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Finweek English Edition - - FRONT PAGE - Sean Ash­ton, CIO at An­chor Cap­i­tal

ADVTECH WINHOLD THE JA­PANESE NIKKEI CASH­BUILD

Ed­u­ca­tion, along with health­care, is an emo­tive is­sue in South Africa. This i s due

largely to two dy­nam­ics: the fail­ure of Gov­ern­ment to main­tain an ac­cept­able stan­dard of both pub­lic health­care and ed­u­ca­tion, and a rel­a­tive lack of sup­ply or com­pe­ti­tion in the pri­vate sec­tor, re­sult­ing in the fees that are charged by pri­vate providers re­main­ing

un­af­ford­able for many. How­ever, those who can af­ford the fees will still pay up due to the al­ter­na­tives be­ing so poor. In the case of pri­vate school­ing, this is clearly ev­i­denced as many top ‘ brand name’ pri­vate schools are charg­ing up­wards of R100 000 per an­num for tu­ition and still have long wait­ing lists.

Th­ese dy­nam­ics make for great in­vest­ment fun­da­men­tals: a ma­ture pri­vate school can gen­er­ate EBITDA (earn­ings be­fore in­ter­est, taxes, de­pre­ci­a­tion and amor­ti­sa­tion) mar­gins north of 50%, and cash f lows tend to be much stronger than earn­ings due to the ten­dency for many par­ents to pay fees up­front at the be­gin­ning of each aca­demic year. Curro has cap­i­talised heav­ily on this op­por­tu­nity in re­cent years, list­ing in 2011 and ag­gres­sively rais­ing eq­uity cap­i­tal to grow its base of schools (via both ac­qui­si­tions and new builds) from 12 in 2011 to 26 cur­rently, with a tar­get of 80 schools by 2020.

The fun­da­men­tals of this busi­ness are fan­tas­tic, but un­for­tu­nately, we ar­gue that the mar­ket has al­ready hand­somely re­warded share­hold­ers for this out­look, with the share ar­guably look­ing too ex­pen­sive (it prob­a­bly gen­er­ated EPS of 12c/share to De­cem­ber 2013 vs share price of R27) – even tak­ing into ac­count the low-ca­pac­ity stage of life of many of its schools.

By com­par­i­son, ADvTeCH is a busi­ness that has been ‘ ig­nored’ by the mar­ket in re­cent years, with dif­fi­cul­ties in its ter­tiary ed­u­ca­tion (poor en­rol­ments) and staff re­sourc­ing di­vi­sions hold­ing back over­all earn­ings growth while man­age­ment has ar­guably been slow to cap­i­talise on the grow­ing de­mand for pri­vate school­ing. We be­lieve the dy­nam­ics are start­ing to change: en­rol­ments ap­pear to be im­prov­ing in the ter­tiary di­vi­sion while the re­sourc­ing di­vi­sion has shrunk to the point of be­ing fairly ir­rel­e­vant in the mix, but un­likely to in­cur losses.

Im­por­tantly, t he group’s pri­vate schools busi­ness (rep­re­sented by Trin­ity House, Ab­botts Col­lege, Craw­ford Schools and Ju­nior Col­leges brands) now rep­re­sent 70% of group prof­its and this is where we be­lieve the group is be­com­ing more ag­gres­sive with its in­vest­ment plans: ADvTECH has over R1bn of capex ap­proved (1/3 of cur­rent mar­ket cap), while a fur­ther R1.7bn worth of projects are un­der in­ves­ti­ga­tion. We also be­lieve the cur­rent profit base of the schools di­vi­sion re­mains well be­low po­ten­tial (due to im­ma­ture schools/new de­vel­op­ment spend­ing) as ev­i­denced by its 17% EBIT mar­gin – this should leave sig­nif­i­cant scope for fu­ture profit up­side.

We es­ti­mate that ADvTECH trades at an 18 times P/E mul­ti­ple to De­cem­ber 2014 – while this ap­pears op­ti­cally ex­pen­sive, we be­lieve this val­u­a­tion is rea­son­able for the qual­ity of the core school­ing busi­ness and is a far cheaper en­try point for in­vestors than Curro. In essence, pri­vate schools rep­re­sent a ‘ dis­counted cash f low cal­cu­la­tion’ on pupils, where rev­enues are al­most guar­an­teed for an ex­tended time pe­riod once a child is en­rolled. In ad­di­tion, tu­ition fees tend to rise well ahead of over­all costs given the de­mand/sup­ply im­bal­ance: we don’t fore­see this dy­namic chang­ing any­time soon, and this should re­sult in grow­ing mar­gins.

We like busi­nesses where mar­gins and re­turns on cap­i­tal are high and where there is a sub­stan­tial op­por­tu­nity to de­ploy in­cre­men­tal cap­i­tal – given ADvTECH’s strong bal­ance sheet (R85m net cash; NAV = R809m) and high de­mand for pri­vate school­ing, we be­lieve this should be a win­ning in­vest­ment over time. The stock has rerated sharply this year, but re­mains ac­cept­ably val­ued to con­tinue de­liv­er­ing good re­turns.

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