KING OF THE KIDS

Eddie Groves is 39. He has long hair, wears cowboy boots to work, travels by helicopter and makes lots of money from running childcare centres. He's also one of a handful of entrepreneurs in Australia who might just join the elite club of billionaires who made money from more traditional pursuits of a generation ago.

Groves is the founder, strategist and dynamo behind ABC Learning Centres, a company with one of the best track records on the ASX and one that seems set to deliver well into the future for retail investors. Groves listed his Brisbane-based childcare group in March 2001at $2 a share. Today the stock is trading at $7. Over the past year, ABC's market capitalisation has swelled to about $1.6 billion as it digested the $385 million acquisition of former ASX listed rival Peppercorn.

This week, Groves was in the news again when he announced an ambitious $200 million deal to acquire a NASDAQ-listed childcare operator, Learning Care Group Inc. With the acquistion of 460 centres from Learning Care '” which will be earnings-neutral for the first six months '” ABC Learning Centres now has more than 1,000 centres.

Most retail investors regard the ABC Learning Centres business as a management business, in which the core business is the efficient operation of childcare centres. And in many ways it is a simple enterprise: all the centres have a similar look and feel and each is worth $1 million; EBIT margins are about 20%. But in reality the success of the stock relates as much to Groves' ability to constantly build and acquire new centres that can match the standard of his existing assets. He must constantly ensure that his relatively large chain of centres stays free of the kind of problems that have troubled other chains, problems such as staff disputes and poor quality buildings.

On a wider front, Groves must also make sure his company is ahead of the game in exploiting any changes to government policy in the area of childcare support.

In June, Groves hit one of his first market setbacks when the influential stockbroker Merrill Lynch issues a negative report on ABC Learning Centres, citing integration problems related to the Peppercorn takeover. As it turned out, any problems resulting from the merger have been ironed out and ABC Learning Centres' stock price has now recovered and exceeded its price earlier in the year.

For long-term investors reviewing ABC Learning Centres, the company offers many of they key facets Warren Buffett-style investors seek in equity investments: it is run by a manager who 'loves the company'; it is arguably '” at least in terms of brand recognition '” a consumer monopoly; it enjoys very strong earnings growth (earnings per share growth in 2005 was 26%); and it is conservatively financed, with net gearing of 18% this year. Having said that, the stock does not hit all Buffett's buttons: return on equity is a lowly 7% in 2005

GROWTH SPURT
	2004	2005	2006 (e)
Sales	$80m	$161m	$566m
Net Profit	$21m	$38m	$88m
Yield	1.6%	1.8%	2.6%
Franking	100%	100%	100%
PER (relative to ASX)	1.56	1.25	0.5

Moreover, unlike some of Australia’s best-known companies that are linked with outstanding entrepreneurs '” Harvey Norman for example '” Groves and ABC Learning Centres may well have many decades of profitable growth to go. Only 12 months ago, ABC Learning Centres controlled only 327 centres; that figure has trebled in a little over a year.

No wonder Groves has attracted some of the canniest institutional investors, such as David Paradice of the boutique managed fund Paradice Coopers, who says: "The way he has managed a difficult acquisition like Peppercorn and kept his occupancy rates and quality levels up to standard has been phenomenal."

Peter Guy, the renowned Melbourne value investor who has been a supporter and investor in ABC Learning Centres from its float, told Eureka Report earlier this year: "I knew they were a cottage industry with great opportunities for growth; they were intent on growth and I understood their business model. It was possible to have a stab at what the EPS might be at 100 centres, 200 centres, 300 centres, etc. While one could not be precise about the time frames, that precision did not matter to me." EPS at about 20¢ this year is due to double to around 40¢ by 2007, according to the company's house broker, Austock.

Groves, like vintage-period Gerry Harvey or Oracle's Larry Ellison, is wildly ambitious, shrewd and upsets plenty of people '” from unions to shareholder associations '” on his journey to the top. But again and again Groves and the ABC Learning Centres share price comes up trumps. This strong share price has put ABC Learning Centres into the ASX Top 200 with a market capitalisation of well over $1 billion.

Eureka Report caught up with Groves on the eve of his US takeover announcement.

James Kirby: With more than 600 centres on the books of ABC Learning Centres, what percentage of the Australian privatised childcare market do you have at the moment ?

Eddie Groves: We’ve probably got about 16%.

JK: And what would you think is the optimum market share. How far can you go with that?

EG: I think you could probably get to about 23%.

