Think Childcare (TNK.AX) – Merger Arbitrage and Bidding War – 100% Upside

Current Price: A$1.51

Offer Price: A$1.75

Upside: 16% (+113% eventually realized)

Expected Closing: TBD

Press release

This idea was shared by Dan.

 

Australian childcare services provider Think Childcare has recently received preliminary takeover interests from two parties. The first non-binding proposal came at A$1.35/share from Alceon Group (private equity firm with US$2bn AUM) and another one, week later (23rd Nov), was an overbid from a childcare group Busy Bees at A$1.75/share. The company is still reviewing the proposals without any further updates released so far.

Although the situation is still in rather early stages, there are several aspects that make the proposals (especially the Busy Bees one) particularly interesting:

  • There is a substantial chance that the offer from Busy Bees (at A$1.75) could go through. Busy Bees is a strategic buyer, which currently owns over 660 childcare services across the globe including 65 services in Australia (vs 86 owned by TNK). Busy Bees entered the Australian market in 2018 through the acquisition of 30 nursery centers and doubled the number of centers since then. The group is certainly aiming for global expansion and has recently made several acquisitions worldwide: Sep'19 - entered the US market and made further acquisitions in Italy, Jan'20 - UK, Feb'20 - another acquisition in the US. TNK, which showed relatively impressive performance during the pandemic and expects substantial growth in the next 3 years, seems like a decent fit for expansion in Australia. The financing is not in question, as Busy Bees is backed/owned by a large Canadian pension fund ($204bn net assets as of mid-2020). So far it's not clear if approval from FIRB (foreign investment authority) will be required, however, given the size of the acquisition, there should be no issues with the regulator. Media reports indicate that a firm proposal could be announced before Christmas.
  • Both offers come at an opportunistic timing and just a few weeks after TNK has substantially increased its CY2020 guidance. The new guidance indicates a strong rebound from the COVID impacted H1'20 performance with attendance and enrolment at the majority of the centers at or above pre-COVID levels. These positive trends are expected to continue going forward. The company has also announced new underlying EBITDA guidance (A$22-A$23m), which is significantly above 2019 levels (A$14m) and above the previous guidance (A$15-A$17m). Most of the improvement was due to organic growth.
  • Busy Bees price comes at 6.6x CY2020 EBITDA guidance and 10.5x 2019 EBITDA. Comparison with 2019 peer results and performance during 2020 indicates that the price has headroom for improvement. In 2018 the company has done an equity raise at A$1.99/share (by issuing 9% of shares). Buyers might need to raise the price to this level in order to incentivize more shareholders to accept the offer.

The downside to pre-announcement stands at A$1.25/share (-17%). However, given the recent interest from two credible buyers, which clearly state that the company is worth more, I expect the eventual downside to be lower. Meanwhile, there is additional upside from potential bidding.

 

Valuation

Given that CY2020 guidance of peers was not available, the relative comparison of 2019 results is provided in the table below:

The proposal comes at 10.5x 2019 EBITDA vs peer valuation of <7x, which definitely doesn't scream undervalued at a first glance. However, the company is growing fast, executes 10+ new center acquisitions per year (quite cheaply, see section below), and therefore has reported considerably better 2020 performance than its peers'. H1 results showed revenues increasing by 3%, underlying EBITDA up by 24%, and NPAT up by 63% YoY, whereas TNK peers reported significant losses on all metrics. Moreover, in November the company has increased its CY2020 underlying EBITDA guidance from the previous A$15-A$17m to A$22-A$23m, considerably above the $14m generated in 2019. Whereas, the projected profitability of its peers seems to be just in line with 2019. 

Of course, some of this growth was non-organic and achieved through M&A. During H2'19 the company acquired 15 new centers. 11 of them were expected to generate $4m underlying EBITDA in CY2020, so assuming the remaining 4 had similar profitability, the acquired EBITDA was supposed to be (without the pandemic) at around A$5.5m. This year in August TNK acquired another 6 new centers with an annual EBITDA of A$1.25m and 4 more in November with an annual EBITDA of $2.1m (the effect from these latest acquisitions likely had no/minimal impact on the improved EBITDA guidance yet). So overall it seems safe to assume that given the COVID-19 impact and excluding H2'19 and 2020 acquisitions the adjusted CY2020 guidance would stand at around $16m-$17m, which is still a 13%-19% improvement over 2019 results.

