09-Apr-2020: I've never liked G8 Education much - mostly because they were started by a trucking company owner and loaded up with people from financial backgrounds rather than with any experience in childcare - and that refers to both the board and the senior management. The main reason I didn't like them however is that they were serial aggregators - they were another roll-up model, buying private childcare centres and rolling them into their corporate structure; The business model was simply arbitraging the higher multiple that the market was prepared to attribute to childcare centres that were part of a listed company versus private childcare centres. I had similar concerns back in the day about other roll-up models like GXL and RFG. They always come undone eventually. They either get into serious debt to fund their acquisitions or they just keep issuing more shares. Remember ABC Learning? It all works fine, until it doesn't.
As these companies grow, they have to make bigger and bigger acquisitions to move the dial. If the arbitrage opportunity is good enough, they attract competition. They will then often try to takeover that competition, and they will usually pay too much to do so. The big issue is that at some point they will either run out of acquisition opportunities, or those acquisitions will be too expensive and will therefore not make good business sense to do. Then the growth stops dead. They have to rely on organic growth instead of acquisitive growth. If their business model was based on expansion via acquisition (buying private companies at less than what they would be worth as part of a listed company, i.e. the private/public price arbitrage) and they have neglected to focus enough attention on their existing business during the period of rapid expansion - as most of them tend to do, then they end up with a rather ordinary business that is ex-growth. That results in a negative market re-rating, and that can often have negative repercussions for their sizable debt - and associated lending covenants. It's like a house of cards, and they all collapse eventually. GEM has taken longer than I expected, and they may never actually go broke, but then again, they also might. One thing is clear, they haven't been a good set-and-forget investment. Roll-up models rarely are. Almost never in fact.
Here are their announcements today (09-Apr-2020):
All shares under the Placement and Entitlement Offer will be issued at a fixed price of $0.80 per new share. The Offer Price represents a 25.9% discount to the last traded price of $1.08 on 2 April 2020 and a 16.1% discount to the theoretical ex-rights price (“TERP”) of $0.95.
--- click on links above for more ---
It's funny how these so-called income stocks end up being nothing of the sort - they are just capital killers in the end. RFG, GEM, no more dividends and their share prices smashed. RFG will almost certainly go broke. GEM are now having to receive waivers from their lenders because they are breaching their own debt covenants. Even GXL was trading at over $10 in mid-2014, then the bubble burst and it was all downhill to their $3.90 low in August 2018. They had then become so cheap that they were snapped up by US private equity (PE) giant TPG at $5.55 in late 2018. Interestingly, TPG had previously offered to acquire GXL at $6.75 (cash per share) in 2016, but that offer was rejected by the GXL board at that time as being grossly inadequate. TPG then sat back and waited for GXL's sub-par management to destroy more value - and were then able to buy the same company 17.77% cheaper at $5.55 two years later.
I think that we'll likely see something similar with GEM at some point, if they survive that long.
Conclusion: Roll ups work really well, for a while, and then they tend to implode. Whether it's childcare centres, vet clinics, food franchises, dental practices, whatever, if you're on the ride, be prepared to jump off at the first sign of trouble!