Yet Another Value Podcast - Chris Colvin thinks Veritas is stealing $HMHC

Episode Date: March 17, 2022

Chris Colvin returns to the podcast to discuss why he invested in Houghton Mifflin Harcourt (HMHC) and why he thinks the deal to sell HMHC to Veritas is much too cheap.Breach Inlet's letter to HMHC: https://www.businesswire.com/news/home/20220223005845/en/Breach-Inlet-Capital-Sends-Public-Letter-to-Board-of-Houghton-Mifflin-HarcourtMy notes on HMHC: https://twitter.com/AndrewRangeley/status/1503704685861273604?s=20&t=BJwJj9NIUfEf4nip2Hlf4wChapters0:00 Intro1:15 HMHC Overview6:45 Situation Recap9:00 Why does Chris believe this deal is too cheap?13:05 HMHC's strange forecast and massive revision19:35 HMHC's advisors conflict of interest22:55 Why did management and the board chose to sell the company now?28:00 HMHC's roll up potential31:25 Veritas's other edtech plays33:35 How does this play out from here?34:05 What if the tender fails and Veritas walks away?49:00 Did HMHC's projections undersell the stimulus money impact?51:00 Closing thoughts

All right. Hello and welcome to the Yet Another Value Podcast. I'm your host, Andrew Walker. And with me today, I'm excited to have for the second time, my friend, Chris Colvin. Chris is a portfolio manager and the founder of Breach Inlet Capital. Chris, how's it going? Great, great. I really appreciate you having me again. Hey, I appreciate you come back on and I'll talk about that Y in a second. But first, let's start this podcast the way I do every podcast. First, with a quick disclaimer for everyone, nothing on this podcast is investing advice. Please do your own work, consult your own. financial advisor, just keep all of that in mind. And then second, with a pitch for you, my guest, you know, I was going back, time flies. You were one of the first 10 or 15 guests on the podcast back in November 2020. People can go listen to that for the full pitch. But, you know, you're a super sharp small cap investor. The last idea you pitched, I thought it was so eventy. I thought it was so good. And it worked out really well. And, you know, people should go listen to that. That was great Canada, great Canadian gaming. That worked out well. And I'm seeing a lot of parallels the idea we're going to talk about today. So without it the way, the stock we're going to talk about

today is HMHC. I know you've got a long history with it. There's an acquisition offer out there, which I think's too cheap. I know you think's too cheap. But I'll just turn it over to you. What's going on with HMHC? Yeah, sure. Thanks again for having me. And yeah, hopefully this has a similar outcome or better than Great Canadian did. So, and disclaimer, as you said, do your own research. My firm does have a position in HMHC. And I would also say, We are not looking to form a group with any investors. So, yeah, HMHC, it's been around since the 1800s. They became public in like the 60s and then went private again in 2001.

And they were owned by a couple private strategics between 01 and 13, before they became public again. So give you that background. This thing's definitely been, you know, bought out before and owned by both private equity and strategics. We got involved. And I should say, first I looked at this in two, 2015 around the time I was launching my fund and I passed on it because the prior CEO had a very

unclear long-term strategy and profits were declining pretty precipitously. So I passed on it, put it in my file or watch list file and said, hey, if CEO changes and they kind of change a strategy, there are some good things about this business. And we got officially involved, took a stake early last year when it was around five, six bucks a share. And our thesis was, it was transforming from good to great business. So you had a business with 30% market share in an oligopoly. There's effectively three players that have 80% share. And so they're the largest. And that was in core curriculum for K through 12 schools. So great market share. And their moat, the primary moat they had was their brand. As they say, in this case,

you don't get fired at a school for picking Hoffton Mifflin's books. So that was a very sticky mode from a 100-year-plus brand. So that was why it was a good business. And we believe it was transforming from a great business or into a great business because they sold or were in the process of selling their non-core consumer books business. And that has since been completed. But at that time, it was up for sale. So that was part of our thesis.

And with that, they were transitioning to more recurring. revenue as books are now, instead of being a hard textbook that you and I had in school with switching to an iPad and a software program. So switching to more recurring revenue, they were cutting a bunch of costs and have a lower cost structure and making it far less capital intensive. So the growth, consistency, and caselo profile were becoming far more attractive. So good to great business. Then you had some unique tail-ins. One was schools reopening. Secondly, you had government stimulus, which ended up being, I think, $200 billion, is allocated to K through 12. And COVID accelerated this concept of one device for each student.

Before COVID, on average, you had one device for every two students, and that's really become one-to-one as obviously kids were homeschooled. So you had these nice tailwinds that would help them in their transformation and accelerate earnings growth and recovery. And a third element of our thesis was an experience CEO, Jack Lynch, had transform or founded five different companies in the ed takes space, or this was, I guess, his fifth. So he had a lot of experience and success. And then lastly, it was dirt cheap. On the math, we were doing on normalized earnings, it was trading at that point at sub five times, and that normalized earnings ended up being very conservative given they continue to cut costs.

