Little people, big money

Kidicorp owner Wayne Wright is aiming for 10 per cent of the market. More than 15 per cent, he says, and 'we'd be seen as the big bad ogre.' Photo / Kenny Rodger

At first glance, you could mistake the large peach-coloured building with the high wooden fence on a very ordinary street in the Auckland suburb of Glenfield for a particularly boring church.

There are no telltale rainbows, butterflies or other brightly coloured signs that might indicate that it is actually a childcare centre.

Inside, though, it's immediately obvious what this brand new building does for its day job. Lots of busy little children are being overseen by early childhood teachers - all possibly oblivious to the fact that way behind the scenes, a legal battle is being fought over exactly who owns all the equipment they are using.

The battle is just a tiny part of the fallout from the fiasco that has been one of Australia's most extraordinary business stories of the past few decades - the spectacular rise and equally spectacular fall of the ABC Learning Group.

ABC began with one centre in Brisbane in 1988. By 2007 it had used hundreds of millions of dollars from taxpayers, shareholders and banks to grow into the world's second-biggest childcare operator with more than 2300 centres in Australia, the United States, Britain, and New Zealand.

In 2007 it reported profits of more than $150 million. But a year later it revealed losses of more than $500 million, and in November 2008 it was placed in receivership, owing nearly $2 billion.

Its New Zealand management persuaded the Australian receivers not to pull the plug here. However Wellington-based liquidator Barry Jordan admits the Glenfield situation - and similar circumstances at three other ABC centres (in Dannemora in Auckland and two centres in the South Island) - is a tricky one. Basically Jordan has been given the job of selling the centres' chattels, to pay back creditors who insist they are owed money as a result of ABC going bust in Australia.

He is quick to stress that doesn't mean he'll be snatching toys out of preschoolers' hands. Instead, he hopes to reach some agreement on price with the operators of the centres. In a related transaction, Jordan is also hoping to flog off some freehold land around the country that had been earmarked for new centres.

Among those who claim they are owed millions of dollars as a result of the collapse of ABC in Australia is Christchurch developer Ireland Developments. In Auckland, another insolvency firm has been asked to try to extract a GST refund of $1.2 million from Inland Revenue to help pay back around $17 million alleged to be owed to yet another company with links to ABC.

But New Zealand has got off lightly. In Australia the ABC debacle has already directly cost taxpayers at least $60 million, as a result of the federal Government being forced to step in to keep more than 240 unprofitable centres running while the financial mess is sorted out. Indirectly of course, it has cost Aussie taxpayers much more, as the bulk of funding for childcare comes from the public purse.

ABC shareholders have also lost tens of millions of dollars and the banks that loaned the parent company money have already written off hundreds of millions.

Among them is Commonwealth Bank of Australia (CBA), which owns ASB Bank and BankDirect in New Zealand. CBA is estimated to have lost at least $500 million - money which would no doubt be quite handy right now.

It has been a somewhat humiliating experience for CBA chief Ralph Norris, who has had to explain to his shareholders why the bank did not detect problems earlier. Norris - a Kiwi who previously ran Air New Zealand and ASB Bank here - has been quoted in the Australian press as saying the bank may consider suing ABC's former directors and auditors.

Parents and teachers, too, have been left fearful and anxious about their future. Fifty-five Australian centres were closed at the end of last year, and last week the Australian Government announced another 30 were likely to be closed because buyers could not be found.

And just as New Zealand investors have read with helpless fury about finance company bosses continuing to drive fancy cars and partying up large in exotic locations, so have Australians been enraged by tales of ABC's flamboyant founder Eddy Groves zooming around town in Ferraris and helicopters; continuing to own houses in Las Vegas, the Gold Coast and in a Canadian ski resort; and generally carrying on as if he had done nothing wrong.

In 2006 Groves was named by a business magazine as Australia's second-richest man under 40. He once skited about swapping war stories with a cigar-puffing Jimmy Cayne, the legendary Wall Street investment banker who many blame for the downfall of Bear Stearns.

There has also been the soap opera of Groves' not-so-private life. He is being sued by his ex-wife, with whom he jointly owned ABC, for more than $50 million. He recently remarried, to a woman who once owned an ABC childcare centre.

