2014 FIIG Securities Limited ABN AFS Licence No

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1 Executive summary (GEM) is Australia s largest publicly listed operator of childcare centres with 234 childcare centres in Australia at the end of FY13 Despite being the largest private operator in the sector GEM only maintains 4% of the total market providing scope for further expansion in what is a largely fragmented market GEM has adopted a disciplined acquisition growth strategy similar to the strategy successfully implemented by S8 Ltd where a number of GEM s senior executives and board members also held positions. In addition to this, we take comfort in GEM s acquisition history to date and public undertakings of the company Key financials ($m) FY13 to 31 Dec 2013 Revenue EBITDA 52.5 EBIT 49.4 NPAT 31.1 Total debt Total debt/ebitda 2.2x EBITDA ICR 11.0x GEM operates a multi-brand strategy which allows centres to operate largely autonomously, whilst overlaying the group s corporate disciplines across the portfolio GEM has a strong equity base with current market capitalisation of circa $1 billion. GEM has historically funded itself through the equity market and in addition has now accessed the bond market twice through FIIG. As a result of the continued equity raisings, GEM maintains a moderate level of gearing. With a significant cash balance at year end, post this issue net gearing will still remain at a consistent, manageable level The fundamentals of the Australian child care sector remain very strong with government spending on the sector continuing to increase over recent years and the provision of child care services is now a central tenet to policy outcomes The demand for child care services is rather price inelastic with demand from higher income demographics very strong whilst lower income households enjoy a higher level of government support $ Total Revenue 1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 The key risk for the child care sector is the performance of the overall economy. A significant and prolonged increase in the unemployment rate would have a negative effect on demand $ EBITDA Investors in the senior unsecured bonds rank behind the secured bank lender, however have protection through covenants specific to the unsecured issue as well as covenants present in the secured bank facility Offering a floating rate of return paid quarterly in arrears of 90 day BBSW %, the bonds provide investors the opportunity to diversify their fixed income exposure into a key sector of the economy whilst earning an attractive floating rate of return H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 1 of 17

2 Background (GEM) was formed through the merger of Early Learning Services (ELS) and Payce Childcare Pty Ltd (PCC) in March ELS was listed on the ASX and operated 38 centres, while PPC, owned by Wallace Infrastructure (75%) and listed property development company Payce Consolidated (25%), operated 60 centres (including 29 managed). GEM s business model is as a consolidator and operator of childcare centres. GEM currently has a portfolio of 234 childcare centres in Australia and a controlling interest in 18 childcare centres in Singapore. The post ABC Learning environment has resulted in the childcare sector in Australia being highly fragmented and as such GEM is the largest private operator, yet accounts for less than 4% of the market. 300 Childcare Centre portfolio H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 Source: FIIG Securities Australia Singapore The board and senior management team of GEM have a strong track record of acquiring, integrating and operating cost sensitive businesses. Chris Scott (GEM Managing Director) was previously the founder and Chief Executive Officer of S8 Ltd. Jenny Hutson and Andrew Kemp (GEM board members) were board members of S8 Ltd. Prior to being acquired by MFS in late 2006 for over $700m, S8 Ltd successfully integrated 36 acquisitions over a 5 year period to operate an integrated travel business with over 2,300 travel outlets under brands such as HarveyWorld Travel, Gulliver s Travel and Zuji. Key factors to the success of S8 Ltd including a disciplined acquisition strategy, a keen focus on improving operational metrics and managing costs in a labour intensive business are directly applicable to the GEM operating model. Operations GEM maintains a multi-brand strategy for its centres rather than going to market with a single corporate identity which ensured the individual centre customers maintain a largely seamless transition once a target has been acquired and also limits and contagion risk across the centre portfolio. GEM child care services brands include: Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 2 of 17

