Reflections on a stock market dog . . .
As a long-time supporter of ABS I think it’s time to reflect on past mistakes and offer my opinion about the current situation and the future prospects for ABS.
Firstly, I share my lessons learned:
1) Transparency is a very valuable thing and all the analysis in the world cannot save you when management is not disclosing important information. When management comes clean after the event (look at the multiple revisions to 1H 07-08 numbers) it destroys all credibility. Transparency is still pathetic (and this only becomes a problem in a bear market, catching out the herd, including myself!).
2) High debt. While I am still a big supporter of leveraging a sound business, ABS highlights the need for basic project evaluation and cost of capital hurdles to be applied to investment choices. Eg. The US expansion, new centre openings/closures. Management has a TOTAL lack of financial discipline, combined with their high gearing was a recipe for disaster. It seems management has not conducted any sort of sensitivity analysis on their business model (exchange rates, margins, demand etc). Again, this is something that only comes to light in a bear market and congratulations to the few that identified these risks – I hope your shorts rewarded you handsomely, I’m sure they did. I am surprised that such a ‘defensive’ industry would lead the market in the downturn/bear market we are experiencing.
3) Shoddy business model. Only recently have we heard the full extent of the developer subsidies to ABS – but still lack any idea of their impact on the bottom line going forward. Perhaps due to management distractions, or incompetence, ABS was unable to convert its remarkable revenue growth into earnings. One of my primary reasons for investing in ABS was the expectation that they would successfully consolidate their businesses to drive margins up and deliver earnings growth (it is ironic perhaps, that this was the motivation for MSPE's stake in ABC US!). In this area ABS failed, and hence their model failed. I think this reflects management incompetence (inability to respond to market conditions, anticipate change), distractions such as the overseas expansion and neglect of the Australian business.
4) Personally: Over-reliance on EPS-driven valuation, rather than considering other measures more. In hindsight, ABS has cleverly/(deceitfully?) inflated their earnings numbers through tricky accounting and the ‘developer fees’ – showing valuation models are only as good as the accounting numbers underlying them. This is a lesson I won’t forget.
Thoughts at present:
- very interesting report published by Comsec that questioned the effects of the removal of the RMC structure on the value of licences and the unwinding of the developer fee model: very pessimistic indeed. But their DCF valuation (which has upped the discount rate and been quite harsh in their assessment of future CF's, still gives ABS a DCF considerably higher than the current SP).
- I find it interesting that management decided to divest a stake in the US business and divest other non-core assets when it was value-destructive and it was not being forced for by its bankers (another example of a total lack of regard for shareholders and failure to make basic financial decisions). I feel this was knee-jerk, but given it occurred in the height of the sub-prime collapse and the market was at its most fickle – doing nothing may have proved more fatal.
- This begs the question: was the business sustainable without the divestments? I believe it was and I also believe management thought it was. In a conversion with MSPE, it was suggested to me that the motivation of the sale was to ‘show’ the market what ABS’ US assets were worth (note the frequent comparisons to the Bright Horizons sale) - so the market would start valuing the entire company on that multiple. Very interestingly, MSPE’s basis for making the investment centres around ABS ability to drive margin improvement in the US business at a time when margins are being crunched in the Australian business. If MSPE feels profit margins can grow during increasing unemployment in the US – why did ABS not consider divesting some Australian/NZ centres (where the multiples would have been much higher and there would be no currency write-downs?)?
- Groves paid the ultimate price for running a business with no financial discipline and dodgy accounting. It was being run like a family business not a public company. I hope that this changes.
What do I think about ABS now?
- Well I totally concede that ABS was and is a poor investment for a start. I think many would have overlooked a lack of transparency (during the ‘boom’ times) and lack of quality accounting information.
- I think the attempts at better disclosure have been encouraging – but management needs to show that they are financially disciplined and focussed on shareholder returns. They are so unwilling to come up with forecasted numbers, not that the market could take them seriously anyway (given the misleading nature of ABS vehement maintenance of its 15%+ growth forecast until the US sale).
- I would like to see Eddy out and a CEO with a track record of sound investment decisions brought in.
- I don’t think ABS will buy back the US business and if it does it will probably overpay due to the conditions placed on the call option by MSPE, the likelihood of a lower AUD by the expiry date and the high chance of expansion in the US labour market by the expiry date.
- ABS is still a highly levered business, so a turn-around in the AUS businesses is the only hope of ABS ever selling for $8+ per share (obvious). But due to developer fees, any COP improvement in the subsidies centres will not be EPS accretive (it will only replace the developer subsidies). At least the end of the developer model will force ABS management into applying financial decision criteria on centre acquisitions/closures – so we have some assurance the management attitude of growing top line growth (at the explicit expense of the bottom line) has come to an end. ABS may take several years to work through its excesses in the past.
- I do not expect a positive return on ABS until ALL the skeletons are out of the closet and we have a 2008-9 forecast (which is post-developer fees and post-RMC removal) – this will be extremely telling. Less exposure to the US, for the short-term is a positive for ABS. My outlook is to ‘wait-and-see’ until some idea of FY08-09 earnings come to light. I think down-side is limited because the market is probably (sensibly) pricing in, to some extent, the risks surrounding rest of the undisclosed information (about AUS margins and the impact of changes to the business model) – it would be wise to do so given the management attitude towards shareholders/transparency.
- A speculative investment in ABS could be considered in 12-18 months time. I don't think the new/re-entering investor will miss out on much by waiting. While the shares are unlikely to go lower than $1.15 they are equally unlikely to head over $2.
