The Intelligent Investor's Gaurav Sodhi recently named G8 Education Ltd (ASX: GEM) as his "most reviled business". He argues that the company's strategy does little more than take advantage of 'multiple arbitrage', whereby it purchases childcare centres for a low multiple of earnings that are then combined into a single entity for which shareholders are willing to pay a far higher multiple.
So does the argument hold up or is the company going to provide stable earnings growth that will fuel a continued rise in share price?
In reading Sodhi's analysis, investors are sure to recall the basket case that was ABC Learning and may agree that G8 is a recipe for disaster. While ABC Learning's execution was extremely poor and more than a few mistakes were made, the success of G8 and the recent listing of profitable childcare provider Affinity Education Group Ltd (ASX: AFJ) demonstrate that the aggregation strategy has merit.
As Sodhi points out, there may not be major synergies that stem from owning multiple childcare centres (other than head office costs, which have fallen from $1,193 per place in 2009 to $455 in 2014). However, the operational improvements that G8 is able to implement from investment in people, learning environments and curriculum are highlighted by a continual reduction in staff turnover and increase in profits.
There is little that shareholders would complain about if they were able to buy shares in profitable businesses at earnings multiples of only four times, which is exactly what G8 has done on a consistent basis. G8 has utilised this strategy to increase its earnings per share for each of the past seven years and its latest earnings announcement detailed a stunning 70% increase in annual net profit.
This track record indicates that management knows what it is doing and a quick look at recent ASX announcements reveals that it believes in what it's doing too. Chairman Jennifer Hutson and director Andrew Kemp recently purchased almost $1 million worth of shares between them.
Foolish takeaway
G8 added an additional 203 childcare centres in 2014, for a total of 455 childcare centres and 32,782 childcare places. G8 estimates that there are 9,208 childcare service outlets in the Australian market, which means that there are still considerable opportunities for further acquisitions. There's a bright outlook for G8 as it continues to take advantage of the highly fragmented childcare industry using its skilled management and operational excellence to increase value.