3 Post ABC Learning (ABC) there are few large private child care providers and as such GEM, with 4% of the market is the largest private provider. The largest provider of child care services in the Australian market is Goodstart Early Learning, a not-for-profit (NFP) provider which took on the major share of the former ABC centres. NFPs are a significant provider of child care services in Australia, which comes with both positives and negatives for GEM. The positive is that the NFPs are unlikely to become competitive bidders in the acquisition market, the negative being the preference for NFP service provision by some parents though ultimately the provision of quality services in a convenient location is the key driver of centre choice. Since we began covering GEM, Affinity Education Group (Affinity) has listed on the ASX with a similar child care centre aggregation strategy, however Affinity is considerably smaller than GEM, and the disaggregated nature of the child care sector in Australia means that Affinity will add very little competitive pressure for the acquisition of centres in the short to medium term. Over the previous four years GEM have acquired a number of centres growing from the 68 centres at the merger of ELS and Payce to the present where they own 252 centres and operate 48 franchises (in Singapore). GEM s acquisition strategy has been to buy profitable centres which are in operation (as opposed to greenfield sites built by developers) and to integrate them and manage a number of key operational metrics and performance indicators to lift individual centre performance in line with the overall group. By acquiring only operating centres they are able to remove a considerable amount of occupancy risk which would be present in greenfield sites as well as removing any construction risk. The model under which the Singapore franchise centres operate is simply a fee for service (the running of the centre) and as such is a low risk operating model, however we do not expect major expansion from GEM into this franchise model. The Singapore business is run out of the Singapore office and represents ~10% of total company EBIT (Earnings Before Interest and Tax). Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 3 of 17

4 Centre portfolio Centres FY10 FY11 FY12 FY13 Early Learning Services Payce Local Kids Kindy Patch Head Start Kids Corner Educare 6 6 Casa Bambini 3 3 Little Einstein 7 7 Pacific Group First Grammar 10 Individual acquisitions Australian owned Singapore owned Singapore franchises Total owned Total group Source: Company; FIIG Securities Centre operations Whilst the company maintains a number of core child care brands, the individual centres maintain a largely autonomous operation; centre directors run the curriculum for the individual centre (within National Quality Standards), teachers are free to teach as they see fit, the choice of capital expenditure, including the provider, is at the centre s discretion (but within preset quarterly budgets and within approval levels which progress up the corporate structure) and importantly, the look of each centre is individual avoiding a corporatized look across the portfolio. Each centre operates the Qik Kids software, a standardised child care management software programme from a third party supplier which is extensively used across the Australian child care sector and which directly interfaces with the government to ensure timely payment of fees, resulting in little working capital requirement to fund growth. Each Friday the centre director submits the centre attendance for the week via the Qik Kids software and the government pays its portion of the child care cost directly to GEM. The Child Care Benefit (CCB) covers up to 45% of child care fees with the parents responsible for the remaining 55%. Parents may then be eligible for the Child Care Rebate (CCR - up to $7,500 for 50% of the gap fee) further lessening the actual parental outlay for child care services. The CCB is linked to CPI and reviewed at budget time each year. We note that the CCB was not changed in the recent budget despite the government looking for significant cost savings. The centres review their fees twice annually (July and January) on a centre-by-centre basis and are not restricted to rises only in line with CPI. Whilst centres set their own fees, GEM generally prices around the middle of the market. The group maintains a one week in advance fee policy for parents, with some flexibility at the centre director s discretion, however we note GEM maintains a very low level of bad debts $423k in the 2013 financial year on $275m in revenue) and this low level has remained fairly consistent year-onyear, demonstrating good internal controls over debtors balances and collections. Each Monday the centre director submits a KPI report monitoring key operational metrics on occupancy, wages, revenue and parental debt with a formal management reporting structure progressing the report up via operations managers, senior operations managers and finally to the general manger of operations ensuring that while centres maintain Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 4 of 17

5 autonomy, that they are closely managed. All staff along this reporting line are incentivized to ensure centres are meeting group expectations of operational and financial performance. The group is well placed to meet the requirements under the Federal government s National Quality Framework with the majority of centre directors former teachers meeting the education requirements of the framework and as of January 2012 all centres were (and remain) fully aligned with the new staff to child ratios. The majority of centres operate under a standard lease of 10 yrs with two five year options in GEM s favour. No centre has a lease that will be up for renegotiation over the maturity of the note issue. Corporate strategy As noted above, GEMs corporate strategy is one of consolidation via acquisition of profitable centres and their associated cashflow stream with the number of centres growing significantly since listing in Key to this strategy is the company s maintenance of acquisition discipline ie. the price they are prepared to pay for centres. GEM have noted publically a number of times that the company will not pay not more than 4.0x EBIT for acquisition targets. Additional comfort for investors is drawn from the covenant package of the notes which provides protections around the level and quantum of secured and unsecured debt that GEM will be able apply to acquisitions over the life of the notes. GEM s historical discipline regarding acquisitions is demonstrated in the table below and is borne out in the company s ASX announcements on acquired centres. Acquistion and EBIT multiples Date Number of centres EBIT ($m) Price ($m) EBIT Multiple 10-Feb-14* Sep Aug Jun Jun May Apr Apr Dec Nov Oct Oct Oct Aug Feb Dec Dec Jan Source: Company releases; FIIG Securities * Transaction announced. Expected update 30 April 2014 Upon completion of the acquisition, GEM then integrates the centres into the groups existing portfolio, ensuring the centres meet with GEM operational metrics. Initially this focuses on ensuring key costs are within the groups expectations for comparable centres and once this has been implemented applying the group s marketing staff to drive occupancy for the centres up to group expectations. The group has a strong track record of bringing acquired centres up to the group level which helps underpin the growing EBIT and strengthening EBIT margin of the company. Any centres Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 5 of 17