and kind of a rebound in billing. So that was the reason that we initially invested, obviously worked out well this first year of ownership, but we were looking forward to owning it many years from here. We had, I think, a $40 price target looking out, 18 to 24 months. And I actually had lunched the CEOs, lives in Charleston part-time, So I had lunch with them, actually three days before that Bloomberg article came out. And from that lunch, I took away that this is going to be looking to, you know,

create long-term value for shareholders and thinks the stock is cheap. Now, it was it about 15 or 16 bucks then? But after that lunch, we saw the Bloomberg news stating that they were looking at getting acquired, that private equity suitors were approaching. We sent a private letter to the board stating, we're not going to tender or vote yes if it's less than $30 a share because again we thought fair value looking out a few years was 40 and obviously ultimately they announced that Veritas would be it's trying to acquire them for $21 per share through a tender structure and we wrote a public

letter outlining the reasons we don't support that why we would not tender our shares since that letter, three other shareholders have written public letters, and I know of others that have considered it and are certainly not happy with this. And since our letter, the tender dot came out. So I'm happy to kind of walk through the four or five reasons we're against the tender, but that's some background. Let's do that in a second, but let's just pause there. That was a fantastic overview. But if I was just to summarize, look, you invested this in early 2021, did well. it. It's done well. But right now, the situation is this company is under merger contract. There's a tender offer outstanding to buy out the whole company at $21 per share. You and I know

Latham Water and Engine have both publicly come out with a letter. I don't know who the other one is, but I've heard from several shareholders. One of my friends, Jonathan has been pushing me for years to look at this company since I've got text messages from him when it was at $3 per share. And I've just had trouble looking, but he was like, I'm so happy driving Chris on. This is way too cheap. Veritas is stealing the company. So I know there's other shareholders out there who think this is too cheap. But that's the overall situation right now, right? $21 per share offer on the table. You and some other shareholders are pushing back. This is too cheap. We either need to stay public or this offer needs to get raised a lot higher. Is that a fair characterization?

Yep. Yes. And I think there's a, as I go through kind of the reasons we're against it, as have been outlined in letters since ours, I think there's a much better path for all shareholders. I'm going to let you go through that path in a second, but I just want to agree with one thing. You mentioned you had lunch with the CEO three days before this, the rumors broke. Obviously, I didn't have lunch, but as it was prepping for this podcast, he was at, I think it was a Goldman conference at the very start of January. And I was put in my notes, I put in my Twitter thing, people go see. He sounded so bullish. He was talking about how great 2022 growth was going to be, all the recurring revenues, how the business was firing all cylinders. I couldn't

believe that he would he would say that like two months two weeks before they would get into deep sales talk to sell the business that you know a fine premium but it's still like nine times EBIT or something like it's nothing great for all the growth and how well that he was talking about the business doing yeah I agree with you you know disregarding by my lunch because I'm not going to quote exactly but but overall the summary from the lunch was focused on creating long-term value, think there's a lot of opportunity and think we're really cheap. And I specifically asked about private equity, taking them out. That was one of my concerns and said, you know, if they bring an offer above fair value or at fair value, then we bring that to the board.

And obviously, we have different views of what fair value is. And we can kind of get into that. So why don't we just start with that? $21 per share, your letter, which it's going to be included in the show notes. I link to it on Twitter, we'll include in the show notes so people can go read off on it fully. But why don't you just walk through? Why $21 per share isn't fair? Because I think the company would say, hey, we ran a full process. You know, you can go read the tender dots. We reach out to a lot of people. There's party A. There's strategics. There's financial people. I think it was like 50 or 60 people in total. We ran a full process. Veritas came out with the highest bid. It was a 35% plus premium to the unaffected share price. If you're going to turn this down, like you're basically saying all of these financial strategic buyers were completely wrong that this was a full and fair process that we ran. Who are you to push back on this? Yeah, I think the first thing is the process. And this is something that wasn't in our letter

because the tender document had not come out that disclosed the process, or this would have been the top of our letter. We believe this was a flawed process. Number one, if you look at the timing, so they started the first meeting to discuss strategic alternatives was in June of last year, they would have just reported trough billings. Their billings at that point

was $400 million annualized. For perspective, in a normal environment, they should be doing $1.2 to $1.4 billion. Why would you consider strategic alternatives when you're just coming off of trough billings, trough earnings? It reminds me of our last podcast was Great Canadian, who sold themselves Like before the vaccine came out, right? Like literally right before casinos could fully reopen, they sold themselves. It's similar in that way, but please continue. Yep, definitely parallels. And then that's the beginning of the process.

The end of the process, the timing I also have struggled, I struggle with, because they announced the deal two days before fourth quarter earnings were due. And not only were those earnings ultimately very strong that we'll get into, but they would have typically offered 2022 guidance. And I would make the argument, if you just look at their fourth quarter earnings, as you said earlier, it implies they're buying this for nine times.

McGraw-Hill was bought for just over nine times, and that's, I would argue, not as good of a business. So on trailing, had they not announced this process, I truly believe, had they not announced a tender in the process, that this would be a $20 plus stock today,

because if you put a little premium to McGraw-Hill on trailing earnings, 10-and-a-half times, now you're talking about a $24, $25 stock. So number one was the timing on the process. Secondly, as I think I saw also in some of your tweets, is the initial forecast was completely sandbagged. And that forecast came out in November after announcing third quarter earnings. And that is what the initial bids were based off of. So they contacted 60 parties, and ultimately 58 of those were gone before the revised forecast.

So this initial forecast, to be specific, said that 2021 EBITDA would be $190 million. Trailing EBITDA at that point, trailing 12 months, was 240. So bidders looked at this forecast and said, wow, there's going to be a huge drop in earnings in the fourth quarter of 21. and then in 22, you're guiding to 270. So now there's going to be this hockey stick. I think any bidder that's private equity firm that's looking at tons of deals every week, quickly looks at that forecast and says something doesn't smell right here and we'll pass, which is what you saw most do.

