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Will Curro Holdings – the private education group – prove as successful as Capitec Bank, the fast-growing mass banking initiative, for Stellenbosch-based investment group PSG? PSG (via its 81,3% held subsidiary Paladin Capital [JSE:PLD]) holds 76% of Curro, which is set on raising R320m in new capital via an AltX listing at mid-year 2011. It’s an ambitious plan at Curro: 40 schools and 45 000 pupils by 2020, with profits after tax of R450m being pencilled in. That would – conservatively – put a R5bn future value on Curro.

To date, Curro has largely been under-played by PSG. But Finweek was acutely aware of the bubbling excitement at PSG’s 2009 AGM, where executives – despite being under instruction to keep a lid on developments about private education – couldn’t contain their enthusiasm about Curro.

Confidence in Curro in the PSG Group [JSE:PSG] has continued to build as the number of private school campuses increased and the profit potential of a national school footprint became more tangible. The similarities between Capitec Bank Holdings [JSE:CPI] and Curro are quite obvious: most notably, that both ventures present an affordable option in an essential service that can be applied to a profitable section of a mass market.

But – like in Capitec’s early days – the market might also be somewhat cautious about Curro, as significant upfront investment is needed to roll out schools countrywide. With Capitec PSG reiterated its uncanny ability to pick an early stage winner at a time when the market was reeling in the collapse of small banking disasters, such as Unifer and Saambou.

Launching a private education venture into the current market is not quite as daunting as launching a new mass banking initiative at a time when small banks were tipping over left, right and centre. But PSG/Paladin are launching Curro at a time when investment sentiment can’t be described as frothy – especially for fledgling businesses that might require investors exercising considerable patience before partaking in profits.

Indeed, private education – apart from the meticulous Advtech [JSE:ADH] – is a segment on the JSE that hasn’t always been a terribly convincing option for investors. Educor, which listed in 1996, endured a short stay, The Learning Corporation flagged and General Securities and Trust (which had a private education component) failed in its attempts to reach the JSE in the late Nineties.

Stanlib small caps expert Shaun Stockigt reckons private education can be a fantastic business and reminds us the market also initially held serious reservations about Capitec’s expansion plan. “To be honest, it’s going to be a challenge for Curro to fund, operate and – particularly – ‘skill up’ an enlarged base of schools. All of those factors could put pressure on expenses in the early years, when cash flow might not be that plentiful.

“But over the years PSG has shown it understands how to put the right amount of capital and intellectual capital into a business. Capitec is a great example of how PSG develops a business.”

Stockigt adds Stanlib holds a position on AdvTech, currently the JSE’s only private education listing, because of its cash flow attractions. “Once the business matures it’s a compelling business model. Basically, AdvTech gets its cash flow upfront in the form of fees and then can expend those funds as needed throughout the year.”

Stockigt says only time will tell whether Curro proves to be competition for AdvTech.

Interestingly, AdvTech CEO Frank Thompson welcomes the news Curro will shortly seek a listing on the AltX. He notes that for so many years AdvTech has been the only private education player on the JSE, which has made it difficult to build up a sectoral understanding in the investment community. “Having a group like PSG – with an excellent reputation in investment – entering this market is a good thing for the sector. It certainly will help build the profile of private education.”

While some have raised concerns about AdvTech and Curro eroding each other’s markets, Thompson discounts such a notion. “Curro and AdvTech aren’t addressing the same markets. In fact, Curro has taken some trouble to explain it isn’t tackling our market head-on.”

Besides, there appears to be plenty of space to play in the private education sector in SA. In that regard, we need to recognise registered private schools currently only cater for 3,7% of SA’s total school-going population.

Curro is cleverly tilting at under-schooled areas, which means it’s unlikely to go scratching for sites in the traditional school belts, such as Cape Town’s southern suburbs or Johannesburg’s northern suburbs.

The easiest analogy for Curro’s offering would be a school pitched below the upmarket private school offering of Crawford and Reddam and in line with top model C schools – but more mainstream than the surfeit of small private schools that operate from renovated residences with no extramural activities.

Basically, Curro offers a large campus with essential infrastructure for sports (two rugby fields, a cricket field, athletics track and tennis courts) and after-hours activities (a hall, computer room and laboratory). There’s also the obvious emphasis on academic excellence.

Curro, which currently boasts a dozen schools with around 5 500 students, generated revenues of R76m and net profit of R5,2m for the year to end-December 2010. At listing, Curro – with around 160m shares in issue – will hold a market capitalisation of between R700m and R800m. The rights offer issue – pitched at a one-for-one basis at 400c/share – would put Curro on a steep earnings multiple, as the group is only expected to break even or make a small profit in its financial 2011.

