Affinity Education In Play As Rival Mounts A Bid

This story features G8 EDUCATION LIMITED. For more info SHARE ANALYSIS: GEM

-Possibility of higher bid price
-Less potential for acquisitions now
-More subdued outlook generally
 

By Eva Brocklehurst

No sooner said than done. Affinity Education ((AFJ)) issued disappointing earnings guidance last week and, as a consequence, its share price slumped heavily. G8 Education ((GEM)) pounced on the opportunity and instigated a hostile bid, buying the stock at around 70c a share on market to take a 16.4% stake in its smaller rival.

The company has offered one share for every 4.61 Affinity Education shares, valuing the target at $162m. The offer is contingent on acquiring a minimum 50% shareholding. A merger would remove G8 Education's largest listed competitor and provide more exposure to suburban and regional locations. Moelis believes G8 Education may be able to increase its scrip offer to the equivalent of 98c a share and still achieve 5.0% accretion.

The broker has assumed no cash component will be included, given G8 Education has historically not obtained bank debt. Moreover, there is unlikely to be competition issues as few of the centres overlap geographies, while the combined market share would be around 10-15% of the national long day-care market. Moelis believes the reaction to Affinity Education's more subdued outlook was overdone and retains a Buy rating and target of 97c. The main obstacle to the transaction proceeding, in the broker's view, is that institutions and retail investors took Affinity Education stock at $1.18 a share in a capital raising less than three months ago!

Morgans always suspected G8 Education would provide an exit strategy for Affinity Education shareholders but did not expect it to happen so quickly after the downgrade. Morgans advises shareholders to remain holders of the stock and await further developments. The board, which considers the approach highly opportunistic and conditional, has also advised shareholders to take no action.

Affinity Education is likely struggle to acquire additional centres at accretive multiples unless it can get its share price to materially re-rate. While Morgans cannot envisage a counter bid being lined up, G8 Education does need Affinity Education to support its own growth initiatives. Hence, a slightly higher bid price could be squeezed out. Morgans sets its price target to 70c, in line with the offer and maintains a Hold rating.

The broker has lowered Affinity Education's average occupancy expectations to 78% from 83% and increased cost assumptions by 3.0%. Of major concern is the recent guidance, which implies second half earnings of just $20-23m. Child care does have a significant second half skew but the company's commentary has not provided a lot of comfort. Of note, softness in occupancy in the first half has been noted among other industry participants and Morgans does not believe this situation is specific to Affinity Education.

The merger transaction could be 11-14.5% accretive to G8 Education, Canaccord Genuity maintains. The broker counts the benefits of increased scale, synergies and reduced competition for assets. The Affinity Education portfolio would also benefit from proposed government funding changes and and an all-scrip bid would enable G8 Education to tap additional funding. Canaccord Genuity retains a Buy rating and $6.81 target for G8 Education, remaining positive on the outlook for the sector.

This broker does not discount the prospect of private equity entering the bidding, in that Affinity Education's low multiple and ungeared balance sheet could be attractive. On this stock Canaccord Genuity retains a Buy rating, given the pull back in the share price and the reasonable growth profile. Target is now $1.07.

G8 Education may need to provide a control premium, in Macquarie's view. The broker takes the opportunity to adjust G8 Education's outlook to account for the removal of underwritten dividends in the medium term, acquisition assumptions and margin compression in FY16 from staffing ratios. Hence earnings estimates are downgraded by 5.0% for FY15 and by 6.0% for FY16. The broker is cautious about the near-term outlook and retains a Neutral rating, suspecting lower organic earnings growth in FY16 and narrowing capital management options may put downside pressure on the stock.

Deutsche Bank envisages strategic merit in the bid, taking out the other listed player at a reasonable multiple of 5.6 times earnings. The disappointing track record of Affinity Education also suggests upside potential with respect to margin improvement and the divestment of underperforming assets.

UBS suspects the amount of expenditure in FY15 means there is unlikely to be additional acquisition settlements until the second half of FY16. Lowering the number of acquisitions G8 Education is likely to settle in the short term results in a substantial reduction in short-term estimates. Hence, this broker reduces its target to $4.41 from $6.22 but retains a Buy rating, arguing the stock is mis-priced at current levels.

On FNArena's database G8 Education has three Buy ratings (UBS, Deutsche Bank and Morgans), one Hold (Macquarie) and one Sell (Citi, yet to update). The consensus target is $4.50, suggesting 45.9% upside to the last share price. This compares with $5.02 before the bid.

In terms of Affinity Education's update, Morgans notes there are some more positive aspects, in that the company is planning to push through an average 3.0% fee increase across the portfolio from July. This is in addition to a fee increase of 2.7% achieved in the first quarter. Costs are under pressure, especially on a wage-to-fee revenue basis, but the company expects this to improve with the introduction of rostering technology later in the year.

The company expects underlying earnings in the range of $7.5-8.5m in the first half and to total $27-32m in 2015. Affinity Education maintains guidance for a maiden 2015 dividend of 60% of net profit, but off a lower earnings base.

Ord Minnett, in response to the downgrade to the outlook, noted the stock's attractiveness as a potential acquisition. The broker moved its rating to Speculative Buy and to High Risk. While the earnings guidance was disappointing, particularly given the downside potential in the range, the operational update was of most concern. Occupancy has fallen sharply, despite the diverse portfolio which operates in a fairly benign economic environment. The broker considers the main catalyst for Affinity Education would be the potential for a corporate suitor to find greater value in the portfolio than what the market is willing to ascribe under the present structure.
 

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