6 which are unable to meet the group expectations or are not a good strategic fit (usually because an individual centres geographic location makes it inefficient to include in the portfolio) are divested, usually to an individual or small operator. The group does not have any set acquisition quota forecasts, rather accesses potential acquisitions as they arise. To date, the company s acquisitions have been largely funded by equity, FIIG s previous bond raising and internal cash generation and the company has also adopted earn out strategies for many acquisitions. Gearing remains moderate as a result of frequent equity raisings. Shareholders have continued to support the group both through the dividend reinvestment plan and through ad hoc equity issues including $80.6m raised in October 2013 (since the previous FIIG Securities fixed rate bond originated deal) through the company s institutional investors. Equity raised since merger Date The group does not develop its own centres, nor enters into transactions with developers for greenfield centres which limits any construction, start-up or occupancy risk for the group and maintains the focus on operating purely as provider of child care services. As a function of operating in the post ABC environment, a high level of attention is applied to Corporate Governance policies and actual or perceived conflicts of interest at GEM. For example, the company does not undertake any related party transactions as a matter of policy. We expect the continued high standards that are demanded from the investor community around these issues to continue. Child care sector Number of shares '000'000 $ 000'000 Date Number of shares '000'000 $ 000' Apr Jul May Jul Jun Feb Aug Feb Sep Apr Sep Jun Oct Jul Oct Oct Dec Nov Feb Nov Part consideration 18-Mar for acquisition 11-Jan Apr Feb Apr Apr Oct Total Source: Company, FIIG Securities The child care sector has become increasingly central to the greater Australian economy with two income and single parent families driving increased demand for long day care services. The provision of day care is a central tenet of policies well beyond childhood education, with workplace participation in particular underpinned by a functioning child care sector. Reflecting the importance of the sector is the increase in government expenditures on early childhood education and care in recent years with over $6bn spent collectively by governments in the 2012 financial year (the most recent year with published numbers). Whilst expectations are the overall funding of the sector will continue to increase, there remains Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 6 of 17

7 political risk in the sector, though demand for services remain somewhat inelastic demand is highest where daily rates are highest (high income families which may be caught by the introduction of any means testing of benefits will not see parents leaving work to care for their child) and at the lower end, as family income decreases, government benefits increase. Only a major jump in long term unemployment numbers would have a significant effect on the sector. 7,000 6,000 5,000 Total government expenditure ($m) % of population attending child care 4,000 3,000 2,000 1,000 - FY06 FY07 FY08 FY09 FY10 FY11 FY12 Source: Report on Government Services 2013, Total government expenditure on early childhood education and care 2012 dollars; FIIG Securities years 1 year 2 years 3 years 4 years 5 years NSW Vic Qld WA SA Tas ACT NT Source: Report on Government Services; FIIG Securities Levels of attendance in the sector are relatively stable with the weakest market being children of less than one year where only 10% of the population attend child care. Attendance as a % of population grows over the next two years before dropping off as children age into school attendance. The industry fundamentals for child care remain positive with the absolute number, and percentage of children aged 0-5 years increasing over recent years as shown in the graph on the left below and the number of long day care places growing at a slower rate over the same period (the graph on the right below). This combination should drive continued high occupancy rates for existing centres with existing children outpacing places year on year. Proportion of children attending childcare Change in Long Day Care places 1,500 1,450 39% 37% 25,000 20,000 10% 9% 8% 1,400 1,350 1,300 1,250 35% 33% 31% 29% 27% 15,000 10,000 5,000 7% 6% 5% 4% 3% 2% 1% 1,200 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY yr olds ('000) Proportion attending (RHS) 25% - FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 Additional LDC places Change pcp (RHS) 0% Source: FIIG Securities; Report on Government Services; Petra Capital Source: FIIG Securities; Report on Government Services; Petra Capital Attendance is also seasonal with occupancy rates building up from the start of the year, as parents return from holidays in January and new attendees gradually enter child care, and as such this first quarter of the year is where GEM focuses the majority of its marketing efforts. The company employs a number of marketing and fee initiatives to attract and keep attendance rates up and due to strong record management the company is able to spot any occupancy deficiency early and act to redress any issues. School holiday periods do not generally relate back to a drop in fees as parents maintain payment through these periods to ensure they hold their child s place at the centre. There is a mix of providers of child care services across Australia including community or NFP managed centres, privately owned, ASX listed (including GEM), government managed and services provided by non-government schools as shown in the table below. The sector remains very fragmented post ABC with GEM the largest provider holding just Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 7 of 17

