BUSINESS DESCRIPTION
AEC Education is a holding company for a group of companies that provide educational services in Asia and the UK. The Company designs exams and training courses focusing mainly on the Malaysian and Singapore markets. In July 2009 AEC acquired Malvern House in the UK. Malvern House College in London is a well known provider of English language courses, as well as University Pathways and Business Diplomas. AEC is listed on the AIM market in London. (Bloomberg Ticker AEC:LN)
2009 was a transformational year for AEC. It started with a small Malaysian education business with a turnover of only £5.5 million in the previous year, but more than doubled its turnover to £13 million and diversified its source of revenues to include 39% generated from the UK in 2009.
THE CHALLENGES for AEC MANAGEMENT
On Wednesday 9th June 2010 AEC announced that its AGM was to be held at its brokers on 30th June and declared a maiden dividend, which came as a surprise to the market, which had waited over 5 months on the results for year ended December 2009, without any indication of when its preliminary figures would be announced. Moreover, the announcement of a dividend without preliminary results seemed to us to be unusual and after the company failed to post the AGM agenda and circular on its website that evening, as promised by the company, we felt that public disclosure left a lot to be desired and we contacted the company. Having heard nothing the next day, we then contacted the AIM regulator to voice our concerns. After two days the company publicly announced its annual results for the year ended 31st December 2009.
The first challenge for AEC is apparent to us. The acquisition of Malvern House and the buying out of other minority stakes not held by the company make it clear that the strategy is to grow its business both by acquisition and organically. However, the management need to realise that growing the business is not always enough for investors. Due to the uncertainty of investing in publicly quoted equities investors need to have the feeling that they are well informed. We have experienced other Holding Companies in the past, such as the industrial holding company James Crean, which had a take or leave it approach to their reporting responsibilities. Ultimately Crean had to be broken up as investors lost confidence in the management’s ability to generate value through the management of a diversified array of businesses. AEC are growing the business rapidly, but also need to take their reporting responsibilities seriously.
The second great challenge for an expanding company like AEC is the task of increasing shareholder value. Given enough credit and shareholders’ funds it is easy to acquire businesses and there is no doubt that there are many viable businesses which are available to be bought during this current economic recession. However, the directors of AEC need to be sure that they are paying an appropriate price and that they are not stripping the assets of the company to make the owners of the takeover targets rich. For example, in the results for 2009 the management talked a lot about the increase in the turnover of the business and the jump in profits, but failed to mention anywhere the fall in Earnings Per Share (“EPS”). In actual fact the EPS fell 19 percent from 3.1p to 2.5p per share. This was a very significant change which management either deliberately did not disclose or did not find to be important. If it is the latter then the investor should not be so confident in the management’s statement about their strategic objectives, as they are unable to measure their success in reaching their goals. If it is the former then the investors should be on their guard, as management will continue to put their own interests ahead of AEC’s shareholders.
One of the contributory factors to the fall in EPS was the increase in the number of shares in issue and particularly the price at which they were issued. Shares were offered as consideration for the businesses acquired. They were issued at a deeply discounted price relative to the market value of the shares, which is a practice which cheats existing shareholders and is one that we have observed frequently on London’s AIM market. It may be argued that AEC would have had to make a rights issue or share placement at a discount to the share price anyway if it was to pay cash, but then at least all shareholders would have been treated equally.
At the end of 2008 AEC had 18 million shares in issue. During 2009 the share price ranged between 16p and 26p, with the average being about 20p. However, to finance the Malvern House acquisition the vendors received 7.5 million shares at 12p on 2 July 2009. Also as part of its fundraising during 2009 AEC favoured the use of Share Placings. For example 3.6 million shares were placed with KSP Investments Pte Ltd on 17th July 2009 at 12p, although the share price on that day was 17.5p. Moreover, we note that the share price was at 21.5p 3 days before the transaction and again over 20p one week later. At the end of December 2009 there were 43.2 m shares in issue and at the time of writing KSP hold approximately 25 percent of AEC’s issued shares. Clearly pre-emption rights have been used in a manner which is detrimental to existing shareholders.
The question for investors going forward is how they should interpret the overpayment for the acquisitions and the stripping of company assets through deeply discounted share placings to favoured shareholders. Well if the company remains quoted then it is less likely that asset stripping on this scale could happen again. This is because it gets harder for management to pre-empt or favour certain shareholders as the company’s market capitalisation gets bigger. Furthermore, those shareholders, who have benefitted themselves from cheap placings or received generous share-based consideration, are unlikely to allow management to overpay for other takeover targets. Therefore they would not patiently accept arguments about strategic expansion if they continually see that their EPS is being eroded.
