Ambassadors Group (EPAX) write up July 2009 EPAX is an educational student travel company that earns 50% on tangible

e capital and trades for 5-9x normalized free cash flow. Student travel programs typically are marketed to teachers, who serve as trip leaders and are responsible for recruiting student participants. Trips generally last 1-3 weeks, are priced in the range of $2,000 to $4,000, and can be touristy or educational in nature. Most of the industry competitors are mom and pops that lack the scale necessary to be consistently profitable. Often they are founded by strong believers in the value of travel for young people, and as such are mission driven rather the profit driven. There are a handful of larger competitors, which travel tens of thousands of students per year. These enterprises have more of a commercial orientation and are more profitable than their smaller counterparts, but their trips are in most cases undifferentiated. Overall, student travel has not grown meaningfully over the past decade. EPAX is a standout in an otherwise stagnant and unattractive industry, because it possesses a unique franchise that has allowed it to grow and take market share for the past 40 years. The franchise is based on the companys affiliation with a nonprofit organization called People to People International (PTPI). PTPI was founded in 1956 by President Dwight Eisenhower, with the mission of fostering peace through cultural exchange. One of PTPIs core activities, and its primary source of revenue, is The Ambassadors Programs. These are the student travel programs administered by EPAX. PTPIs White House affiliation inspires deserved trust on the part of parents. Various connections to local political figures, activities, and attractions, which have been cultivated over a long history of operations, enable the programs to offer enriching itineraries. As a result, the trips are uniquely rewarding to participants. In many cases, students are profoundly affected by their travel experiences. Unlike other student travel programs, The Ambassadors Programs garner a meaningful amount of repeat travel. It is not uncommon for alumni who traveled decades ago to remain involved with the programs to this day, by participating in the informational meetings that EPAX conducts as part of the marketing process. The satisfaction rate for the trips is 98%. PTPI receives a small fee for each student traveled, but EPAX captures most of the economics of the programs. These economics are highly attractive, because of the franchises pricing power, and because little tangible capital is needed. In 2008, the average revenue per student was over $5,000. The average price of EPAXs international programs, the most important contributors to revenue, was $6,300. To my knowledge there are no competing programs that command comparable prices. Historically, gross margins have been 34%, and operating margins have been 15%. In 2009, I expect the company to generate about $15 million of after-tax free cash flow (equal to $0.80 per share), compared to roughly $30 million of fixed assets on the balance sheet. The past two years have been difficult ones. EPAX conducts its marketing campaign from June through November each year, garnering enrollments for travel in the following year. In 2007, the campaign suffered from a defective name list used in the direct mail program, which is the

foundation of the marketing effort. This and a worsening economic environment negatively affected 2008 enrollments, which were down 20%. In 2008, the marketing campaign coincided with a sharp deterioration in economic activity and consumer confidence. 2009 enrollments are expected to number about 35,000, again down approximately 20% from the previous year. One way to measure the difficulties that EPAX has faced is to calculate the cost of acquiring a studentthe student acquisition cost (SAC)by dividing the companys marketing expenditures by the number enrollments produced. From 2003-2007, this number was relatively consistent and averaged $620, while in 2008 and 2009 it was about $1,000. Because the causes of the recent increase in SAC are temporarythe faulty name list has been replaced, and the recession will endlogic suggests that SAC eventually will return to its historical level. In fact, the difficult environment has spurred EPAX to make operational improvements that could eventually push SAC below $620. It is possible that the opportunity to make these improvements resulted in part from complacency engendered by a decade of nearly uninterrupted success (the CAGRs of revenue and net income between 1997 and 2007 were 20% and 17%, respectively). Until recently, EPAXs marketing effort had been led by an employee without professional marketing experience prior to joining the company (he had been a basketball coach), and the direct mail campaign lacked specialized personnel. In 2007 a direct mail expert was added, and in 2008 the head of marketing was replaced by an experienced hire with the relevant skill set. These changes could add rigor to the companys marketing practices. There are already signs that progress is being made. For example, until recently there had been separate websites for different types of trips, and the websites were graphically and technologically primitive. In November 2008, the company launched one consolidated website, and it is significantly more effective in communicating the unique value of the programs. Another improvement is the recent elimination of 40 of the least profitable itineraries, bringing the total offering to 57 from an arguably unwieldy 97. The simplified menu will generate economies of scale for the remaining itineraries if capacity utilization is increased, as is expected. EPAXs earnings power will increase substantially if the SAC decreases from $1,000. At the current level of marketing expenditure (about $40 million per year), I estimate that a SAC of $850 (the average of the historical level and the recent level) would produce annual free cash flow (FCF) of $1.35 per share. A SAC of $620 would produce FCF of $2.35 per share. EPAX shares trade for $13.77. Adjusting for excess cash of $1.16 per share, the enterprise value (EV) is $12.61 per share. The following are the current trading multiples: FCF / share $0.80 $1.35 $2.35 EV / FCF 16x 9x 5x

Estimated 2009 Normalized, SAC = $850 Normalized, SAC = $620

The long-term potential to increase enrollments is large. There are about 29 million 11-19-yearolds in the US. Based on the profiles of past travelers, the company estimates that over 20 million of them have the financial wherewithal to travel on The Ambassadors Programs, whereas EPAXs peak travel volume was only 52,000. EPAX also expects to begin marketing its domestic trips to students located outside the US. The company aims for 15% annual unit growth, through a combination of additional marketing expenditures, increasing efficiency in lead generation, and rising conversion rates. Fifteen percent unit growth would produce higher revenue growth, because of price increases that have in the past exceeded the rate of inflation. The growth rate of free cash flow can be expected to exceed that of revenue, because capital needs are minimal, and there is operating leverage. In light of the long-term growth potential, the future cash flow stream is worth a high multiple of the current normalized level. I think that a private buyer would earn attractive returns purchasing EPAX for 20x normalized FCF. At that valuation, the stock would trade for between $28 and $48 per share, before considering two additional sources of value. The first is the float generated as a result of the trips being paid entirely in advance. The balance of travelers deposits averaged $66 million over the past year, and was invested conservatively in low-yielding fixed income securities. Assuming a 2% after-tax yield, the float generates $1.3 million of income annually. Because the float will grow along with revenue, the earnings of the float will grow at a rate similar to that of the business, justifying a similar multiple. A multiple of 20x yields a float value $26 million, which is equal to $1.41 per share. If interest rates rise, it is possible that the float could be worth substantially more. The second additional source of value can be thought of as a free option. Earlier this year EPAX announced an agreement with Discovery Education to market a new travel program called Discovery Student Adventures. I believe the economic structure of the relationship is similar to that of the relationship with PTPI. Discovery Education is one of the most popular brands among young people in the US. Through its educational content, Discovery has a presence in 1 million US classrooms, representing 35 million students. Even a small penetration of the market opportunity could be meaningful to EPAX. The investment EPAX is making to launch the new initiative is only about $3 million (16 cents per share). The first trips are slated to occur in the summer of 2010. In October, EPAX will report preliminary 2010 enrollments along with third quarter earnings. I believe there is a good chance that enrollments will show year-over-year growth. An end to the declines of the past two years could serve as a catalyst for the stock. This is not a solicitation, nor is it a recommendation. The information and beliefs contained herein are believed to be correct, but there is no guarantee.