JPMorgan Doesn't Advise Buying Advisory Board, Despite 'Strategic Alternative' Talk

JPMorgan downgraded The Advisory Board Company ABCO to Neutral from Overweight, citing limited upside following activist involvement-led 43 percent year-to-date rally that prices in the outcome of potential strategic alternatives.

The downgrade comes after the company’s announcement of exploring potential strategic alternatives after Elliott, a known activist fund, filed an 8.3 percent economic exposure to the stock in January.

“Although we believe downside is limited given ABCO’s recent commentary about pursuing strategic alternatives and a shift in the shareholder base, the shares' risk-adjusted upside is no longer enough to justify entry into the stock for an incremental buyer,” analyst Stephanie Davis wrote in a note.

Possible Alternatives

Davis gave her thoughts on the company’s potential strategic alternatives, including:

1. A margin-focused restructuring.
2. A sale to a strategic acquirer of all or part of the company.
3. A sale to a financial sponsor.

Davis believes the most likely strategic alternatives outcome will be restructuring for margin improvement, yielding share price range of $48–$57.

“Assuming ABCO’s current forward EV/EBITDA multiple holds, a four to eight point increase in margins would yield a share price range of $48–$57,” Davis wrote in a note.

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Meanwhile, a potential strategic sale yields share price of $50–$59 and unlock the highest value to shareholders. At the same time, the analyst noted that such a sale could result in the company splitting up its healthcare and higher education businesses.

“The subset of potential acquirers includes players in the healthcare IT, information services or IT services sector. However, we believe this is also the least likely scenario, as public M&A commentary in the HCIT space points to few active acquirers, especially for deals of scale,” Davis continued.

Finally, a potential sale to a financial sponsor yields share price of $47–$50. Davis believes a take-private transaction could make sense for Advisory Board as it would allow the company to execute on its restructuring strategy out of the public eye.

Analyst's Bottom Line

The analyst pointed out Advisory Board has a business model that is often favored by private equity, with hallmarks including high recurring revenue and solid free cash flow conversion. However, Davis believes leverage could be a limiting factor with his LBO analysis implying a minimum leverage of 8x given a maximum equity contribution of 40 percent.

That said, Davis raised her price target to $48 from $39.

At last check, shares of Advisory Board fell 2.43 percent to $46.10.