This rating might well be taking PSG/Paladin’s deal-making skills into account – something already apparent in Curro’s R40m acquisition of the Aurora private school group. And let’s not forget Paladin has already assisted Curro in raising a 10-year loan facility of R73m with the International Finance Corporation, funds the school might have battled to secure on its own.

Still, such a heady rating is well above AdvTech, which holds a market capitalisation of R2,2bn. While the well-established AdvTech – with Crawford Colleges as its flagship brand – trades on an earnings multiple of around 15 times, there might be a perception that Curro’s model offers more development opportunities and, consequently, more growth potential.

But there’s plenty of work and investment that still needs to be undertaken at Curro. And there is considerably more risk.

AdvTech is fortunate in already having a track record of actual investment without stressing the balance sheet or having to raise funds.

AdvTech’s spend – as per annual reports over the last three years – is R400m. If we allow for inflation this is at least the equal of Curro’s projected spend over the next three to four years. AdvTech has also stated that their long-term capex commitments will continue this trend (see separate box on AdvTech).

Unlike AdvTech – which has the critical mass and brand diversity (Abbots, Varsity College, Trinityhouse, plus specialist education ventures and human resourcing) to generate sufficient operational cash flow to fund developmental initiatives – Curro is at a capital-hungry stage in its development.

PSG CEO and Curro non-executive director Piet Mouton says each new school costs between R40m and R70m to set up – an estimate subject to the vagaries of property prices and building costs.

If the long-term plan is for Curro to hold a portfolio of 40 schools, then Finweek would estimate capital expenditure to be in the region of (at least) R2bn over the next five years.

The rollout over the next few years is intense, but efforts are focused on areas where Government will probably not be building new schools and the likelihood of new private schools being set up is limited. Curro has building plans this year in the following centres: Hermanus, Mossel Bay, Serengeti, Polokwane and Roodeplaat. Curro is also building two new schools in Nelspruit and Burgersfort, plus possible developments in Port Elizabeth, Krugersdorp and Centurion next year.

Its expansion plans stretch beyond 2012, with sites already identified in Century City, Melkbos, Somerset West (Cape Town), Hillcrest, the KwaZulu-Natal North Coast and two sites in Johannesburg, as well as Limpopo, Rustenburg and the Northern Cape.

And the tally for those developments? Roughly R750m between 2011 and 2014, which suggests Curro is looking to more than double its size. Of course, the big question is whether size will also bring a commensurate increase in bottom line profits (see box on Curro’s profit drivers).

If its development follows the classic J-curve pattern, we might suspect Curro would be in need of further bridging finance over the years ahead. If Curro’s share price holds up on the back of early successes then further rights issues to raise fresh capital may well make sense.

That would also help in relation to acquisitions (such as the recent Aurora deal, worth R40m), where highly rated (or well-regarded) scrip could be used as currency to ensure vendors – who will more than likely be skilled educators – remain on board.

Mouton stresses that while the schools need capital in their early stages there will be a convincing up-tick in profits over the years to come. “We do see a typical J-curve at the schools. The rights offer being proposed at Curro means the company won’t sit with a messy balance sheet and its income statement will look more solid.”

One analyst says while the market was likely to be enamoured with Curro there were inherent risks in pushing the businesses to reach critical mass. The analyst’s main concern was about underperforming schools and a possible drag on the company. “There’s no doubt once a school is established and running properly it becomes a powerful annuity income earner and a reliable cash generator. But if a handful of schools aren’t filling up you could have problems. There’s a very high fixed cost base in running a school, with virtually no variable cost per scholar. Something like that would definitely drag on the performance of a private education group with a portfolio of assets.”

Clearly, there are risks in early stage private schooling ventures. However, fundamental demand for private education will probably see private investors delving for what scrip they can grab at Curro.

PSG/Paladin are certainly chalking up their confidence by indicating a willingness to underwrite Curro’s pre-listing rights offer – an exercise that will see Paladin fork out at least R240m. Mouton notes: “It’s a sizeable cheque Paladin is writing. It’s all in the belief in the future of Curro’s business model.”

Finweek is reasonably sure Curro’s founders – who own the balance of the shares – will probably not be in a position to follow all their rights. Gut feel is Curro’s founders will probably look to trading the nil paid letters, which should allow PSG (and other investors) to pick up additional shares in the business.

