ABS a.b.c. learning centres limited

not a bad story...

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    7:36 AM Feb 28, 2008
    Alan Kohler

    Back to school, Eddy


    Maybe ruthless hedge funds did attack ABC Learning Centres with the aim of forcing a margin call on Eddy Groves and his wife, although at this stage that is a mystery. If they did, the opportunity for it was provided by the company’s half-yearly result on Monday night.

    It was a very bad result, very poorly reported by the company – something that has been lost in the subsequent drama of the founder and CEO being sold up by his margin lender.

    The fact is that after 18 years ABC Learning’s operations are still burning cash, and the flame is getting bigger not smaller, although it is very hard to tell exactly because ongoing operations are not separated from those that have been bought during the year, as retailers do.

    According to the P&L account, revenue went up $439 million in the latest half year but costs rose $483 million. The biggest increase was salaries. That led to a 42 per cent fall in net profit.

    Also, revenue includes “discount on acquisition of Leapfrog Nurseries”, $51.1 million, plus “liquidated damages” of $26.2 million, explained in a footnote as being paid by developers for underperformance on their contracts. These should not be counted as operating revenues.

    In general the P&L account gives the impression of being a hodge-podge of cost and income items thrown in without explanation.

    In some ways the cash flow accounting is even worse. There are two cash flow statements – one in a PDF presentation and another in the formal financial statements.

    The PDF one basically shows that the entire net operating cash flow went on interest ($81.1 million cash flow and $80 million net interest). Tax paid of $22.1 million produced negative cash flow for the half of $19.8 million.

    There is an item in this statement called “other income” which is minus $57.4 million (that is, the opposite of income) and is unexplained, although it matches a figure in last year’s half-yearly accounts called “working capital changes”, also negative $57.4 million.

    Those figures are not to be found in the main cash flow statement in the formal accounts, which are depressingly simple (for a shareholder): income from operations $988.3 million, payments to suppliers and employees, $907.2 million, interest and financing costs $87 million, tax $22 million. Cash burn, $20 million, which tallies with PDF version.

    In addition to that cash outflow, $468.4 million was raised from borrowing and new share issues, and $522.8 million was spent buying stuff – centres etc. Total cash burn $74.2 million – last year positive cash flow of $28.4 million.

    By the way, in the note to the accounts on “finance costs” there is a figure of $17.8 million (last year $1.9 million) called “borrowing costs”. This is not interest expense – that gets a separate line, and totals $62.8 million. Does it represent fees paid to banks?

    In the balance sheet, the main asset is “intangibles” of $3 billion – that is child care centre goodwill. The property plant and equipment is only $657 million.

    At balance date there were 2323 centres in the books, which means the average goodwill against them is $1.3 million. How is that arrived at? What was paid for them?

    When banks look at figures like those – which show their loans are supported by massive, internally-valued goodwill, and very little stuff they know they can definitely sell, they become very edgy indeed.

    And when investors see costs rising faster than income and cash flowing out the door, they get edgy as well. Edgy banks and edgy investors mean that it’s the management that is on the edge.

    When the dust settles and Eddy Groves is quietly reflecting on what happened, and trying to learn from the mistakes and to rebuild, he should focus on the combination of very tight financing, very low return on the equity capital (below 10 per cent), still burning cash after too many years and bad presentation of accounts.

    Both he and the business should survive as long as these lessons are learnt.

    As I understand it, Groves now owns 12.1 million shares in the business instead of the 20.2 million he had last week, after his personal margin lender sold him up, but he still has a strong incentive to get the value of his stock back to what it was.

    As for the business, it will likely go forward without the 1000 centres it owns in the US. These will be sold because the banks that funded the acquisitions want the money back – probably because they don’t trust Groves’ management any more. The 112 UK centres may have to be sold as well.

    And the snakeskin boots-wearing, Ferrari-driving Eddy Groves will then have to knuckle down and manage child care centres in Australia for a cash profit, month after month, year after year. That’s what business is all about, especially now.

    The hedge fund attack on Tuesday was more a symptom than a cause of this company’s woes.
 
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