TNK had higher occupancy levels during H1'20 - it was 80% vs 69% at GEM and 62% at MFD (CY2020 guidance is just 67%).

YTD stock price performance also suggests TNK stands out among its peers - TNK pre-announcement price was at pre-COVID levels (12th Feb), while GEM is down 32% and MFD decreased by 19%.

Adding up all these points, it seems that the premium valuation of TNK is justified, while at 6.6x CY2020 estimated EBITDA multiple, there is some headroom for a better offer as well.

Some more highlights on peer performance:

GEM:

  • H1 occupancy was 69% vs 80% for TNK.
  • H1 underlying EBITDA fell 36%, NPAT decreased 56% YoY. Revenue was down 28% YoY.
  • In November the company has provided an update showing YTD (10 months) underlying EBIT at A$98m compared to A$132m CY2019.
  • During the year the company has also made a large dilutive equity raise of $300m priced at A$0.80/share (vs pre-covid A$2.00/share and current A$1.20/share).

MFD:

  • H1 occupancy was 62%, while full-year guidance stands at 67%.
  • H1 revenue fell 43%, EBITDA 32% and NPAT 41% YoY.
  • By the end of October, the company provided full-year EBIT guidance at A$5.6-A$5.9m vs $5.9m in 2019.
  • NPAT guidance stands at A$3.8-$3.9m vs $3.3m last year.

 

TNK

Think Childcare Group offers child care services in Australia and is also engaged in management and consultancy services to third parties or incubator partners. TNK owns and manages 74 centers under the Nido brand name.

In 2017 the company has moved away from acquiring new centers on the market to developing their own services or acquiring them from third-party incubators. Acquisitions criteria is 75% utilization rate and $250k+ EBITDA.

The company acquires the new services rather cheaply (4x EBITDA) and then continues to grow them, improving the utilization rate/occupancy and profitability. Effective multiple (purchase price and earn-out/LTM EBITDA) of the services acquired in 2018 is now significantly better vs the 4x multiple made at the time the center was purchased:

In 2020 August, TNK has acquired 6 new Nido centers + 4 further pipeline services (for further development). In November, the company has acquired 4 more Nido centers, including 2 from Think Childcare Development and 2 from third-party incubators.

Currently, the company has 51 more new childcare centers (half from 3rd party incubators) in the pipeline worth over A$100 ($25 EBITDA), which it expects to acquire in the next 3 years.

In 2018 the company raised about $10m equity at A$1.99/share (to fund further purchases of childcare services). It issued about 5m shares (8.6% of the current shares outstanding). In 2019 it raised A$18m at A$1.58/share selling 11.5m shares (19% of current share capital).

18 COMMENTS

  1. Alex Rackwitz

    Thanks.

    Big q why does it trade at 16% spread to an indicative bid from a proven knowledgeable acquirer?

    I don’t know situation well. My guess could be market is scared of a management / board that agreed to exclusivity at $1.35 per share which looks obviously too cheap. And this is after they had already upgraded their forecast. Is management going to be retained by Alceon and receive chunky performance based packages? Busy Bees on the other hand might get rid of them / will not offer the same upside.

    Does it even matter? It requires a shareholder vote to go through it seems. What does shareholder registry look like? Management could argue its better to have a firm bid in hand after exclusive DD than an indicative proposal at a higher price.

    It’s worth noting that the company is 2.0x levered post the recent transactions. So the 30% uplift in the Alceon offer required to match Busy Bees is “only” 20% change in enterprise value.

  2. DanX

    Thanks, Alex. Some good questions you raised here.

    I guess the most important point that I did not include in the write-up is that Mathew Edwards (CEO and managing director, which has been with the company in its various forms for nearly 20 years) owns 23.55% of TNK. As scheme mergers in Australia need approval from 75% of the votes cast, this amounts close to a blocking stake. So his vote/incentives is definitely a risk here. And it is not clear if after managing and growing the company for over 20 years, he would be willing to give away the control now.

    However, if the CEO wasn’t interested in selling the company, he could’ve rejected both proposals straight away saying that it undervalues the company or something like that. Instead, even at A$1.35/share, they’ve agreed to give Alceon the due diligence and entered into an exclusivity period. This shows that the board is definitely interested in a sale and it seems to me that this could be a similar situation to another Australian case (Link Administration), where the board has granted due diligence to a buyer just to beat out a better proposal.

