Pembury Lifestyle listing viewed as fairly opportunistic in some respects
Pembury Lifestyle Group will be listing on the JSE on 31 March 2017. While we believe the demand for affordable private education in SA will create significant investor interest in this business model, we view this listing as fairly opportunistic in some respects. In essence, the business is being brought to market with a thinly capitalised balance sheet (R1.6m NAV) in an industry that requires substantial capital investment.
Furthermore, the precapital raise valuation of R200m in our view gives credit for either 1) the successful conclusion of the capital raise of R140m in order to acquire the schools currently leased, 2) continuation of the current lease terms of the schools, or finally, 3) securing bank financing to acquire these schools. In respective of the latter two options, our conviction levels would be low. As a result, the valuation which investors are being asked to support has circular elements to it. Given enthusiasm for the affordable private schooling business model in South Africa, we believe appetite for the listing may be high, but we find the pre-capital raise valuation metrics unappealing.
In light of the current shortfall of quality education and the success of (and multiples obtained) companies like Advtech (ADH) and Curro (COH), it shouldn’t come as a big surprise that another private education business is coming to market. We like the SA schools space in South Africa and companies like Curro and ADvTECH are trading at elevated PE multiples on the market. It appears Pembury is looking to leverage off the positive sentiment (and strong industry fundamentals) to value their new operation. Management have lofty ambitions and, on paper,the business case seems sound.
Our initial take is that there are higher quality entry points into the private education industry, with both ADH and COH offering investors proven business models and management teams whohave alreadybuilta strong trackrecord.
Capital markets are intriguing and we will follow this listing with great interest. Pembury’s capital raise and listing may indeed find support, but institutional shareholder support is likely to be absent (due to the future-based valuation of what is in essence currently an Opco with very little NAV) and the capital raise will hence likely rely heavily on retail investor support. Assuming the group is able to raise the R140m capital, the equation post listing will be very different. The properties can be paid for and they will have the ammunition to test their novel business plan and the model is likely to work. If they are unsuccessful with the capital raise, we expect they will pursue alternative funding to acquire the properties, however it is unlikely they will get this through conventional sources. What the capital raise does is enables the group to acquire the properties at what are currently low values (given they have not been purpose built) and, hence, have low rents. Without the capital raise, we are concerned that if fresh leases were to be signed (some of the leases have short remaining durations), escalations could be significant, placing the value of the current“Opco”under pressure.
The Group was founded in 1999 with retirement villages and expanded into the Education sector in 2014. The Pembury business itself is an intriguing one and their aim is to make independent education accessible and affordable to more communities. The business model is based primarily on converting properties which had other proposed uses (retirement villages, leisure, accommodation etc.) and converting them into schools. This means a much lower capital cost than a new school and if they fill the schools, an attractive return. The fees will range between R20 900 and R49 500 per annum (around 20-25% less than competitors and similar or slightly higher than government schools) with a focus on midsizedcampusescateringforaround600-1 200 pupils.
A key concern we have with how the business is operating under the current structure, is the sustainability of the current rental charge. At present the business leases the structures from a third party owner. It would appear as though the owners of these structures could start placing upward pressure on the rental charge once they appreciate how profitable these properties are as operating schools. This creates a situation whereby raising equity capital is essential for the future profitability of Pembury under the current operating model. Without the capital needed to acquire the schools, the group could find itself at the mercy of the property owners who could charge rentals more aligned with the profitability/market value of the asset in question. To protect the sustainability of the business model, management are makingthe correctstrategic decisionby raisingcapital.
The investment case
While we believe management are making the correct strategic decision in their quest to raise capital, we also believe the valuation being placed on the existing pre-capital raise equity requires a leap of faith from investors in the future projections of profitability, as well as what the current assets of the group are. In essence, new shareholders are putting up 100% of the capital to receive only 40% of the equity interest in the newly capitalised entity. Using the financial forecasts in the investor presentation it appears as though management value the current operating business at R213m. This is for a business that should generate R70m revenue in 2017 (Dec year-end), an EBITDA loss of R600k and an after tax loss of R4.5m. A business with only R1.6m of shareholders’ equity is being valued at over R200m, prior to the capital raise, on the basis of the DCF value of the schools they are yet to acquire with the proceeds of the capital raise. The valuation of the existing business appears high, with the group’s justification being that once the capital is raised, the future EPS prospects present a compelling growth profile relative to the earnings multiple. While this may indeed be the case, we feel that multiple is not compelling enough and for that reason we have chosen to not participate in the listing and will, instead, evaluate Pembury’s progress and continuously evaluate the investment case. We acknowledge the fact that investors who partake in the IPO will not face the same business risk as the existing shareholders, as the money raised will be used to significantly de-risk the business (via the acquisition of properties).
Should the listing go ahead as planned and the market afford management the opportunity to raise additional capital above that envisaged in the IPO, we would place a high probability on the group adding additional capacity which would result in suppressed EBITDA margins and lower than initially anticipated EPS. This, however, does not necessarily signal the wrong capital allocation decision given how profitable the schooling model can be once operations pass through the initial J curve. Curro have adopted this strategy incredibly well since listing in 2011. The difference with Curro, however, is that they had/have a large shareholder of reference (in the form of PSG) who are willing and able to underwrite rights issues at high multiples, affording them the freedom to expand the schools networkaggressively.
Investors should bear in mind that Pembury is still very early in its life cycle and their projections assume market appetite for their new approach and offering. At present Pembury has 1900 students in 19 schools. Clearly there is a long path to reaching criticalmass.
P.T.O for salientlistingdetails.
• Pembury intend listing 353m shares at 100cps, representinga marketcap ofR353m (onthe Alt X)
• R140m shares to be placedat 100cps
• This fresh capital will be spent on acquiring the schools that are currently being leased from their respectiveowners
• Applicationcloseson 24th March2017
• As at December 2016, PLG generated R32.3m in revenue, an EBITDA loss of R7.1m and R5.4m worth of after tax losses
• Using management’s expected earnings trajectory the listingpricewouldimplya 24m F-PEratioof18.3x
• This compares to Curro that trades on 12m F-PE of 74.9x and a 24m F-PEof 53.2x
• Advtech trades on a 12m F-PE of 22.4x and a 24m FPEof 18.5x
Article by Anchor Capital Research