Now, I don't know that, but just to me, that initial forecast was certainly sandbag, and I feel confident in saying that they ultimately reported their 22 guidance, 22 forecast, $270 million of EBITO. If I can just to pile on here, so the initial forecast, which is done in November. So there's like six weeks left in the year, 196 in EBITO for 2021, 270 million in EBITO for 2022. Then January comes out. Bids are almost two, and they have to do revise.

2021 EBITDA comes in at 270. As you said, they did 2022 in 2021. They were off by 40% on their 2021. projections in six weeks, and then they update their 2022 EBITDA to from 270 to 286, 2000, 2003 EBTA goes from 308 to 350. I mean, these are massive moves, especially for a business, which I think we'll probably talk about this in a second, a digital recurring revenue subscription business that should have insane amounts of operating leverage, right?

So when your EBITDA goes from 270 to 300 or whatever, all of that's going to come through to the bottom line. And I think it's important to point out the initial. forecast came out in November, right? I think early mid-November. I think earnings are like November 6th or something. So that's the six weeks you referenced. But initial bids were due December 15th. How in the world did the board not go to bidders and say, you know what? This initial forecast is way low. Like two weeks left in the year, you've got to have a good sense that you're going to be way above 190 million of EBITDA or 196 million. So, yeah, sandbag initial forecast. And then to your point on the revised forecast, so that came out in January. And at that point, there were only two of the 60 bidders remaining. And one of those not disclosed, I think it was party B, maybe in the document.

It is. But they ultimately passed because I think they had their own kind of, it was either integration or financing or funding issues. So you're kind of left with one real bidder, i.e. veritas. And let's talk about that forecast real quick. the operating leverage for 22 was negative, and the operating leverage after 22 was low to mid-30s, and they have publicly touted 65% incremental margins for a year plus. I've got this in my notes, but they're literally in their investor deck. I put the tweet.

They've got a slide that says 65% of incremental billings throw through to free cashable average, not 65% of EBITR, 65% of incremental building. This is a business with insane operating leverage. And as you're saying, their forecasts are calling for almost de-operating leverage as they grow. Yeah, de-operating in 22, and then about half that. And I'm comparing apples to apples. They actually give, if you dig deeper, the tender doc gives you their free cash flow projections. It's not in the table, but then it's later.

And when you do the math, it's like 33 or 34% incremental market. margins, what happened to the 65% margins that not only have you been guiding to, but they actually had been achieving thus far in the recovery since they had reduced the cost structure. So, yeah, the revised forecast, I think the other thing that was concerning are a couple other elements in just the process itself. So February 17th, Ferretas submitted the $20 bid. a revised bid based on the revised forecast. The board goes back February 18th and says, no, you got to submit $21 a share. Yep. They agreed to 21 that day. If you read the tender doc, February 18th, and the board didn't say you have to agree today or this is going away. I mean,

they had no other bidders at that point because it was based on this revised forecast. But I thought that was interesting, but the board asked for $1 or more. Veritas said, sure. Yeah, that sounds great. Yeah, we'll do that. So I think that was interesting. Also, a couple other things I didn't like. I would just say to be a fair and balanced neutral

part, I don't disagree. It's quick to turn it around, but I do think like Veritas is an experienced private equity bidder. I have seen in past docs where a board comes back and says, hey, 20 isn't enough. We need 21. and the bidders can respond pretty quickly because they know where their bottom line is. So I don't 100% disagree with you, but just to be kind of a little bit fair and balanced there.

Yeah, no, it doesn't surprise me. They responded right away. And yeah, no, I hear you. But I do think it's just like maybe a little nugget that that wasn't a whole much more to ask for. And then, of course, the structure, when we talk about the process, instead of a boat, it's a tender. And that's crucial that's a huge negative for us as shareholders. And I thought it was laughable that in the Tender Dock,

when they listed the reasons, the reasons you should agree to this merger, because they had, here's the positives, here's the negatives. Listed under positives was this is a Tender, which that is not a positive as a shareholder. And I'm going to have a quick public service announcement here. ISS and Glass-Lewis need to start making recommendations on tenders because I think you're going to see more tenders happen and in the world where passive shareholders, the Vanguard guards and the Black Rocks of the world can own over 50% of the shares, which is all you need in the tender, they're going to base it on, they often will base it on proxy recommendations.

There is no proxy recommendation. And I think they have to change that. and provide a recommendation on this. Because it's effectively the same as a vote. You're just voting with the tender. That's really interesting because the classic, you know, merger herb event-driven thing is tender offers are the best because they happen really fast, right? You get your money. There's less chances of a deal falling through.

There's less chances of something going crazy. When the tender offer happens, all the financing, it's going to be super fast. But that is interesting. It is a way to kind of get around, hey, maybe this was a flawed process. Hey, maybe somebody, you know, there's something in there that ISS and Glass Lewis wouldn't do and you can do this really quickly and kind of before anybody really pays it. That's a really interesting comment. Yeah. And the last thing I'd say just on the process is conflicts of interest.

