BBY Limited ABN 80 006 707 777

BBY Company Research 4 December 2013

Affinity Education Group Limited
AFJ TARGET PRICE A$1.50 BUY 1.0X
Affinity Education has been established
to be a leading provider in the Australian
market of high quality education and care
to children aged six weeks to 12 years.
Moira Daw
+61 2 9226 0164
mxd@bby.com.au
Swapan Pandya, CFA
+61 2 9226 0073
sxp@bby.com.au
David Fabris
+61 2 9226 0262
daf@bby.com.au
This research is current at the date of publishing for any updates to; or the currency of this document, speak to your advisor. BBY does and seeks to do business
with companies covered in its research. As a result, Investors should consider this report as only a single factor in making their investment decision. For meanings
of ratings and other important disclosures, please refer to the disclosure section at the end of this document.
New ASX Listing at A$1 Trying to be another G8 Education (GEM)
Affinity Childcare Limited (AFJ) is a start up. A$77M is
being raised (77M shares at A$1.00/sh) to acquire 57
childcare centres and management rights to 11 centres
located in Queensland, NSW, Victoria and Northern
Territory. As part of the acquisition of one of the larger
groups of childcare centres AFJ is acquiring two
freehold properties which will be disposed of after
listing. The management business is being acquired
from interests related to the Chief Operations Officer Ms
Gabriel Giufre. This business (Eternal Echoes) was
established in April 2005. We initiate coverage with a
A$1.50/sh target price and a BUY recommendation. Our
12 month target price is equivalent to a FY14 PE of 15x
and EV/EBIT multiple of 11.9x. This places AFJ at ~45%
discount to GEM.
The key planks of the business strategy are:

Professional management to lift the performance of the
centres

Retention of existing branding and trading names

Improved opportunities for staff leading to higher staff
retention rates

High educational standards to improve the quality of the
product offered and maintain high levels of occupancy

Operating the centres in seven regional clusters which will
allow additional centres to be added with minimal change
in overheads

To acquire operating centres without freehold property

Not to undertake green-field developments

Entering into long term lease arrangements for a
minimum of 5 years

Paying acquisition multiples for groups of centres around
EV/EBIT multiples of 4x to 4.5x

Continuing to manage the 11 managed centres for a fee,
with the possibility of acquiring the centres at a later date
if the acquisition multiples stack up

An acquisition strategy based on price, number of places,
quality, occupancy and geographic fit
The key immediate challenges for AFJ will be:

Business set up because this is essentially a green-fields
operation (albeit that the AFJ team has operations
experience).

Integration of 68 centres into the corporate framework

Implementation of new financial reporting software


Company Data

Number of shares 89.5M
Market capitalisation M
Free Float (%) 85
12 month high/low -
Average monthly turnover -
GICS Industry Group

The AFJ business and G8 Education (GEM) business have
very similar business models but GEM has a track record of
acquiring and integrating well and driving growth of 25-30%
pa. AFJ is a green-field operation, albeit with a well
credentialed board and management team. We think that the
unconsolidated market will continue to throw up well priced
acquisition opportunities and therefore there should be no
reason for AFJ to pay more than ~4x EBIT which is the
multiple paid by GEM and the multiple paid by AFJ for the
groups of centres acquired (single centres have been
acquired at higher multiples).
Chart 1. Comparison AFJ and GEM

Source: Affinity Prospectus, BBY Estimates for GEM

AFJ GEM
FY14 PE [x] 10.75 20.00
FY14 EV/EBITDA [x] 6.9 13.5
FY14 EV/EBIT [x] 7.3 14.2
Childcare centres
Owned - Australia [#] 57 202
Owned - Singapore [#] 18
Managed [#] 11 48
EBIT margin [%] 14.8% 18.0%
Market Cap [$M] 89.5 941.0
Track record Greenfield 3 years



Affinity Education Group Limited BBY Research
BBY Limited 28 November 2013 2
Financial Summary
Affinity Education Group Limited Share Price (A$) $0.00 Mkt Cap (A$M)

Year ending December 31 A A F F F



Profit & Loss (A$M) 2012A 2013F 2014F 2015F
Total Revenue 0.0 0.0 82.5 83.7
Growth (%) nm 1.6
EBITDA 0.0 0.0 14.0 14.8
Growth (%) nm 5.8
Dep'n and amort'n 0.0 0.0 (1.6) (1.6)
EBIT 0.0 (2.1) 12.5 13.3
Net interest expense 0.0 0.0 0.3 0.9
PBT 0.0 (2.1) 12.8 14.2
Growth (%) nm 11.4
Tax 0.0 0.6 (3.8) (4.3)
NPAT Underlying attrib. 0.0 (1.5) 8.9 9.9
Growth (%) nm 11.4
NPAT Reported 0.0 (1.5) 8.9 9.9
Normalised NPAT 0.0 (1.5) 8.9 9.9

