Find people on the street and ask them: "Would you rather invest in online tertiary education businesses, or primary and high schools?"
IM would wager the answer will be online tertiary. It’s the more exciting option, with promises of great growth.
Curro was once considered in the same light, yet investors are down as much as 80% if they bought at the crazy peak in December 2015.
As investors tend to learn the hard way, investment success is a function of what you buy and what you pay for it. A juicy story at a silly price is still a poor investment. A boring story at the right price can be highly rewarding.
During 2016, Curro’s price-to-book ratio (share price divided by NAV per share) was running at more than 3.5 times. Because of the effect of debt, this doesn’t mean that every R1 invested in a school was valued at R3.50 by the market. There was R650m in net debt against an equity balance of R4.2bn on the balance sheet, so the market was putting a multiplier of three times on the cost of each school.
Considering that Curro was selling the promise of a growing middle class and the need for improved education, IM can see how the market drove up that valuation in a time of euphoria around JSE growth companies.
Fast-forward to today and Curro is trading at NAV per share.
Growth investors have walked away, realising that rolling out a school network isn’t as easy or as quick as they had hoped.
To be fair to Curro, the company achieved a revenue compound annual growth rate of 21% from 2014 to 2020, which wouldn’t be a failure unless you’ve told stories of wild potential growth.
The same euphoria found its way into Stadio, which is an aggregator of tertiary businesses rather than a builder of one. Much like Curro, Stadio traded at multiples of book value until 2019, when the share price started trading at NAV. Since then, Curro’s share price has stuck to NAV and Stadio’s has picked up to trade at a nearly 70% premium to book value.
There’s a critical difference between the two groups, relating to the underlying business model and how this rolls up into NAV. Stadio buys rather than builds and has paid significant multiples for its underlying businesses. Curro has made a few acquisitions along the way, but the bulk of the school footprint has been built, not bought.
Curro’s NAV represents the historical depreciated cost of the schools, while Stadio’s is a roll-up of what the underlying companies were acquired for.
A premium to book for Curro means the market believes the schools are worth more today than when they were built. A premium to book for Stadio means the market thinks Stadio underpaid for its acquisitions.
If you’ve ever looked at what Stadio paid for businesses such as CA Connect, you’ll know these weren’t bargains.
Curro is clearly the unloved child in this family, especially after a R1.5bn rights offer last year to pay down debt.
This hammered earnings per share and irritated the market, which has perhaps created an opportunity.
The schools are not operating anywhere near full capacity. Built schools are running at 66% and acquired schools are at 78%. When expressed based on what the built schools could eventually hold, the portfolio is running at only 56% capacity.
This is the growth story that Curro has promised for years, with the key difference now being that many of the schools are focused on filling their high schools. Logically, a school fills from the bottom up. Once running closer to full capacity, the returns improve dramatically as the benefit of operating leverage comes through.
This is similar to a hotel or airline model where all the profit is made on a handful of rooms or seats.
To catalyse the share price into action, Curro needs to significantly improve its yield on assets. In 2019, before Covid caused havoc, Curro generated earnings before interest, tax, depreciation and amortisation of R693m on an asset base of R10.5bn, a yield of 6.6%. That’s a real estate investment trust-type return, which is why Curro is trading at its book value rather than at a premium.
As an asset-light model, you would expect Stadio to be generating far more impressive yields. In line with that expectation, operating profit as a percentage of assets is about double that of Curro. But if you pay a large premium to book value, your effective return on that book should be measured relative to what you paid per share, not the NAV per share.
Curro at NAV shouldn’t be ignored and perhaps Stadio at a hefty premium to NAV isn’t the obvious choice.
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