While in size, the collapse of ABC Learning Centres is relatively trifling, the effect of its demise is arguably more significant than any insolvency since HIH closed its doors in March 2001.

More than 100,000 children attend child-care centers run by ABC Learning Centres. The Australian Government last year paid more than $300 million in subsidies which have effectively ended up in the hands of ABC.

In the scale of business disasters, the Eddie Groves’ ABC debacle will join the likes of Bond, Skase, Spalvins and Goldberg. While it has not been alleged that any crime has been committed (although ASIC is currently investigating ABC in relation to disclosure issues), the speed and nature of its demise remain startling.

Few investors were surprised when highly geared asset plays by Centro, MFS, Allco or Babcock encountered difficulties. In their nature these were inherently risky businesses, highly leveraged to a property and asset bubble. By contrast, ABC Learning Centres sold childcare services, a business which is, on its face, defensive and straight-forward. What’s more, the company receives hundreds of millions of dollars in guaranteed revenue in the form of government rebates which increased steadily over time (ABC rose fees almost in tandem with government increases in childcare rebates). It seemed that former milkman, Eddie Groves, and his wife Le Neve, had stumbled across a goldmine.

In December 2006, shortly after ABC announced its US expansion plans, the company was briefly worth $3.4 billion. A few months earlier, ABC announced that it had made an annual profit of $81.1 million. As it turned out, most (if not all) of the $81.1 declared profit was not really a profit at all, but allegedly included cash payments paid by developers which should have been “split” over a number of years, but was front-loaded by ABC.

The image portrayed by Groves throughout ABC’s downfall has been one of Eddie the “victim”. The CEO who went down with the ship. As Groves noted to the AFR last week, “people always look for someone to blame but at the end of the day businesses don’t always get it right, boards don’t always get it right, CEOs don’t always get it right, CFOs don’t always get it right.”

How the “innocent mistake” excuse will wash with regulators who are investigating ABC’s conduct remains to be seen. Sources have alleged that ABC’s major holders, including the Singapore Government, are furious at Groves’ conduct.

Groves’ was also one of the highest profile recipients of a margin call in Australian business history. Groves’ personal stake in ABC, once worth around $140 million (his estranged wife Le Neve held a similar stake) was reduced to zero in late February after his shares were sold by margin lender Citibank. Groves complained loudly and publicly that Citi had failed to properly warn him of the impending sale (Groves was briefing investors in Melbourne when Citibank sold the shares). The complaint is remain somewhat ironic given that the value of Groves’ stake, had it not been sold by Citi, would have been zero.

As for Groves being a victim, that notion must be considered in context. While Groves took negligible cash payments from ABC, he and Le Neve had also been net sellers of ABC shares since 2005. While Eddie did purchase $32 million in ABC shares between May 2006 and November 2007 (in various tranches), he sold $40 million worth of shares months earlier.

Then there is the small matter of ABC’s payments to an unknown company called Queensland Maintenance Services. QMS is mentioned in ABC’s 2006 and 2007 Annual Reports as having received substantial payments for renovation and maintenance works. According to the AFR, ABC paid QMS a further $70 million in 2007/08. Groves claimed that he “never had a stake in [QMS]. Don’t now, never did, never.” Coincidentally perhaps, the registered office of QMS is at an apartment part-owned by Groves. There is also the inconvenient fact that QMS was owned by a man named Frank Zullo, who just happens to be the former husband of Groves’ sister.

The confessed $70 million payment to QMS in 2007/08 is especially surprising given Groves’ claims in November 2007. In an ASX announcement, Groves stated that “with only about 100 centers of the current [Australian] portfolio requiring renovation, the company’s capital requirements are expected to reduce significantly as a percentage of the asset base.” This was in stark contrast to what Groves told the AFR last week when he claimed that “QMS in 2007 did 250 internal renovations and 330 external renovations in a year.” ASIC is not believed to be investigating Groves’ statement to the ASX. In total, ABC paid QMS approximately $170 million for renovation and maintenance.

ABC also had a very close relationship with financial adviser, Austock. Austock advisers, Vin Harink and James Andronis, assisted ABC on its company-making acquisition of Peppercorn Child Care Centres and CDC. (The sale was spurred by former Peppercorn boss, Michael Gordon, who approached ABC). Cynics might suggest that Austock had something of a vested interest in ABC acquiring Peppercorn, CDC and a host of other centers. During 2006 and 2007, Austock (whose former Chairman, Bill Bessemer, sat on the ABC board), collected more than $43 million in fees from ABC, largely due to capital raisings to fund the acquisitions. Groves owned a 4% stake in Austock during that period. (Austock is another victim of the ABC collapse, with its share price slumping from $1.80 to $0.31 since listing last December).

While it wasn’t obvious to many, especially shareholders like the Singapore Government and Lazard, ABC was a bomb waiting to explode. Its major problem, as with most commercial child-care centers, is that notwithstanding government funding, the business model is not profitable. Based on write-downs (which have still not been confirmed), ABC has not made a profit since listing (admittedly, its cause would not have been helped by fees paid to QMS and Austock). As Crikey has reported in July, ABC expanded by paying exceedingly generous prices to child-care centre owners using its over-inflated scrip, creating the mirage of increasing earnings. At the same time, ABC’s profitability declined as the company grew.

There is also the often forgotten issue that ABC’s competitors are largely not-for-profit community child care centers. When your main competitor doesn’t have shareholders to please or brothers-in-law to pay, the situation becomes ever more challenging.

Peter Fray

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