Ord Shares 0.0 89.5 89.5 89.5
Options 0.0 0.0 0.0 0.0
Fully Diluted 0.0 89.5 89.5 89.5
FD Wgted Av Shares 0.0 89.5 89.5 89.5

Cashflow (A$M) 2012A 2013F 2014F 2015F
Customer receipts 0.0 2.0 82.5 83.7
Supplier Payments 0.0 (4.2) (68.4) (68.9)
Net interest paid 0.0 0.0 0.3 0.9
Taxes Paid 0.0 0.0 (3.8) (4.3)
Net operating cash flow 0.0 (1.9) 13.9 11.6
Capex 0.0 0.0 (1.6) (1.6)
Net investing cash flow 0.0 0.0 (1.6) (1.6)
Dividends paid 0.0 0.0 0.0 (2.5)
Net financing cash flow 0.0 0.0 0.0 7.5
Net Change in cash 0.0 (1.9) 12.4 17.5
Net cash at end of period 0.0 (1.9) 10.5 28.0
Free cash flow 0.0 (1.9) 12.4 10.0
Change in working capital 0.0 0.3 (8.9) (17.5)

Balance sheet (A$M) 2012A 2013F 2014F 2015F
Cash 0.0 1.4 13.8 31.3
Receivables 0.0 0.0 5.5 5.6
Inventories 0.0 0.0 0.0 0.0
Current assets 0.0 1.6 19.5 37.1
Tangible Assets 0.0 3.1 3.1 3.1
Investments 0.0 0.0 0.0 0.0
Goodwill 0.0 61.2 61.2 61.2
Total assets 0.0 68.2 86.1 103.7
Payables 0.0 0.2 9.2 9.3
Current Term debt 0.0 0.3 0.3 0.3
Long term debt 0.0 0.0 0.0 10.0
Total liabilities 0.0 1.9 10.9 21.0

Total Shareholder Equity 0.0 66.3 75.2 82.7

Investment summary 2012A 2013F 2014F 2015F
NPAT reported 0.0 (1.5) 8.9 9.9
NPAT Underlying 0.0 (1.5) 8.9 9.9
EPS Reported (1.7) 10.0 11.1
EPS Underlying (1.7) 10.0 11.1
EPS Growth (%) nm 11.4
P/E Underlying (x) 0.0 0.0 0.0

Dividend (/sh) 0.0 0.0 0.0 6.7
Payout Ratio (%) 0.0 0.0 60.0
Gross Yield (%)
Net Yield (%)
Franking (%) 100.0 100.0 100.0 100.0

Key Ratios 2012A 2013F 2014F 2015F
Profitability (%)
EBITDA 0.0 (2.1) 14.0 14.8
EBITDA/Rev (%) na (104.6) 17.0 17.7
EBIT 0.0 (2.1) 12.5 13.3
EBIT/Rev (%) na (104.6) 15.1 15.9
NPAT 0.0 (1.5) 8.9 9.9
NPAT/Rev (%) na (73.2) 10.8 11.9

ROE (%) na (4.5) 12.6 12.6
ROA (%) na (6.2) 16.2 14.0
ROIC (%) na (4.6) 13.7 15.1

Financial Strength
Debt to equity (%) na 0.4 0.4 12.5
Net debt ($M) 0.0 (1.1) (13.5) (21.0)
Net debt to equity (%) na (1.6) (17.9) (25.4)
Net Debt to EBITDA (%) na 0.5 (1.0) (1.4)
Interest Cover EBIT (x) na na 42.5 14.2
Current Ratio (x) na 0.8 1.8 3.4
Quick Ratio (x) na 0.8 1.8 3.4

Valuation
Operating cash flow 0.0 (1.9) 13.9 11.6
CFPS ( - FD) (2.1) 15.6 12.9
Price/CF 0.0 0.0 0.0
BV per share ($) 0.7 0.8 0.9
Price/Book Value (x) 0.0 0.0 0.0
NTA ($) 0.0 5.0 14.0 21.4
NTA per share ($) 0.1 0.2 0.2
Price/NTA (x) 0.0 0.0 0.0

EV/Sales (x)
EV/EBITDA (x)
EV/EBIT (x)



Source: BBY, Company Reports. BBY contributes all company estimates to Bloomberg, Thomson Reuters, FactSet and Capital IQ.
Note: Numbers displayed are a sub-set
The ESG (Environmental, Social, Governance) score is a measure of the sustainability and ethical impact of an investment in this company or product. ESG scores
range from 0.1 (min) to 100 (max). ESG scores are provided to BBY by Bloomberg and are only available for those companies that disclose ESG data to
Bloomberg.
Affinity Education Group Limited BBY Research
BBY Limited 28 November 2013 3

Investment Summary

Outlook

Our thesis is that corporatised childcare offers value creation opportunities through consolidation and
by extracting cost efficiencies. There is a risk that the Federal Government will mandate more
operational changes that add to costs. There is a Productivity Commission review in process at the
moment which is to address how to make child care more flexible, affordable and accessible.
Demand for childcare is supported by demographics and the likelihood of continued or even increased
government support. Opportunities to improve profitability abound because the industry is still largely
an inefficient cottage industry. Earnings improvement is likely to come from scale, staff rostering and
management information systems.

