This leading fund manager names their top takeover target in microcap land

For small cap investors, education technology has come increasingly into focus in the wake of the COVID-19 disruption.

The central thesis is that a slow and steady shift towards online solutions was suddenly forced to accelerate, and companies with a first-mover advantage could be set to benefit.

The shift hasn’t escaped the attention of small cap fund managers, some of which have increased their allocation to the space on a sectoral basis.

Others have taken a high-conviction view on specific stocks, and late last week Stockhead spoke with Harley Grosser, principal and founder at Sydney-based investment company Capital H Management.

One of Capital H’s largest holdings is in Schrole Group (ASX:SCL), the online teacher recruitment platform primarily serving international schools in the Asia-Pacific region.

Capital H made its initial investment in Schrole last year, and Grosser remains bullish on the stock following a strategic investment from US company Faria Education.

Headquartered in Portland, Faria provided a $5m funding facility to Schrole in May which will convert into a 19.99 per cent cornerstone stake.

Synergy play

Despite the historic volatility, 2020 hasn’t been all bad for ASX small caps (especially gold stocks), with no less than 33 companies reporting calendar-year gains of more than 100 per cent.

But while Schrole felt the brunt of the COVID-19 selloff, it stayed under the radar during the April/May rally — and Grosser said that provided Faria with a nice opportunity.

“The timing of the deal (with Faria) off the back of the pandemic meant they ended up doing the placement at a lower lower price than they otherwise would’ve been able to. But regardless, I think it’s a real game changer for the business’s growth outlook now,” he said.

For Grosser, one of the key attributes Faria provides is scale. The company has around 3,000 international schools on its platform and another 8,000 domestic US schools. By comparison, Schrole’s existing customer base numbers around 400.

The other benefit is that Schrole’s core service — teacher recruiting — complements the Faria platform which is based on the ManageBac online student learning system.

“When you integrate the two it’ll be a broader offering, and if Schrole do their job well they’ll have access to that international school network,” Grosser said.

“It adds value to Schole’s platform, because it’s a network-effect business where more schools attracts more candidates and vice versa.

“And I think Faria saw the potential for them to help catalyse that because they (Schrole) have a good business that needs to scale quickly. Faria already has 3000 school partnerships and now they can add a teacher HR capability.”

As part of the integration, Grosser reckons Schrole can increase the number of schools on its platform from 400 to 800 over the next 12 months.

“If you do that the model will be profitable, and Faria will participate in that as 20 per cent shareholders,” he said.

Bidding war?

On the corporate side, Grosser said recent history also indicated that Faria’s strategic investment put Schrole in the mix as a potential takeover target.

He cited Faria’s acquisition of the SchoolsBuddy software platform, where the company opened with a 50 per cent stake and moved onto outright ownership.

But sector-wide, Faria aren’t the only player looking to expand their foothold in the Asia-Pacific. There’s also Tes, the UK education group which was acquired by private equity firm Providence Equity Partners in 2018.

“I’d say Tes are Schrole’s biggest competitor in the emerging platform market for international schools recruitment,” Grosser said. “They’d have to be watching now that SCL has the backing of a bigger partner, so I wouldn’t be surprised if there’s some tension there (between Fariah and Tes).

“Faria has a head-start, but if the integration works and Schrole’s growth accelerates, I think it makes for an attractive target — a $20m market cap company with $6m of cash.

“I’m not saying a takeover will happen next week, but there’s two potential acquirers and at some point it makes sense for them to have a go.”

Sector trends

Across the listed ed-tech space more broadly, Capital H also holds a smaller position in Kip McGrath (ASX:KME), the education centre operator which is slightly larger than Schrole with a market cap of around $45m.

While ed-tech isn’t necessarily a core focus of the fund, he said companies did have an opportunity to try and capitalise on the accelerated shift to online.

Grosser isn’t the only fund manager to flag the sector’s potential, although the price action among ASX small caps in the space has so far been mixed.

Here is the three-month, six-month and 12-month price performance for the cohort of ed-tech stocks tracked by Stockhead:

Code	Name	Price	12M return	6M return	3M return	Market Cap
3PL	3P LEARNING LTD	0.75	7.1%	-15.7%	-27.2%	$104.6M
JAN	JANISON EDUCATION GROUP LTD	0.32	-5.9%	-30.4%	3.2%	$67.1M
OLL	OPENLEARNING LTD	0.195	44.4%	18.2%	N/A	$28.6M
RCL	READCLOUD LTD	0.255	0.0%	-20.3%	-22.7%	$25.0M
RTE	RETECH TECHNOLOGY CO LTD	0.39	-1.3%	-4.9%	-2.5%	$87.3M
SCL	SCHROLE GROUP LTD	0.015	7.1%	-28.6%	66.7%	$15.4M
KME	KIP McGRATH	1.00	14%	-22%	1%	$45.3M

“It does seem as though from a customer perspective, there’s not much pressure to charge less for online classes (compared to in-person classes). It’s a similar level of productivity, but it can also be more profitable because the cost to deliver is generally much lower,” Grosser said.

“If you look at education and teaching more broadly, it’s generally a market that moves slowly — you wont see schools or teachers just change the entire way they’re operating overnight. But then we had this event where they were forced to.

“For stocks with ed-tech exposure, what would have taken three to five years has happened in a couple of months, so I think it’s primetime for companies that can execute with those tailwinds.”