FOOL ON THE HILL
An Interesting Spin-Off Investment

This month specialty travel company Ambassadors International will spin off its Education Group, which Whitney Tilson says is its best business. He thinks the spin-off could unlock substantial shareholder value.

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By Whitney Tilson
February 6, 2002

While I have occasionally written about stocks I own, such as Berkshire Hathaway (NYSE: BRK.A), Imperial Parking (AMEX: IPK), AAON (Nasdaq: AAON), and Huttig Building Products (NYSE: HPB), I've generally shied away from doing so because I worry about someone accusing me of trying to "pump-and-dump" a stock or some such nonsense. Consequently, most of the stocks I've written about are my second-tier ideas (which have still done well, as you can see from "My Report Card for 2001."

In fact, much to my chagrin, the stocks I've written about but didn't own in some cases -- especially recently -- have done better than those I've owned. For example, the nine stocks I recommended in my October column, "Bargain Shopping in Uncertain Times," rose an average of 36% by the end of the year, and the worst performer was the only one I owned, Berkshire Hathaway (up 2%. Grrrr!). For better or for worse, going forward I'm going to make more of an effort to put my money where my mouth is and write about stocks I like enough to own.

Ambassadors International
To that end, this week I'd like to discuss Ambassadors International (Nasdaq: AMIE), a specialty travel company that will soon spin off its best business, the Education Group, to shareholders. Spin-offs like this are often excellent places to find attractive investment situations, so let's dig into this one further.

Ambassadors International is run by Peter Ueberroth (former head of Major League Baseball and the Los Angeles Olympics) and his brother, John. Its main business is organizing international educational travel and sports programs, primarily under the "People to People" name, for high school and college students, little league and other sports teams, and so forth.

This may sound like a mundane, commodity business -- and it is for most companies in the industry -- but not for Ambassadors International, primarily because the company has the exclusive right to use the People to People name until at least 2020. People to People International is a private, non-profit organization dedicated to the promotion of world peace through cultural exchange. It was founded by President Dwight D. Eisenhower in 1956 and was originally administered by the U.S. State Department. Seven presidents since President Eisenhower have served as honorary chairman of People to People.

According to Ambassadors International's 10-K, the company "believes that its long association with People to People has been a major factor in its ability to provide quality educational student and professional travel programs, and that this relationship provides the Company with greater access to foreign governmental agencies, officials, and institutions. The Company also believes that its association with People to People and the continued efforts of management have provided the foundation for the Company to develop and maintain strong strategic alliances, including but not limited to those with Yosemite National Institutes, U.S. Tennis Association, the Amateur Athletic Union, USA Volleyball, Wrestling, and Swimming, U.S. Soccer, and Babe Ruth Baseball."

In short, the 45-year-old People to People brand name is well known and respected worldwide in this field, providing Ambassadors International with a robust, enduring competitive advantage. The numbers support this conclusion:

  • Ambassadors International's Education Group (consisting primarily of the People to People programs) has an operating profit margin of a mind-boggling 50%. For comparison, Microsoft and Amgen, two of the most profitable companies I can think of, have operating profit margins of 47% and 46%, respectively.
  • Over the past five years, Ambassadors International has grown its top line at 33% and its bottom line nearly as fast.
  • Return on invested capital is 38%.
  • Free cash flow over the past year was $18 million and net operating profit after tax was $12 million.
  • The company has no debt, $138 million in cash and $111 million of current assets after deducting all current liabilities.
  • Its business has wonderful cash flow characteristics. Customers pay for their trips many months in advance, so Ambassadors International has cash flow that substantially exceeds reported profits and generates interest income on the "float" from such payments.

Flaws
No business is perfect, however, and Ambassadors International is no exception. The primary problem is that, in an attempt to build a specialty travel empire, management acquired over the past five years a number of other travel-related businesses for "developing, marketing and managing meetings and incentive programs" and "providing comprehensive hotel reservation, registration, and travel services for meetings, conventions, expositions, and trade shows." This is classic "deworsification." Ambassadors International has little or no competitive advantage -- and consequently has struggled to break even, much less earn its cost of capital -- in these areas.

Valuation
When I first looked at this stock about eight months ago, it was trading at $22. With $10.30/share (now $11.12) in net current assets, no debt and trailing earnings of $1.85/share (now $1.86), the stock was undoubtedly cheap, but I wasn't trembling with greed.

Then, after September 11th, the stock cratered -- along with the entire travel sector -- as investors feared that people wouldn't travel anymore. It fell immediately to $17 and then when management appeared to be having second thoughts about proceeding with the spin-off, the stock dropped as low as $13.40. When I started buying in late October at $14, AMIE's enterprise value was a mere $29 million, equal to 1.5x, 1.4x, and 2.1x trailing 12-month earnings, free cash flow, and net operating profit after tax, respectively. Any way you cut it, this stock was ridiculously cheap.

Of course, earnings going forward aren't going to be anywhere near historical levels for some time, but after speaking extensively with management, I became persuaded that the company would remain profitable and that bookings were holding up surprisingly well. Most importantly, over time I felt that young people would continue taking summer trips to Europe and other developed countries, as they always have.

Now that the stock has rebounded by about 50%, is it still cheap enough to buy? I think so, which is why I've been adding to my position recently. In some ways, it might be a better buy -- or at least a safer one -- than it was in October for two reasons: First, with the war on terrorism progressing well and no further attacks on Americans, the fear of traveling has subsided. Thus, there is significantly more reason today to believe that Ambassadors International will quickly return to its former high levels of profitability. Second, the uncertainty in October about whether the company would proceed with its announced spin-off has been largely removed.

The spin-off
Last April, Ambassadors International announced that it was considering spinning off its Education Group -- which includes the lucrative People-to-People programs discussed above -- and in November, the company filed a Form 10 with the SEC and said it planned to complete the spin-off sometime this month. This is a sensible plan, as the true value of this franchise was not being fully recognized by the market because it was bundled with the other inferior businesses.

So what are the pieces worth? Let's look at the Education Group first. Trailing NOPAT (net operating profit after tax, which excludes interest and other non-operating income) is $1.38/share. Though results over the next 12 months will certainly be lower, if we assume this is the earnings power of the business and apply a 12 multiple -- I think a business of this quality could easily be worth twice this -- you get $16.56. Add $2.51 of net current assets (mostly cash), and the total is $19.07 -- nearly today's stock price.

As for the remaining business, trailing 12-month revenue is $19 million and the loss was $0.9 million. Despite the small loss, I figure at the very least this business is worth its net current assets of $8.61/share (a tracking stock for this business has been created with the ticker AMIEV, but has not yet traded), which gives us a total value of both parts of $27.68 -- decent upside from today's price. And things really start to get interesting if you believe, as I do, that the Education Group could trade at 20 times earnings or more, and the remaining business could be turned around.

Conclusion
After the run-up since October, this is no longer a "trembling with greed" situation, but I think there is limited downside given the exceptional, cash-rich balance sheet, and the upside could be significant. That's good enough for me, especially given the paucity of undervalued stocks in the market today.

-- Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of Ambassadors International, Berkshire Hathaway, Imperial Parking, AAON, and Huttig Building Products at press time. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com/.