AFJ is a start-up with the proceeds of the IPO used to acquire 68 childcare centres (including 11
managed centres). There are risks with a green-fields operation and much will depend on the skills of
the management team. It is impossible to be definitive on a team that has never operated a business
together previously and in our view, this factor alone means that AFJ must trade at a very healthy
discount to its listed peer G8 Education (GEM). Some may comment that GEM was a start-up but the
GEM management team was comprised of seasoned acquirers who had previously built the S8
business from a fledgling to a ~A$700M market cap company. The AFJ management team have not
worked together previously and the CEO and CFO have had no previous experience in childcare.

Offsetting this key concern is that the childcare business is not a difficult business to run. We think
that a worst case situation is that initially there could be some degradation of the margin or a slippage
in occupancy rates. This expectation has been built into the float pricing.


Valuation and target price

In determining the valuation and target price for AFJ we have taken the following into consideration:


Earnings based multiples of comparative companies

DCF of business without further acquisitions

DCF of business with acquisitions (the assumption used is 20 centres with an average of 75
places purchased each year for A$1.3M per centre)

Dividend yield

Start up nature of the business with an untried management team
Our base case DCF without further acquisitions is A$1.51/sh.

Affinity Education Group Limited BBY Research
BBY Limited 28 November 2013 4


Table 1. DCF valuation

DCF 2013 A 2014 F 2015 F 2016 F 2017 F 2018 F 2019 F 2020 F 2021 F 2022 F 2023 F
31-Dec-12 31-Dec-13 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18 31-Dec-19 31-Dec-20 31-Dec-21 31-Dec-22 31-Dec-23
0 1 2 3 4 5 6 7 8 9 10
EBIT (Total Group Incl. Assoc) -2.1 12.5 13.3 14.4 15.0 15.6 16.2 16.9 17.5 18.4 19.3
TAX -0.6 3.7 4.0 4.3 4.5 4.7 4.9 5.1 5.3 5.5 5.8
DEPRECIATION 0.0 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6
AMORTISATION 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
MAINTAINANCE CAPEX 0.0 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6
EXPANSIONARY CAPEX 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
INCREMENTAL WORKING CAPITAL -0.2 -3.4 -0.1 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2
ACQUISITIONS 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
FREE CASHFLOW -1.3 12.2 9.3 10.3 10.6 11.1 11.5 12.0 12.5 13.1 13.7
GROWTH -1058.3% -23.2% 10.3% 3.1% 4.0% 4.0% 4.0% 4.0% 5.0% 4.9%
EBITA -2.1 12.5 13.3 14.4 15.0 15.6 16.2 16.9 17.5 18.4 19.3
2014 F 2015 F 2016 F 2017 F 2018 F 2019 F 2020 F 2021 F 2022 F 2023 F
FREE CASHFLOW 12.2 9.3 10.3 10.6 11.1 11.5 12.0 12.5 13.1 13.7
DISCOUNT 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352
DISCOUNTED VALUE 11.0 7.6 7.5 7.0 6.6 6.2 5.8 5.4 5.1 4.8
SUM OF P.V 66.9
TERMINAL VALUE AT FY2023 F 155.6
DISCOUNT FACTOR 0.352
PV OF TERMINAL VALUE 54.8
PV OF ENTERPRISE 121.7
DEBT -13.5
NET VALUE FOR SHAREHOLDER 135.2
NUMBER OF SHARES ON ISSUE 89.5
NPV 1.51 $

Source: BBY Estimates

If we dial up acquisitions to 20 centres per annum (75 places at a cost per centre of A$1.3M) our DCF
increases from A$1.51/sh to A$2.16/sh.


Table 2. Comparison with GEM

Mkt Cap FY14 FY15 FY14 FY15 FY14 FY15
(A$M) PE PE EV/EBITDA EV/EBITDA EV/EBIT EV/EBIT
GEM 991 27.4 21.0 19.3 13.5 20.6 14.2
AFJ (float) 89.5 10.8 9.0 7.3 6.9 8.3 7.8
AFJ (target price) 134.25 15.0 13.5 10.5 10.0 11.9 11.1
AFJ disc to GEM 134.25 (12.4) (7.5) (8.8) (3.5) (8.7) (3.1)


Source: Factset, BBY Estimates

In our view, the start up nature of the business means that until there are runs on the board the stock
should trade at a significant discount to its DCF. We acknowledge that the gap between the earnings
multiples of AFJ and GEM should also see AFJ trade at significantly lower multiples.

