-diligence is completed on Feb. 18, 2019. We think there’s a low probability that the offer price will be lowered, as we expect the BGH consortium, which includes founder Rod Jones, knows the company sufficiently well to avoid the emergence of unknown problems via due-diligence.

Navitas’ first-half result was good despite the 14% fall in statutory NPAT versus the prior comparable period. The statutory result was impacted by AUD 14 million in one-off takeover related costs, the closure of SAE colleges in the United States, the cycling of strong earnings in its PEP business, and startup costs relating to new University Partnership contracts. The statutory result is likely to be impacted again in the second half of fiscal 2019 should the planned sale of the SAE colleges in the U.S. proceed as we expect, which represents around AUD 60 million or 6% of annual group revenue.

The 6% increase in first-half group underlying EBITDA to AUD 74 million was broadly in line with our AUD 147 million full-year forecast and management’s full-year EBITDA guidance of AUD 148 to 153 million. The first-half increase in EBITDA margin to 16% from 15% in the previous corresponding period remains below management’s 17% target but not to a worrying level. The key driver of the strong underlying performance is the core University Partnerships division, which comprises around three fourths of group EBITDA, and which is growing more quickly than it has done historically. The 5% growth in equivalent full-time students in semester 3 was in line with management’s long-term target and our forecasts.

Operating cash flow was impacted by costs associated with closing discontinued businesses in the first half, falling 9% to AUD 38 million. However, free cash flow (operating less investing) improved by 1.4% to AUD 23 million due to a number of factors such as a lack of acquisitions and the deferral of advisory fee payments. Net debt was reasonably flat at AUD 207 million as at Dec. 31, 2018 and credit metrics remain strong, with an interest coverage ratio of 20 times and gearing ratio of around 2 times. Should Navitas remain as a standalone listed entity, we would expect these metrics to improve due to the capital-light and cash-generative nature of the company in addition to expected sale proceeds from the U.S. SAE colleges.