Education Development Corporation ("EDUC") is a children's book publisher and toy maker that has been on a steep decline over the past few years. The children's education industry is incredibly saturated and a challenging industry for success - especially against a backdrop of online learning options and potential recession.
With a near 90% stock price decline over the past 5-years, EDUC has certainly not been immune to the many industry headwinds. See stock chart below:
However, I'm not here to tell you the children's book publishing industry is bound to inflect and EDUC will likely pivot into 2024 and 2025. That might be the case, but I'm not at liberty to make a call one way or the other. I don't know the industry well, nor do I think a compelling investment case hinges on that to play out. There have been a number of wonderful articles covering EDUC's history - I recommend glossing through those first.
Instead, I'm here to tell you that, EDUC could quite literally triple over the near term on condition two things happen:
1. They don't go bankrupt
2. They sell their company's headquarters
Let's dive into number 1 first:
Is EDUC going bankrupt?
The company has - for the most part - been net income positive for many years. Just looking back at the last 5 years, only in the most recent year was EDUC operating at a loss. See chart below.
Due to higher than normal interest rate costs, a bloated inventory, and a softer consumer, the company has faltered. However, it isn't inconceivable to imagine many of those issues will disappear. After all, inventory will either be written off or sold, interest rates have / will largely normalize, and debt will be paid off in short order. Besides, the company has a substantial enough balance sheet today to weather the storm - especially after the recent adjustments to their revolving credit line.
(Source: Company Filings, 8K, August 16th, 2023)
Let's take a look at the balance sheet to determine net asset value.
(Source: Company Filings, 10Q, as of August 31st, 2023)
According to the most recent 10Q, EDUC has a book value of $45MM. Not bad against a sub $9MM market cap valuation. However, some of those items are likely overstated and some are likely understated.
First, lets cut inventory by 25%. They've done a nice job reducing current inventory to more normalized levels from the bloated $77MM February 2022 balance, however even at $54MM, I doubt they'll be able to get a 100% recovery. 75% of that figure brings us to $41MM in value.
Next, let's assume 90% collections on the Accounts Receivable. That brings us to $1.8MM. Then, let's ignore prepaid expenses and take a closer look at the cash balance.
Though the balance states $1.5MM, that is likely understated. In the subsequent events section of the recent 10Q, EDUC noted that they sold their property located at 10302 East 55th Place, Tulsa, OK. As noted in the 8K snippet above, the revolving credit lender required the company to list the property for sale as a condition. That property is listed as assets held for sale of 0.81MM on the balance sheet above. However, that value is cost, not market. As of September 11th, 2023 that asset was sold for...$5.1MM. A whopping 6.2x premium to its carrying value on the balance sheet.
Those funds will immediately be used to pay down debt and bolster the company's cash position - actions which are not reflected in the most recent balance sheet above. If we assume a 7% - 8% commission and closing cost expense on the sale of the property, we can expect EDUC to earn roughly $4.7MM in cash from the sale - or nearly 50% of it's market cap.
So let's put it all together.
Cash = $1.5MM (current on balance sheet as of August, 2023) + $4.7MM (sale of property)
Accounts Receivable= $1.8MM
Inventory = $41MM
Total discounted current assets = $49.0MM
Total liabilities = $54MM
So, putting it all together we have roughly negative $5MM in heavily discounted net current asset value less ALL liabilities.
But wait, EDUC is selling another property for sale, which leads us to number 2 of the investment case:
Can they sell their company headquarters?
As of November 15th, 2023, EDUC announced that they intent to sell their headquarters and distribution warehouse located at 5400 - 5402 South 122nd East Avenue, Tulsa, OK.
See press release here.
According to the company, the property appraised for $40.51MM in July 2023. Let's check that math with a back of the napkin calculation.
Property Square Footage: 402,255
Per Square Footage Market Rent: $14
Total Potential Gross Income (PGI): $5.63MM
Conservative Office / Warehouse Vacancy Factor: 15%
Total Effective Gross Income (EGI): $4.8MM
Expense Ratio: 35%
Total Net Operating Income: $3.11MM
6% Cap Rate: $51.86MM
7% Cap Rate: $44.45MM
8% Cap Rate: $38.89MM
In this market, I think a value somewhere between a 7% cap and 8% cap makes sense for a NNN fully occupied office / warehouse.
I also opted to use a 35% expense ratio instead of a slightly higher ratio (which is typical for office) given that EDUC will be leasing back the space from the would-be buyer and is going to be responsible for a large chunk of the expenses.
For purposes of this exercise, let's assume a flat $40MM purchase price - somewhere in between a 7% cap and 8% cap.
Once the property sells, EDUC will be leasing 216,855 of space. If we again assume a $14/SF lease, that equates to a roughly $3MM annual lease obligation plus whatever pro-rata share of expenses they are responsible for. Since they occupy 54% of the building, let's assume their expenses will run at 54% of the property's expenses. If we err on the side of caution and anticipate a 45% expense ratio, that would equate to $1.92MM annually. 54% of that figure is $1.04MM.
So, putting it all together, EDUC will net roughly $37MM after closing costs and commissions (7-8% fee) in exchange for an annual lease obligation of just over $4MM.
Now, after the sale, our -$5MM adjusted NCAV has just turned into $36MM. To arrive at that figure I just added the $37MM in cash from the sale of the HQ and subtracted the $4MM in annual lease expense. That's a per share value of $4.20 - or roughly 4x upside to today's price.
However, the business is still bleeding and definitely lost a substantial amount of cash (excluding one-off items) last year. However, I would venture to say a 75% discount to current assets post sale doesn't really make sense for a company that historically has made money. I'd say a more appropriate guesstimate of value is 75% of NCAV post sale of the real estate. Mind you, that doesn't include some of their other inventory and land assets (which according to the 8K issued yesterday, they'll have to sell if they can't sell their HQ by end of March.)
Based on these assumptions, I believe shares should trade closer to $2 pre-sale of the real estate and closer to $3 once the sale is executed (which I envision will be sometime in the first half of 2024).
The 75% discount should give enough wiggle room for some additional cash burn over the next couple quarters.
If you don't think EDUC is going bankrupt, shares should double.
If you think EDUC can sell their real estate and pay down debt, shares should triple.
Whichever scenario you believe in, $0.99/share seems like a steal.