We have set out 12 month target price at A$1.50/sh at 50% premium to the listing price and a 45%
discount to GEMs FY14 PE multiple and a 46% discount to GEMs FY14 EV/EBIT multiple. In our
view the discount to GEMs multiples is warranted because:


GEM has a track record of above market earnings

GEMs forecast (sanctioned by the company in a recent presentation) EPS growth for FY 14 is
~30%

GEM has a track record of rewarding shareholders with quarterly dividends

GEM has demonstrated that it is able to lift occupancy (p 230nps from 1H12 to 1H13), improve
margins (up 200bps from 1H12 to 1H13) and reduce staff turnover (from 14.9% to 11.6%)

GEM has proof of its acquisition discipline because it has acquired 62 centres at EV/EBIT
multiples of 4x
Affinity Education Group Limited BBY Research
BBY Limited 28 November 2013 5

AFJ plans to operate a business along the same lines as GEMs business but it is unable to point
to a track record.

When Shine Corporate (SHJ) floated on 15 May 2013 it was compared with listed peer Slater and
Gordon (SGH) which had been operating in the public domain for six years. SHJs float multiple was
20% (1.6x PE) less than SGH but it closed the first day at a 51.5% premium to the listing price and
today it is trading at a 76% premium to the listing price and a 18.8% PE discount to SGH. In our view
there is a significant difference between the SHJ listing and the SGH listing. The differences are:


SHJ was an operating business with an established management team and a CEO who had been
with the business for >25 years. AFJ is a start-up with a new CEO and CFO. The COO has been
in the childcare industry for almost a decade albeit in much smaller organisations.

SHJ floated on 15 May 2013 when the All Ordinaries was 5144 and the market PE was ~14x.
Today the All Ordinaries is 5346 and the market is pricing FY14 earnings at ~16x.

Risks

Positives

The AFJ business appears to us to be a G8 Education (GEM) look-alike business in terms of
objectives and operating structure. In our view the positives are:


Industry dynamics. The childcare centre in Australia is fragmented with some 6,000 childcare
centres. AFJ estimates that there are 4,000 childcare centres in its addressable market.

Centres acquired. The centres to be acquired with the float proceeds appear to be well located
and of an appropriate size (~75 places). Occupancy levels are high (~84%) which implies that the
centres are well regarded, however upside from improved occupancy is limited.

Acquisitions in FY14. We think that AFJ will make acquisitions once integration is complete and
the groups operating platform is stable ready for further growth, noting that the prospectus does
not assume any acquisitions in 2014.

Will not own land. AFJ intends to dispose of two freehold development sites acquired as part of
a group of childcare acquisitions.

Regular price increases. AFJ assumes that daily rates will increase by A$3-5 on 1 July 2014.
We assume that AFJ like GEM will introduce regular small fee increases. In the mums and dads
owned centres it appears that fee increases have not been a regular part of the business which
often meant fee increases when they did come were relatively material. This proved to be an area
of concern for parents.

Low capex business. The only capital expenditure required in a childcare centre is minor
refurbishment comprising paintwork, furniture, fittings and soft furnishings. This should be
approximately equal to depreciation.

Regional clusters. The establishment of a regional framework should allow AFJ to fold more
centres into the structure with minimal additional overheads.

Debt. The proforma balance sheet estimates that AFJ will have no debt. It has access to a
A$20M facility to fund further acquisitions plus banking facilities to fund working capital and capital
expenditure of A$15M (reducing to A$9M after receipt of accrued benefits and rebates). The
coverage ratios are EBIT+ rent/Interest + rent of no greater than 1.75x . Debt to Debt + equity of
0.35x and average occupancy for the last 12 months of greater than 75%.

Board. The board is well credentialed headed by ex Mayne Group CEO Stuart James. Jeff
Forbes (ex CFO of Cardno) brings significant acquisition expertise and financial discipline to the
Board.

Management. The management team is well qualified with both childcare and financial
experience.

Free float Post the capital raise existing shareholders will own 15.7% of AFJ which will be
escrowed for 2 years





Affinity Education Group Limited BBY Research
BBY Limited 28 November 2013 6
Negatives

Green-field operation. AFJ was incorporated in May 2013 and although the COO Ms Gabriel
Giufre owned and operated one centre and managed 11 centres and has been in the business
since 2004 the AFJ management team is a new team. CEO Justin Laboo has a background in
property management with a focus on the other end of the life cycle aged care. The childcare
business is not operationally complex and he should, in our view, be capable of making the
transition.