INTERIM RESULTS FOR THE 6 MONTHS ENDED 30th JUNE 2010
The headline numbers were impressive with turnover up 169 percent to £8.6m. Without the acquisitions the turnover would only have increased 5.8 percent. Despite the rising top line the profit after tax actually fell 12.2 percent to £338,000, representing a net profit margin of only 3.9 percent, which is a poor rate of profitability for an educational franchise.
EPS fell 46 percent from 1.3p to 0.7p per share. This is much greater than the fall in net profit and is due to the massive dilution arising from shares being issued to pay for three acquisitions at share prices which were detrimental to the existing shareholders.
Net cash has fallen from £3.15m in June 2009 to £2.41m at the period end. This is a key number, which will need to be monitored by shareholders in future periods, until the management prove that they are able to do more than overpay for acquisitions.
On 16th September 2010 AEC’s Singapore subsidiary was awarded the EduTrust Certificate for four years by the Council of Private Education in Singapore. This is significant, as a four-year certificate has been granted to only 11 of the 1,000 plus private education institutions in Singapore. The benefits of the EduTrust Certificate are faster processing of student visas and easier access to government services.
Management state that they remain confident of the outcome for the full year, but exactly what they are confident of remains a mystery to shareholders, as no targets have been published.
Management refer to some challenges for the group, but they are not specific. They mention significant expenditure on marketing and systems. Systems expenditure is necessary and acceptable, but we are suspicious of additional expenditure on marketing which eliminates any profit for shareholders, where there is no clearly stated long-term plan. We are even more disturbed by the statement that they are “continuing to seek acquisitions, which are synergistic and easily integrated”, as it is not at all clear that management are capable of making sensible earnings enhancing acquisitions.
The challenges mentioned above probably relate to the most significant of the 3 acquisitions, which was Malvern House in the UK. Malvern accounted for £4.1m of the £5.2m extra acquisition-related revenue. Malvern House’s activities were disrupted in Q1 by the UK Border Agency’s review of student visas. Management have attempted to reassure investors by stating that they anticipate the strong growth in student numbers across the Group to offset the impact on the year as a whole. They do not specifically state that this review was a one-off event and that things at Malvern House specifically have returned to normal, but refer to some remaining uncertainty here, although they returned to more normalised trading from May 2010.
There is no interim dividend, which would have reassured shareholders that management are acting in their interests. The promise of a full year dividend subject to H2 results is of little comfort.
An investment in AEC largely depends on how you view management’s ability to deliver and the economics of the industry in which they operate. The management conclude with the statement that there are substantial opportunities for growth and that the demand for AEC’s business and vocational offerings remains buoyant in Asia and that the interest in UK university qualifications and English language learning also remains high.
WHAT IS AEC EDUCATION WORTH?
We used our own numbers and brokers estimates for 2010 and 2011 to arrive at a valuation of 34p per share. That represents a potential upside of 79% from the current 19p asking price. This is based on a fairly conservative 3% earnings growth rate from 2012 to 2020.
There is one major risk for AEC and that is the more stringent immigration policy being introduced in the UK. This could adversely affect Malvern House. Europe has seen disproportionate increases in the numbers of foreign students registered with language schools connected to illegal immigration. These schools are now being targeted by the authorities. However, the Malvern brand name is well known for TEFL courses and should survive any purge of the current system. Moreover, the diversification of revenues for AEC should make the earnings more stable going forward and management should be able to leverage on the Malvern House brand name through their Asian network.
Looking at AEC’s closest quoted peer Education Development International plc (“EDI”), AEC at 19p per share has a Price earnings “PE” ratio of 7.5 for 2010 and 6.3 for 2011, with dividend yields of 1.5 percent and 1.7 percent in those respective years, whereas EDI’s PEs are 9.1 and 8.0 for the years ending 30 September 2010 and 2011. EDI’s dividend yields are 1.6 percent and 1.8 percent for the respective years. This represents a potential 21 percent price upside for AEC based on the 2010 PE or a 27% price upside based on the 2011 PE. AEC’s dividend yield is twice as much as EDI’s.
The cheapness of AEC is a reflection of its size, as it only has a market capitalisation of £8.4m. By comparison EDI has a market capitalisation of £66m. However, market cap and turnover at AEC have more than doubled over the last two years and with the prospect of continued growth in business and language courses in Malaysia and Singapore the shares may eventually have a significant upward re-rating.