As a long-time supporter of ABS I think it’s time to reflect on past mistakes and offer my opinion about the current situation and the future prospects for ABS.
Firstly, I share my lessons learned:
1) Transparency is a very valuable thing and all the analysis in the world cannot save you when management is not disclosing important information. When management comes clean after the event (look at the multiple revisions to 1H 07-08 numbers) it destroys all credibility. Transparency is still pathetic (and this only becomes a problem in a bear market, catching out the herd, including myself!).
2) High debt. While I am still a big supporter of leveraging a sound business, ABS highlights the need for basic project evaluation and cost of capital hurdles to be applied to investment choices. Eg. The US expansion, new centre openings/closures. Management has a TOTAL lack of financial discipline, combined with their high gearing was a recipe for disaster. It seems management has not conducted any sort of sensitivity analysis on their business model (exchange rates, margins, demand etc). Again, this is something that only comes to light in a bear market and congratulations to the few that identified these risks – I hope your shorts rewarded you handsomely, I’m sure they did. I am surprised that such a ‘defensive’ industry would lead the market in the downturn/bear market we are experiencing.
3) Shoddy business model. Only recently have we heard the full extent of the developer subsidies to ABS – but still lack any idea of their impact on the bottom line going forward. Perhaps due to management distractions, or incompetence, ABS was unable to convert its remarkable revenue growth into earnings. One of my primary reasons for investing in ABS was the expectation that they would successfully consolidate their businesses to drive margins up and deliver earnings growth (it is ironic perhaps, that this was the motivation for MSPE's stake in ABC US!). In this area ABS failed, and hence their model failed. I think this reflects management incompetence (inability to respond to market conditions, anticipate change), distractions such as the overseas expansion and neglect of the Australian business.
4) Personally: Over-reliance on EPS-driven valuation, rather than considering other measures more. In hindsight, ABS has cleverly/(deceitfully?) inflated their earnings numbers through tricky accounting and the ‘developer fees’ – showing valuation models are only as good as the accounting numbers underlying them. This is a lesson I won’t forget.
Thoughts at present:
- very interesting report published by Comsec that questioned the effects of the removal of the RMC structure on the value of licences and the unwinding of the developer fee model: very pessimistic indeed. But their DCF valuation (which has upped the discount rate and been quite harsh in their assessment of future CF's, still gives ABS a DCF considerably higher than the current SP).
- I find it interesting that management decided to divest a stake in the US business and divest other non-core assets when it was value-destructive and it was not being forced for by its bankers (another example of a total lack of regard for shareholders and failure to make basic financial decisions). I feel this was knee-jerk, but given it occurred in the height of the sub-prime collapse and the market was at its most fickle – doing nothing may have proved more fatal.
- This begs the question: was the business sustainable without the divestments? I believe it was and I also believe management thought it was. In a conversion with MSPE, it was suggested to me that the motivation of the sale was to ‘show’ the market what ABS’ US assets were worth (note the frequent comparisons to the Bright Horizons sale) - so the market would start valuing the entire company on that multiple. Very interestingly, MSPE’s basis for making the investment centres around ABS ability to drive margin improvement in the US business at a time when margins are being crunched in the Australian business. If MSPE feels profit margins can grow during increasing unemployment in the US – why did ABS not consider divesting some Australian/NZ centres (where the multiples would have been much higher and there would be no currency write-downs?)?
- Groves paid the ultimate price for running a business with no financial discipline and dodgy accounting. It was being run like a family business not a public company. I hope that this changes.
What do I think about ABS now?
- Well I totally concede that ABS was and is a poor investment for a start. I think many would have overlooked a lack of transparency (during the ‘boom’ times) and lack of quality accounting information.
- I think the attempts at better disclosure have been encouraging – but management needs to show that they are financially disciplined and focussed on shareholder returns. They are so unwilling to come up with forecasted numbers, not that the market could take them seriously anyway (given the misleading nature of ABS vehement maintenance of its 15%+ growth forecast until the US sale).
- I would like to see Eddy out and a CEO with a track record of sound investment decisions brought in.
- I don’t think ABS will buy back the US business and if it does it will probably overpay due to the conditions placed on the call option by MSPE, the likelihood of a lower AUD by the expiry date and the high chance of expansion in the US labour market by the expiry date.
- ABS is still a highly levered business, so a turn-around in the AUS businesses is the only hope of ABS ever selling for $8+ per share (obvious). But due to developer fees, any COP improvement in the subsidies centres will not be EPS accretive (it will only replace the developer subsidies). At least the end of the developer model will force ABS management into applying financial decision criteria on centre acquisitions/closures – so we have some assurance the management attitude of growing top line growth (at the explicit expense of the bottom line) has come to an end. ABS may take several years to work through its excesses in the past.
- I do not expect a positive return on ABS until ALL the skeletons are out of the closet and we have a 2008-9 forecast (which is post-developer fees and post-RMC removal) – this will be extremely telling. Less exposure to the US, for the short-term is a positive for ABS. My outlook is to ‘wait-and-see’ until some idea of FY08-09 earnings come to light. I think down-side is limited because the market is probably (sensibly) pricing in, to some extent, the risks surrounding rest of the undisclosed information (about AUS margins and the impact of changes to the business model) – it would be wise to do so given the management attitude towards shareholders/transparency.
- A speculative investment in ABS could be considered in 12-18 months time. I don't think the new/re-entering investor will miss out on much by waiting. While the shares are unlikely to go lower than $1.15 they are equally unlikely to head over $2.