Integration risk. The new management team needs to set up a new organisational structure,
complete the acquisition process, deal with staffing and operational issues and bed the
acquisitions down. This needs to happen within a 12 month period in which occupancy must be
maintained and operating performance improved in order to meet Prospectus Forecasts. There is
always a risk that something in the integration process will fall between the cracks.

New accounting and management systems to be implemented. Timely, relevant and accurate
information is a vital ingredient for good management. AFJ needs to implement new accounting
and management software whilst dealing with integration and operational issues. Again it will be
relatively easy to see how a lack of information could cause issues.

Paying too much. Not paying too much for childcare acquisitions is the first step towards driving
shareholder value. It appears that the acquisition multiples paid by AFJ for its groups of centres
have been reasonable. Maintaining this acquisition discipline will be a vital ingredient for success.

Reputation risk. Successful childcare operations are very dependent on maintaining a quality
product and not encountering any issues which could damage the brand. This risk has been
partially negated by AFJ because it does not intend to re-brand and will maintain the existing
names of the childcare centres.

Occupancy levels are already high so the opportunities for upside from increased occupancy is
relatively low. Increased occupancy has the greatest impact on NPAT. Sensitivity analysis shows
that NPAT for FY14 would increase by 9% (A$0.7M) if occupancy levels increased by 1%.

No dividend yield in FY14. The dividend payout policy has been set as 60% of NPAT. No
dividend payment has been forecast for FY14. If a dividend is paid in the first year it is unlikely to
be franked.

Goodwill. Acquisition of childcare centres will mean recording goodwill on the balance sheet.
This will be subject to annual impairment testing.

Related party transactions. Chairman Stuart James has been rewarded for advancing AFJ
A$0.5M on 13 September 2013 which will be repaid and he will be issued with 500,000 shares and
be able to subscribe for 1.5M shares at A$0.95/sh. Gabriel Giufre was issued with 1,881,450
shares before the issue of the Prospectus and vended the Boyne Island child care centre to AFJ
for A$1.575M (for 400,000 shares and the balance in cash). Ms Giufres management business
was vended to AFJ for A$1M payable in shares. The management business is forecast to
generate A$0.6M in gross fees in FY14. Ms Giufre or her husband Chris Giufre has indirect
interests in 9 of the managed centres. These management centres have been ear-marked as
possible future acquisitions, subject to agreement between the parties. CEO Justin Laboo was
issued with 250,000 shares prior to the Prospectus being issued.

WHAT COULD GO WRONG?

Management

The management team is untried. However, key staff are well credentialed and although the CEO
and CFO do not have direct childcare experience we have no reason to believe that they will not be
able to make the transition:


CEO Justin Laboo. Justin spent from 2005 to 2012 with FKP property Group starting as head of
corporate finance with responsibility for mergers and acquisitions. From November 2006 to 2012
he headed the retirement village segment, part of which was housed in the listed property trust
Aveo Healthcare (previously Forest Place Group Ltd). Aveo has 76 retirement villages, 12,000
residents, 9,791 retirement units and a property development business, as well as investments in
the United States and China.

CFO John Bairstow. John has a background in accounting and finance most recently with the
Transaction Value Advisory Group at PwC. He has held senior positions with Stanwell
Corporation Limited and GdF Suez. John has had no direct experience in the childcare sector but
Affinity Education Group Limited BBY Research
BBY Limited 28 November 2013 7
has experience across a range of industries.

COO Gabriel Giufre. Gabriel has had 14 years experience in the child care sector and has been
responsible for the operation of Eternal Echoes since 2005.

National Operations Manager Fiona Alston. Fiona has 22 years experience in the childcare
sector and holds a degree in early childhood studies.

Management information systems

Financial software. The implementation of SAP is a key part of the integration strategy. This is a
green-fields installation which is some ways makes for more trouble-free SAP installation. There
are no systems and processes to be adapted. The systems and processes will be developed as
an integral part of the SAP system. PriceWaterhouseCoopers has been engaged to project
manage the implementation of SAP and to advise on the integration plan before and after the IPO.
The end objective is to produce a weekly flash report which will be rolled up from individual centre
to cluster to group. The integration and system implementation is expected to be completed within
the first three months of operations.

Insufficient, incomplete or untimely information. Without timely accurate information it will be
difficult for management to take action to avert problems as they arise. The danger is that revenue
could be lost (occupancy less than expected) or costs could blow out (in particular labour costs).
The EBITDA margin in the FY14 forecasts of 14.8% is below the 18% achieved by GEM and
integration or information systems issues could carve a few percentage points from the EBITDA
margin.

Implementation issues

Retention of key staff. It is important that AFJ maintain its key staff at centre level. These front
facing staff members are the key to success. Therefore maintaining high staff morale through the
integration process will be paramount to the success of the business.