So we saw this in Great Canadian too. Actually, if I remember right, Evercore was the advisor to HMHC. They also provided the fairness opinion. So I know we're seeing this and seeing it more often. I remember when I was in banking, you always, if I recall, you always had a different bank, which makes sense to the fairness opinion. There's a huge conflict there. Yes, we should certainly get this deal done so we can get our banker fee. And that fairness opinion used first quarter estimated net debt of $3 million. Their year-end net cash was like $120 million. So you're talking

about a dollar per share of value that leaked just by saying, you know what, we're going to base this on a estimated March 31st instead of using the actual balance seat at 1231. And my guess is that March 31st was based off, again, a very low forecast. They don't give you the, you know, the details to get in there. And the last thing on conflicts and interest are two other things. A fairness opinion. Can I just, can I add one thing on Everc? One person when they heard you were coming on stock HMHC, they said, hey, I'm really pissed at Evercore worked with HMHC on this because Evercore apparently does a lot of banking for Veritas on the other side. And they said, you know, not to accuse a banker of feeding the, of kind of, you know, working with, but they said

they think Veritas has a lot of work with Evercore. And maybe that had Evercore put their thumb on the scale a little bit there too. So I don't want to accuse them everything. That's unconjectured rumor. People are saying that type of stuff. But I know. Actually, that was the last on the conflict of interest, on the fairness opinion, they didn't actually name the transaction comps. At least I didn't see it, which that's fairly uncommon, like to not even list what transaction comps are using, but fine. But the last thing I was going to say on conflicts of interest. And again, like you said, not accusing anyone of anything. These are just facts that the tender dock discloses that Baratos paid Evercore $75 million over the last 24 months.

So there, well, that must be where my friend got from. I didn't realize it was source, but that's why people are saying it, right? Like Ferritus clearly works with them. And it's strange to have the private equity firm pay them so much and then have them advise the target. Very strange stuff. And again, give the fairness opinion. Yeah. So those are just facts. They were banker, fairness, opinion, received 75 land. Take those facts and form our opinions, right? So go ahead. No, speaking of conflicts, injures, that, that's great. I do want to talk about, so bankers can be conflicted. private equity would love to buy every business for a song, right? But it comes, I want to come back to

the management team and the board of the directors, right? Like, it seems strange to me that a management team in November would put together a forecast that was so off on the EBITDA forecast. And when it did, and then in December when the process started, if I was the board, I'd be like, holy crap, like, are EBITDA is going to be that much higher? We're gushing cash flow. Like, maybe we need to pause and evaluate. Like, look, earnings are 40% higher. Our business is 40% more value. we need to rethink everything, right? It seems a very strange time to go and sell the company. So I want to talk about maybe conflicts of interest from the management and board point. Why do you think that they're recommending a sale right now? Why do you think they didn't?

Obviously, a lot of shareholders pissed at this. Why would they go with a quick sale, not kind of reevaluate, maybe think about staying public, maybe asking for higher price, all that type of stuff? Yeah, it's a great question. I don't have the answer to that. I think it's the question that we're all asking. What I can point to is the board owns, I believe, 0.3%. If you remove Jack Lynch, they own 0.3% of the shares. Yep. Now, part of our assessment, when we look at a potential portfolio company, is what is the experience, which I touched on, Jack has very experience and alignment of incentives. And Jack himself had good alignment. Now, I don't know, the tender doc says that there has been no employment contracts executed, I would find it very hard

to believe that Jack is not staying on. And I think unless you know what that employment contract looks like, it's kind of tough. I think it's just speculation. So, and I don't want to speculate on maybe for all I know Jack is retiring, but I suspect he's staying on. There's probably a nice incentive package there. I don't want to speculate, but I will say like, Look, as you said, insider ownership here is very low. Jack owns, I think it's 400,000 shares of stock and another 600,000 so of stock options. So on a $20 stock, that's not nothing, but it's not huge, right? So I could imagine a world, you know, AutoZoon, or sorry, Academy Sports is a company I've been looking at a lot recently. And they have a fantastic CEO. And what happened was private equity bought a business. They were having trouble and they got a fantastic CEO by saying, hey, we're going to give you stock options to buy a ton of this company on the cheap. It's very levered. It's a little distressed right now. If you can make this work, you're going to make tens of millions of dollars. And I could imagine, yeah, there's no agreement between Jack and Veritas, but he says, hey, he knows himself,

I'm the best person to run this business. If this goes private, they put some leverage on it. I can get some stock options. And if I keep executing, I can really juice this thing. You know, so that would be my congestion. I don't know if you want to add anything to that. Yeah, because we don't know if Jack's thing on an employment agreement, we're speculating. I think if you asked any shareholder, when you asked me, why would the board agree to this? I can just turn to excluding Jack, that group of board members owns very little stock, number one. And then two, I would want to know what the post cop is. And I think one of the letters written out there suggested giving Jack more cop.

And I would be on board with that as well. I think he's done a great job running the business. If we need to pay him based on if you hit these targets, you know, this stock gets to $30, $40, as long as it doesn't get to where the compensation obviously is materially hurting the shareholders, I think you could create a nice alignment there. So we can talk about the better path. And I think that should include going to Jack and saying, hey, not sure what you had with Veritas, but here's a deal staying public where you can make a lot of money.

if you create shareholder value. And that was what one of the letters, actually a friend of mine, Persad, wrote on his own, but we've known each other for years, been in similar situations, owned the same companies, think similarly. And that's what he put in his letter,

which I thought was a really good idea. This is the charter, even Tesla did it, right? You give the CEO and you say, hey, we're going to put some aggressive share price targets out there. But if you hit them, you're going to make multiples and multiples of money.

right. Give him, hey, 100,000 shares, stocks at 20, 100,000 shares vested at 30, 150,000 shares vested at 40, 200,000 shares vest at 50, and you've got to hit those in five to seven years. And if you hit them, yeah, you're going to get really rich, but shareholders are going to be super happy, right? You doubled the company, and it really aligns interest well. And I'm with you because he joined this company in 2017. I think he's not a really solid job. And honestly, he's probably been underpaid for how good of a job he's done in selling the Concord divisions, getting this business on the right track. Yeah, I agree with you.

