Vocation Seen Offering Re-Rating Opportunity

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-Plenty of acquisition upside
-Strength in state-based funding expansion
-Moelis draws comparison with Navitas
 

By Eva Brocklehurst

Vocation ((VET)) has hit the boards at the ASX. The company was formed by the merger of three vocational education businesses and offers a national service including recruitment, education and training. The market for vocational training is around $8.8 billion a year and the company is positioned for the increasing shift to demand-driven funding, which allows eligible students to choose their providers.

Stockbroker Moelis likes the fact that industry consolidation offers earnings upside within this fragmented sector, that consists of around 5,000 registered training organisations. Vocation has the chance to acquire many bolt-on providers, because of its access to cash and scrip for acquisitions. The company has a national presence via eight organisations. Once restructuring is finished the company should offer a complete service from recruitment to education and management of students. Moelis has initiated coverage of the stock with a $2.50 price target and Buy rating.

The three foundation companies were AVANA, BAWM and CSIA, which have combined to deliver the corporate structure that Vocation has taken to its IPO. Although separate entities, the three have worked together and management believes they offer complementary business in terms of geography and industry. This integration is the critical risk the company needs to manage, in Moelis' view. Vocation is currently registered to deliver 78 qualifications across a variety of industries.

The merger and restructuring has resulted in three channels. The new enterprise division provides customised training to employees of large corporate and government clients, including the likes of Telstra ((TLS)) and ANZ Bank ((ANZ)). The direct division provides training to students on an individual basis both face-to-face and online, while the solutions division offers ancillary services training for government clients and registered training organisations.

The tertiary vocational education sector is heavily regulated by the Australian Skills Quality Authority. Moelis expects the increasing regulation of the vocational education sector will benefit larger incumbents and drive scale advantages. There appears to be substantial scope for Vocation to expand by acquiring other providers which offer different qualifications and expertise that can be rolled out on a national basis, or that provide immediate access to a new state or federal funding sources. Moelis argues this is an important driver of earnings upside, offering immediate accretion given the company's low cost of equity and debt funding.

Changes in the domestic economy have underpinned demand for an educated workforce with a practical emphasis on vocational training, making it an increasingly important recipient of government funds. Management believes the company has a sustainable competitive advantage with its national presence and ability to access state-based funding contracts. Moelis notes that pro-forma enrolments in FY13 were dominated by Victoria, at 78%, an inevitable function of the location of the foundation companies. Nevertheless, it highlights the opportunity for state-based expansion should the same shift to demand-driven funding occur as took place in Victoria from 2009-12.

South Australia instituted demand-driven funding in 2012, Queensland is planning to introduce it in 2014 and NSW in 2015. Management estimates that the market is highly fragmented, with only half of the 5,000 organisations likely to be receiving state funding. Using the Victorian market as a template, Moelis notes less than 5% of those on the funding list received more than $5m in state funds.

Moelis is confident the FY14 prospectus forecasts can be achieved and there's an organic revenue growth rate, realistically, of 15% beyond FY14. A considerable level of forecast revenue has already been contracted. Vocation recognises revenue as a student progresses through a course rather than upon enrolment and payment of fees. In the enterprise segment, 89% of forecast FY14 revenue for the second to fourth quarters is already contracted.

Direct revenue represents 22% of the prospectus forecasts and new enrolments 18% of the forecast total. Moelis is comfortable with the full year revenue target for this division, at $22.3m, although it's not as visible as the enterprise stream because of that division's contract-based nature.The solutions stream is forecast to come from the outsourced management solution, RTO Edge. There is the risk that clients my not achieve targeted enrolment growth but Moelis observes the division generated $13.5m in revenue in the first quarter, representing 26% of FY14 prospectus revenue, and new course enrolments in the first quarter were 32% of the full year forecast.

The closest listed comparison is Navitas ((NVT)). Moelis believes that company's track record and size offers insight into how the market could price Vocation, should the company's integrated model prove successful.

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