When I wrote about the travails of listed tutoring company Kip McGrath (KME on the ASX) it seemed they had been thrown a lifeline by another Australian company Editure Limited.
Since then I have received several emails from current and former franchisees, prompting me to take another look at the company. What I have found is raises serious concerns about whether KME is actually a viable business.
What’s been happening
KME have made two recent announcements via the ASX. The first stated that Lindy Hyam was passing the Chairmanship back to Kip McGrath (she’s staying as an independent director) and that Richard Ryan and Joe Ewart (respectively the Chairman and Chief Executive of Editure) had been appointed to the Board.
This is good and bad news. The bad news relates to Ms Hyam’s tenure as Chairman. Why was it so brief and who decided that Kip McGrath should replace her, given that his recent involvement at KME seems hardly covered in glory? The good news was about the appointment of Ryan and Ewart, both well-regarded business executives. Ewart has previously worked for Avatar Academic (USA) and DB Education Services as well at the top level in Goldman Sachs, Deutsche Bank and BT Wolfenson. Ewart’s link with DB is interesting as the company is now called Editure Education Services UK after Editure purchased a 25% shareholding for £100k in March.
The second announcement was about KME’s AGM and Explanitory Memorandum (to be held on Oct 11). This 86 page tome is a turgid read even by the standards of corporate documents. At its heart it seeks approval to convert Editure’s and the McGrath’s unsecured loans into convertible notes as well as reappointing Ewart and Ryan to the Board (they were only appointed in September with no vote from shareholders).
In all of KME’s twists and turns one basic fact isn’t clear to me. Just who is Editure? Editure Capital Pty Limited has five investors who are also ‘major shareholders in Editure Limited’. However the AGM document refers to the two legal entities as though they are one and the same, i.e. that KME is entering into a commercial relationship with Editure Limited via Editure Capital.
- A vote to ratify the prior issue of 3.5m shares in KME to Editure for Aus $209K. These shares cost 6 cents when the market is trading at about 3 cents and represent about 13% of the voting stock
- Switching Editure’s Aus$490K unsecured loan into a convertible note. This will be done at $40,286,68 @ 6 cents and $500,000 @ 9 cents giving a total of between 6,227,000 and 7,487,670 shares (difference being with and without interest)
- Switching Aus $500K unsecured loan from Kip and Dagnija McGrath for 5,555,556 shares @ 9 cents
The convertible notes proposal would, if it applied just to Editure, be recognition of what was effectively a last gasp rescue deal. But I’m not sure the same logic applies to the McGraths, because if they if they demanded repayment of their loan it would likely bankrupt the company in which they hold the majority of shares! There are various caveats, for example Editure Capital’s existing shares are to be held in voluntary escrow for 12 months, but ceases if KME is merged, sold or someone acquires 25% of it, for example from the 35+% of shares controlled by the McGrath family.
The convertible note proposal has strike prices of 6 and 9 cents, which looks generous in comparison to the recent share price of around 3 cents. But this is significantly below the 11.90 -15.99 cents Net Assets Per Share calculation on page 63 of the AGM document.
As part of their AGM process and to comply with ASIC regulatory Guide 74, KME commissioned an independent expert opinion for shareholders from Crowe Horwath (CH) that makes up 61 of the 86 pages of the AGM document (title Annexure to this Notice). For ordinary shareholders it makes unpalatable reading. For example CH conclude:
- The Editure Transaction is ‘Not fair but is reasonable’ and is ‘Not fair for the non-associated shareholders’
- ‘The McGrath Transaction is ‘not fair but reasonable’ and is ‘Not fair for the non-associated shareholders’
However CH also think the overall deal is advantageous because it:
- Introduces another strategic investor to Kip McGrath
- Is a better deal than the one struck with La Jolla Cove Investors
- There is ‘No visible present alternative to the Editure Transaction’.
The bottom line seems to be that CH thinks that without these deals KME is at serious risk of going broke. I agree, but I think some of their recommendation merit further debate, for example:
- If Editure Capital Ltd is a strategic investor, why have they said they don’t plan to put any more money into KME, nor make any changes to its business model or management?