I mean, I think he's done a phenomenal job and would be happy to pay him much more and align it with a higher share price. And I think there's a scenario where that could be more attractive than maybe what what do you get as a private company. But, but, but yeah, let me go, let me go, well, I'll ask you first. Is anything else on the process that you want to talk about here? No, I think that's, there's a little, but no, I think that's, that's the big, the big pieces. Let me ask you a qualitative question. One of the things I was surprised by, so again, I'm not an expert on this company.

I followed them tangentially for a while. I brush up on them for the podcast, obviously. But one thing I surprised by was the CEO says, hey, we've got a significant barrier to entry for new companies. 30% market share, as you said, pretty sticky business, Salesforce. Like, you're not. not going to be a startup company and come and be able to just sell to grade K on reading or something, right? Like, there's real benefits to scale and Salesforce and everything. And if you, if you can do that, like often the best thing is just go sell yourself to HMHC and they'll plug you, they'll plug you into their huge distribution part. So there's a barrier to entry there. I was a little surprised there hasn't, they haven't done much bolt on M&A and stuff. I don't

think they've bought a business in the past five years or something. So my two questions there were, am I missing something? Is it strange that they haven't done M&A or is there just a lack of opportunity? And then part two, the question was, do you think Veritas is looking at this company and saying, oh, great, this is a levered roll-up story, right? Like, we buy them, take them private, and we accelerate their growth by going to do a bunch of accretive bolt-on acquisitions. Yeah, great question. So the first part of that question, they have not done M&A, and I think it's because they've really been focused on transforming the core business itself, sell off the non-consumer business, get the cost structure low, transition to more digital. And they had

started to, so if you think about the K-12 market, there's the core piece, which there's basically three big players, then McGraw-Hill and Savas, which was part of Pearson. And then you have what I would call, in core, think of your reading math sciences, everyone's got to take K-12. Then they have an extensions and supplemental market. And the easy way to describe that is think of materials for students that are either behind the curve or ahead of the curve. And that is a business where they have like 10% share, and part of their strategy was growing that share. And that was going to come through two avenues.

One was going to their schools, their customers, and saying, look, we already served this core material. Now we've created our own products and the extensions, and we think we can offer more here and try to get their share and extensions up to core, which is why all of us keep referencing, seeing normalized billings, I think the reality is it's going to be much higher than normalized billings, materially higher because I do think they'll gain share. The other part of gaining

shares, so there's an organic piece coming up with their own products and selling based on they have the best platform because they can serve everything. The second piece, and they've actually been pretty vocal recently about, is the opportunity to acquire smaller startups that have great product, but don't have the scale to get into the doors of the schools and to go sell this thing nationwide. So that was a key part of the strategy going forward. When you look at some of their materials out there, it was focus on making sure organic growth and we've got the business going the right direction. Then it's M&A and then it's return of capital. So hadn't seen it yet because they had to get the transformation done and obviously

COVID impacted that. In some ways, accelerated the transformation, but probably took some more work is that was a major kind of setback from a Billings perspective. But that was definitely part of the opportunity. If you think about Veritas, they bought Cambium Learning. I think it was in 2018, if I recall, which is in the space. And then I believe they also bought the K through 12 business from Lexus, if I'm remembering, right? But they bought Lexus and then they're keeping the K through 12 piece of that. So they're already starting a roll up here.

Do you know, I had forgotten about that about Baratoss. So obviously they've got expertise in the space. Do you know Veritas? I don't think they said it on the, I don't think they said it in the press release or anything. Do you think they're planning to merge this with the other businesses they have? Are they going to run this as a standalone and just kind of be like, we've got lots of plays on that ed tech space?

I don't know, of course, but I would suspect I don't see why they wouldn't ultimately merge these entities. I mean, the cost savings, the cost synergies, there has to be some. And then second, I think there should be probably some revenue synergies. That would be my guess. I think the public, what HMACC has stated publicly, you know, as part of the tender, they release the materials that the employees get. And in those materials, they imply or directly state that it will be a standalone. loan, but I would suspect that down the road they're going to merge these entities.

And as one letter pointed out, if you read those materials, they say, look, this merger's happening. There's just some customary closing conditions. And that's one of the things I think it's been frustrating from the shareholder perspective. This is not a done deal. The ultimately, the board doesn't control the company. It's ultimately down to the shareholders. I think the employees, they own shares. And so is that unfair to not make clear to them that, hey, you've got a right here. It's not a vote, but you have a right to tender or not. And oh, by the way, we plan to stay as a standalone entity.

But the company buying us has acquired two other companies in the space in the last 36 months. No, I'm completely with you there. though at the same time, I feel like it's a tender offer, right? What do you say other than it's subject to customary closing conditions and stuff? My shadows are getting crazy here. But no, I'm completely with you there. Let me ask you, okay, so we've got the $21 per share offer on the table, right? And from here, there's two paths.

Shareholders can, you know, hopefully shareholders get together. And if everyone agrees, this is, if shareholders think this is undervalued, shareholders don't tender. and then either Veritas can bump their bid or Veritas walks away and HMHC is a standalone publicly traded company and we can go from there. So I want to walk down both paths. Let's start with path number two. Say the tender offer fails and Veritas walks away.