JK: Where does that figure actually come from? Where did you get it?

EG: Well there’s about 4,500 childcare centres in Australia and I’m thinking we could get to about 1150, something like that. So that’s 25%, because we will grow the market as we grow.

JK: Are there many more centres left out there for you to buy?

EG: Yes, there are lots of individuals still and we’re still constructing a fair few so this year we’ll do a couple of hundred in total and that will be sort of half and half '” half acquisition, half construction.

JK: And this is all happening outside of the stockmarket?

EG: Yes.

JK: It’s an unusual year in that you had it pretty rough at one stage as the stock fell below $5 earlier this year (it's now about $7) after Merrill Lynch came out with a pretty sceptical report about the takeover of Peppercorn. Were there any reasons to be sceptical at the time?

EG: Oh I don’t think so. I just think that the analyst at the time really just didn’t have his finger on it. I mean, he believed one thing. I knew he was wrong. I would like to have told him more details there but it’s a very sensitive time coming up to the end of the full-year result but I knew what the results were going to be and then I knew where we were going this year so no, I just think he got that wrong.

JK: You told me the last time we spoke you had a sort of SWAT team that flew around the country renovating centres. You have something like three of those now have you?

EG: Yeah we do. Well we’ve got a number and they’re renovating about 14 to 15 centres a month.

JK: And at a price of about $125,000 for a centre. Is that right?

EG: Yes. Probably more like about $150,000.

JK: $150,000 per centre, so that’s what you generally have to spend to get a centre up to your level?

EG: Yes, that's right.

JK: And then what’s the average value per centre?

EG: The average value per centre is probably running about $1 million now.

JK: Is that the core value of the company when you boil it down. Is that the core financial proposition of ABC?

EG: Yeah, that’s the core value on the balance sheet. (ABC Learning's total asset were about $1.1 billion).

JK: Now looking at that whole area of growth, there isn’t another Peppercorn out there for you to buy at the moment is there?

EG: No, no there’s not, which is a good thing.

JK: I would have thought it was a bad thing, because from an efficiency point of view it means you’re going to have to do much more work to acquire skill.
EG: Oh no, I think it’s actually sometimes harder when you take on a huge amount like that. I mean, everybody’s expecting everything immediately and it takes you a long time to get [through] those projects, a lot of hard work. When you’re sort of doing them little bits at a time, four and five centres a week and settlement, it’s a lot easier.

JK: Now the market is expecting an $88 million net profit after tax in 2005-06, up from $38 million this year. Is that on target?

EG: Yes.

JK: Is there any reason to believe that that target is conservative?

EG: No, I mean I think it’s an ambitious target but it’s a comfortable target. We always try to set out ones that we think are realistic and then we try to beat them by a little bit. I certainly wouldn’t say conservative, considering, you know, to be doubling our profit from last year so it’s a big effort, but you know it’s ambitious but we’re on track.

JK: At the age of 39, there's probably no need to talk to you about succession, but is there a risk that the company is too dependent on you?

EG: I think that probably is [the perspective] from the outside. From the inside that’s not the case; there are some very capable people within the company and, yes, I probably have the dream and the vision and drive the business but [there are ] very capable people doing those day-to-day jobs.

JK: Talking about the people around you, I suppose the most intriguing appointment so far has been your hiring of the former federal Minister for Childcare Services, Larry Anthony. Can you tell me what Larry Anthony brings to the table?

EG: Well people have got to remember that prior to Larry going into politics he worked as a merchant banker, so he has very good skills in that financial area as well. He's been negotiating with the banks, which takes pressure off me because that takes a long time but, you know, hopefully Larry will eventually move into investor relations.

JK: What about his government role?
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EG: He’s got a good grip on that and definitely his political connections '¦ I mean, child care is political. I’d be not truthful if I didn’t say we didn’t want him because he has got some excellent political connections and we need to be able to sell our message. ABC is very good at what it does and I think sometimes gets a bum rap on what we’re motivated by, and people don’t want to talk about all the good things that we do. We just needed someone to spread that message for us, to the politicians, which I think he’s done well.

JK: What are government payments worth to you, say, per child in each centre?

EG: I’ve never really done it like that. I’ve never really looked at it. All I’ve ever looked at is the overall funding; it's down to about 44% of our total revenue, so the families are paying more. [The Government] is paying the 56% but I mean that will change when the 30% rebate starts to kick in later on during this year. The new 30% rebate for familes should push the total chilcare funding to families from the Government up to close to 60%. Now that’s not money we’re getting back. I mean, the family is paying for it and they’re getting it back so our ratio won’t change, but it will certainly make it a lot easier for the families once that money starts coming through.

