November 2018 marks the tenth anniversary of the collapse of ABC Learning, which at the time was the largest publicly listed provider of childcare services globally.
ABC Learning had centres in the UK, US and New Zealand, however it was in Australia, where it accounted for a quarter of the day-care sector, that the collapse generated most public interest as the childcare arrangements of over 110,000 children hung in the balance.
Our team worked with senior management to take control of the large and complex receivership in the 18 months following its collapse. We restructured the business (including the carve-out of unprofitable and underperforming centres via a separate government funded vehicle dubbed ‘ABC 2’), returned the core business to profitability and completed a sale to the not for profit Goodstart, which remains Australia’s largest provider of care services.
While the receivership achieved the best possible outcome for parents, children and carers, investors from ‘Aussie battlers’ to the Singaporean state investment fund, who had seen the potential of ABC Learning, had invested and lost. So how did a business with a market capitalisation of $2.6 billion and reporting EBITDA in excess of $300m collapse so spectacularly? Was it the unlucky victim of credit conditions at the onset of the Global Financial Crises, or a flawed business with a failure of corporate governance? Are there lessons in its collapse for the childcare sector today?
Why did it happen?
ABC Learning was a symbol of the excesses that preceded the financial crises, as opposed to a victim of the financial crises itself. It had grown rapidly, from 43 centres in 2001 to more than 1,000 in Australia alone (2,000 globally), largely through acquisition. These acquisitions were financed through increasing debt, and to a lesser extent equity, rather than through profits.
The scale and pace of ABC Learning’s acquisitions created an ecosystem of childcare operators who developed and combined childcare centres with the sole objective of selling them to ABC Learning. As ABC Learning grew in scale it needed to acquire ever more centres to maintain earnings growth momentum, which inflated valuation metrics, while arguably the standard of due diligence on the purchased centres was declining.
Although cash flow statements in ABC Learning’s annual reports were clouded by ongoing acquisitions, a focus on the operating cash flows would have shown a business unable to service its growing debt. The question was never raised as to why the business wasn’t increasing its financial strength as a result of its relentless acquisition.
What has changed in the sector?
ABC Learning’s collapse cast a long shadow over the childcare sector in Australia. Financiers withdrew from the industry in the immediate aftermath, impacting the development of new centres which subsequently restricted the supply of new childcare centres. A period of restricted supply supported increasing daily rates and profitability for operators. As a result this reinforced a recovery in supply of new centres and increased investor interest, including several high profile private equity investments.
The last twelve months have seen an increase in media commentary around the potential oversupply in this sector, which has weighed heavily on the share price of listed operators and potentially stopped at least one initial public offering. Changes to the government funding model have also contributed to the sectors uncertainty.
While this uncertainty coincides with a peak of investment and debt funding, it would be an over-reaction to draw too many parallels between the potential headwinds the industry is currently facing and the circumstances that led to ABC Learning’s collapse.
While we saw a peak in valuations through late 2016 and 2017 as chains looking to build scale pursued a period of acquisition and expansion, in recent months we have subsequently seen the industry self-correct with pricing metrics returning to long term trends. Operators and investors have become more discerning in their commercial due diligence, focussing on childcare services with maintainable income supported by both local demographics and high quality ratings.
What are the key lessons?
ABC Learning’s collapse wasn’t a reflection of the childcare sector. It did not collapse as a result of changes in government policy, demographics or economic conditions. It was a fundamentally flawed business which collapsed under the weight of unsustainable debt the moment it could not get new funding.
The one clear lesson to be drawn from ABC Learning’s collapse is that bigger isn’t always better, and investors should never lose sight of underlying performance, where a business buys earnings growth through acquisition.