Company Overview– G8 Education is a childcare centre operator providing developmental and educational child care services mainly in Australia. GEM conducts a range of childcare service activities, including the acquisition of childcare centres, industry related project management, services and consultancy. Gem also operates child care centres both owned and franchised in Singapore.

Analysis– GEM owns and operates 395 child care centres throughout Australia and Singapore. Management has a proven Mergers & Acquisitions (M&A) strategy and the highly fragmented market provides a significant opportunity for further industry consolidation. Management estimates GEM has under 10% market share with an addressable market of 4,000 centres. Considering GEM’s demonstrated ability to improve returns, we expect debt and equity markets to support future growth. GEM’s solid organic profile has impressed, reflecting both management expertise and favorable industry dynamics. Margin expansion has been driven by increased portfolio occupancy, pricing growth and cost control. We expect further improvements and see the industry continuing to benefit from structural tailwinds such as strong demand, constrained supply and government support.
 

Various child care centres within the group (Source - company Reports)

The favourable medium term industry outlook is underpinned by anticipated continued strong demand for child care services, coupled with constrained supply and government support. Further we expect solid Australian GDP growth, low unemployment and high female workforce participation. GEM has established a strong track record of value accretive M&A, having acquired 288 child care centres since 2009, growing EBIT from $1.3m to $49m in CY2013. With less than 10% market share and a robust pipeline we expect GEM to continue consolidating the highly fragmented Australian child care services market, supplementing mid-single digit organic growth. In addition to GEM’s disciplined acquisition model whereby the company pays no more than four times forward EBIT, Management expertise has driven improved portfolio occupancy levels while effective cost control has ensured margin expansion. We have been impressed with organic growth achieved in the business and growing returns on capital. The key concern that we have for the business is deviation from acquisition pricing discipline may dilute returns.


Revenue Growth (Source - Company Reports)

G8 Education (GEM) formerly Early learning services provides high quality, developmental and educational child care services throughout Australia and Singapore. The company was formed in 2006 in response to increasing government regulations making it harder for single centre operators to survive. Early Learning Services listed on the ASX in December 2007 with 38 owned centres. A key event in the Company’s history was the March 2010 merger of Early Learning Services with Payce Child Care to form G8 Education with a combined total of 69 owned and operated centres. The expansion program has seen the group acquire a total of 288 child care centres from various vendors since 2009 including 63 centres in February 2014 with 4,254 places increasing thee portfolio of owned centres to 315 with a daily licensed capacity of 23,339 places. GEM’s business model is to identify, acquire, integrate and manage child care centres. Management target is four times EBIT multiple as the maximum it will pay for child care centres.


NPAT Growth (Source - Company  Reports)

Management has adopted a disciplined acquisition model aimed at opportunistically consolidating the fragmented child care industry with a strong focus on delivering increased returns for shareholders in our opinion. Purchasing centres at a four times centre EBIT. GEM forecasts year forward EBIT based on historical performance combined with growth assumptions following due diligence. Importantly th company does not pay for operating synergies or EBIT improvements it intends to drive from the target centres. GEM may offer vendor some cash up front plus a deferred and conditional settlement which shares acquisition pricing risk with the vendor. Scrip may be offered to vendors for consideration as a means of maintaining the four times EBIT pricing multiple whilst allowing the vendor to share potential upside in the group. GEM may debt fund the part of the acquisition cost as general rule of thumb, no more than 40% of the enterprise value.


EBIT Growth (Source - Company Reports)

GEM principally looks to add value to acquired centres by applying operational expertise to lift occupancy and margins. The company generally targets profitable centres in reasonable condition with occupancy levels of more than 80% located in favourable catchment areas. The key areas in which the company aims to increase EBIT profitability at the centre are: (1) Cost effective centre marketing and refurbishment attempts to drive occupancy up. (2) Applying its operational expertise such as more efficient roster management the company aims to reduce employee expenses. (3) Stronger purchasing power and economies potentially save on other operating expenses.


Registered births growth (Source - ABS)

Some of the macro drivers driving the business are as follows: (1) The medium term outlook for the domestic economy with low to mid-single digit GDP growth rates coupled with historically low unemployment levels, supports a favourable demand cycle for long day care services in our view. (2) The heavily regulated domestic child care industry has been a direct beneficiary of Government incentives aimed at increasing female workforce participation, child care affordability and the birth rate creating structural tailwinds in our opinion. (3) The number of children aged from zero to five years and number of single parent families living within a catchment area impact demand for child care services. In 2012 there were 309, 582 registered births in Australia, up 24% on 1999. In our opinion growth bodes well for long day care services demand. (4) In addition to requirements for child care during work hours, demand for child care services is driven by parents’ wishes for child’s educational development and social interaction with other children of similar ages.
 

G8 Daily Chart (Source - Thomson Reuters)

Some of the micro drivers driving the business are as follows: (1) Centre licensed capacity per day is regulated. GEM has been increasing its licensed capacity across the group via targeted acquisitions. (2) The daily rates charged per child remain at the discretion of the operator with generally premium services at premium prices, looks to increase rates bi-annually, ultimately above cost inflation. (3) GEM endeavors to lift occupancy levels to 80-90% by cost effective centre marketing, expanding service offerings and centre refurbishment. (4) Employee expenses typically account for 58% of sales (72% of total costs). Due to implantation of National Quality Framework wages continue to trend upwards as workers and educators become more skilled. (5) Rent expenses are GEM’s second largest cost item given the strategy is to lease premises rather than own. Rent expenses run at 12% of sales at Australian operations typically growing in line with CPI.

While trading on a premium multiple, GEM appears well positioned to deliver double digit EPS growth over the next few years. A highly fragmented market continues to offer numerous opportunities to support expansion through acquisition. While we acknowledge there are risks associated with integrating roll up strategies, management have demonstrated a good track record so far. We put a BUY recommendation on the stock at the current price of $4.73.

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