Over the past few months allegations have been made of improper related-party transactions, "improperly transferred" funds, handy political connections, inappropriate financial accounting practices and shambolic records. There have also been rumours about Groves' fondness for gambling.

Politicians, parents and investors have been stunned to learn that far from being highly profitable, hundreds of ABCs were in fact losing money.

In June a Senate inquiry is expected to report back on what changes might be needed in the sector.

Academics and community organisations have relished the opportunity to voice their concerns about the danger of allowing private operators to exploit government funding. Among them is former Kiwi academic Sue Newberry, now an Associate Professor of accounting at the University of Sydney.

In a joint submission with childcare policy expert Deborah Brennan, Newberry has urged the inquiry to consider "fresh thinking" about ways public funds should be used in the sector. "No other country in the world has a policy mechanism like this, and no other country has experienced such overwhelming dominance of child care provision by the corporate sector," the pair wrote.

To dominate the sector in Australia, ABC needed a market share of only about 20 per cent. In New Zealand it claims to have around 8 per cent of the daycare market, excluding kindergartens and kohanga reo. Its main rival, Kidicorp, has about 6 per cent. Kidicorp is now one of the players keen to buy ABC here.

ASK anyone in New Zealand's childcare sector what attracted them to the industry and they will give the same answer. "It's all about the kids," they will reply. Like Miss Universe contestants, they will gush about enriching the lives of our most precious resource.

It would, of course, be an odd industry to spend much time in if you didn't have a genuine love of little people. Yet plenty of money men (and women) have been attracted to the sector too.

ABC's investors included the Singaporean Government's investment arm, Lazard Asset Management and Morgan Stanley's private equity arm. Australian investment bank Macquarie also got involved in childcare here, but sold out to ABC in early 2007. The New Zealand Superannuation Fund was also an investor in ABC. (The fund also invested in Kidicorp.) It's easy to see what the attraction might be. It's a cash business, with a captive market, with

most fees paid in advance. Not only that, but roughly two-thirds of the revenue comes from the Government.

The numbers involved are impressive by any business standards. ABC has 127 New Zealand centres which look after around 8000 children and employ more than 2000 staff. Kidicorp has more than 90 centres licensed for 5600 children and employs around 1600 staff. Both companies use lots of different brands, to counter the perception that they are big, faceless corporates.

The next two big private players are Lollipops and Kindercare, with roughly 60 centres between them. Lollipops is also believed to have put in a bid for ABC New Zealand, in conjunction with a private equity firm.

Reading the briefing prepared for new Education Minister Anne Tolley in November, you can understand why centre operators in New Zealand might continue to be optimistic about the future, even in the face of a prolonged recession.

Early childhood education has almost doubled its share of the education budget since 2005, to an amount expected to be nearly $1 billion this financial year. Since 2000 enrolment rates have risen by 8 per cent. In the same period spending has increased by around 11 per cent per year in real terms and is expected to continue to go on increasing due to a mini baby boom, growing demand and greater numbers of centres becoming eligible for higher subsidy levels.

The reasoning behind such government generosity is a belief by the OECD that investment in early childhood education has among the highest net social benefits of all public investment.

For all this, though, Labour politicians have been uneasy about subsidising private operators. Labour did not originally intend to allow private operators to take part in its 20 Hours Free scheme (since renamed 20 Hours ECE by National), introduced after the 2005 election. The Early Childhood Council likes to think it persuaded Labour that this was inherently unfair and against parental choice, but cynics note that at the time Labour was struggling to compete against National in the pork-barrel stakes.

In any case, parents have voted with their feet. In the past four years the most notable trend in the licensed sector has been the decline in the number of children attending kohanga reo, playcentres, and kindergartens - and a massive growth in all-day centres and home-based networks (see Pg 14). Around 60 per cent of all-day centres are privately owned.

Last August a report commissioned by the Ministry of Education noted there was anecdotal evidence of "aggressive acquisition" by Kidicorp and ABC.

"The increasing administrative complexity and costs involved in operating an ECE service, combined with opportunities to realise efficiencies and provide centralised support through a corporate structure, suggest that the trend is likely to continue," it suggested.

