Headquartered in Chicago, Adtalem Global Education is a global provider of for-profit education. Its roots date back to 1931 when Herman A. DeVry founded DeForest Training School, which would eventually become DeVry University. Several acquisitions and a recent name change later, Adtalem became the diversified educator it is today, serving over 120,000 students across disciplines ranging from business to medicine. After proving to be resilient during the financial crisis, the company faced several challenges, including heightened regulatory scrutiny and increasing online competition. Yet, a new leadership team has taken a discerning eye to the entire portfolio and what remains today is a unique collection of valuable and growing institutions.
Optimizing the Portfolio
In early 2016 Adtalem’s stock price had fallen to its lowest share price in a decade over concerns that heightened regulatory scrutiny and increased online competition had become too much for DeVry University to bear. The company named board member Lisa Wardell as its new CEO, in hopes that she could breathe new life into a misunderstood collection of educational assets. She quickly took action to turn the ship, none more important than to increase the focus on return on invested capital and shed any assets that did not meet muster. Over the past few years, she settled outstanding regulatory investigations, sold off both DeVry University and Carrington College and shifted capital allocation to strengthen the balance sheet and repurchase shares. The risk and growth profiles have now both dramatically improved.
Several Long Runways
The shift in Adtalem’s educational portfolio has been nothing short of dramatic. Approximately 76% of total company operating profits now come from medical and healthcare schools, including well recognized brands like the Ross University and Chamberlain University. With doctors and nurses both in short supply, these schools clearly stand to benefit. Another 12% of profits come from the company’s schools in Brazil, where for-profit providers are valued partners in the government’s ambitious goals to improve educational attainment. And finally, the remaining 11% of profits come from some of the best brands in professional certification, including Becker CPA review and ACAMS, the largest international organization dedicated to financial crime prevention. As a whole, Adtalem expects to grow revenues 5% to 7% annually and generate returns on capital of 12% to 14%.
The Right Leadership
CEO Wardell has consistently made decisions that were difficult in the short term but best for the long-term. DeVry University, despite being the flagship institution, was no longer a sacred cow. Carrington College, which had been acquired under prior leadership, was no longer a never-ending turnaround project. These decisions freed up capital to fuel the fastest growing institutions, strengthen the balance sheet and return to shareholders. Since the baton was passed to this management team, Adtalem has repurchased nearly $200M in stock, while still accumulating a net cash position of nearly $2 per share.
A Long Term View
Despite this impressive transformation, Adtalem’s stock price suggests that investors still view the company through an outdated lens. The long runway of demand fueling the company’s growth across healthcare, professional certification and emerging markets is both secular and more immune to past challenges. As of December 31, 2018, shares traded at $47.32, a 5.7% discount to our private market value of $50.16.
Founded in 1993, Affiliated Managers Group (AMG) is one of the largest asset management firms in the world. Through its affiliates, AMG offers institutional, retail and high net worth investors investment products across a wide range of traditional and alternative strategies. As of September 30, 2018, AMG had $830 billion in assets under management (AUM).
Unique Business Model
AMG operates a unique manager-of-managers business model - purchasing meaningful equity interests in small-to-mid-size boutique asset managers, and in return, receiving a fixed percentage of revenues. AMG’s partnership approach allows for its affiliates’ management teams to own significant equity and to maintain complete operational independence. AMG does not directly manage investments nor the day-to-day activities of its affiliates. Instead, the Company provides strategic, operational and technological support, and importantly, access to its distribution platform.
Sustainable Competitive Advantages
Beyond the intangible value of its affiliate brand franchises, AMG’s competitive advantages include its investment product mix and its global distribution network. With investments in 39 affiliates, including alternative asset managers AQR Capital Management, ValueAct Capital Management and BlueMountain Capital Management, as well as global/international managers, including Tweedy, Browne Company, Artemis Investment Management and Harding Loevner, AMG is the buyer of choice for asset managers seeking a partnership with significant equity while maintaining operational autonomy. We believe investors are underestimating the strength of AMG’s franchise and its focus on alternative investments and global equities.
Not the Typical Asset Manager
AMG has over 25 years of successful partnerships and a strong product line-up in growth areas, leading to a long record of organic growth from cash flows. Although not completely insulated from the issues surrounding passive investing, AMG is a well-diversified institutional-oriented active asset manager with approximately 73% of its AUM invested in alternative strategies and global equities. Not surprisingly, AMG’s largest affiliates are alternative asset managers and/or are internationally focused and/or based. This makes AMG one of the largest alternatives managers in the world with alts representing approximately $322 billion in AUM, or 39% of its total. Factor investing and alternative beta pioneer AQR Capital Management accounts for 27% of AMG’s AUM. Through its partnership, AQR has grown from $12 billion in AUM to $226 billion today.