I think you argued $40 per share in value. Like what would you like to see for that value to get realized? Engine proposed do a big tender offer right now to buy back a ton of shares at 21 or 22, move on from this and then go for it as a standalone. Would you like to see that? Would you like to see them really lean into organic growth? What would you like to see as a standalone if this deal fell through? Yeah, good question. And I think it's worth touching on evaluation. If you take the low end of their normalized billings, it implies like $1.75 or free cash flow, put a market multiple, which I call 60 and a half times. And I think this is better than the average public business,

especially as this transform transformation continues. But that gets you to like a $29 a share. If you take the mid-cycle billings, they get you to over $250 per share of free cash flow, apply a market multiple, and that's how you get a $40 stock, which is what we were getting when you look out a few years. And I think you'll see multiple expansions.

SAS peers trade for seven and a half times revenue, which implies this is a $70 stock. And again, I'm not saying it should be $70 today, but that just kind of shows you the potential upside and expansion. you have an NOL that's worth about $2 per share, a net cash balance sheet, and those are things that the NOL we're not getting paid for, and that's future upside. And, of course, I think there's going to be big synergies we talked about. And it's also worth noting when the CFO was hired back in, I think it was 16, it was a $20 stock

back then. So there hasn't been truly any shareholder value created since he joined. And that just shows you this. This isn't like they bought some huge premium and it's never been here. And it's a much better business today than it was in 2016 when I was a $20 stock. And also cheaper on enterprise value basis because net cash versus a lot of debts. But I think the better path, I agree with what some of the other shareholders have written at a high level. I think if it were totally my decision, what I honestly, if Veritas walks away, who I hope they walk away if they're not willing to pay materially more,

then I would go lever the company two times on last year's EBITDA, which would end up being sub two times on this year's EBITDA. You can go buy back 20% of the shares at today's share price. And that would convert to, you know, a stock that's doing, you know, on low end of billings over $2 per share of cash. So on mid-cycle billings over $3 a share. Put a market multiple. You're talking about $35 to $5 stock.

And that should still give you, so you do two times leverage on last year's EBITDA, ultimately less than that on the forward EBITDA. And this thing's generating cash. So you should be able to also have the capital to go do some M&A. Because I think that is an opportunity to expand their extensions and supplemental product portfolio and really increase their market share there. So I think it's both those scenarios. And I think the only other thing I'd add, again, when I was. reading the conference from the beginning of January and going through the decks and stuff, like, this is a business. The revenue retention is off the charts. It's going to print cash flow.

There's tons of operating leverage. Like, this is a business. This is why private equity loves these businesses. It's a business that can support a lot of debt because it should be non-cyclical with selling into schools, non-cyclical, very steady with that revenue retention. Like two times EBDA, two-time leverage is not crazy on that type of business, especially the leverage is going to come down really quickly because of both the cash flow generation and the growth. I'm with you. So as a standalone business, what you'd like to see is kind of what I'll call the engine model, right? Hopefully, Veritas walks, buy back a bunch of shares at the Veritas price. So the ARBs and everyone who were in it for the ARB can get the heck out. It's going to be

an accretive price. And the remaining shareholders who believe are going to own more of the company. And hopefully the company grows and it's going to prove to be very cheap. So that's one route. And I'm with you there. Let's talk the second route. You know, we get into, I think the tender expires at the beginning of April. We get to the tender offer date. And Veritas sees, hey, we don't have the shares to close this deal. We need to bump to get some of the Chris or the engines or the other shareholders who have said, we're not tendered into this price. It's way too cheap.

So they're talking about a bump. You have said, I think you said, on a market multiple, this business would be about 29 or 30. I think engine threw out a $40 per share price on the company. What price do you start saying, all right, bird in the hand worth more than two in the bush? What price is you saying, all right, I'm going to tender my shares into this? Yeah. And before I answer that, I should clarify on that first scenario, they stayed public.

I was talking about two times gross leverage. They would still have right now $135 million of cash flow. Great point. Great. Yep. Yeah. So net leverage, we're talking like one and a half going much, much lower. So in that scenario, you have the ability to buyback stock plus plenty of cash to go do your

roll up of smaller companies. And you made the great point that I should have stated also, you could pay $22 a share. So the folks that want to tender at 21, well, now you can get a dollar higher and those that like me that want to stick around and see a longer term opportunity. So it's a win-win for everybody. But in the scenario, I would just say I'm a little greedier than you. I would say you offer 21. So the ARBs get there 21 and then everybody else saved the dollar and can get it a little higher, but I'm with you there. Yeah. Yeah. So to your question of what price would I accept, we said in our letter that we thought it should be $29 a share. Honestly, our letter was a little more conservative because I told you our private letter said $30 a share.

