BFAM - Bright Horizons Family Solutions

[glorysk87]

I've been looking at Bright Horizons for some time now, and haven't been able to make a decision on it yet.  To give a quick summary - the company provides both retail and employer sponsored child care, mostly through their full service dedicated child care centers.  Not too complex.  I'm torn on the name, so I want to use this thread as a sounding board, and hopefully get some feedback.

 

The negatives:

- There is a VIC writeup that lists BFAM as a short candidate (https://www.valueinvestorsclub.com/idea/BRIGHT_HORIZONS_FAMILY_SOLTN/136791).  I think this is a pretty poor writeup and I don't think the author makes a compelling case in the slighest.  The gist is that it's a short on valuation, which I think we would all agree is not the best of ideas.  The author does some speculation on why the company is in a weak position competitively, but I disagree with most of the arguments and find them both speculative and weak.

 

- Valuation is the standout negative here. Company trades at 30x earnings.

 

- Labor costs could be a negative. They're the largest expense by far, and if wage inflation really catches on, margins could be pressured.

 

- Reliance on operating leases - they utilize ~700mm in operating leases

 

- Services like Care.com that allow parents to find individual caretakers could prove to be a risk.

 

The positives:

- Scale - they're 6x larger than the next closest competitor - this means they are the only provider able to service large-scale clients, and they have the size to roll up a fragmented market

 

- Longstanding relationships - making a decision to entrust your child to someone is a decision that isn't made likely. Once that decision is made and validated (ie. the parent trusts BFAM), it becomes a very very sticky relationship.

 

- Solid ROI for employers - An employer that signs with BFAM to offer childcare services earns a return via reduction in employee turnover and higher job satisfaction (and thus productivity) for employees

 

- Low customer concentration -  largest client is <2% of revs, largest 10 clients are <10% of revs

 

- Very strong macro drivers - Millennials are now the largest generation in the country, and the majority of them are still before child-bearing age.  There is going to be a boom in child births in upcoming years/decades.  Further, women in the millennial generation have shown a high proclivity to work full time rather than be stay-at-home-moms, increasing demand for child care. 

 

- Pricing power - the company is able to raise prices pretty much every year without fail.  Once a child starts going to a BFAM facility, parents are very reluctant to change the routine simply based on price.  Especially because typically, the child is only there for a few short years - most parents are willing to eat price increases to keep continuity in a child's life, because they know that it's temporary (ie. they start regular school by the age of 4 or 5).  Demand has been, and should continue to be high enough for the market to bear steady price increases.

 

 

Overall, to me this has all the makings of a phenomenal business.  Strong macro drivers, incredible pricing power, exceptionally high demand with very little commercial competition, a market ripe for consolidation, etc.  Valuation is where I get hung up, but if we assume the current growth rate can be maintained through the millennial child boom, the company should be worth much much more a decade from now.

 

Does anyone have any thoughts? Would love to get feedback from others.

[GregS]

My questions would be this:

 

What advantage does scale provide in an industry dependent on local reputation and connections, and low barriers to entry?

 

Related, what benefit do they provide in a roll up scenario?  In other words, if they pay fair prices for a center, where do they extract the additional value and increase returns? 

 

I'm skeptical that BFAM can really buy up centers and increase returns by cutting costs because they can centralize corporate functions.  Small centers won't have big corporate expenses.  Regional companies are not going to sell out at bargain prices.  Rent and wages will be the same.  I'm also skeptical a national brand will mean much of anything in day care.

 

That said, they can certainly raise cheap capital to expand rapidly with macro tailwinds.  But you have to watch how much you are paying for that growth.

[glorysk87]

The benefit of scale is the ability to sign large scale contracts with employers.  If you're an employer with employees in 15 states, you can't offer childcare services as a benefit unless the company you contract with also has a presence in all 15 of those states.  One off local shops simply don't have the breadth to serve this type of customer.

 

In terms of a roll-up scenario...I never said they'd extract additional value from an acquired center.  It's simply added to their portfolio and is a form of external growth.  But do keep in mind that every center they add contributes to the compounding return of the portfolio as they're able to drive price increases across a wider store base.

 

I don't think the thesis is at all predicated upon BFAM being able to increase returns.

[KJP]

The benefit of scale is the ability to sign large scale contracts with employers.  If you're an employer with employees in 15 states, you can't offer childcare services as a benefit unless the company you contract with also has a presence in all 15 of those states. 

 

Is that right?  Why can't an employer offer employees a childcare benefit in the form of a voucher that can be used at any daycare provider?

 

Also, I'm a former Bright Horizons customer who did switch because a new daycare center opened in a much more convenient location.  The new place is also half the price of BH.  We were concerned about disrupting our toddler's routine, but actually like the new place more, particularly because our child's two "teachers" are there every day.  At BH, the same people were not there every day.  This is purely anecdotal, so take it for what it's worth.  But the experience did suggest to me that the company lacks any real competitive advantage, at least in the non-corporate market, and there are few, if any, barriers to entry in the business.  So, if you're paying 30x earnings, you really must be convinced that there are major competitive advantages in the corporate market that will lead to outsized returns for quite a long time.

 

Also, the business is quite capital intensive because of all the space it needs to operate.  Based on your description, I assume the company funds most of its capital needs through operating leases, which create significant operating leverage.  What happens if there's a significant downturn that pushes unemployment up significantly?  Although the demand for third-party childcare is pretty inelastic when both parents are working, I imagine it's one of the first expenses to be cut when one parent loses his or her job.

 

[glorysk87]

Anecdotal evidence even in a one-off basis is helpful. Thanks for the feedback.

 

The valuation and the operating leases were both mentioned in my initial post, so those have been contemplated, and are the main negatives to the investment case.

 

I'm not currently invested in BFAM, mostly because I wasn't keen on paying 30x earnings, so I mostly agree with you. I just wanted to get other opinions to see if there was anything I was missing.

 

I do think that the macro drivers are going to be staggering in the next 10 to 15 years. The millennial generation is just now beginning to enter the phase of having kids, and seeing as it's by far the largest generation it will be a massive tailwind. So that part is compelling.

 

I think my strategy will be to simply wait until BFAM goes on sale (if it ever does).

[glorysk87]

BFAM finally cracked this morning, on tepid-but-not-terrible earnings. I still think it's too expensive. I have a soft buy target of $50 at which point I think it's worth looking at more seriously.