MindCamps Preschool Limited

MindChamps Preschool Limited ("MindChamps" or the "Company") is offering 30,449,600 shares at $0.83 per share in which 2m shares will be for the public and the balance for placement. The market cap of the Company will be $200.5m. The IPO will be subject to over-allotment option. Separate from the offering, the Company also entered into an agreement to sell 28,930,800 shares to Cornerstone Investors.

The IPO application will close on 22 Nov 2017 at 12pm and you can start trading on 24 Nov 2017. You can apply for the shares at the ATM and internet banking platforms of DBS/POSB, OCBC and UOB, as well as the mobile app of DBS. You can find the prospectus here.

Principal Activities

The Company is currently the largest operator and franchisor of premium range preschool centres in Singapore and currently operates 6 company-owned-company-operated ("COCO") preschool centres, 30 franchisee-owned-franchisee-operated ("FOFO") preschool centres and 8 FOFO reading and writing centres in Singapore.
(Note: Premium pre school child care centres charges > >$1,700 per month for a 5-day week or 5.5 day week full day programme)

The Company has also developed a franchise model overseas, where it has 4 COCO and 2 FOFO centres in Australia, one FOFO Centre in UAE and 3 FOFO centres in the Philippines. 

Mindchamps is the only preschool operator globally to nurture children using Champion Mindset, an intellectual property owned by MindChamps that was researched by award-winning neuroscientist, Professor Emeritus Allan Snyder FRS. 

According to the prospectus, the curriculum is the result of over a decade of research and development in the 4 domains of early childhood education, neuroscience, child psychology and theatre. 

The Company operates in 3 business segments of education, franchise and others as presented below:

Financial Performance

The revenue has been growing at a CAGR of 30% and has grown from $10.8m in FY2014 to $18.4m in FY2016. The revenue is likely to continue growing as the Company steps up its franchising arrangements globally. Revenue continue to grow from $8.8m to $9.2m in 6M2017

While revenue has increased, net profit has also grown in tandem with improving margins. The net profit hit a high of $5.8m in FY 2016. However, it seemed like 6M 2017 profitability has taken a hit. Let's see if we can find out more.

According to the prospectu (page 82 and 83), the reason for the drop in net profit was because the 6M 2017 revenue is mainly due to recurring revenue stream from its operations and does not enjoy any master franchise license fees that occurred in 6M 2016. This will probably improve in 2018 when the master franchise agreements are finalised with China First Capital Group and Hillhouse.

Based on the adjusted EPS of 2.23 Singapore cents for FY 2016, the Company is listing at a historical PER of 37x! Considering the drop in profitability in 6M2017, unless the 2nd half picked up significantly, the performance is unlikely to beat that of FY2016. The only positive takeaway is that the recurring revenue of the Company has been trending upwards, while the non-recurring revenue can be quite erratic.

The Company also prepared a pro forma financial statements assuming it has acquire 80% equity interest in MindChamps Serangoon, 75% of MindChamps Zhongshan Park, Australia acquisition, 49% in MindChamps Changi and 6.42% of MindChamps PreSchool Franchise as part of its listing as shown below.

Based on the pro forma financials and the enlarged share capital of 241.6m shares, the EPS for FY2016 would be 2.58 Singapore cents. This would translate into a listing PER of 32x.

According to the balance sheet as of 30 June 2017, the Company has an intangible assets of $21.8m and bank borrowing of $11.4m, shareholders' equity of $4.54m. After accounting for the IPO proceeds, the shareholders equity improved to $54.3m with cash of $49m and debt of $0.66m. See pro forma below.

The adjusted NAV per share of MindChamps is $0.218 versus its IPO price of $0.83, implying a price to book of 3.8x.

Use of Proceeds

The Company intends to use proceeds to repay Acquisition Loan and to fund expansion plans.

Dividend Policy

The Company will keep all the profits generated for FY2017 for its operations but intends to distribute at least 40% of its net profit after tax generated in FY2018 as dividends.

What I like about the Company

• Largest operator and franchisor of premium range preschool centres in Singapore - You need a strong base to grow and Singapore's pursuit for high quality education forms a good foundation in which the Company can then expand regionally and globally. I like the ambitious target which the Company set for itself. It is not just Asia and China, it wants to conquer the world! (of course whether they can achieve it is another story but at least they show strong ambition). See the potential key strategic markets for global expansion below

• Strong intellectual property - The preschool owns its own IP and "MindChamps" curriculum to nurture our future generation. They are in control of their own destiny if the curriculum is proven to be of real value, parents would be most willing to spend on their children's education
• Scalable business model - The franchisee model is highly scalable once you own the intellectual property that is well sought after. The Company has shown that it was able to establish franchisee operations in Singapore, Australia and UAE. The model can be replicated to a more homogeneous country like China as well as United States where quality preschools are very expensive. The franchising model of charing a fixed % of revenue allows high financial returns without the capex! 
• Clear growth path - The number of centres has grown from 26 in FY2014 to 54 at the date of the prospectus. According to the prospectus, there are 35 FOFO centres yet to be established and some be commencing operations in 1Q 2018. There are clear growth path outlined for the different regions. The Company has also signed MOUs to grow globally.

