Tutoring is a massive international business with few international brands. Kumon is one of those brands; arguably Kip McGrath, the listed Australian tutoring franchise company, is another. The question is, with its shares at rock bottom, a disastrous foray into higher education, and the tutoring industry in transformation, will Kip McGrath still be around in a year?
It’s a tough question and one that is attracting interest from various parties. Kip McGrath (KME on the ASX) is essentially a tutoring franchise business. They sell franchises to ex-teachers and take an annual fee. The problem is that their fixed fee franchise model is out of date and they are facing a very different competitive landscape online, both in their core markets of Australia and the UK but also in emerging markets like South Africa and the USA. KME is trying to address these challenges by attempting to shift franchisees onto a full service model where they pay a 20% franchise fee on revenues. At the same time KME is building an online offering, although it’s unclear how franchisees fit into this, for example is the online service to be sold directly by KME, via franchisees or as an add-on for existing clients? The question is whether the company survive financially to implement these changes.
It doesn’t take an MBA to see that KME are strapped for cash flow to re-engineer their business. In late 2010 KME did a Aus$9m convertible note deal with San Francisco-based La Jolla Cove Investors. The first tranche of convertible notes gave KME a small amount of money but the deal went sour with shareholders who rejecting extending the arrangement at an EGM in July. KME even wrote to shareholders saying, ‘..the LJC agreement … did not live up to expectations. LJC’s early conversion to shares and their subsequent sale of significant numbers had a negative impact on the company’s share price.’ While this relationship may be over KME still owe LJC Aus$150k at an interest rate of 4.75% which at the current share price of less than 3 cents is a marketable parcel. It gets worse for KME who have admitted they are in breech of their banking covenant with National Australia Bank (NAB). KME also had to tell shareholders that, ‘NAB advise the company that while it had not waived its right to take action at a later date in respect of the company being in breech of the interest covenant on the funding facility, it will not be taking action at this point in time.’
KME also managed to make a Aus$3.47m loss in 2011 on a turnover of just Aus$6.43m (2010 Aus$8.09m). This was largely the result of a disastrous extension into the higher education market where KME purchased a company offering degrees to foreign students. With education being the third largest export earner you’d think this was a smart move but the day before Christmas, the Queensland government cancelled the accreditation of the Kip McGrath Institute of Business Australia.
The last part of this sorry saga is KME’s ‘strategic alliance’ with Editure, actually an investment via a company controlled by a group of major shareholders at Editure, who have agreed to provide Aus$500K via a ‘Subscription Agreement’. Aus$210k of this is for 3.5m shares (at 6 cents – the current share price is below 3 cents) plus an unsecured loan of Aus$290k, with the possibility of another Aus$250k loan. The deal must be approved by an EGM in September. Even is passed, KME still looks like a patient on life support. The upside of this arrangement is that Editure is a much larger, well run international education company. I think this strategic alliance may well evolve into a reverse takeovera/cquisition, a smart move as buying KME would move Editure into the B2C market in exactly the same way as did Pearson’s purchase of TutorVista.
I wouldn’t be surprised if KME ends up delisted from the ASX (how you can have a listed company with such a tiny turnover is another question). This may be possible with the support of the McGrath family as they and related entities control about 37% of the shares, or an investor could make a bid but given the illiquid market in KME shares this would have to be at a significant premium.
Even KME’s auditor (Forsythes) seem to think bankruptcy a better than even bet. In their end of year accounts (to 30 June 2011) they wrote, ‘There is significant uncertainty whether the company will be able to continue as a going concern and therefore whether it will be able to pay its debts as and when they fall due and whether it will realise its assets and extinguish its liabilities in the normal course of business and at the amounts stated in the financial report.’
Kip McGrath and the Australian Stock Exchange may be 12,000 miles from London but the repercussions will be felt here as much as Australia, given that in 2011 the UK was KME’s largest market and they are still actively selling franchises both in England and Ireland.