Global Reach May Have Forced Australian Child-care Giant Into A Corner

The Age

Thursday February 28, 2008

Malcolm Maiden

ABC Learning Centre's overseas investments may be hurting its Australian operations.

ABC Learning's decision to consider selling a chunk of assets to an unidentified bidder sets in train a process that will go some way towards deciding whether investors who bought into the group during its precipitous share price dive on Tuesday made the right call.

A second clue may come today, in the form of a substantial shareholder notice, if Singapore's sovereign fund, Temasek, was one of the investors wading in on price weakness after paying $7.30 a share, or $400 million, for a 12% stake in May. ABC really needs to sell not much at all if it is to maintain faith with investors. Remember that the group maintained profit guidance for a 15% earnings rise in the full year on Monday, despite a 42% slide in first-half net profit to $37.1 million that had serious quality issues.

It also said that it was under no short-term debt pressure, after negotiating a new three-year, $1.2 billion facility in December. As I said yesterday, these statements are either accurate, or they are not. If they are accurate, there is no need for a fire sale, or a sale that threatens the group's strategy.

Eddy Groves' great discovery a decade ago was that the child-care industry was extremely fragmented, and under-managed. It offered not just scale economies with the accumulation of market share, but earnings leverage from the application of what in other industries would be considered standard business processes.

Child-care centres have relatively high fixed-cost bases, and can be relied on to lose money if their occupancy rates are 50% or less. Between 50% and around 80% they are profitable, but the return on capital employed is not exceptional. Above 80%, revenue flows straight to the profit line, and returns leap. Groves proved adept at buying market share, rationalising it in local markets to boost occupancy, and investing in his centres to keep occupancy rates high.

But Australia was a finite growth play. ABC listed in March 2001, and less than five years later Groves was at the limits of its Australian growth, with a 23% share of the Australian market, and 36% of the market controlled by commercial operators. It needed a new growth forum, and Groves chose the US and Britain, which offered similar fragmented market dynamics.

The problem for Groves is the debt that funded the overseas expansion is weighing heavily on earnings. ABC saw earnings overcoming the overseas debt load progressively. Assets sales that free up cash to pay down debt can speed up the process - but if they derail the overseas growth strategy or expose it as flawed, ABC's chances of winning back investor support will be seriously hurt.

Expectations that ABC's share price dive had triggered margin calls and forced sales at board level were confirmed yesterday when Eddy and Le Neve Groves detailed share sales that halved their stake to 3.8% (with possibly more sales to come), and executive director Martin Kemp and non-executive director David Ryan announced sales that wiped out Ryan's stake, and decimated Kemp's.

Kemp also detailed a sale of 2 million shares on Friday, at $3.75 a share, well above the low of $1.15 on Tuesday after Monday's profit report, and Tuesday's closing quote of $2.14. It will be scrutinised by the ASX, but has to be another sale forced by margin calls.

The forced sales will be more evidence for those in the market who believe that margin lending and stock loans that enable predatory short selling by hedge funds are combining to produce routs such as the one ABC endured on Tuesday, and the debacle will no doubt be examined by ASIC as part of its investigation into the way debt-financed shareholdings and short-selling are interacting.

There are no simple remedies or responses, however. Disclosure of margin loans to directors would make them an easier target for short selling. Requiring disclosure of stock loans by institutions to short-sellers would pressure the institutions to quit the practice - but short selling is also an important source of liquidity for the market, which needs both buyers and sellers. ASIC boss Tony D'Aloisio told the Senate Estimates Committee last week that on the basis of what it has learned so far, ASIC was not contemplating "immediate action".

CRAIG Drummond's appointment as executive chairman of Goldman Sachs JBWere ends an era at the investment bank, as Terry Campbell steps down after 50 years with Were, and since early 2005, GSJBW. As chief executive, executive chairman and in the final year non-executive chairman, Campbell was the firm's key relationship manager in this decade and the former, and critical in the firm's participation in key deals, including each three Telstra privatisation share sell-downs.

Drummond continues as chief executive, but will share the role with Stephen Fitzgerald, who has been running Goldman Sachs' asset management operations outside the United States from London.

The dual-leader structure is a Goldman specialty: Christian Johnston and James McMurdo are co-heads of GSJBW's investment bank (which is advising ABC), and GSJBW's financing unit is run by Mike Everett and Anthony Miller. On Wall Street, Jon Winkelried and Gary Cohn are co-chief operating officers of Goldman itself, and when JBWere and Goldman joined in early 2005, Were's Drummond and Goldman's Andrew Stuart served for a time as joint chief operating officers. In the area of fast judgement calls, in particular, the Goldman view is that two heads are better than one.

mmaiden@theage.com.au

© 2008 The Age

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