Maintaining occupancy. At centre level there should be very few changes, therefore in our view,
it should be possible for AFJ to maintain occupancy.
THINGS THAT THE MANAGEMENT TEAM HAVE NOT DONE BEFORE


The following things have not been done by the management team previously:


Business integration. Integrated a number of childcare facilities into a centrally managed group
(Justin Laboo in his previous position with FKP has had experience in integrating aged care
facilities) and the establishment of a regional organisational structure.

Management information systems. Implemented a new management information system

Financial markets experience. Been responsible for reporting to financial markets

Acquisitions. Acquired child care centres (Justin Laboo was responsible for the acquisition of
aged care centres and retirement villages when he was with FKP)

Roles in listed company. This is Justin Laboos second role as a CEO of a listed public
company (previously as CEO to Forest Place Group) and it is a first for CFO John Bairstow.

Managed 68 centres. COO Gabriel Giufre was previously the CEO of Eternal Echoes and as
such was responsible for the management of 11 childcare centres. Her responsibilities have been
scaled up to include the 57 owned centres plus further centres as acquired.

UPSIDE IS ALL ABOUT ACQUISITIONS

AFJ has an acquisition facility of A$20M provided by Commonwealth Bank of Australia (CBA) for a
period of three years. This facility should be sufficient to acquire ~15 childcare centres with an
average of 75 places.

The Prospectus states that no acquisitions have been forecast for FY14 but we understand from
management that as soon as it is satisfied that the integration is bedded down, the systems are
working and that cash flows and earnings are stabilized it will begin acquiring centres. We understand
that AFJ has engaged agents on an exclusive basis to source childcare acquisition opportunities. We
also understand that these agencies could have approximately A$100M of childcare centre acquisition
opportunities on the books at reasonable acquisition multiples (ie ~4x EBIT).

Affinity Education Group Limited BBY Research
BBY Limited 28 November 2013 8

REWARD FOR PROMOTERS/MANAGEMENT

Free shares have been issued to the Chairman and senior management. Details are as follows:

Table 3. Free shares
Management/Board Position Free shares Comments Total Shares
Stuart James Chairman 500,000 For seed capital shares 2,556,300
Stuart James Chairman 75,000 Discount
Justin Laboo CEO 250,000 250,000
John Bairstow CFO 125,000 125,000
Gabriel Giufre COO/Vendor 1,881,450 Eternal Echoes 3,281,450
Jeff Forbes Director - 20,000
Stephanie Daveson Director - 30,000
Total shares 2,831,450 6,262,750
% of shares on issue 3.2%
Source: Company data


BBY FORECASTS

Our forecasts include acquiring 15 childcare centres for ~A$20M each year. Debt to equity plus debt
ratio used is in our forecasts is between 30-40%.


THE NAME OF THE GAME

There are two aspects to The Game

Buying at the right price; and

Improving operations and increasing margins.

All acquisitions to date have been made at EBIT multiples of ~4X. We understand from discussions
with management that pricing discipline will be maintained.


The name of the game or the winning formula for childcare operations is:

Maximise occupancy;

Minimise staff turnover at director and supervisor levels;

Match staffing with occupancy levels on an intra-day basis;

Keep quality high;

Emphasise education rather than baby sitting; and

Find a way to accommodate staff cost increases.

Increases in occupancy levels flow to the bottom line because most of the costs are fixed.
Management and supervisory staff costs, rent and property related costs and head office costs are
fixed. The only variable costs are consumables and, incremental direct staff costs.
For example, in the Australian child care portfolio a centre with an occupancy rate of say 75% and an
EBIT margin of 18% could become a 28% EBIT margin business if occupancy levels reached 90%.
There are instances of well located child care centres where occupancy levels are 90%+ and EBIT
margins are close to 30%.


Staff turnover is an issue for child care centres. GEM has a high retention rate at the director and
supervisor level but suffers along with the rest of the industry with high staff churn at lower levels.
Industry sources tell us that as long as there is stability at the top and the parents are kept informed of
staff changes, the oh, Jacks favourite carer has gone he was so happy with her syndrome is not
such an issue. We are not so sure on this one, but staff turnover is an issue for all childcare centres,
so it is unlikely that AFJ will be in a worse position than its competitors.


Micro-managing the rostering of staff is a relatively easy way to lift margins. The industry norm
labour/revenue is 65% in Australia for for-profit operations. Experience to date shows that efficient
rostering can add 5% to EBIT margins. This is one of the fruits of professional management v cottage
industry management.

