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The following segment was excerpted from this fund letter.
AFYA Ltd (NASDAQ:AFYA)
The Fund also owns a position in Afya Ltd. Afya provides medical education in Brazil and trades on the NASDAQ. ~80% of the business, by revenue, is generated by operating for-profit undergraduate medical schools. This is a ~50% margin, 100% occupancy business that grows its student base 3-7% a year, and has pricing power similar to top private universities in the United States. Afya provides 8% of all of Brazil’s medical seats. Unlike US for-profit schools and top private non-profit schools, 97% of Afya’s graduates find employment and are able to make back their tuition within 5 years.
There are significant barriers to entry, with the Brazilian health ministry certifying each school that’s built and awarding each new seat. Public schools are also available, are hard to get into, and are free to those that are accepted, although those facilities are considered somewhat lacking compared to Afya’s technology forward schools. Brazil is also under-doctored, with only 2.4 doctors per thousand people vs 3.5 per thousand people in OECD countries. This is a great business.
Another ~10% of revenue is a lower but still solid 30% margin business, where Afya provides residency and medical specialization programs. Programs are offered both online and in-person. During the epidemic the Company cut the pricing of its largest online prep offering, harming margins, and doctors felt the in-person classes weren’t worth the risk of contracting Covid. All types of classes are now being attended, and my expectation is for the business to bounce back this year.
The remaining portion of the business is a collection of currently unprofitable SaaS businesses that help doctors run their practices, digitally prescribe medications, treat patients, and connect service providers with physicians. Fundamentally this is a good idea. Doctors are not generally trained in running their offices or maximizing their economic opportunity. Afya’s services aim to help their doctors and the wider community solve this need.
Each of the offerings is generally the number 1 or number 2 provider, but the segment suffers from many of the issues of the small-cap US tech sector – the total addressable market size is uncertain, the competition is significant, and it’s unclear how profitable they can be. Afya has deployed significant amounts of excess capital to build this segment in a relatively short period of time – it’s unclear it has been a good use of capital. At the beginning of the year, they changed leadership of the segment, and checks indicate new leadership is more operationally focused than the last.
In 1Q22, the company’s medical education and continuing education businesses grew over 25% while the SaaS businesses posted underwhelming results. The company trades for a 13% free cash flow yield on conservative estimates assuming a meaningfully worse exchange rate to the USD, the currency it’s stock trades in, than the Brazilian Real suffers today – and almost 20% on less conservative estimates. The company’s revenue and costs are almost entirely in Brazilian Real and the company is lightly levered.
There are several options to generate value in the short term.
- The Company’s unprofitable SaaS business could become profitable more quickly than expected.
- The Company could become more strategic with the SaaS business, publicly declare its slowing investment, or spin it off.
- The Bertelesmann family, which obtained a majority stake in several transactions over the past year, could take the company private.
- The team could just execute on the existing business, but without the Covid impediment.
The stock is cheap, the business is good, there are growth opportunities inherent in the basic opportunity set, and significant options to accelerate shareholder value creation.
I like our prospects.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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