A Bidding War for Advisory Board Company

18 July 2017 | by Sean Stannard-Stockton, CFA

The post below is an excerpt from the recent ENSEMBLE CAPITAL QUARTERLY CONFERENCE CALL. You can read the full transcript HERE.

I’d like to provide a brief update on Advisory Board Company, whose stock has doubled since March of this year. As we described in our blog post about the company written at that time, Advisory Board provides software and consulting services to help hospitals reduce the cost of health care while improving patient outcomes.

The US health care system is fundamentally inefficient to a degree far out of step with the rest of the world. While Americans pay 50% more per capita for health care than the best in class health care system provided in Switzerland, the life expectancy here is as low as that seen in Chile and the Czech Republic, who spend 75% less per capita than we do. As you can see in the chart we published in our post on the company, health care systems around the world fall on a curve that neatly describes the relationship between per capita spending and life expectancy. The US is the only country where this relationship between spending and outcomes is fundamentally broken.

Earlier this year, market participants sold Advisory Board stock down to its cheapest valuation in history outside of the 2008-2009 financial crisis. Investors were concerned by the slowdown in Advisory Board’s revenue growth and worried that the company’s significant push into providing services to higher education institutions was a mistake, despite education suffering from similar issues around weak student outcomes in relation to runaway costs.

As with all of our assessments of a company’s fair value, we focus on cash generation. Both of Advisory Board’s businesses generate outstanding levels of distributable cash flow even while offering long-term growth potential.

Earlier this year, the activist investment firm Elliot Associates, run by famed hedge fund manager Paul Singer, recognized the disconnect between Advisory Board’s public market price and the actual intrinsic value of the business. After taking an 8% position in the company, Elliot Associates pushed the company to sell themselves, likely splitting up the education and health care business to two separate buyers. The stock has been rapidly appreciating ever since, rallying over 10% in early July as Bloomberg reported that United Health was emerging as the leading bidder for health care while private equity firm Vista was the mostly likely bidder for the education business. With earlier reports suggesting over 20 bids had been submitted for the company, it seems clear that no matter what price the company ends up selling for, or even if a deal falls through, Advisory Board is a company with significant intrinsic value that the market has underappreciated.

We sometimes use the phrase that we bring a “private equity approach to public market investing.” This simply means that we make investment decisions not as stock analysts seeking to guess which way the stock will move, but as business analysts seeking to understand the economic value of the companies we analyze. We believe that over time, public markets value stocks on the same basis as private markets do. In this way, markets are efficient over the longer term.

But in the short term, public markets often misprice stocks relative to pro rata ownership in the company they represent. This is what Benjamin Graham meant when he said that “In the short run, the market is a voting machine but in the long run it is a weighing machine.”

Ensemble Capital’s clients own shares of Advisory Board Company (ABCO).

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