    Regarding your question of choosing Alceon (private equity) over Busy Bees, this is a legitimate risk (especially with the CEO’s length of tenure and stake size). However, the exclusivity was agreed on when no competing proposals were in sight yet and even if the management is indeed leaning towards a financial buyer, Busy Bees offer at a 30% premium looks like a good reason to negotiate a sizeable bump. Anyway, I find it hard to believe that Alceon’s proposal with its current price of A$1.35/share will be chosen as the final offer here.

    Regarding the spread, CEO’s stake could be one way to explain, although, its worth noting that initially, the spread used to be much smaller at around 6%. It increased substantially only by the end of last week and narrowed again today to 11%. Part of the widening could also be attributed to the prolonged silence from the management or even to the selling pressure by the end of the year.

    Overall, the set-up seems interesting to me, although I agree that this is not a “risk-free” situation.

    Other significant shareholders (mostly various Funds):

    – Matthew Edwards – 23.55% – CEO and managing director.
    – FIL Limited – 10%
    – Australian Super – 8.4%
    – Regal Funds – 8%
    – Microequities Asset Management – 5.8%
    – Celeste Funds Management – 5.7%

  3. ijw

    The risk could be that there are some other holders who don’t mind holding on, and who are friends with the CEO? Mark Kerr is the Chairman and also owns 4%. Kerr gets $130k a year and would essentially give this up for what is a premium of several $100k.

    Also Kerr has a lease outstanding to TNK:

    “Mark Kerr (Non-Executive Director), via an indirect interest, has a partial interest in an operating child care service leased to the Group. The lease on the property commenced on 7 November 2016 on an outgoings only basis, until February 2017 when rent payments commenced. The lease has a gross commencing rent of $260,000 per annum. The quantum and terms of the lease are commercial and reasonable for the property.”

    Not sure how to weigh this information though. Since lease is likely arms length.

    But why would they be happy to sell out around what is essentially the market price of the past couple years? Normalized income is estimated to be nearly $7 million in 2021. So this could either be positive as a higher bid could be likely or if Busy Bees does not bid higher it could mean it falls through. Either way though, risks seem manageable, and was lucky to get some shares at $1.53.

  4. blades

    I think this is an interesting idea, and will try to put a bit of money to work here.

    My bet is that the CEO was probably involved in the Alceon offer. In which case, Alceon, a PE shop, would likely offer the CEO a deal to continue running the company, including a significant equity provision, although likely requiring some rollover. Note the language in the Alceon offer indicating that as an alternative to an all cash transaction, it would consider a transaction in which some of the consideration was in a private company. However, now that the company is in play, no way they can go back to the Alceon offer.

    I thought it was odd that the busy bee‘s offer indicated that it was subject to “final“ approval from its board of directors. Not a typical provision in an offer letter which is supposed to create a comfort that the bidder is ready to go on the terms proposed.

    I couldn’t find Edwards’ age, which is highly relevant to his thinking about the BB offer. Fun fact, on its website description of managment, pictures of the team are of them as children.

    1. ijw

      Why would he be involved in the Alceon offer? It seems like a low ball offer. The more I think about this situation the more I think this would fall through if no higher bid shows up, or if Busy Bees does not off a higher price. Why would the CEO and Chairman accept an offer that is below where it was 2 years ago, unless the business has been structurally impaired?

      This seems to be a 10-15% (usually closer to 15%) Ebit margin business. When I look at forecasts for 2021 revenue for TNK, I see revenue of $170m. That means EBIT of $17-23m. So why would the CEO sell out at an EV of $150m? And market cap of $110m. (Not counting lease liabilities here).

      Or is there a reason why TNK would be structurally less profitable than the other two? I can see how all the acquisitions probably created a bit of a mess, and 1-2 years from now this company could earn quite a bit more.

      Not too unhappy to just hold here and see what happens.

  5. ijw

    Further increase of EBITDA guidance to $27.5-28.5m, a 20% increase, and a trading halt now. Curious to see what news will be.

    1. ijw

      It is a 10% increase, not sure how I got 20%.

      But it is a bit puzzling why this still trades at a discount. With two offers at $1.75, this is close to certain to going through? With somewhat decent odds of a higher bid? 10x earnings does not seem expensive for a somewhat above average growth business.

