The curious case of Curro

March 16th, 2017 by Brian Kantor

To reward shareholders you have to over deliver- executing well is not enough

When the CEO of a highly successful JSE-listed business aims to “reward shareholders” with a maiden dividend, as Curro CEO Chris van der Merwe has recently promised, one takes notice (Business Day 1 March 2017), particularly because the company is undertaking an impressive programme of investing in new private schools (now 128 of them) with room for the company to grow further and faster. Its plan is to open seven new campuses a year, housing 15 to 18 new schools, intended to take the company to 80 campuses and 200 schools by 2020 and to increase its enrolment from the current 47 000 to 80 000. A longer term potential market for as many as 500 fee paying schools in SA has been suggested.

The 2016 financial year was an extraordinarily good and busy one for Curro. It raised an additional R1.75bn in equity capital to fund about the same amount of capital expenditure. Since 2013 Curro has been investing over R1bn a year in expanding the business. But the growth in the operating lines in 2016 were equally impressive, so helping to maintain a superb track record in executing its business plan. Profits after tax (which was minimal thanks to large depreciation allowances) have grown from R40m in 2013 to R168m in 2016 while the growth in cash generated from operations (helped by the same heavy depreciation and amortisation) has been even more impressive, from R106m to R404m in 2016. These were excellent improvements in organically generated cash flows, but not enough to fund the large current capital expenditure programme.

Why then pay out cash to shareholders rather than continue to reinvest in additional assets? These assets appear to be able to return more than would ordinarily be required by shareholders from other investments with similar risks. Is the value added for Curro shareholders in the form of returns on their capital that are well in excess of the (opportunity) cost of such capital, not reward enough to encourage retaining cash on behalf of shareholders rather than paying it out?

After all the rewards for shareholders come in the form of total returns: capital appreciation plus dividends. And as Warren Buffett has long demonstrated, paying dividends is by no means essential for generating high total returns, indeed dividends may reduce them if paying out cash constrains the scale of value-adding investment programmes that shareholders would have great difficulty in finding for themselves.

The problem however for Curro and its shareholders and managers is that, despite its considerable operational achievements and well executed growth plans, the company has not in reality rewarded shareholders since late 2015. It was then that the value of Curro shares reached a peak of over R52 but are now trading below R48. As may be seen in the figure below, Curro shares performed spectacularly well between 2011, when they traded at R8.92 and its peak of R52.65 in December 2015, equivalent to an annual average compound return of about 42%.

 

Curro has run into a problem faced by many well-managed companies. That is investors come, understandably, to expect excellent operating results and re-value the company and its management accordingly. They expect more and therefore prove willing to pay up more in advance to own a share of the much appreciated company and its management.

Hence it becomes ever harder for the company to perform well for shareholders given the much more demanding starting values. Unusual share price appreciation (best measured relative to the market as a whole) of the Curro kind, realised until year-end 2015, comes with surprisingly good outcomes, not just good outcomes. Surprisingly poor performance is as likely to be punished in the share market. Under promising and over delivering is the mantra for rewarding shareholders, of whom managers will be an influential minority. Curro clearly greatly surprised the market between 2011 and 2015 as it delivered fully on its promises, but since 2015 has not been assisted by the share market, which has moved mostly sideways. In recent years it has performed well but not better than expected (though offshore investors, measuring performance in US dollars, will regard 2016 with much more favour than their SA partners, given the stronger rand, which was up by about 20% in 2016).

To address this issue, Curro has indicated not only a willingness to pay dividends but to raise debt and debt ratios to supplement internally generated cash flows to fund growth. Cash flows are still expected to increase even though they are somewhat depleted by dividends to be declared.

The company has also revealed an intention to list separately a further entity on the JSE to pursue promising opportunities in tertiary education in SA. Why then list a separate company rather than pursue this opportunity from within the existing structures?

The answer may be that to do so would raise a new opportunity (Curro reprised) to surprise the market with a successful new listing, that is to surprise investors and so achieve capital appreciation more easily than it could do within the established Curro. To expand the tertiary education offering within Curro, with its already large scale, such a build-up of tertiary capacity may not make a very obvious difference to its growth trajectory and the already highly favourable expectations of investors revealed by a demanding share price.

Therefore paying dividends to shareholders will help them fund the new company. Note that the controlling shareholder, PSG, which helped launch Curro and owns 52% of it, must support any new listing. Cash withdrawn from Curro will help PSG fund its share of the new venture that with its small beginnings could surprise the market all over again and reward its shareholders accordingly by over delivering.

It might be sensible for the minority shareholders in Curro to follow any lead given by the controlling shareholder – that is to receive cash dividends from Curro and invest in the new venture and hope to be rewarded for doing so. 15 March 2017

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