Edit: This company has been sold from the Hypothetical Ethical Portfolio at the closing price of $1.50 on Tuesday 25 February. At the timing of writing, I sold half my real life shares at close, and it is likely I will sell the rest tomorrow. The thesis below has broken. I sold my shares and will not buy back. I've had hysterical emails in response to this post saying things like "Big, big, Big mistake...The hugest you will probably ever make. I would like to see you get any money back from these people." I don't appreciate the ramblings of people who have allegedly been badly burned by those involved with Affinity Education, if they do not even understand the basics of publicly traded shares. I was very promptly emailed about this company within 48 hours of publishing the thesis below, I have done further research and sold my shares. If you have been burned by these people, feel free to not send me abusive emails. The first emailer was very helpful and polite - if you can't be those things, go vent your frustration elsewhere.
So I was a little slow in bringing Affinity Education Group Ltd (ASX: AFJ) to the attention of readers. The shares have broken new highs today, continuing a (lucky) run of outperformance for my personal portfolio that I never dreamt of and truly hope will be repeatable.
Affinity Education owns 57 childcare centres, and manages another 11. The company has been rolling up childcare centres for the last year, and was listed on the ASX at $1 per share in December 2013. The prospectus forecast pro-forma revenue for the six months ending 30 June 2014 to be $37.7 million. The company expects revenue of $43.6 million in the six months leading to 31 December 2014. The prospectus projects NPAT of $7.8 million for the 12 months ending 31 December 2014, putting the company on a forward P/E ration of around 17 at the current price of $1.45 per share.
I bought shares in Affinity at $1.40 based on a simpleton comparative analysis with G8 Education (ASX: GEM), which owns 233 centres in Australia, and has an interest in 66 centres in Singapore. G8 recently announced it would buy another 63 Australian childcare centres for $105 million.
Affinity has a market capitalisation of about $129 million, and I think it's reasonable to say that the downside valuation for this company is roughly the price G8 Education would pay for it. Based on G8's most recent purchase, I'd say the downside for Affinity Education is $110 million, assuming that their childcare centres are of the same quality as the 63 G8 is planning to purchase.
G8 Education has a market capitalisation of $1.25 billion, yes, you read that correctly. G8 Education also has over $100 million in debt, but I'm going to ignore that in my analysis as a built in margin of safety. Affinity Education doesn't really have debt, but it has a lease liability of over $4 million. To be extra harsh, I'm going to add the lease liability, plus the market cap of Affinity, plus $15 million just because, and pretend that Affinity Education is being valued by the market at $150 million.
So we have a childcare centre operator with 66 centres (ignoring the managed ones) trading at $150 million, and a childcare centre operator with 362 centres (including the managed ones and the ones they are about to purchase, just to be extra nice) trading at $1.25 billion. But let's adjust that again, on the basis that G8 is 25% overvalued, and say that is actually worth a round $1 billion.
So based on my hypotheticals the price per childcare centre for each company looks like this:
Affinity Education: $2.3 million per childcare centre
G8 Education: $2.7 million per childcare centre
Now I'm the first to admit there could be some problems with this analysis. For example perhaps the management at G8 is superior to Affinity Education. Undoubtedly, the larger size of G8 Education makes cost efficiencies easier to generate. Perhaps, staff can be retained more easily, and maybe their businesses in Singapore are just that much better than the Australian ones. Potentially the exposure to foreign currency is a plus.
Maybe Affinity Education has bought the worst Childcare Centres on the market, or their centres are simply not as impressive as G8's. Because of a relatively short history as a company, we just don't know when it comes to Affinity Education.
However, I’m happy to hitch my wagon to the master of operations at Affinity Education, Gabriel Giufre. Ms Giufre has 14 years of experience working in childcare, is a major shareholder, and build up Eternal Echoes Pty Ltd, a company that sold its management rights to Affinity. She will be assisted by Ms Fiona Alston, who seems like the kind of person who will make sure that the childcare centres nurture their young charges. If these women deliver, I think Affinity Education will be rerated.
There's always a risk with investing in newly listed companies, and I would far prefer it if Ms Guifre was the CEO, although perhaps it is good that she focuses on operations without the burden of capital allocation. Justin Laboo, the CEO, has experience managing a portfolio of retirement villages, of all things, so here's hoping the maxims about second childhood translate to business experience. Happily, he has children, so should be alert to the needs of the children under the care of Affinity. Overall, I'm willing to invest, based on a risk reward analysis, and I bought shares a few weeks ago at about $1.40 per share.
I'm adding Affinity Education to the Hypothetical Ethical Share Portfolio today, at a price of $1.45. I consider it the riskiest addition to the portfolio, to date. The biggest risk is that the company does not meet prospectus, in which case I may actually sell the shares (depending on the size of the miss). If this is the case, I will also sell Affinity from the Hypothetical Ethical Share Portfolio and record the loss on the portfolio scoresheet, accordingly.
Update: Quite recently, I've had a reader raise concerns about the whether this company deserves to be in the hypothetical ethical share portfolio. He contends it does not. In the meantime, I am selling Affinity Education from the Hypothetical Ethical Share Portfolio, at today's closing price of $1.50 - a blemish, that's for sure. Update will be forthcoming.
The Author owns shares in Affinity Education. Nothing on this website is advice, ever. This post is for entertainment (and for my own reference!)
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