This is not investment advice and is general in nature. Do your own research before taking any positions in the securities listed below
Why $KME is interesting
$KME came on my radar because a few fund managers I respect invested in the stock. Recently the stock has traded off a bit, to $0.8/$45m, so I thought I would take a look.
Unit economics
Before I launch into a deep dive into this business; a reminder of the simplistic unit economics for $KME:
Unit Economics = 80-100 students per store -> $60 per week -> $250k per store -> 650 stores ->15% profit share (10% basic, 20% gold) = FY22 Revenue $24m (largely from Aus, Aus Corporate & Europe)
Like most oversimplifications there are a few things that this does not capture:
How store capacity scales with blended online use
Corporate stores generate the full $250k (not just the 10-20% share above)
FY22 impact of TutorFly acquisition is yet to show in financials fully
The difference in run-rate sales for stores (e.g. mature centre in Aus vs. new store in Asia)
Nonetheless, this is an reasonable way to understand where $KME make money.
Possible reasons for some share price pressure
Whilst I do not know why any stock trades up/down; some reasons for pressure on the share price could be:
UK & Europe is an important geography for them and economically they are in a worse place than Australia at the current point in time
Incremental Capex costs ($2-3m p.a in FY21 & FY22) associated with the acquisition of corporate stores mean that dilutive fundraising could occur (noting they do have >$6m of net cash)
Further spend on iKip and big marketing spend dragged down FY22 P&L
Being a micro-cap, liquidity has dried up a bit in this space
Big risks with $KME
I consider the major risks with $KME to be:
Corporate should have a lower multiple than franchise income: Moving to c.20% corporate (currently, <5%) is a move away from a 'capital light' franchise model & should mildly weigh on their market multiple. For example; if you are acquiring corporate stores at 1x NPAT why should $KME be worth >20x NPAT but for a strong franchise footprint?
Agency issue for Corporate vs. Franchise: Whilst they give franchise owners the first right for new students, there are always reputational issues with franchise models. Examples include:
Buyout costs for franchisees
Any tech/products they roll out to franchises are at a reasonable cost (e.g. iKip and Gold Service)
When Corporate gets to keep profits (e.g. 100% online clients)
The diminishing value of physical store network: Overall the bricks & mortar tutoring space is highly fragmented. What's more, the online vs. in-person, services suggest the following:
Older students are more likely to get tutoring than younger students
By demographic a 2017 ABS study showed 12% of 6-11yr olds had online teaching vs. 22% for >18yr olds and this would be much higher following COVID-19
Management love dilution: Although the huge share issuances around 2010-2014 can be forgiven when this was a fairly different business, the share count has increased c.3% p.a. in the last 8 years. In addition, there have been other dilutive factors
$0.9m of share options for management (namely Storm)
$2.0m of shares for TutorFly founders
Valuing Kip McGrath:
Generally, I think the most sensible way to value $KME is to simplify its drivers. Unlike my analysis of large caps I do not think a detailed DCF is sensible given the volatility of this business
Operational cash flow will grow at c.12-15% p.a. (based solely last 5yrs average)
Run-rate capex will be c.$4m (explained below)
Dilution will be 3-4% p.a. (per historical averages)
So at 13x forward free cash flow it is not unappealing. However, I remain somewhat cautious at this price given the lack of visibility on future capex (even if my top-line numbers are conservative)
Conclusion: As evidenced by $KME's growth, there is clearly appetite for tutorial franchising and tutoring on a blended basis (mixed online/physical centre). Kip McGrath's network of centres are already being well levereaged to grow online, but COVID-19 has bought all of this forward. Nonetheless, I would like to see one of the following before acquiring shares:
Some capital constraint (e.g. reduce marketing spend, greater TutorFly revenue or fewer dilutive director stock options)
Entry price closer to 10x FCFF
Results from the capex for corporate stores
Overall I think this is certainly a company with a lot of potential and I will watch it closely but I am not loading up at $45m/$0.8 just yet
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