The report, by Health Outcomes International, noted benefits of corporatisation such as taking administrative tasks away from teachers, freeing them up to teach. It also mentioned the potential for better business practices. However it also noted concerns that the sector might become less diverse "and bring an increased profit focus at the expense of quality".

"Although it is not a foregone conclusion that corporatisation would result in these impacts ... the Ministry may wish to monitor the clustering of services within large profit-driven entities and the impacts of this for sustainability, diversity and quality," it suggested.

It was a game of tennis that led to Kidicorp owner Wayne Wright getting involved in childcare.

Wright started his career in construction and in the 1970s went to California and founded a large construction company, specialising in retaining walls. After several years in Texas he sold up and returned to New Zealand a wealthy man in 1993.

He was playing tennis with a doctor friend who wanted some advice on how his wife could better run a childcare centre she owned. Wright helped the couple write a business plan and ended up putting some money in himself. One thing led to another and they soon found themselves building a childcare empire.

"We had enough money - all the money that we needed - and it was really just looking for an opportunity to make a difference in the lives of children," he recalls.

His son, Wayne Wright jnr, originally joined the business as general manager but left to pursue an MBA and other interests. His father hopes his son might soon return so he can finally retire.

Wright senior quickly figured out that economies of scale were the key to making the business a success, and Kidicorp listed on the stock exchange in April 2004 after backing into defunct gambling company Feverpitch. At that stage, he says, getting money from the public seemed the easiest way to raise capital, and it also provided him with an exit strategy. But he soon found himself struggling to keep everyone happy.

"I could never satisfy the teachers who always wanted a raise, the parents who didn't want any increase in fees and the shareholders who wanted a dividend. I didn't think it was going to get quite that big." He delisted the company in 2007.

According to Wright, labour accounts for two-thirds of Kidicorp's costs. Property costs make up another 13 per cent; food, toys and equipment another 5 per cent; and tax and interest and so on another 16 per cent. On the revenue side, around one third comes from parents and two-thirds from the Government. While revenue is fairly fixed, a Government requirement for most ECE teachers to have formal qualifications by 2012 has significantly pushed up labour costs, as demand for qualified staff has exceeded supply.

The 20 Hours ECE scheme has also put pressure on margins, as many centres claim the Government does not give them enough money to meet their costs. Wright concedes that many centres have come up with sometimes devious schemes to persuade parents to pay extra. But he denies there's big money to be made.

"Most of us, the big guys, and all of the people that are in the sector, it's more of a cause than anything else. You work very collegially. I've got very good relationships with Kindercare, or even ABC. We're not competing per se, we're just out there servicing a need. There's more demand than supply."

Wright says he had doubts about ABC's success some time ago. "The profitability numbers were too high and now it's become obvious why they were too high, because they were capitalising off operating expenses... It made no sense because it was driving up the cost of the businesses. And the wages they paid - they drove the wages up in New Zealand by 20 per cent, right across the whole sector."

He claims the Australian branch of the company got greedy.

"They got to 20 per cent [market share] and they started charging more. That's not the case here. We are, in terms of revenue, about the same size as ABC here. But they're not growing, they're dead in the water. We're adding another 1200 places this year. We've got four centres opening in April."

Wright is the kind of guy often described as someone who doesn't suffer fools. He happily admits that his tendency to be outspoken sometimes lands him in trouble.

In November Auckland academic Baljit Grewal wrote about the ABC situation on an international education website.

"Childcare is a tough business for corporates to handle," he said. "It can only be run efficiently as a small business. The main reason is that when it operates as a corporate business it becomes top heavy - epitomising all the bad habits of capitalism."

Grewal referred to the "golf-playing mafia in the head office" and claimed that ABC was "notorious for over-management". He also had a go at Kidicorp, claiming it had lost many employees "due to management high-handedness".

Wright notes that about this time, Kidicorp parted ways with its national operations manager. While he concedes ABC staff are paid higher wages, he claims his own company has a below average staff turnover. "We think the majority of our employees are pretty happy."

