Buying ABC Learning after the collapse

It was an audacious bid aimed at forging a bold new direction in childcare. Adele Horin recounts how a group of charities pulled off the deal of the decade to buy ABC Learning.

IT IS 6.30 on a Sunday night when Evan Thornley, the internet millionaire and champion of progressive causes, calls his friend Michael Traill in Sydney. ”Mate,” he says, ”this sounds like a crazy idea …” The idea is that a non-profit consortium buy the ruined ABC Learning childcare empire. At the time, in November 2008, ABC consisted of more than 1000 centres in Australia, 53,000 childcare places and 14,000 staff, and controlled 15 per cent of the market.

Thornley, and the think tank he chaired, Per Capita, were passionate about the importance of early learning. And now the single-biggest childcare asset in the country was up for auction by receivers McGrathNicol. The hyper-active Thornley, then an MP in the Victorian Parliament, thought to himself: ”While we’re talking policy someone else is going to buy it.”

It was an audacious idea. How could the non-profit sector, even in the gloomy markets that then prevailed, raise say $170 million to outbid the billion-dollar private equity firms that were circling? Nothing like it had been contemplated before. But Thornley, who made his fortune developing and then selling the LookSmart internet search company, had worked in Silicon Valley when ”Google and eBay were in garages”. Silicon Valley, Thornley says, ”unconstrains your thinking”.

So begins an extraordinary chapter in Australian corporate history. If the rise and fall of Eddy Groves is not compelling enough, how the empire he amassed ended up in the hands of a bunch of charities after a bidding war with a private equity firm is just as gripping. David beat Goliath, the white knights beat the black, the non-profits beat the profiteers.

In the process a remarkable alliance was forged between some of Australia’s biggest, and often competing, charities – Mission Australia, the Benevolent Society, the Brotherhood of St Laurence, and a small group called Social Ventures Australia – and a coterie of high-profile bankers, commercial lawyers, tax experts and corporate heavyweights. Some worked free of charge, and others for cut-rate charges, and reduced success fees.

Even more importantly, the hugely complicated deal was underpinned by a new investment model that could become a template for funding other large-scale social businesses. Philanthropists, instead of being asked to donate to the non-profit company the charities established to buy the centres, were asked to invest $1 million or so in unsecured eight-year notes for a return of 12 per cent a year. The return is inferior to an investment in a similarly risky for-profit venture but a return nevertheless, and for a good cause – a company run with business discipline for a social purpose.

Next week the deal will be sealed. The GoodStart consortium will hand over a cheque to acquire 550 centres, with the purchase of another 128 to be finalised over the next four months.

It has been a wild ride since that Sunday night when Michael Traill took the call in his Sydney home, and Thornley told him the sale of ABC would be a ”once in a generation opportunity”. Traill, a former executive director of Macquarie Bank who had left in 2002 to form Social Ventures Australia, an outfit that ”invests in social change”, needed little persuading. ”Sounds interesting,” Traill responded in his typically understated style. The deal was to consume months of his life.

Toby Hall is one of a new breed of chief executives who run major charities. In a former life the head of Mission Australia was a top-tier accountant and high-flying entrepreneur. Mission Australia was already negotiating to buy 29 of the so-called unviable ABC centres. And when Traill rang to suggest a consortium buy all the profitable ones – more than 700 at that stage – it struck a chord. Hall had fantasised about such a proposition. ”But I didn’t think we could do it. It was too big.” It would mean Mission Australia buying an organisation twice its size.

Before long Richard Spencer, chief executive officer of the Benevolent Society, and a former corporate lawyer, was engaged in the conversation. And what a conversation it was. Over months Thornley, Traill, Hall, Spencer and others, met to discuss what they called the ”social purpose” of the venture. What was the point in charities owning a childcare empire?

In the past 15 years or so competitive tendering for government contracts in welfare and employment services has cooled relations between the major charities. Big personalities and big egos have also meant collaboration has been more rhetoric than reality. When Thornley, a board member of the Melbourne-based Brotherhood of St Laurence, invited its chief executive, Tony Nicholson, to join the conversation, a critical meeting was convened to acquaint the board members of the Sydney-based charities with the Melburnians. Like a council of Mafia godfathers, four chief executives, two chairmen, respective board members and senior staff sized each other up across the board table. ”Fundamentally, we talked philosophy,” says Spencer.