In May 2018, Nathaniel Dalton was named chief executive officer, succeeding Sean Healey. Mr. Healy, who will serve as Executive Chairman, had to abruptly step down because of health issues. As one of the Company’s founders, Mr. Dalton has served as AMG’s COO since 2006 and was named president in 2011. We have a great deal of confidence in Mr. Dalton’s leadership abilities and believe he will continue to execute a similar capital allocation strategy to that of his predecessor.
Intrinsic Value Greater Than Current Share Price
With a December 31, 2018, closing price of $97.44, AMG shares traded at a 50% discount to our private market value estimate of $195.00 and at only 6.3x Calendar 2019 Cash EPS. In our view Wall Street is failing to distinguish and reward AMG and its heavily-weighted alternative-asset affiliate business model from traditional active management firms.
Founded in 1946, Knowles (KN) is a leading supplier of acoustic components to smartphone and hearing aid manufacturers. Only a handful of competitors have the technology and scale to serve the marketplace. In smartphones, Knowles further distinguishes itself through vertical integration: it engineers and manufactures its own products. Investors’ fixation on quarterly unit volumes has resulted in fears over peaking smartphone demand. However, Knowles’ expertise, vertical integration and newfound operating leverage positions the company for a long runway of profitable growth across smartphones and connected devices, with diversification offered by hearing aids and industrial components.
Acoustics As A Core Competency
Today, Knowles is a leading supplier of the miniature microphones that are used in smartphones, essential components for hearing aids, as well as advanced components used in power supply, radar, and satellites. For over 75 years, Knowles has steadily built upon its expertise in acoustics. By the mid-1990s, Knowles’ acoustics technology was used in consumer electronics, and in the early 2000s, Knowles’ miniature microphones helped make thin mobile phones a reality. By 2011, Knowles had shipped 2 billion of these microphones, and crossed the 10 billion unit milestone in 2017.
Vertical Integration In Smartphones
Voice-controlled audio uses are already becoming more prevalent globally, much as the way “touch” uses were years ago. Rather than integrating its applications into the standard chips provided by the large chip makers, Knowles has moved digital signal processing onto the microphone itself (“Intelligent Audio”). This differentiates Knowles from the competition because it gives the company the ability to sell proprietary hardware and software together, thereby freeing them from being locked into any single chip. Also, integrating “chip” capabilities into the microphone enables Knowles to process audio signals locally, without having to interact with the cloud. This not only saves power on the devices and bandwidth for data, but also adds the benefit of privacy of users’ data.
Improved Free Cash Flow Potential
Over the past 2 years, Knowles has refocused its business through the divestiture of non-core units and reduction of gross debt. The company has already established the base technology that it needs for voice-controlled audio applications, so it is unlikely to require substantial increases in development expenses in the near future. The same can be said for the efficiency of Knowles’ manufacturing capacity. With its existing positions in smartphones, hearing aids, and industrial capacitors, plus a new and growing Intelligent Audio business, Knowles’ refocused operations and improved balance sheet should substantially improve free cash flow generation.
Investors are focusing on the near-term decline in global smartphone volumes. However, the long-term opportunity for Knowles is growing the revenue it derives per device, by selling its new Intelligent Audio capabilities with its microphones. Its largest microphone competitors do not focus on audio engineering, and also have to pay higher costs because they often buy their microphones from third parties. Knowles’ focus on its core competency is paying off with potential clients. In the last year, the company has reached agreements to provide “SmartMics” to 3 major Chinese companies, and won the audio software contract for Facebook’s newly-released home device, the Portal. As of December 31, 2018 the stock traded at $13.31, a significant discount to our estimate of its private market value.
Investing in small cap and mid cap stocks is more risky and more volatile than investing in large cap stocks. The intrinsic value of the stocks in which the Funds invest may never be recognized by the broader market.
On this page, we candidly discuss three individual companies to illustrate our investment process. These companies are current holdings of certain Funds, one of which was a top performer for the quarter, one was a new addition to a Fund, and the other was, in our view, undervalued by the market. The information and our opinions were current as of December 31, 2018, but are subject to change. The information shown does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. These securities do not represent all securities purchased, sold, or recommended to investors during the period. Investors that were not invested in a Fund that held each stock for the entire holding period shown will not have experienced the performance shown. Past performance does not guarantee future results. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of any Fund or of any particular Fund itself. Portfolio holdings are subject to change. Click here for the top holdings of the Funds.