JK: So the ratio of Government income at ABC Learning at about 44% of total income won't change?

EG: No.

EG: It hovered around 50–51% for many years, so it has come down over the past few years. And that’s just a sign of a strong economy with people getting paid higher wages.

JK: Talking about higher wages: how are you coping with wage pressures within the centres and the wage component of renovation costs?

EG: Well I mean a lot of the wages pressures have come through the different states now. We’ve always increased our fees at the same time but, you know, it’s just a balancing act when it comes to that.

JK: And what’s the outlook on that? Are salaries going to settle for a while or is it going to keep going at that sort of pace?

EG: No, I think you’ll find that it settles. I think that was a big jump that they sort of needed to have. (Childcare workers received an average increase in wages of about 15% earlier this year).

JK: That was almost like a generational jump on the index sector of child-minding salaries?

EG: That’s exactly right.

JK: Do you still have ambitions to move into schools?

EG: We still have an ambition to be able to provide services for schools. I think there’s been some confusion in political circles that we wanted to actually own and run the school, which we never wanted to do. All we wanted to do was provide services that I think we’re very good at: the maintenance, the renovations, the marketing and the IT.

I wanted to create a pathway for our children from the childcare centres. But I think there’s been some confusion around the fact that we wanted to own and run the school and that caused a bit of a political furore in Queensland. They changed the law [saying], 'You can’t have this and you can’t have that, and so we’re pushing ahead with the idea we want to provide services for schools. We necessarily don’t have to have a school ourselves directly. We could go and offer those services to any school.

JK: But that is pretty small portion of the business now, I presume?

EG: Oh absolutely. There’s none started as yet, but we’re going to do something. We’re going to push ahead because we believe it’s important to have that pathway for our children in our centres.

JK: What about growth outside of Australia itself?

EG: I think our next opportunity will be overseas in the same vein: the early childhood, to child care, day care. I think there’ll be opportunities that come up and we need to find that because by the time 2008 rolls up in Australia it will be pretty much just organic from constructions. There’ll be the odd acquisition but we need to look for that growth elsewhere.

JK: Are you actively doing that in any region?

EG: Yes, North America.

JK: Would you be prepared to make an acquisition on the stockmarket there?

EG: Yes, definitely. We would be prepared for an entry from the point of view of acquisition or from a listed or non-listed, or even start with construction. But for our attitude, you wanted to get a bit of a scale going there: you’d have to get a decent-sized acquisition.

JK: So what’s the minimum we’d be talking about?

EG: I would think you’d enter the market for somewhere around $100 million. (The Learning Care acquisition announced on November 16 will be completed in early 2006; the deal lifts ABC Learning Centre's gearing ratio of 50%.)

JK: What percentage of the shareholder base would be retail these days?

EG: I’d say it’s probably about 26%. I think institutional got as high as 79% in the early days. I think that’s come back a little bit. I’m guessing, but I’m thinking it’s probably only about 73–74%.

JK: You've had arguments with the Australian Shareholders Association about an options package (The ASA has criticised a nil-paid options plan for senior ABC Learning executives.) Has that settled yet with the shareholder’s association and did you think they had a point?

EG: We’ve created a lot of shareholder wealth and the company’s very good, and so we thought to ourselves, 'Well, we probably didn’t pick up what we should have and so therefore we put it the way we set it up.

I mean, people could argue rightly or wrongly, and we’ll see what takes place with that. I don't think the shareholders have a real problem with it; we haven’t heard anything from them directly, so I’m presuming there’s no real issues. So far the proxies have been coming in pretty much in favour so we’ll just have to wait and see what happens.

JK: And when does that pan out?

EG: The AGM is on November 23.

JK: Do you track your stock price? It's about $7 at the moment after a soft patch earlier in the year.

EG: I certainly let it do its thing. I don’t get overly concerned about it. The only time it ever dipped down was during that month or so with the Merrill Lynch report. That was disappointing but that was a good lesson, I suppose. There was nothing we could have done about it in the company; it had a life of its own during that stage. From the point of view of where it was at the time '” I think it was about $5.40 or something like that, knocked off to about $4.80 at one stage and it held up very strong at $6.30. And the market’s been a bit soft in some areas and it’s held up well so I think people see it as what it is and I think we’ve got a good track record now and we just going to have to keep performing.