It’s going to be a most interesting exercise…

HISTORY

The story of Curro

Curro was founded by teacher Chris van der Merwe in Durbanville in mid-1998. Van der Merwe, now CEO of Curro, decided the opportunities in public education were limited, and together with his teacher wife, opted to take 20 students each and focus on the foundation and intermediary phases (primary school) in a private capacity.

The local community’s interest was overwhelming, so much so that Van der Merwe had to move into a church building and then build the Curro’s Durbanville campus in 2000 (with a 100% loan from Absa).

Curro’s alliance with PSG’s Paladin Capital was, however, not Curro’s first flirtation with the corporate sector.

In late 2006 Educor – then owned by Naspers (Finweek’s parent company) – acquired a 26% stake in Curro for an undisclosed amount.

While Educor also secured the right to extend its stake to a maximum of 75%, the 26% stake was sold back to Curro’s management a couple of years later (also for an undisclosed sum).

Why Curro passed in and out of Educor is not clear. But one suspects it could probably be linked to internal developments at Educor rather than being interpreted as a pronouncement on Curro’s prospects.

Newly formed Paladin made its first move on Curro in July 2009, acquiring 50% of the share capital for R50m. A year later Paladin acquired another 26% stake for R52m to gain outright control of the private education venture.

At the beginning of this year Curro acquired 100% of Aurora College, a private school in Randburg, for R42m.

At this juncture Paladin has seen its investment in Curro (assuming a pre-rights issue enterprise value of around R400m) almost triple in value. ¦

Curro’s profit drivers

* South Africa’s public education system is in decline

* A growing middle class that’s placed an emphasis on a quality education

* Private school attendance has the potential to double

* No new schools being built in affluent areas

* Operating in areas where private schooling is lacking

* Barriers to entry for other players

* Affordable fees could drive student numbers

AdvTech

Chalking up cash flow

These days AdvTech is anything but fodder for punters dabbling in penny stocks

Punters brave enough to back debt-laden AdvTech back in 2001 – when its price dipped to as low as 15c/share – would have almost chalked up a “forty-bagger” – with its shares currently sitting north of 540c on the JSE. These days AdvTech is anything but fodder for punters dabbling in penny stocks. Since CEO Frank Thompson took the helm in May 2002 there’s been an emphasis on building enviable education brands, with sterling academic results and managing the delicate capital flows of the business by balancing the up-front fee inflows with the sizeable capital demands of a sizeable school/college network.

AdvTech’s latest annual report shows almost 50% of its issued shares are in the hands of large institutional shareholders: Coronation Fund Managers holds 17,7%, Sanlam 13,8%, Old Mutual 10,3% and RMB 7,7%. The profiles of AdvTech’s top investors speak volumes about the group’s successes over the past six years and the attraction of well-run private education businesses as an investment option.

AdvTech’s results include around 15% of revenue and earnings generated by its array of human resources assets. It can’t therefore be seen as a pure education play.

But the annual report does show its education division – comprising Crawford Colleges, Trinityhouse, Rosebank College, Varsity College and Abbots (among others) – spinning R1,26bn in revenue and yielding a nifty R216m in operating profits. That represents a trading margin of 17%, a figure that could – in a good year (and 2010 was a tricky year for AdvTech) – presumably touch a wholesome 20%.

While AdvTech’s last financial year wasn’t its best performance by a long shot, it was reassuring to see cash generation still underpins the business. Writing in his annual preview, Thompson notes the delay of certain capital expenditure projects in order to match better revenue growth resulted in the significant decline in the group’s capital creditors. That led to a 15% drop in free operating cash flow before capital expenditure of 54c/share. But cash conversion of earnings remained strong and Thompson points to free operating cash flow before capex per share amounting to 145% of earnings.

Thompson notes that strong cash flow enabled AdvTech to earn almost as much in interest as last year, despite the very significant drop in interest rates, and – more importantly, in our opinion – fund capex of R105m, acquisitions of R20m, tax of R78m and capital distributions to shareholders of R84m from its own resources.

AdvTech could then enter its 2011 financial year with an un-geared balance sheet. And Thompson has the comfort of a 23% increase in fees received in advance when it comes to contemplating cash flows for its new financial year.

In considering the investment merits of a newer business such as Curro, it’s perhaps instructive to depict AdvTech’s broader expenses in some detail. Over its past financial year capital commitments topped R94m and operating lease commitments (mainly the provision of leasehold educational premises) came in at R385m. Thompson explains those commitments included the opening of a new Trinity-house school in the West Rand. “Our first tangible result of our commitment to building this brand.” 

 
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