And it was before the projections and the tender docs and everything came out. So you were writing, as I call it, in the fog war, there's new information that's come up. And if you take our 29 plus $2 of NOL value. That's 31. Said differently. Take her 29 plus the fact that there is going to be, I think, some synergies. So think about that. And secondly, that scenario where I told that we buy back to 20% of the shares just levering it gross two times. That gets you easily to a $35 stock, I think pretty quickly north of 30. So I would like to see $30. That's where I'm going to tender my shares. If they came out tomorrow and said 28, I would still not be tindering my share. which someone can say, well, that's crazy. But that only sounds crazy because you're anchoring it to this very low $21. If you look at their trailing EBITDA, apply a slight premium to McGraw-Hill's buyout, which, to be clear, I think this is a better business. McGraw-Hill has a liar, a lot of higher ed tech exposure, which is much more competitive market, and they have very little share in the K-12 extensions and supplemental. So if you take McGraw-Hill, apply a one-term, one-and-half-turn. premium on trailing EBIDA, you get to a low to mid-20s. And obviously, we're not near normalized billings from what the company is publicly stated. That doesn't include the benefits of a tender and everything. So $30 would be, if I own 100% of the company and you were Veritas and said, what do I have to pay you? It would be $30 a share. Yeah. No, look, I don't, I don't disagree with

you, but I think if they bumped it, I think if they bumped this to $26 to $28 per share, I think ultimately they'd be able to get this done. There'd be some shareholders who weren't crazy happy. But again, it comes down to burden. It comes down to the burden. I agree with you. Yeah. I do agree with you. We take a, you know, we've owned companies for over five years. So we're probably a little bit more of a longer term holder than I think maybe a lot of public. Than me who started ramping up on this a week. ago and is overheroed pining like he's an expert. Yeah, but no, yeah. So I, but yeah, I agree with you. I think if they, especially at the

high end of that, but I think 21, you know, you have a bunch of passive investors and something I would say, obviously every shareholder needs to make their own decision. But I think for those that say, well, this is going to pass because there's all these passive. investors and ISS isn't going to give a recommendation. And I don't want to take the P&L hit. I will again point out that I think this could, there won't be much. I could be wrong, but you'll see event-driven guys sell if this deal ends, and Veritas walks away. But on a valuation fundamental basis, I think 21 is cheap on today's numbers. And so I'm willing to say, look, I'm willing to take the risk they walk away. In fact, I hope they do, because I think there's a lot

more upside. Yeah, look, I mean, this is a business that's growing, you know, mid to high single digits, great revenue retention, huge operating leverage, as we've talked about, a great cash flow, non-economically sensitive. Like, if I told you about that business and we just blinked it up, nobody would think that's a nine times EBITDA, 10 times free cash flow business, right? You'd be saying, oh, this is a 12, 13, 14 times EBITDA business may be higher. As you said, with the market multiples thing, you know, so I don't want people to anchor on that. I think the most important thing, you can correct me wrong. I've talked to a lot of shareholders. Now, maybe because of the passive flows and the

RAB dynamics and everything, it go a little bit. I think there are a lot of shareholders who are with you. Like, if this price is under 25, I think there are a lot of shareholders who just say, hey, I'd rather the company lever up, buyback shares to get the ARBs out, shrink the share account, and then keep growing because I think it's going to spit off a lot of cash flow. And I think we could be looking at $40 in 18 months, especially with the share repurchase dynamic. Yeah, I would say I heard from a lot of shareholders after I wrote my letter. Obviously, since I am not forming a group, did not engage with those shareholders, but I've got a lot of feedback.

I don't know of one shareholder, active shareholder, that thinks $21 is near fair value. I mean, how often do you see four separate main? managers come out and write public letters. And we're not an activist. We've, we've written some letters, but that is not our strategy. So I think that's important. And the thing I left off when shareholders consider, should they tender or not, I said, I think we truly have downside protection based on the trailing earnings power, but probably arguably more importantly, I don't want to speak for them, but Engine publicly came out and said, look, we want to nominate directors and pursue this tender offer or buyback path as soon as possible. So I don't think shareholders will

be left with what do we do now. And although we're frustrated that CEO and board presumably have accepted this tender, we still would love and are willing to give Jack, would love to give them a compensation package that pays them for that upside. I don't think there's any, yeah, I think it's a little different in Great Canadian where I think at shareholders were done with the CEO who actually ended up, that was kind of a funny story, ended up getting fired because of, did you ever kind of tangent here? But I remember a little bit of why the CEO got fired at this point, COVID time flies. But I do remember, was it right before or right after the deal closed? But yeah, I remember that there was. Yeah, I forget the specifics. But,

but in this case i don't think it was pretty is uh is how i would put it kind yeah something about evading some backs like going to get vaccine somewhere he shouldn't have that was it yeah he so he said he was a hospitality worker and he drove like a hundred miles from their headquarters and was like oh yeah i'm a front line worker i need to be boosted to the front of the line for the vaccine allegedly he said all this and it came out and the board had to fire him because of that that was it yeah yeah and that scenario i think gerald were frustrated we're in this scenario i think we're all economic beast and I think we look at it and say look he's done a great job jack we would happily love to have him continue to run the company give him a bigger compensation package and and

you've got this engine who's got a great track record and and again i can't speak for them i don't know what they would ultimately do but they've got these publicly said hey we would like to nominate board members and execute this buyback plan what i would love to see here you know is i'd love to see the tender offer fail or they can boost it to 30 i'll take 30 right but the tender offer fail. And then in the next proxy, it comes out. Engine has put someone on the board who has a 6% owner's stake in the company. So you've got a big shareholder involved. And then Jack gets, as I call it, the charter treatment, right? If you can get the shares to 30, 40, 50 in the next five years, you're going to create huge value. We're going to give you so much money and you're going to be a

multi, multi, multi, multi millionaire based on that. And then six months later, I'd love to start seeing all of the compounder bros start talking about and putting tweets up of, oh, hey, HMHC, it's a business that grows, great operating leverage. They're committed to a 2X leverage target, so they keep buying back shares. The CEO is really incentivized. There's an aligned board, and it's a great business. And you see like Scuddle Blurb come out with a piece talking about how good and sticky the HMHC businesses and stuff. And, you know, just like all the people who I really respect it, but this becomes the micro, the small cap compounder bro ed tech company. Like, that's what I would love to see because I think this business could do that and would create a lot of value going that path.