Affinity Education Group Limited BBY Research
BBY Limited 28 November 2013 9

Childcare is all about keeping the payers happy. The parents must be satisfied that the quality is high
and that the standard is consistently maintained. Childcare is not like turning out a widget. The
product here is the most precious of all possessions - a young person in their formative years. The
recent introduction by the Federal Government of the National Quality Framework was based on the
premise that the first five years of a childs life shapes their future their health, learning and social
development. Quality of the childcare product is paramount and will make or break a childcare
centre.


LABOUR REQUIREMENTS IN AUSTRALIA
In 2010 the Federal Government introduced the National Quality Framework and the new compulsory
National Quality Standard as a way of improving the quality of early childhood education and care
throughout Australia. The standard covers staff/child ratios and educational standards and the
changes are phased in over a period from 1 July 2010 until 2020.
The framework also includes a new national rating system for assessing childcare centres.


Table 4. National quality standard staff/child ratios

Long day Care and Preschool
Age Group Staff ratio Timeframe
0-24 months 1 to 4 1-Jan-12
25-35 months 1 to 5 1-Jan-16
36 months - school 1 to 11 1-Jan-16
Mixed Proportional 1-Jan-12
Family Day Care
Mixed Groups 1 to 7 1-Jan-14
Outside School Hrs No change No change

Source: National Quality Framework for early Childhood Education and Care


Table 5. National quality standard educational requirements

Long care day centre/preschool

Size Requirement Timing Start Date
> 25 children 1 early childhood teacher All day 1-Jan-14
<25 children 1 early childhood teacher Some of the day 1-Jan-14
Each Centre 50% diploma 1-Jan-14
Each Centre 50% Cert III 1-Jan-14
> 80 Children 2 early childhood teacher All day 1-Jan-20
> 60 children 2 early childhood teacher Half day 1-Jan-20
Family daycare
Position Requirement Start date
Co-ordinator Diploma level 1-Jan-14
Day Carers Certificate III 1-Jan-14

Source: National Quality Framework for early Childhood Education and Care



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CAN THE CHILDCARE INDUSTRY MAKE AN ACCEPTABLE RETURN

Can you make a return from childcare? Should childcare be a not for profit enterprise?

The Senate Select Committee Enquiry into Education, Employment and Workplace Relations
References Committee Provision of childcare (November 2009) (post the demise of ABC Learning)
stated that the matter of who runs childcare centres, provided there is real diversity and genuine
choice, is less important than the dedication, commitment and quality of care demonstrated by those
who provide it..childcare centres are not just a business they must be in the service of the
common good.


The ability to make an acceptable return is obviously all about the price paid and the efficiency of the
operations. Small operators are facing a double whammy the multiples paid have halved and banks
will now only lend 50% of value compared with 65% previously. This bank induced distress means
that the small operators need cash and although reluctant to accept the low multiples on offer from
AFJ (and GEM) there are few viable alternatives.


AUSTRALIAN CHILDCARE INDUSTRY

IBISWorld estimates that CAGR over period to 2015 will be stronger than GDP at 5%.
Larger operators are expected to benefit from childcare moving from child minding to education.
Competition for staff is likely to favour the larger operators who are able to offer more of a career path
than those at the smaller end of the market.


Workplace participation by mothers continues to grow due in part to cost of living pressures and the
opportunities presented by tight labour markets. This is likely to continue to fuel demand for childcare
places.


The Australian Government pays a childcare benefit and a childcare rebate. The childcare benefit is
means tested. The childcare rebate of 50% of childcare payments up to a maximum of $7,500 is not
means tested. Federal Government budgetary pressures may see the childcare rebate means tested.
In our view this would not have a material impact on the demand for childcare places.


One of the key planks of the Federal Governments election policy was the Paid Parental Leave
Scheme where parents are to be paid for six months at their rate of pay capped at the equivalent of a
A$150,000pa salary. In our view, this could be positive for childcare centres because:


It could encourage greater female workplace participation

It removes from childcare centres demand for the least profitable element of childcare operations
(ie babies under six months old)
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PROSPECTUS FORECASTS

The Prospectus Forecasts do not include any acquisitions. In our view, it would be wise for AFJ to
hold off making acquisitions until it is happy that is management team and its management
information systems are operating.

The Prospectus forecasts include a A$3-A$5 per week fee increase. Regular fee increases (once or
twice a year) are to be put in place.

