Bright Horizons Family Solutions: Recovery Already Priced In

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Investment Thesis

Although we see a gradual recovery after the lockdown, Bright Horizons Family Solutions (NYSE: BFAM) is still far from its pre-pandemic conditions. The staff problem will put pressure on the company’s margins, and revenue will recover to pre-pandemic levels only by 2023. The company’s balance sheet has also weakened during the pandemic. Even despite the solid buyback, we expect ROA and ROE to be far from pre-pandemic levels by the end of the year. Nevertheless, the company is already trading at the level of 2019, although its revenue and profitability are still significantly lower. According to our assessment, BFAM trades at a premium to our estimate of fair value. We rate shares as a Hold.

Company Profile

Bright Horizon Family Solutions specializes in child care and early education services; in addition, the company provides consulting services on admission to schools, colleges, and universities. The business is focused on working people who can use the services both directly and through an employer – since BFAM has an extensive network of centers open at the offices of large companies. For example, specialized centers are open at AT&A, Samsung, Unilever, and many others. The list of Bright Horizon services is as follows:

  • Early Education and Preschool for Families. This segment includes Infant Care, Toddler Care, Preschool, and Kindergarten services.
  • Family Solutions for Employers. In this segment, the company provides On-Site Child Care, Back-Up Care, Elder Care, and College Coach services.
  • EdAssist – Solutions for Employers. It includes Workforce Education and Student Loan Support.

The company provides its services both directly to parents (B2C) and through employers (B2B). As of Q3 2021, there are more than 1300 corporate clients, of which 190 companies are included in the Fortune 500 list. Contracts with B2B clients are designed for 3-10 years, due to which BFAM generated a stable cash flow before the pandemic.

The company operates in North America (USA, Canada, and Puerto Rico), Europe (the Netherlands, UK, and India). The revenue structure is presented below:

pie chart of BFAM revenue structure by segment and geo

Created by the author

Industry Overview

The child care market is very stable, and only macroeconomic and demographic changes can affect it. During the pandemic, there was a redistribution of demand relative to Bright Horizons services. Due to the lockdown, home care services and consulting services have become in demand. When restrictions were partially lifted, parents actively used the services of nannies. Due to Backup Core services, the company has reduced the impact of COVID-19 on business. However, the bulk of BFAM’s revenue comes from full services.

According to the US Department of Labor, there are about 45% of families in which both parents have permanent jobs. Of this 45% of families, more than half (60%) have at least one child. Child-care is a sustainable market estimated at $ 58.6 billion by 2021 and is expected to grow at a CAGR of 3.9% by 2027.

Bar chart of US child care market size

Grand View Research

The target market is highly fragmented; Bright Horizons, with a share of about 4-5%, is one of the largest players in the industry and competes with 600 thousand companies. Due to its strong competitive positioning, BFAM can maintain sustainable growth in the long term, especially in the B2C segment.

Financial Performance

Before COVID-19, the top line grew at a CAGR of 10%, but in 2020 revenue fell by 25%. However, BFAM is recovering quickly after the pandemic. As of Q3 2021, BFAM has already opened 95% of all its institutions, and its services continue to be in demand. According to management, at the moment, they cannot cover the demand for about 3-4% of the current revenue. By the end of 2021, revenue is expected to grow to $ 1.75- $ 1.77 billion (about 15% YoY).

Historical bar chart of BFAM revenue

Created by the author

According to the results for nine months of 2021, the gross margin almost recovered after 2020 to 23.8%, largely due to participating in government support programs, including availing certain tax deferrals, tax credits, and federal block grants funding in the United States. Due to the support, BFAM has reduced labor costs by $ 32.2 million.

BFAM historical margins line chart

Created by the author

Despite the support from the government, in the last reporting period, BFAM faced a shortage of staff and, as a result, an increase in wages. It is expected that due to a shortage of staff, margins will be under pressure at least until Q3 2022.

Bright Horizon’s balance sheet has also weakened significantly due to COVID-19, Net Debt / EBITDA is 8.3x, with a coverage ratio of 1.5x.

BFAM Net Debt to EBITDA chart

Created by the author

The current return on assets remains significantly lower than it was before the pandemic. In the near term, ROA is likely to be under pressure due to staff issues. In December 2021, management announced a new $ 300 million buyback. According to our calculations, with an unchanged balance of liabilities, the asset-to-equity ratio after the repurchase will be 3.6x, and the ROE, other things being equal, may reach 6.5%, which is still significantly lower than in 2019.

BFAM ROA and ROE chart
Data by YCharts

Thus, although we are seeing a gradual recovery, BFAM is still far from its pre-pandemic conditions. The staff problem will pressure the company’s margins, and revenue will recover only in 2023. The company’s balance sheet has also weakened during the pandemic. Even despite the solid buyback, we expect ROA and ROE to be far from pre-pandemic levels by the end of the year.

Valuation

Our DCF model is not conservative. We expect revenue to grow in line with the Wall Street consensus, with a subsequent slowdown in the growth rate to a pre-pandemic average of 10%. Although the growth potential in the B2B segment is exhausted mainly due to many Fortune 500 companies are already in the client list, we expect BFAM to maintain this growth rate until the end of the forecast period. Although margins are likely to be under pressure at least until Q3 2022, in our model, we assume that the indicator will recover in 2022. Other relative indicators are predicted based on historical dynamics and the current trend. The terminal growth rate is 5%, which is also quite bold, since the average population growth in the US since 2010 is 0.7%, and the Fed’s inflation target remains at 2%. Our assumptions are presented below:

BFAM financial projections

Created by the author

Based on our assumptions, the expected dynamics of key financial indicators are presented below:

BFAM expected dynamics of key financial indicators

Created by the author

With the cost of equity equal to 10%, the Weighted Average Cost of Capital [WACC] is 8.1%.

BFAM Weighted Average Cost of Capital

Created by the author

With a Terminal EV / EBITDA of 17.67x, our model projects a fair market value of $ 5.9 billion, or $ 98.4 per share. The company is trading at a 29% premium to our estimate of fair value.

You can see our model here.

Bright Horizons does not look cheap by multiples, and trades more expensive than peers. It is noteworthy that the company used to trade on a similar EV / Sales before the pandemic, so the market has already included the restoration of profitability of the business in the price, which has not yet happened.

BFAM CHGG LOPE GHC HMHC
P / E 111.3x NM 14.6x 5.8x NM
EV / EBITDA 38.9x 28.6x 7.9x 8.6x 10.6x
EV / Sales 5.3x 5.6x 2.8x 1.0x 2.5x

Source: SA

Conclusion

Bright Horizons is the leader of one of the most sustainable industries, which has suffered significant losses due to the pandemic. Although revenue is expected to recover only in 2023, and margins are under pressure due to a shortage of personnel, the shares are trading at the level of 2019. In our opinion, the market takes into account the recovery in the price, which will not happen until next year. According to the EV / Sales multiply, the company is trading at the 2019 level, although its revenue and profitability are still significantly lower. According to our assessment, Bright Horizons is trading at a premium to a fair price. We are neutral on BFAM.



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