Mindchamps PreSchool - RHB Invest 2018-04-23: Building A Brighter Future

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MINDCHAMPS PRESCHOOL LIMITED CNE.SI

Mindchamps PreSchool - Building A Brighter Future

• We initiate coverage on MindChamps with a BUY recommendation and Target Price of SGD0.95 (16% upside). It is a dominant player in Singapore’s premium range of preschools. Last year, it expanded into Australia and signed master franchisees in China, Myanmar and Vietnam. 
• On the macroeconomic front, we like the company’s strong branding position to tap into Asia’s rising middle class, and increasing willingness to spend on children’s education. 
• We expect earnings to grow at 29% CAGR over the next three years with the full-year contribution from the Australian acquisitions to be the main propeller of its earnings growth this year.

Well-entrenched in Singapore to capitalise on “kiasu” parents.

• MindChamps is a popular preschool brand in Singapore. Amongst the premium range of preschool centres, it has a dominant 38.5% share. This is built upon a strong brand name as well as a unique curriculum that inculcates passion in learning. 
• The Singapore market is characterised by its dual-income households, low birth rates, highly competitive parents, and a high willingness to spend on children’s education. As such, we believe the strong foothold in the Singapore premium preschool segment would serve as a steady cash cow for the group.

Australia to be key driver of growth this year.

• MindChamps Preschool (MindChamps) acquired four preschools in Australia in Nov 2017. These schools have existing operations and higher EBITDA margins (+1.6ppts) compared to its preschools in Singapore. 
• We estimate the full-year contribution from these schools to generate 20% growth in the group’s EBITDA in 2018.

Asia’s rising income and willingness to spend on children’s education.

• The group plans to expand abroad via the franchise model. Last year, it signed new master franchisees in China, Myanmar and Vietnam. These countries have a rising middle class with an increasing number of young professionals, who would like to provide the best education for their children.
• The increase in foreign investments in the early childhood sector has also raised parents’ interest in premium preschools. We believe MindChamps’ solid brand name in Singapore would put it in good stead to capture the growing early childhood education industry in these emerging markets.

Initiate coverage with a BUY and SGD0.95 TP.

• Our Target Price is based on a blended valuation methodology comprising of target EV/EBITDA of 19x, in line with peer average and DCF. We expect EBITDA to grow at 29% CAGR over FY17-20F on the back of the opening of new schools and expansion of the franchisee network. This is more attractive compared to its peer average of 22%.
• Key risks include changes in government policies that may affect the operating environment of private preschools, reputational risks, if any, of the schools not able to deliver consistent standards and overpaying for acquisitions.

INVESTMENT MERITS

Well-entrenched to tap on “kiasu” Singaporeans

Strong brand name backed by a unique curriculum.

• MindChamps has the largest market share amongst the premium range of preschools centres in Singapore. The popular preschool chain markets itself as having a unique curriculum that builds passion in learning in early childhood. It believes that teaching how to learn is more important than what to learn in the preschool years, as this lays a strong foundation for future academic learning in the formal schooling years. 
• We think this pedagogy would resonate well with the young millennial parents, who grew up with the unpopular rote learning education system in Singapore.

A high willingness to spend on children’s education in Singapore.

• Singapore market is characterised by its dual-income households and low birth rates. The increase in the female workforce participation and the number of dual-income households have raise the households’ ability to spend on early childhood education. Singaporeans are also highly competitive, leading to a high willingness to spend on children’s education.
• In 2017, the average full-day fees for preschool is SGD1,029; 20% more than the median fees of SGD856. We note that the gap between average and median fee has been widened. Over the last five years, the gap between the average preschool fees and median preschool fees has almost doubled to SGD173 (2012: SGD100). 
• We believe the expanding gap despite the Government’s move to open more affordable government-linked preschools depicts that many parents are willing to spend more to give  their children the best head start in life.

Australia as a key earnings driver this year

Full-year contribution from the Australia acquisitions would be a key growth driver.

• The group completed the acquisition of four preschools in Sydney, Australia for a total consideration of SGD17m in Nov 2017. We estimate this to imply a multiple of 3.8x FY17 P/EBITDA or 11.4x FY17 P/E. Based on historical numbers, the Australian company-owned-company-operated (COCO) preschools generate higher  EBITDA margins compared to MindChamps’ COCO preschools in Singapore.
• We note that the Australian preschools have been rebranded to MindChamps and managed to raise fees by around 10% at the start of the year. We estimate the full-year contribution from these schools to generate 20% growth in the group’s EBITDA in 2018.

COCO preschools forms a steady cash generative base.

