KGIC Inc LGLTF

Paradigm Capital comments on Loyalist Group Limited

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According to Paradigm Capital:

https://is.gd/deESdP

Loyalist Group Ltd.

Stock Rating: Hold

12Mth Target: $0.10

Tough Q2; Major Restructuring Announced

Investment Thesis.

Loyalist is an interesting roll-up opportunity to leverage the growth of the Canadian ESL market; however, near-term financial uncertainty (both income and balance sheet) keep us on the sidelines.

Event

Loyalist's Q2 results were below expectations as negative revenue influences from 01 spilled over into Q2 and opex was higher than expected. The company announced a major restructuring program aimed to deliver $15M in annualized savings beginning in H2.

Details

- Q2 details: Revenue and adjusted EBITDA came in at $13.2M (down 23% y/y) and a loss of $5.7M versus our forecast of $14.6M and a loss of $2.5M. LOY indicated that revenue weakness was owing to a continuation of negative factors spilled over from 01 (lower volumes and excessive price discounting). Tuition fees of $8.2M (vs. $9.4M forecast) were down 42% y/y. Direct costs were in line at $11.1M; however, G&A came in at $8.3M (vs. $6.6M forecast), primarily owing to higher-than-expected costs related to the agency businesses (producing operating losses of "$740K for this division). The company also took a further $21M writedown to goodwill and intangibles (on top of $13.2M in Q4).

- Major restructuring program announced: LOY announced a restructuring plan aimed to deliver up to $15M in annualized cost savings (headcount reductions, reduced marketing spending, streamlined operations), with the vast majority expected to be implemented in the next 30-60 days. The company is also targeting organic revenue growth through expanding and/or modifying programs (Pathway, Seasonal camps, Night school) that could generate $4M of incremental revenue in 2016 and $11M in 2017. A proposed name change to KGIC Inc. (King George International College) is to be voted on at the AGM (Sept. 10). KGCI is LOY's most recognizable brand and represents almost half of run-rate school revenue.

- Guidance updated: The company indicated that EBITDA levels forecast in the 3-year projections issued on June 19 are still achievable, but at lower revenue and lower opex levels. Break-even EBITDA is expected to be achieved during 04/15, with modest profitability by mid-2016 (in line with our forecasts). Management believes that Q3 should show signs of improvement, both in terms of operating costs and revenue levels.

- Estimate changes: We have lowered our revenue forecasts to reflect a slower recovery in tuition fees and reduced expectations for the agency business. This is offset by assuming LOY achieves "$13M in cost savings in 2016, resulting in essentially no change to 2016e EBITDA (Figure 2). We have not included any contribution from the new revenue initiatives.

Conclusion

Overall, the operational miss doesn't come as much of a surprise given the weakness in Q4/01 (new management took over late in the quarter). Management has aggressive plans to restructure the business, and with the recent fund raising and based on updated guidance (which is in line with our forecasts) we believe it should have sufficient resources to execute on this. That said, we expect the shares will remain range-bound until fundamentals start to improve. Hence, we maintain our Hold rating and $0.10 target price.