Yeah. And I think there's, of course, there's always execution, risk, operational risk, and just macro. But this is a business that it has some lumpiness based on adoptions calendar, but that's becoming less lumply, less lumpy, but generally less cyclical business. There is some ties, municipalities, and their budgets, but generally less cyclical. This isn't a business where we were talking about before the podcast. You have to worry about where is consumer spending going to end. end, right? This is a much more defensive business than that, and becoming obviously a better

business as it goes to more SaaS. So I agree with you. That's the hope. And I think it's a realistic one if this tender does not happen, which hopefully doesn't. Let me ask one more question. I know a big thesis, not the core thesis to HMHC, but a cherry on top of the thesis for HMHC had been, hey, in the wake of COVID, there's all this money that's, you know, the build back butter money or whatever, that's just going to get flooded into the municipalities into improving education, all this sort of stuff. And HMHC, 30% market share, as you said, they're going to be a mammoth beneficiary of that.

So my two questions you are, is that still playing out on the cars in the horizon? And I'm looking at the projections. It's fine growth, but I don't see like a wave of federal money. Do you think they undersold that in the projections? Yes. I mean, I think the projections undersold from a top line perspective, Number one, because there is $200 billion of stimulus to K through 12.

And to be clear, it's not 30% of $200 billion, obviously, because that's going to go to a lot of different pockets. Improving the HVACs, testing, all that sort of stuff. Right, right. And I think if I remember right, Lapping Water actually did do some math on here's the potential from that. I don't have it all top of my head. I think I have seen that from them, yeah. Yeah, which if you think about it, we go lever up two times gross, which is one and a half. or something net. And then we have the surge in billings and cash flow. We could quickly pay that

down, right? It makes it even more attractive because you have the stimulus funds coming through the next few years. The other reason that I think the forecast is low, certainly on the bottom line, as we talked about incremental margins, but on the top line, the normalized billings of one, two, to one four, where they were historically, that was based on a 10% extensions and supplemental share. And I do believe that Jack and his team will ultimately gain share through, if you think about really their pitches, they're the only ones that basically sell the full services. McGraw-Hill has very little extension of supplemental, platinum equity bought them from Apollo. I think probably, and they've already made an acquisition, I think they're going to try to do more

of that. And then Savas, as far as I know, the other big player doesn't, has very little extension and supplemental. So Hofton has the best kind of playbook. They can bring you the full menu. And so if they're able to gain share in that, that would imply that normalized billings is a higher number than what it's been historically. Perfect. Well, Chris, I think we've covered most of the main points here, but I want to make sure, is there anything we didn't touch on an HMHC that you think we should have touched on? Anything we kind of gloss over that you wish we had hit harder? Looking through, I don't think so. I think we touched on everything.

I think he did a great job, as always, is asking questions. I think that the summary, again, is for the reason I won't rehash, but we think the process is flawed because of the forecast and the other things we talked about. We think the value is this bid or tender extremely under values the business, looking at trailing earnings. and comps and kind of the future. The other thing is it makes little sense to go sell this when we're still recovering from COVID and early in that transformation. I think there's still future sources upside from it.

And lastly, I think they're just a much better plan here with compensating the CEO, doing the buyback, and you've already got an activist shareholder publicly say they would nominate directors to help kind of get the board more aligned. So there's a very clear, I think also different. from Great Canadian is there is a much more clear path on what the future looks like, the shareholder base and hopefully the management team and everything. So the downside from my perspective is to not tindering is very low.

And I think some people would ask, if you don't tender and it happens, you're still going to get the $21. So if they ultimately get 50%, but the downside's low. And I think the upside's huge because a non-tender scenario, as we talked about, this is a 30 and really a 40 plus dollar stock in a few years, I think. Look, I'll wrap it up with neither of us is looking to form a group with anyone. We want to make that clear. But if you are a shareholder or a potential shareholder, you know, you should do your own work,

come to your own conclusions. But if you think this deal is too low, you should send a letter to the board and let them know, hey, I think this deal is too low. And if Eritus wants it, they need to pay a spare price. And if they don't, I'm not going to tender my share. And I would support, you know, buying back shares, doing a tender officer. to shrink the share account, get the ARBs out. So I would just say, you know, if you're a shareholder or potential shareholder, do your own work.

We're not looking to form a group, but, you know, let the board know that you don't support this deal and don't tend to your shares because then Veritas will have to bump or we can try to run the more shareholder-friendly playbook. Do you want to add anything to that? No, I think that's well, well summarized. Perfect. Well, Chris, appreciate you coming on. I'm hoping this one works out as well or better than great Canadian.

And we were talking before. I know you've got a lot of other great ideas and I know we have some overlap. So we're going to have to have you back on hopefully quicker than it took from the last time. But I'll include a link to the breach inlet letter in the show notes. People can go ahead and read that to see more of the thought process here. Chris is on Twitter under a breach inlet. I'll include a link to that if people want to slide on into his DMs. But Chris, thanks so much for coming on and looking forward to the next time.

Yeah, really appreciate it. Great job, as always, Andrew. And look forward to hopefully a great outcome again here and talking to the future. Perfect.