They liked each other, and found common commitment to early learning, especially for disadvantaged children. A non-profit owner of a childcare empire could reinvest the surplus to improve quality, influence government policy, and use the centres as a base to demonstrate cutting-edge practice. It could, in short, give tens of thousands of children over time a good start in life that could make all the difference.

The GoodStart consortium was on its way.

For Trevor Allen, high falutin’ talk about ”social purpose” was taking up too much time. As the head of mergers and acquisitions at KPMG, the global accountancy and financial services firm, he is the classic hard-headed deal maker. He had helped do the deals to privatise the Commonwealth Bank, and he had helped put Optus on the map. KPMG had been involved in the death-throes of the Groves empire, preparing a diagnostic report for the board. It knew the terrain, and in the coming bidding war, it was looking for a gig. It saw an opportunity for itself as an adviser to a potential suitor. But which suitor?

”A non-profit ticked all the right boxes,” Allen believed. It would benefit from the backing of the government and the childcare union, neither of which, it was understood, wanted ”another Eddy Groves”. And Allen saw how charities held some financial cards over for-profit bidders, being exempt from a range of taxes. With the wages bill at ABC amounting to $400 million a year, savings in payroll tax alone would total $20 million.

Allen also thought a non-profit was probably better for the country. ”Yes, there was altruism,” he says. ”But we looked at it selfishly. We thought a non-profit had the best chance of winning. I don’t do this to come second.”

KPMG were auditors for Mission Australia, and by the time Allen approached its boss, Hall, the number-crunching for the consortium was already in full swing.

Australian private equity company Champ and Rob Koczkar, of rival firm Pacific Equity Partners, were providing pro bono advice to help the consortium develop bid strategy, due diligence and

pricing. What was a business with a ”nasty history”, as Traill described it, really worth?

But by July 2009, it was time to get formal. The consortium hired KPMG for a peppercorn sign-on to drive the deal. If they won, KPMG would get success and total fees of several million dollars. It was hardly chicken feed but still a discount. Eight parts of the KPMG business were ultimately involved, including mergers and acquisitions, tax, demography and IT. Other companies were coming on board: public relations firm Parker and Parker, willing to do 80 hours pro bono before charging; and the law firm Gilbert and Tobin. If they lost, the charities would be liable for $750,000 in fees to advisers. They were a mean bunch; the work would be worth at least $5 million at market rates.

Big charity is used to working with big business. But usually it is as a philanthropic ”partner” and everyone is on best behaviour. Here KPMG had to structure a complicated deal, and there was no Mr Nice Guy, not from Trevor Allen. His offsider Will O’Neill played good cop.

”In the early days things got a little bit heated,” Allen admits. ”I was concerned they weren’t moving quickly enough. I am a ‘deal’ person and they wanted to focus on broad social purpose issues.”

Also KPMG, with little to gain from second place, pushed for a higher bidding price than the consortium felt it could manage. It is understood the syndicate and its competitors put in non-binding bids of $150 million to $170 million in the first stage in August 2009, a sum that further homework revealed was way too much.

But raising the money was a big ask. The three major charities agreed to invest $2.5 million each for a 15 per cent return under the capital structure that Traill had sketched out. That left a huge gap.

Enter Robin Crawford. He was one of the six founders of the ”millionaires factory”, Macquarie Bank. But he ascribes much of his fortune to luck. That disposition makes him sympathetic to the less lucky in life. When he retired from the bank to go ocean racing, he also became chief fund-raiser and chairman of the Chris O’Brien Cancer Centre.

He made the ideal chairman of the GoodStart company. Along with Traill, he started hitting friends, acquaintances, super funds, and foundations to invest in the 12 per cent unsecured notes. There was hardly a rush: ”A lot of wealthy people had all sorts of reasons why it didn’t suit them.”

He committed $5 million himself, a handful of others committed around $1 million; eventually 40 social investors came on board, including those investing $100,000 or so to bring the social investment component of the deal to $22.5 million.