• MindChamps operates two business model for its preschools – COCO and franchisee-own, franchisee-operated (FOFO). Currently, the group has seven COCO preschools in Singapore and four COCO preschools in Australia. Managed directly by the group, we note that the COCO preschools have higher enrolment rates compared to FOFO schools.
• Given that children typically stick to the same preschool – barring any unpleasant incident and MindChamps being able to collect one month’s school fees in advance – we believe the COCO operations form a steady cash generative base for the group. With the full-year contribution from its Australian acquisitions, we expect the COCO preschools to generate at least SGD6.5m of EBITDA for the group annually.

From Singapore to the world

Scalable business model.

• Moving ahead, the group plans to expand more aggressively through its franchisee network. The franchise model would allow the group to achieve a stronger footprint across the world, without bearing the operations costs and capex. The robust model also allows the group to break into new markets through suitable partners with local knowledge. 
• In the long run, the group targets to achieve a majority of its income from the franchise segment.

Pipeline of schools coming up.

• As at end-2017, the group opened 49 FOFO centres in Singapore, Australia, the Philippines and the United Arab Emirates (UAE). This includes not just preschools, but also infant care services as well as reading and writing classes. We note that there are additional 115 FOFO centres, which were granted licenses but have not been established yet. We expect these centres to be ramped up over the next five years.
• Although the FOFO centres only contribute around 40% of 2017 EBITDA, we think the growth outlook from this segment remains bright. The group has identified the US and UK as key strategic markets for expansion. As such, we believe there is still potential for the group to sign on new master franchisees in the near future in the aforementioned markets, as well as markets in the region including Malaysia, Korea, Taiwan or Japan.

Diversifying into other areas.

• MindChamps has previously diversified to provide reading and writing classes. Last year, it introduced infant care services and Actors Centre Kids. The expansion of product offerings allows the school to grow its brand name and  presence through the cross-selling of products to its existing network of students and parents. It also allows students from other preschools to sign up for individual programmes. At the moment, we have not modelled the earnings potential from these expansion programmes, as the impact to its bottomline is still negligible. However, we believe it could start to contribute, as the number of FOFO reading and writing classes increase.

Establishment of MindChamps Preschool Global Fund and China Preschool Fund.

• On 9 Apr, the group has established a USD50m global fund with Temasek Holdings Ltd’s indirect wholly owned subsidiary – Palace Investment. The global fund would invest directly or indirectly in MindChamp’s other local education fund products that have the objective of establishing and acquiring preschools and operating them under the MindChamps brand.
• MindChamps typically sets up local education funds with local partners, which would be used for fundraising purposes for the establishment or acquisition of preschools. An example is the China Preschool Fund – set up with China First Capital Group Limited (CFCG) – which targets to raise an initial tranche of USD200m.
• Notwithstanding the local education fund’s target and potential fundraising through the sale of limited partnership interests to limited partners, we estimate the USD50m worth of funds committed by Palace Investment could potentially acquire up to 10-15 preschools.

VALUATION

Initiate with BUY and Target Price SGD0.95

• Our Target Price of SGD0.95 is based on a blended valuation methodology comprising of EV/EBITDA and DCF. We use both EV/EBITDA and DCF, as the education business typically generates positive free cash flow.
• We peg MindChamps’ valuation to 19x FY18F EV/EBITDA, in line with peer average and derive at a Target Price of SGD0.95. MindChamps’ EBITDA margin is similar to its peer average at the moment. But notably, we expect MindChamps to deliver a 3-year EBITDA CAGR of 29%, higher than the peer average of 21%. We also think EBITDA margin would likely increase over the years, as MindChamps scales up through the expansion of its franchisee network.

• Coincidentally, our DCF cross-check also derives at the same Target Price of SGD0.95. Nevertheless, we caveat on the potential shortcomings of using only a DCF valuation in MindChamps’ case. 
• The group has guided to expand its preschool count mainly via the franchisee model. Its net income and capex may vary widely, depending on how much of a stake MindChamps may take in the local education funds (e.g. China Preschool fund) that it has set up with its partners. The market risk premium is likely to be very different, if the group made major investments overseas and dwarfed Singapore’s earnings contribution.

KEY RISKS

Reputational risk.

• MindChamps’ growth outlook is greatly dependent on its ability to maintain a reputable brand name through consistent high standards. As the group continues to expand the number of preschool mainly via the franchisee model, it may be increasingly difficult to monitor the standards and day-to-day operations of each school. Any quality lapses could lead to a long term negative impact of its reputation and brand name, even if it is an isolated case.

Government risk.

