Shares in takeover target Affinity Education Group Ltd (ASX: AFJ) remain above the offer price of a larger rival after the childcare centre operator issued a spirited defence when it announced its half-year profit results.
The stock is trading flat at 83 cents, but that's above the 80 cents that its larger rival G8 Education Ltd (ASX: GEM) is offering for Affinity Education.
The target is trying to convince shareholders that the stock is worth more when it posted a 128% surge in revenue to $87 million and a 76% increase in underlying earnings before interest, tax, depreciation and amortisation (EBITDA) to $8.6 million for the six months to end June 2015.
Management also promised to declare a maiden dividend in February and issued a robust outlook with underlying EBITDA expected to expand significantly to between $30 million and $32 million for 2015 (its financial year is the same as the calendar year), compared with the $17.9 million figure it posted in 2014.
Investors will also be pleased to see a 311% uplift in operating cash flow (excluding acquisition costs) to $15.6 million given concerns surrounding its aggressive growth by acquisition strategy.
Higher occupancy, a 5.7% increase in fee collection and better cost control are driving growth for the second half of the year, but investors should watch its EBITDA margin closely as that actually fell heavily in the first half of this year to 9.9% from 12.8% for the same time last year.
Management blames lower occupancy over the comparable periods but is trying to reassure investors by stating that current occupancy of 81% is significantly higher than it was since June 30 2015 and that the fundamentals for the industry remain robust thanks to the growing number of mums returning to the workforce and government support.
Half of Affinity Education's income comes from government rebates and subsidies and management thinks there's still plenty of room to grow via acquisitions as it has $70 million in undrawn loans and a conservative gearing ratio of 13%.
But the best way for Affinity Education to win support from the market is to bed-down and improve the performance of its existing portfolio of centres before returning to its aggressive acquisition strategy.
I don't generally like roll-up companies (those that grow by acquiring smaller operators) unless they trade at a nice discount and Affinity Education does appear to fit this bill as it is on a 2016 consensus forecast price-earnings multiple of around 8x.
That is close to a 25% discount to G8 Education and management is urging shareholders to reject the offer. G8 Education may have painted itself into a corner as it declared its offer as final.
Affinity Education is in talks with a private equity group about the sale of the business and it's noteworthy that management has not given any update on this in its profit announcement.