- There are investors out there who might be interested in KME, as education and tutoring companies have recently attracted investment from companies like Pearson, TSL Education, Washington Post, GIMV and Veronis Suhler Stevenson. The real barrier for many potential partners would be as much about the performance of KME’s senior management team,(who negotiated the La Jolla Cove deal) as it would be about the business.
To my mind, CH’s report shows how hard it is to understand the international education sector. For example, they compare KME to fifteen education companies in Australia, Asia, South Africa and the US. Yet only one (The Washington Post, who own Kaplan) is actually involved in tutoring. In the UK they look at Promethean (a whiteboard manufacturer) but seemed unaware of companies like Fleet Tutors (the largest agency in Engalnd), Justin Craig (backed by Piper Private Equity) and BrightSparks Education (50% owned by TSL Education). In Australia they mention companies who operate in the consumer education sector, but almost none in the K-12 or tutoring markets. Locally they could have looked at 3P Learning (owners of Mathletics), Mathematics.com.au (whose Maths Online software is sponsored by McDonald’s) and others. Internationally their review could have included Sylvan (VC-backed), Schulerhilfe (Germany), ClubZ, Huntington Learning and others based in the USA. Finally, you’d think they might have twigged to TutorVista, the online Indian tutoring company Pearson paid US$140m for in January! Were I a teacher giving a test about CH’s understanding of the international tutoring market, they would get 4 out of 10 (fail).
Problems in the UK?
By turnover the UK is KME’s largest market with 217 centres (38% of all centres and 43% of YTD revenue), yet it barely rates a mention in the AGM documents. It should, for a very important reason. Apparently 13% (24) of UK franchisees have served written notice to KME that they wish to immediately terminate their franchise agreements due to ‘repudiatory breach of contract’ on behalf of the Franchisor, with a smaller number giving two months notice. If correct, this situation would likely put a sizable dent in KME’s forward revenues.
The online ‘Elephant in the Room’
KME’s development of an online product seems to be the key to their planned turnaround, but here they face two serious problems. On the one hand they are entering a very competitive market. For example, in Australia they will be going head-to-head with Mathsonline sponsored by McDonald’s with almost 75% of all Australian secondary students and schools signed up. Mathsonline is owned and built by Patrick Murray, who is also behind Conquer Maths and Buddy Maths. In the UK they will run into BrightSparks Education and the AQA’s new online tutoring service MyTutor (AQA are the UK’s largest exam board). Add to this mix US players above and KME ‘s online play may jump them from the corporate frying pan into a tech bushfire.
In regards to selling an online product outside Australia, KME may have more problems because such a move may impact their existing territorial franchise agreements. Even if it doesn’t, the core issue will be how can you sell franchises and a competing online product at the same time? Their argument will be that online complements the franchisees’ business but I doubt franchisees see it that way. This is a huge gamble for KME even with Editure’s technology and backing (if that’s what the Editure deal is really about).
KME is a company on life support. It seems too small to be listed and its traditional business model is under huge strain in what is a very competitive and rapidly changing market. If the AGM proposals pass, and the company can be turned around, then the share price should recover and there would also probably be more liquidity in the market for KME shares. There is also the possibility of a reverse takeover by Editure (with the company either remaining listed or becoming delisted), another option that could be advantageous for shareholders.
However, which ever of the turnaround options is chosen, the outcome is far from assured, and so my concerns are for the existing franchisees as much as the minority shareholders.
So what might I do if I were a director at KME?:
- Inform the ASX about the UK situation
- Ask CH whether the recent developments in the UK impact on their report?
- Start talking to other players in the education and tutoring market internationally
- Look at whether delisting may help cut costs and give greater flexibility to the recovery strategy?
- Consider splitting the company into separate franchise and online tutoring businesses?
Fortunately I’m neither shareholder nor Board appointment at KME. I wish them all luck!