• Government regulations on early childhood education is subject to changes and could potentially hinder expansion plans or the price increase ability of MindChamps. Singapore’s Ministry of Education (MOE), for instance, announced in Nov 2017, that children from MOE kindergartens would be given priority to enter the primary schools that share the same compound. This could lead to a lower demand for private pre-schools.
• Nonetheless, we believe that the Government would not eradicate premium preschools. In 2012, Prime Minister Mr Lee Hsien Loong, during his National Day Rally speech, advocated for a diversity of operators, saying that different parents have different views of their children’s needs. According to the Early Childhood Development Agency (ECDA) website, there are 1,449 full-day childcare centres in Singapore, of which only 91 (6%) are private premium child care centres, defined as those that charge above SGD1,700. As such, we believe there is certainly room for premium preschools to continue having a presence in Singapore. 
• It is however, important for Mindchamps to continuously upgrade and innovate such that its fees commensurate with the quality it provides.

Increase in competition.

• While Mindchamps has the No 1 market share in Singapore premium preschool segment, the overall preschool education sector is still fragmented and competitive. Competitors may adopt similar teaching methods and curriculum to fight for market share. Competition may also arise from the MOE kindergarten.

Ability to raise funds for its China Preschool Fund.

• The China Preschool Fund, established with CFCG, aims to raise an initial tranche of USD200m through the sale of a limited partnership to Limited Partners. The fund would be used to acquire preschools in China. Inability to the raise the funds would hamper MindChamps’ growth in China. 
• At the moment, we have not factor in any income streams from the establishment of these sub- franchisees in China yet.

Overpaying for acquisitions.

• Thus far, MindChamps has acquired several preschools in Singapore and Australia. As the early childhood education sector becomes more attractive, MindChamps needs to avoid overpaying for an acquisition or acquiring poor assets, which could dilute the group’s profitability.

FINANCIAL DISCUSSION

We estimate revenue to chart a 17% CAGR over FY17-20F.

• We expect FY18F revenue to grow by 42% to SGD32.2m, mainly driven by the full-year contribution of its Australian acquisition in 2017. Since management highlighted Australia as a key strategic market for MindChamps, we expect additional preschool acquisitions this year. For the Singapore market, we assumed the group to open/acquire one preschool per year through to FY20F and raise school fees by 3% each year.
• As at 2017, Singapore market made up 96% of MindChamps’ revenue while Australia contributed only 4%. We estimate the Australian market contribution to rise to 23% in FY18F following the full-year consolidation of the acquisitions made last year.
• We also think this geographical breakdown could change significantly over the next few years, as the group opens more franchisees abroad. We highlight that there could a potential upside from our estimate, as we have not factored in the contribution from the establishments of the China franchisees since it is subjected to the number of acquisitions to be made by the China Preschool Fund.

We expect earnings to grow at a 29% CAGR over FY17-20F.

• We believe earnings could grow ahead of revenue, on the back of margin expansion. As the group expands its scale through its franchisee network over the next few years, we believe operating cost as a percentage of revenue would be reduced, leading to better margins.

Healthy balance sheet.

• Following the equity placement, Mindchamps is in a net cash position of SGD32.4m, as at 31 Dec 2017. This gives it ample debt capacity to gear up for any future acquisitions or preschool establishment.

COMPANY BACKGROUND

From Singapore to the world.

• MindChamps is the largest preschool operator amongst the Singapore premium range of preschools. Currently, the group also has operations in Australia, the UAE and the Philippines. Last year, it signed new master franchisees in China, Vietnam and Myanmar. These markets are likely to commence operations this year. As at 31 Dec 2017, the group has 10 COCO schools and 49 FOFO schools operating.
• Under the COCO model, the group generates revenue through the school fees of enrolled preschool children. In the FOFO model, the group generates one-off franchise license fees, recurring royalty fees and miscellaneous support fees for administrative and marketing purposes.

Approach at MindChamps.

• MindChamps pedagogy revolves around the concept of the three minds:
  1. The Champion Mind – celebrating the individual’s uniqueness, going beyond conventional wisdom and overcoming adversity to achieve success.
  2. The Learning Mind – “Learning How to Learn” strategies that actively assist the child to understand, store, recall and synthesise information and concepts.
  3. The Creative Mind – connecting multiple perspectives and integrating them to generate new, creative ideas.
• The group has a unique sensory, motor, intellectual, linguistic, emotional and social (SMILESTM) programme. It involves stimulation of the brain through various activities. This program is based on MindChamps’ extensive research in the field of neuroscience, psychology and drama.

Juliana Cai CFA RHB Invest | http://www.rhbinvest.com.sg/ 2018-04-23

SGX Stock Analyst Report BUY Initiate BUY 0.95 Same 0.95