Weighing up roll-up risk
Your portfolio
ROLL UP, roll up. Gather round and witness the wonder as riches fall from the air and silk is spun from the cotton tail of a bunny rabbit named Mopsy.
It’s all the rage, this roll-up thing.
Evolve Education Group is another in the current crop of initial public offers which use a float to finance the acquisition of a several businesses into a new listed company. Others with similar models are industry training group Intueri and retirement village group Arvida.
It’s possible the craze was sparked by an Australian outfit named Affinity Group, which raised A$75 million ($81m) a year ago to buy 57 childcare centres mainly in New South Wales and Queensland.
Investors in the offer at A$1 a share have done fairly well despite the company missing its interim profit forecast, with Affinity shares trading comfortably above A$1.20.
A director and chief operating officer of Affinity is one Gabriel Giufre, a shareholder in several childcare centres acquired by Affinity, as was her husband, Chris.
A founder, promoter and lead adviser to Affinity’s float was a company called Kern Group, run by Greg Kern.
This side of the Tasman, Evolve Education is also being advised by Kern Group and Wraith Capital, a company belonging to Queensland-based Chris Giufre. Same people, same idea. Evolve was created in May this year as an acquisition vehicle for childcare centres. Its share offer aims to raise $132.3m from investors, at $1 a share, to help finance the purchase of two early childhood education businesses – Lollipops Educare and Porse – as well as a further 55 childcare centres.
The purchases are due to be made on December 4, the day after the offer closes.
As with other roll-ups Intueri and Arvida, Evolve’s debut on the NZX also marks its debut as an operating business.
The process is a remarkable shortcut on the traditional private equity style roll-up, in which private investment funds buy businesses in a fragmented sector, stick them together and trade them for a while before flicking the group though an IPO.
The upside is that it allows a group to be put together with a minimum of upfront investment, as well as speeding up fee payments to its creators. The downside is that investors in the IPO have less information about whether the business will be worth more than the sum of its parts.
Touching on fees momentarily, the deal looks like being a good one for Kern Group and its associates. In payment for shortterm loans covering set-up costs, Kern Group, Wraith and a superfund associated with Affinity director Stuart James receive a 100 per cent return on their money.
James, who loaned A$1m in June and A$100,000 in October and November, gets A$2.4m back two days after Evolve lists. Kern, who made two loans of A$100,000 in October and November, gets A$400,000 back. Giufre likewise.
In addition, fees of A$1m and A$300,000 are payable to Kern and Wraith respectively.
As well, Kern, Wraith and James each own 2.3 million Evolve shares, equivalent to stakes of 1.3 per cent post listing. All up, the three will end up being well rewarded for their work in setting up Evolve.
New investors are getting a business with prospective revenue in the year to March 2016 of $136.2m, generating net profit of $16.6m. Dividends are expected to produce a net yield of 4.7 per cent in 2016, based on the $1 offer price.
Evolve will have a mix of dedicated childcare centres and in-home care, with about 69 per cent of its revenue coming from government funding. It aims to benefit from consolidation by ‘‘streamlining systems and operations, continuing development for teachers and facilitating administration and compliance activity’’.
Growth will come from further acquisitions.
How well this will go is hard to say because Evolve hasn’t tried it, yet, but the idea has been popular in Australia.
While Affinity has done well, rival G8 Education had a rocketing run this year, its shares gaining from around A$3.25 in February to A$5.50 in September. The stock has eased back since then to about A$4.50 but still represents a strong performance, particularly in light of its price of A50c in early 2010.
Students of history may be interested to note that G8 was formed in March 2010 from the merger of Early Learning Services and Payce Childcare. Early Learning Services, itself pursuing a roll-up strategy, was lossmaking at the time partly because of litigation costs incurred after cancelling deals to buy a number of childcare centres.
Kern, a non-executive director of Early Learning Services, resigned on March 25, 2010.
The pre-merger annual report from Early Learning Services chief executive Christopher Sacre has some useful insights for Evolve investors. While commenting on the promise of the merger, he noted the discovery that ‘‘the childcare industry is also not ‘recession proof’ or protected from such economic downturns’’ as in 2009.
High workforce participation, particularly among women, ‘‘is considered a primary driver of the childcare industry’’, he said. Conversely, ‘‘when Australia’s unemployment rates rose to a high not experienced for some time, childcare occupancy levels across Australia were adversely affected’’.
When downturns occur, ‘‘it is crucial to ensure wage costs are effectively managed’’.
These are all sensible comments and by extension perhaps show how New Zealand’s economic environment is currently quite attractive for a childcare business.
However, in my view the simultaneous roll-up and float process adds unnecessary risk for retail investors.