Table 6. AFJ Prospectus forecasts Income Statement
Period 6 mths to 6 mths to 12 mths
31-Dec-12 Jun-14 Dec-14 Dec-14
Revenue 2.0 37.8 43.6 81.4
Employee costs 2.7 23.4 24.7 48.1
Bui lding occupancy costs 0.5 5.6 5.7 11.3
Direct expenses 0.3 3.8 4.0 7.8
Acquisition costs 6.9 -
Integration expenses 0.5 0.4 0.4
Other expenses 0.6 1.0 0.6 1.7
Total Expenses 11.6 34.3 35.0 69.3
EBITDA (9.6) 3.5 8.6 12.1
Depreciation 0.1 0.4 0.4 0.8
EBIT (9.7) 3.1 8.2 11.3
Net finance expense 0.1 0.1 0.0 0.2
Profit before tax (9.8) 2.9 8.2 11.1
Income tax expense (0.8) 0.9 2.5 3.3
Statutory (loss)/Profit (9.0) 2.0 5.7 7.8
Adjusted EBITDA
EBITDA 3.5 8.6 12.1
Centre refresh 0.4 0.4
Intetration expenses 0.4 0.4
Pro Forma EBITDA 4.3 8.6 12.9
EBITDA % 11.3% 19.8% 15.8%
EBIT % 10.2% 18.8% 14.8%
Source: Prospectus Forecasts AFJ
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BBY Limited 28 November 2013 12


Table 7. AFJ Pro Forma Balance Sheet

Pro forma balance sheet
21-May-13 Pre listing Offer AcquisitionPro Forma
(A$) (A$M) (A$M) (A$M) (A$M)
Current assets
Cash and cash equivalents 1.0 0.4 71.0 (70.0) 1.4
Trade and other receivables
Assets held for sale 0.3 0.3
Total currernt assets 1.0 0.4 71.0 (69.8) 1.6
Non current assets
Property plant and equipment 3.1 3.1
Deferred tax assets 1.8 0.4 2.2
Intangibles 61.2 61.2
Total non current assets - - 1.8 64.8 66.6
Total Assets 1.0 0.4 72.8 (5.0) 68.2
Current liabilities
Trade and other payables 0.2 0.2
Employee entitlements 1.4 1.4
Lease liabilities 0.3 0.3
Pre listing funding 0.8 (0.8)
Total current liablities - 0.8 - 1.2 1.9
Employee entitlements
Other
Total non current liabilities - - - - -
Total Liabilities - 0.8 - 1.2 1.9
Net Assets 1.0 (0.4) 72.8 (6.2) 66.3
Issued share captial 1.0 72.8 1.4 74.2
Reserves 0.7 (0.6) 0.1
Retained earnings (1.1) (6.9) (8.0)
Total equity 1.0 (0.4) 72.8 (6.2) 66.3
Source: Prospectus AFJ


Table 8. AFJ Pro forma Cash Flow

6 mths 6 mths Year
30-Jun-14
(A$M)
31-Dec-14
(A$M)
31-Dec-14
(A$M)
Cash flow from operations
Receipts from customers 37.6 43.5 81.1
Payments to suppliers (32.3) (35.2) (67.5)
Financing costs (0.1) 0.0 (0.1)
Pro forma net cash flows operations 5.2 8.3 13.5
Cash flows from financing
Finance lease payments (0.2) (0.2) (0.5)
Pro Forma net cash flows financing (0.2) (0.2) (0.5)
Pro Forma cash flows 4.9 8.1 13.0
Source: Prospectus AFJ


Table 9. AFJ Board and management

Directors Role Directorships Background
Stuart James Non Exec Chairman Greencross CEO Mayne Group
Phosphagenics
Justin Laboo CEO/Exec Director GM FKP Group
Gabriel Giufre COO/Exec Director MD Eternal Echoes
Jeff Forbes Non Exec Director CFO Cardno
Stephanie Daveson Non Exec Director Prn Corrs Chambers
Management Role Directorships Background
Justin Laboo CEO/Exec Director EGM FKP Group, CEO FPG
Gabriel Giufre COO/Exec Director MD Eternal Echoes
John Bairstow CFO/Co Secretary PWC
Fiona Alston National Ops Mgr Childcare background
Source: Prospectus AFJ
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Table 10. Key Events

Event Dates
Broker Firm offer opens 18-Nov-13
Broker Firm offer closes 29-Nov-13
Allotment/issue Shares 3-Dec-13
Acquisition completion 4-Dec-13
Dispatch shareholder statements 6-Dec-13
Listing on ASX 11-Dec-13
Source: Prospectus AFJ


Table 11. AFJ Sources and uses of IPO funds

Sources A$M Uses A$M
Offer proceeds 75.5 Initial Childcare centres 69.1
Issue shares S James 1.4 Cost of offer 5.9
See Capital repaid 1.4
Pre listing expenses 0.5
76.9 76.9

Source: Prospectus AFJ


Table 12. AFJ - Ownership

Shares %
Directors, Snr Management 6,262,750 7.0%
Other existing shareholders 7,313,250 8.2%
Seed investors 500,000 0.6%
New shareholders 75,450,000 84.3%
Total Shares on issue 89,526,000 100.0%
Source: Prospectus AFJ

Affinity Education Group Limited BBY Research
BBY Limited 28 November 2013 14
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