Daniel Petre, a former Microsoft executive, invested $1 million after a golf game with Traill. ”Enjoyed the company but not my golf,” he emailed when signing up. ”It’s pretty sad,” says Petre, ”but there’s lots of wealthy people who’ll write cheques for $10,000, very few who’d write a cheque for $1 million let alone for this sort of entity.” It was neither philanthropy nor hard-headed investment but a fish in between.

NATIONAL Australia Bank was getting a deserved reputation for being the ”socially responsible” bank. It was fortunate Crawford had a high-level contact in its deputy chief, Michael Ullmer, ”a nice man, not pushy”. The bank eventually agreed to provide $120 million in loans and guarantees to be repaid over five years.

All the pieces of the financing jigsaw were coming together. A visit to ABC’s head office in Brisbane and to childcare centres assured the consortium the business was better than ”the McDonalds of childcare” it had been painted. It was salvageable with good management, and the management team installed by the receivers was impressive. Head office alone had cost Groves $90 million to run when $45 million would be enough.

Big charity bosses have contacts in the highest level of federal government, and it was time for the Brotherhood’s Nicholson, and Mission Australia’s Hall to work theirs. The government agreed to lend $15 million over seven years, and state governments rushed approval of the tax concessions.

By November 2009 there was one competitor left standing, the private equity firm Archer Capital. Ironically the partner running the deal, James Carnegie, had learnt his trade under Traill at Macquarie Bank a decade before. Highly intelligent but politically naive, he revealed his intention to sell the childcare empire for a profit within two or three years of purchase.

The childcare union was whipping up a storm of protest. But negative publicity was unlikely to sway the receivers. Representing banks owed $1 billion, McGrathNicol was obliged to take the best deal.

It took nerves of steel for the consortium to set the final bid price. Like a poker game, it is all bluff and bravado, pressure and posturing. The receivers’ advisers, UBS, strongly implied the consortium’s new indicative sum fell well short of the opposition’s.

It seemed all was lost. KPMG pressed to lift the bidding price. But Crawford responded in an email that a high purchase price and high debt servicing costs would reduce the surplus for investment in quality: ”If we are outbid, so be it.”

With a bid believed to be around $100 million, GoodStart won. Everyone was too wrung out to celebrate. KPMG’s Allen denies he is the changed man others say. He admits, however, to pleasure in doing a deal ”that changes the face of the country”.

Now the consortium’s real challenge begins. The charities have little experience in childcare. They have set up a separate non-profit company, and maintained the ABC management team installed by the receivers. But the stakes are high.

There is a massive business to run, big sums to pay back to the banks, the social investors, government and the charities while ensuring a surplus to raise standards.

Failure will mean turmoil again for childcare. But success will mean a bright new era for tens of thousands of children.

Adele Horin is a senior Fairfax writer.

The ABC learning curve
NOVEMBER 2008
- ABC Learning Centres collapses owing creditors an estimated $1.6 billion just weeks after founder Eddy Groves steps down as chief executive of the childcare giant.

- Evan Thornley, internet millionaire, social activist and at that stage Victorian Labor MP, starts trying to put together a consortium from the non-profit sector to buy the former childcare empire.

JANUARY 2009
- The doors close on 55 ABC Learning childcare centres, with 4000 children offered places at nearby centres.

DECEMBER 2009
- The GoodStart syndicate, made up of two Christian and two secular welfare agencies, outbids private equity company Archer Capital to win control of 678 ABC centres – 185 in Victoria – making it Australia’s largest childcare provider.

- ABC Goodstart says it will have an annual turnover of $600 million from 678 centres, but stresses that the company is designed to provide affordable, quality childcare.

MARCH 2010
- A creditors meeting in Brisbane hears that the bill from the collapse of ABC Learning Centres has blown out to nearly $2.7 billion.

APRIL 2010
- Eddy Groves appears before the Federal Court as part of an examination by administrator Ferrier Hodgson into whether ABC Learning traded while insolvent.

MAY 2010
- Next week the GoodStart consortium will hand over a cheque to acquire 550 centres, with the purchase of another 128 to be finalised over the next four months.