  6. ijw

    Alceon has acquired nearly 20% stake and matched $1.75 offer. And this is one of the conditions (which seems somewhat aggressive), to probably put pressure on Busy Bees:

    “The Alceon Revised Proposal is also conditional upon the Group ceasing all discussions and
    due diligence in relation to alternate proposals, in the absence of the Group receiving a new
    proposal from a third party that is demonstrably superior to the Revised Alceon Proposal.”

    With increased guidance, if Busy Bees sticks to the 6.6x multiple, they could easily offer $2-2.2 now.

    I suppose Alceon realized that Busy Bees might be serious and offer significantly higher, or they get to buy TNK for about 5x EBITDA. Either way, win/win for Alceon.

    And I thought this was interesting as well:

    https://cdn-api.markitdigital.com/apiman-gateway/ASX/asx-research/1.0/file/2924-02308965-3A555429?access_token=83ff96335c2d45a094df02a206a39ff4

    $500k ebitda at 90% utilization per childcare center. That implies $40-50m EBITDA is possible.

  7. DanX

    TNK released very positive annual results. Underlying EBITDA for the group was A$26.8m, confidently outperforming the last updated guidance of A$24m-$25m and marking 89% increase YoY. EPS increased 93% YoY to A$0.20/share. Childcare centers attendance has rebounded to above Pre-COVID levels. The company expects to open 7 more services in the first half of 2021, 16 in 2H’21 and additional 3 in 1H22. Total expected EBITDA from the current pipeline is A$15m (50% growth from the current levels).

    TNK also announced A$0.12/share final dividend (total worth A$7.3m vs A$3m last year) payable on the 26th of March to the record holders as of 16th of March.

    Market has reacted very positively to the results with TNK price jumping above the most recent Busy Bees offer and the company currently trades A$2.17/share (spiked to A$2.25/share initially).

    The latest proposal from Busy Bees now stands at 6x 2020 underlying EBITDA vs 6.55x for GEM.AX and 5.76x for MFD.AX. So the current offer absolutely ignores significantly superior operational performance and growth prospects of TNK and also misses any takeover premium.

    Shortly put – I think that another price bump from Busy Bees is likely, while the downside from the current prices is well protected. There is a small risk that the current A$2.10/share proposal will go through. And even if both buyers would walk away now (highly unlikely), the chances are that TNK share price would jump up.

    Presentation – https://cdn-api.markitdigital.com/apiman-gateway/ASX/asx-research/1.0/file/2924-02345594-3A562130?access_token=83ff96335c2d45a094df02a206a39ff4

    1. Sean McMahon

      Thanks for the update. I agree with your analysis. I think a bump is a real possibility, and their investor presentation from a few days ago reads like an argument that the company thinks so, as well. I think the worst case scenario is A$2.10 + A0.12, which would still provide an annualized return in the high single digits.

      1
  8. ijw

    One concern I have is that they add back lease expenses as if it is not a real expense. But looking in the cash flow statement, it does appear to be very real. Any thoughts on this?

    1. AG

      The ‘underlying Ebitda’ and ‘underlying NPAT’ include lease rental payments of $18.831M which are the actual payments/CFs that they have on their leases. They add back the ‘Depreciation and impairment on right of use assets’ ($12.909M) and the notional ‘Interest on lease liabilities’ ($11.621M) which are non cash expenses. The implementation of of AASB16 resulted in a negative impact of $5.7M on net profit that they are adjusting back. Presumably that impact would turn positive in later years (notional interest expense on a particular lease is lower over time as the lease liability gets amortised, but that is not reflected in lower payments).

      “Think Childcare Group recorded a statutory net profit after tax NPAT (statutory) of $7.2 million (2019: $2.0 million). The current year NPAT (statutory) was impacted by AASB 16 Leases which adjusts for lease rental expenses of $18.8 million and deducts depreciation and impairment for right of use assets (being the leases) of $12.9m and deducts for notional interest expense of $11.6m. These entries give rise to a net negative impact of $5.7m. Adjusting for the impact of AASB16 Leases and other underlying costs, the NPAT (underlying) performance of the Group is $12.2m and comprises the following”

      3
  9. Sean McMahon

    Not sure what to make of the CFO resignation in the middle of an acquisition process.

  10. dt

    I think it might be a good time to close TNK idea.

    +113% return in 4 months.

    Dan, thanks for sharing, this one turned out great!

    There is still 3% spread remaining to the acquisition price, however, the offer still in non-binding stage (although likely to close as expected) and the timeline is not yet clear. There might be some further upside from franked dividends if these are paid before transaction closes.

    3

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