G8 Education Ltd (ASX: GEM) is probably no stranger to many investors – with a market cap of $1.2 billion – as it follows its strategy of aggregating child care centres, mainly in Australia.

G8 has 471 Australian centres and 18 in Singapore with a total of 35,221 licenced places, generating earnings before interest and tax (EBIT) of $145 million annually. But despite its size, the company still has a tiny share of the child care market in Australia – with latest estimates of around 5%.

G8 tried to acquire fellow childcare centre operator Affinity Education Group Ltd (ASX: AFJ) last year but was pipped at the post by private equity firm Anchorage Capital with a higher offer. At the time, Affinity had built up a portfolio of 161 centres, despite listing in December 2013 to start a portfolio of 57 owned centres and management rights for a further 11 centres.

The growth of both G8 education and Affinity illustrates the benefit of size and scale as well as the ability to tap equity and debt markets for fresh capital as required.

It also illustrates the ability of companies to use their pricing power to make cheap acquisitions. When a company listed on the stock exchange is trading on an earnings before interest and tax (EBIT) multiple of 10x or above, acquiring privately-owned companies for multiples of around 4x EBIT is child’s play (no pun intended). As scale benefits accrue, companies like G8 can reduce their operating expenses, and increase their margins. G8 has also managed to increase occupancy rates and organic growth.

Another company that could be on the takeover list is Think Childcare Ltd (ASX: TNK), which has 32 childcare centres (and manages a further 12), and a market cap of $42 million. Think could be in the sights of G8 or other large childcare operators for a number of reasons…

  1. The problem with the childcare industry is that many are individually owned and operated (around 84%) with another 15% managing services with 2-24 services (according to the Affinity Education Prospectus). For a company like G8, acquiring a group of centres from one owner/operator likely makes much more sense that trying to acquire the same number from individual operators.
  2. G8 announced today that it is aiming for between $50 and $150 million in centre acquisitions in the 2016 calendar year.
  3. Think is currently trading on an EBIT multiple of ~6x, and while G8 has consistently stated it tries to limit buying centres to 4 x EBIT, the attraction of picking up 30 centres in one go could be attractive enough to override that ‘rule’. G8 was willing to pay more than 6.5 times EBIT when it initially bid for Affinity.
  4. CEO and founder Mathew Edwards owns 34% of the shares in Think, so if G8 can entice him to sell up at an attractive price, institutional shareholders may fall like dominoes.

Foolish takeaway

Based on today’s results, Think still looks attractive on its own two feet, whether a bid materialises or not. At the current price of $1.06, shares are trading on a P/E ratio of 8.8x trailing earnings and paying a partly-franked 6.8% dividend yield. Having the founder as the largest shareholder and CEO is another bonus. Add this one to the watchlist.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.