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After the mauling last week of ABC Learning's share price, Eddy Groves had to do two things that potentially conflicted with each other: reassure a market spooked by the subprime crisis that ABC was not a debt-laden pile of pre-school junk; and maintain ABC's growth prospects, which rested heavily on its expansion into the US and Britain.
It was a dangerous juggling act, but the provisional deal ABC has struck for the sale of 60% of its US child-care business to Morgan Stanley Private Equity is better balanced than was expected. The growth story Groves has been marketing since he ran out of expansion space in Australia two years ago is attenuated, but it is not wiped out, and in Morgan Stanley, Groves has a new, heavyweight partner.
The deal is still to be nailed down (Morgan Stanley must confirm funding, for one thing), and there is an element of debt shifting involved. The joint venture will take on debt to be added to the equity that Morgan Stanley Private Equity and ABC hold in a 60%-40% ratio, and it is the debt and equity combination that produces the $US775 million valuation the partners place on the deal.
ABC's total proceeds of $A750 million come from the 60% equity share it extracts, and proceeds from an as-yet unpriced issue of convertible notes in ABC to Morgan Stanley capable of converting into a 10% shareholding.
But when ABC shares resume trading today, any remaining short sellers on the register after last Tuesday week's share price selling frenzy will be nervous. Singapore's sovereign fund, Temasek, Lazard Asset Management and others that bought in as the shares slumped from $3.74 to a low of just $1.15 and a close of $2.14 will be relaxed.
ABC will use the $750 million it banks from the sale of 50% of the equity in the US business and the issue of convertible notes to roughly halve its debts, in doing so putting to bed speculation that it is at risk of defaulting on covenants.
The child-care company that Groves founded will emerge with a conservative balance sheet, a 40% interest in a potentially powerful US joint venture with Morgan Stanley, and full ownership of its Australian and British child-care centres. It will also have Morgan Stanley on board as a new prospective substantial shareholder, alongside Temasek, which boosted its stake from 12.45% to 14.66% during the market rout, and Lazard, which moved from 12.2% to 13.9% (existing stakes will be diluted by the issue to Morgan Stanley).
Groves will be able to continue marketing ABC's offshore interests as a source of growth, and the implied earnings before interest, tax and depreciation multiple of 14.1 times on the sale will ease concern about the value of Groves' empire.
Ahead of this deal, intangible assets of just over $3 billion on ABC's balance sheet more than account for net assets of $2.23 billion. The intangibles are basically goodwill created by serial takeovers of child-care centres at prices above net asset value. They are, in effect, a balance sheet judgement call about the strength of the assets acquired, and their potential revenue and earnings. (At its most elemental, the fear that drove ABC's share price into the gutter just over a week ago was that Groves' judgement was faulty.)
One provisional deal does not constitute a value warranty for the entire group. But the valuation multiple compares well with a straight sale multiple of about 13.2 times paid in January by private equity firm Bain Capital in its $US1.3 billion purchase of US child-care chain Bright Horizons, and must give ABC investors some comfort.
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Groves was smart enough to renegotiate ABC's debt into a $1.43 billion, three-year facility in December as the subprime credit crisis continued to fester underneath a fool's rally in the sharemarket.
But the child-care group's December-half result showed that overseas expansion was not paying off - or at least, not paying off as quickly as the myopic market demanded.
The December-half profit was low quality, with a mark-to-market write-down of $36.5 million on ABC's 19.9% Funtastic shareholding and a $17.8 million fee on the December debt consolidation combining with a leap in net interest charges from $18 million to $55.4 million to drag earnings down. The 42% profit decline the group posted still needed help from one-off profits, in the form of a write-back of part of the cost of a British child-care chain acquisition, and the booking of penalty payments by developers.
Morgan Stanley had made contact with ABC before the crisis occurred, and it rang in again after the Tuesday sharemarket massacre. Groves would have known by then that asset sales were needed to reassure investors that ABC was safe.
The challenge always was to work out a way to do the sales, and get enough cash to put a meaningful dent in the debt without derailing the offshore strategy. Against expectations, Groves may have succeeded, and in doing so, reminded investors that in markets such as these, fear can get out of hand. When it does, the herd can get caught, and braver investors such as Temasek and Lazard can make money.
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- reprinted from The Age