• Reputable partners for Global Expansion - MindChamps have signed exclusive business partnership with China First Capital Group and Hillhouse Capital. The parties intend to operate preschools and kindergartens under the MindChamps brand in China, Hong Kong, Australia and United States. These business partners also invested as cornerstone investors in MindChamps and there is strong alignment of interest
• Blue Chip cornerstone investors - The cornerstone investors are of excellent quality. Please see more detailed analysis on the cornerstone investors below
• Infection point - This Company is in an inflection point where it needs capital to grow and a listing will help achieve both credibility and provide the funds for which it can execute its business plans. The listing will allow it to grow faster through mergers and acquisitions
• Competent management, well connected Board and world Class Advisory Board - The management and board comprise competent individuals and the founder, David Chiem, surrounded himself with an esteemed advisory board who will help "brand" the Company and provide knowledge and credentials to the Company. The advisory board is presented below.

Some of my Concerns

• Loss of IP / Rise of Competition - The Intellectual Property developed by the Company can be "stolen" from unscrupulous franchisees and re-marketed by them. This would be one of the major risk and the mitigant will probably be careful scrutiny by the Company and operating in jurisdictions with known legal recourse (not sure about China). Also disclosed in the prospectus, the Company is currently in legal lawsuit in Australia for breach of term sheet. (not sure why a term sheet can be breached as it is usually non-binding in nature).
• Partnerships fail to work - Other than loss of IP, the biggest risk is execution risk where partnerships with CFCG and Hillhouse fail to work out and the expansion plans are derailed, especially in the China or elsewhere. The mitigant is that if the partnership fail to work, then the "cornerstone" investments made by CFCG and Hillhouse will suffer as well. There is at least some alignment here. 
• Intervention by government for preschool segment in Singapore  - Government intends to raise the quality and affordability of preschools here and public spending in this area will hit $1.7 billion by 2022. While MindChamps target the higher end segment, the availability of better quality preschools at more affordable pricing may result in competition and pricing pressure. The preschool segment is currently not regulated or mandated by government. If the pre-school segment is regulated, it will likely kill off all the premium schools in this sector
• High valuation - The IPO valuation is as premium as its school fees. It doesn't come "cheap". Investors are paying a premium for the business. Is it still a value buy?  The cornerstone investors seemed to think so
• Competition - This is a fragmented market with many competitors, including EtonHouse, Pat's Schoolhouse, Brigton Montessori etc. While MindChamps currently has the largest market share, it does not mean the market share can be maintained in future
• Non big 4 auditor - The auditor is Nexia TS  Public Accounting Corporation. While not belittling the smaller accounting firm, i would prefer to see a more established auditor with more resources as the Company scale up its operations globally

Cornerstone Investors

Let me spend a bit more time on the cornerstone investors today as it forms the key part of my investment decision and chilli ratings.

China First Capital Group is listed on HKSE (ticker code 1269) with a market cap of ~ USD 2.3b. It has a few business lines and since 2016, expanded to education and schooling services business both within China and abroad. It is currently trading at lofty valuation on the HKSE and will be a "natural acquirer" if the founders of MindChamps decide to exit the business in future. You can find some of their investments in this space here.

Hillhouse Capital Group was founded by Zhang Lei and his own life story has been a very interesting journey. He is a highly respected both in China and abroad and set up Hillhouse in 2005 with the backing of Yale Endowment. Fast forward to today, Hillhouse is a well known name in both the public and private equity world . You can read more about his speeches here and his investment in MindChamps is a good endorsement of the the Company and its future business. Hillhouse invests with a long-term time horizon and employs a fundamental, bottoms-up approach. The funds managed by Hillhouse has generated good returns to its investors.

Target Asset Management was established in 1996 and practise value investing strategy. According to Motley Fool Singapore, Target Asset Management's founder, Teng Ngiek Lian is one of the 4 great investors in Singapore which you need to know. You can find more about Target's investment philosophy here. 

While I wouldn't call Singapore Press Holdings a great investor, they have showed conviction by increasing its stake in MindChamps. They first invested $12m in MindChamps in 2014 and they followed up with an additional 4.84% for the IPO.  SPH now owns about 26.84% of MindChamps and will own about 20% post IPO.

With the ringing endorsement by 4 different parties and some with "value investing angle", it seemed like this is an investment which you can hold for the long term and their presence is of great value to me.

Shareholders

From the table above, the founders (husband and wife) continue to hold about 51.65% of the Company, with SPH owning 20%, the 3 cornerstone investors holding 11.97% and the public holding the remaining 13.35%. 

Considering the founders are locked up and the other investors are long term investors, the free float will be tightly controlled with only 13.35% of the share capital in public hands.

Peer Valuation

The valuation of MindChamps is expensive by any historical metrics! I frankly don't know how to "value" this company since i am not privy to its future projections but the "growth" must be exciting enough for the cornerstone investors to invest in this. The presence of Target Asset Management is particularly "disturbing" given the perceived lack of "value" in the IPO valuation. 🤔 Is there something of value which we don't know? 

My Chilli Ratings

I like the sector and the growth projectory presented by MindChamps. It seemed like it is at an inflection point where growth and profitability will pick up in 2018 when the Company scales up globally. The key risk will be execution. Can the Company execute its growth story? The 3 cornerstone investors and SPH seemed to think so, should we take a leap of faith? 

I will give it a one chilli rating for the IPO launch given the high valuation but a 2 chilli for the longer term. I am willing to take a bet on its longer term prospects given the quality of the cornerstone investors.

Given the small float, the IPO should stay above water if the placement is done well. I will subscribe for some shares and hold it for the longer term. 

Will you subscribe for the IPO?

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