Share price running but profitability still crawls ::

Author: Fiona Tyndall
Date: 15/12/2006
Words: 492
Source: AFR
Publication: The Financial Review
Section: Companies and Markets
Page: 21

Becoming the second-largest child-care provider in the US and breaking into the UK market is an impressive feat for ABC Learning, but analysts are concerned about how the child-care group fuels its appetite for acquisitions.

ABC Learning will add $23 million to earnings this financial year and $110 million next year and become the second-largest private child-care provider in the US, just 11 months after entering the market.

Little wonder investors piled into the company yesterday, running up its share price by close to 10 per cent in early trading before it finished up 9 per cent or 77? at $8.62.

But some fund managers remain unconvinced, in fact highly critical, of the babysitting group.

The scepticism was based on the return that the company gets on its equity, a figure boss Eddy Groves does not think is a suitable measure, as it can be changed easily by increasing debt.

ABC Learning's return on equity is about 10 per cent, but should be about 20 per cent in order to justify its lofty share price, according to some market watchers.

In order to get to a 20 per cent return, ABC Learning needs to make its latest purchases on an acquisition multiple of six times earnings before interest, tax, depreciation and amortisation, and have done it with borrowed money, rather than raising more equity.

After much grumbling from the market about the dilutive effect its regular capital raisings have had on return on equity, ABC Learning chose to fund the $680 million in acquisitions via a new debt facility.

But the acquisition multiples are varied. La Petite was bought at 7.3 times enterprise value to earnings before interest, tax, depreciation, and amortisation inclusive of synergies, Busy Bee at 3.6 times EBITDA and Macquarie's child-care centres for 5.5 times, against ABC Learning's multiple of about 13 times fiscal 2008 earnings. ABC didn't reveal the level of debt each of the companies carries.

"Within 18 months they need to make the acquisition price equivalent to six times net profit after tax which would then add enough profit to drive return on equity to justify the current share price," said fund manager Roger Montgomery of Clime Capital.

"Everyone is focusing on earnings growth, not profitability."

There is also a concern that an equity raising could be slated for June 2007.

Analysts said ABC Learning would come close to fully utilising its $1.6 billion existing debt facility, soaked up by the three acquisitions, the completion of centres under development and the renovation of other sites. "We believe a material equity raising is possible in the June half," said one analyst.

The company has already increased its issued capital to almost 400 million shares from around 13 million when shares were issued at $2 just five years ago.

The analyst doesn't think the company is as overpriced as Mr Montgomery suggests, but agrees the share price has run hard.

"It is possible that investors may get excited about the UK, but given the integration risks and another potential equity raising, the current market pricing appears about right," he said.

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