It has to be said that not all Wright's former colleagues buy his image as a straight-shooter. In 2007 he had a fairly public falling out with one of his main backers. Carmel Fisher, of Fisher Funds, surprised some investors when her company agreed to sell its 19.9 per cent stake in Kidicorp when Wright decided to launch a full takeover. Independent advisers Grant Samuel made it clear they thought Wright's offer was far too low, despite the fact that it had never made a net profit of more than $1.6 million in the time it was listed, and in the previous two years had "significantly underperformed its budgets".

Among other things, the Grant Samuel report noted that management believed the company "suffers to some extent by being a public company and posting profits in a sector where there are significant government subsidies." While the impact of this perception could not be quantified, "the removal of the requirement to publicly report its result and achievements may enable Kidicorp to grow more quickly and be more innovative".

Back then, the report noted Wright's "ambitious plans" to roughly double the number of children under Kidicorp's care until it had achieved a 10 per cent share of the market - a goal that required something like 25 per cent growth each year.

It's a goal Wright is sticking to. Asked why 10 per cent is the magic number, he replies: "We figure that if we ever got past 15 per cent, we'd be seen as the big bad ogre in the sector."

For the record, Fisher says Kidicorp simply proved to be a disappointing investment, largely because it was not particularly well managed.

"The dynamics of the sector are superb. To us, it's a little bit like the aged care sector, so demographically you've really got a target market for life. Kids need childcare and the way women are returning to work and all that sort of thing, so it's a nice macro trend. But it still needs good micro management."

Sarah Farquhar, the newly appointed head of the Early Childhood Council, agrees that there is indeed money to be made in childcare - although she denies that it is making many people rich.

She acknowledges that academics, in particular, are sceptical of private involvement in the sector, but questions whether there is evidence to back their assertions.

"It's like any business - some can be run very profitably, others maybe less profitably. Community centres tend to be at greater risk because they can have changing personnel in terms of committee members who sometimes may not have very much experience in financial administration, but having said that, there are some very successfully run community centres as well, so there is a lot of variability out there."

Ultimately, it is parents who choose what service they want to use, says Farquhar.

Meanwhile, at ABC New Zealand, general manager Craig Presland is also trying to remind himself that it's all about the kids.

Presland took over the job three weeks before ABC Australia went bust. It goes without saying that he had no inkling that it was in any kind of trouble.

Since November Presland has worked hard to reassure parents and teachers that it is business as usual on this side of the Tasman. He appears to have succeeded - occupancy levels have remained at a healthy 84 per cent despite the parent company's problems.

But given his previous business background - he has worked in the dairy industry, for Fletcher Building, ran shared services for district health boards in Auckland, and ran the Forward Steps childcare group when it was owned by Macquarie - he is clearly somewhat frustrated that further expansion has had to be put on hold while a new owner is sought.

After initial interest from a staggering 180 parties, the field has been narrowed down to three bidders, he confirms, all local companies experienced in childcare. He had hoped a sale would be announced last month, and admits the credit crunch has delayed things. However, he still hopes an announcement will be made within days.

In January Wayne Wright was reported as saying that the sale of ABC in New Zealand was an opportunity to rationalise the sector.

"They've bought a lot of centres over the last two years that I would have thought are marginal in the first place," he told the Herald. . "So [it] just gives you an opportunity to ... close down some of the ones [where] there's too many in an area or they need serious upgrades to meet regulatory requirements or those sorts of things."

Wright says he doesn't recall making the comment, and is now precluded by confidentiality agreements from commenting on how many ABC centres might be losing money. He prefers to suggest that some of the centres might be better run by owner-operators "because of their geographic or demographic location."

Should Kidicorp prove to be the successful bidder for ABC New Zealand "a number of those centres would be sold off to local owner-operators in the fullness of time," he says.

Presland insists that none are likely to be closed. "Sure, it's not ideal with what's gone on in Australia, but we've continued. We've had very loyal staff and parents and without that we would have really struggled, so we're very appreciative of that and certainly don't take any of that for granted...

"At this stage, working with [Australian receivers] McGrath Nichol, we're confident all the centres will remain open. But of course it does depend what the new owners want to do with the business and that's an unknown at the moment."