8 4% of the market. Goodstart Early Learning, a NFP, is the largest provider of child care in Australia operating 655 former ABC centres. Child care management by type (%) Latest trading results NSW Vic Qld WA SA Tas ACT NT Community managed Private Non-government schools Total non-government Government managed Total Source: Report on Government Services 2013; FIIG Securities GEM revenue and earnings continue to grow since it was first formed as would be expected with the companies centre accumulation strategy. The maintenance of a disciplined approach to acquisitions going forward should continue to see improvements in the headline numbers. This growth has continued over the last year that FIIG has covered this issuer. Total revenue grew 53% over the last 12 months to $275.2m with EBIT growing 68% to $49.4m reflecting the company s ability to deliver on its EBIT accretive acquisition strategy over the last year. Since 2010, the underlying compound annual growth rate for revenue and EBIT are an impressive 43% and 64% respectively. The outstripping of revenue by EBIT is reflective of management s ability to add value to acquisitions through applying the group s administrative and operational disciplines to newly acquired centres. Profit and loss $'000 (Y/E 31 Dec) Child care sales 270, , ,157 65,249 Mgt fees and royalties 1,872 1,851 1, Interest 2,039 2,368 1, Other , Total revenue 275, , ,899 66,549 Employee costs 159, ,311 82,802 42,307 Occupancy 33,323 22,800 18,390 8,252 Total expenses 222, , ,115 58,545 EBITDA 52,518 31,936 26,784 8,004 EBITDA margin% 19.1% 17.7% 18.7% 12.0% Depreciation and amortisation 3,129 2,530 1,901 1,137 EBIT 49,389 29,406 24,883 6,867 Financial costs 4,790 2,538 2,188 1,318 Profit before tax 44,599 26,868 22,695 5,549 Tax 13,527 7,660 5,444 2,069 Net income 31,072 19,208 17,251 3,480 Source: Company; FIIG Securities Margins were also improved by the acquisition of some higher margin premium centres during the year, organic growth within existing centres and the mix of places within the company s portfolio. At financial year end 2013 the company maintained a moderate level of debt bank debt and $70m in the previous senior unsecured notes) giving rise to a gearing ratio (Debt/ Debt + Equity) of 27.3%. We note that the net gearing calculation Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 8 of 17

9 (which would include the substantial cash of $114m) would be significantly lower, however FIIG expects a substantial portion of this cash to be utilised for the centre acquisitions announced on 10 (in conjunction with the proceeds of this note). As noted above the company has funded its acquisitions to date through a mix of equity funding, debt and operational cash flows. This is borne out in the graph below which shows the sources and uses of funding from the cash flow statement over the last four years. $m 250 Uses of cash flows Dividends paid CAPEX Acquisition of businesses Net proceeds from borrowings Net proceeds from equity issues Net cashflow from operating activities FY10 FY11 FY12 FY13 Source: FIIG Securities The graph notes the $198m net proceeds from equity issues undertaken over the past three years as well as the significant level of operating cash flows above dividends, reflecting the cash contribution applied to funding acquisitions over this period as opposed to returns to shareholders. The $119m raised from equity in FY13 includes the $80m raised in October last year post the previous FIIG originated fixed bond to continue to fund the company s expansion. Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 9 of 17

10 Senior unsecured bond issue and structure Senior unsecured bond offering Summary terms Issuer Offer size Ranking Minimum parcel size Face value of each Note Maturity date Issuer call option Bondholders will benefit from an incurrence based covenant package. The covenants below should be read in conjunction with Clause 5.1 and Clause 5.2 of the Conditions section of the Preliminary Information Memorandum. The covenants offer investor protections in three primary areas: Negative Pledge G8 Education Limited (unrated) Up to A$50 million Senior Unsecured A$50,000 A$1,000 March 2018 (four years) March $103 March $ Change of control Investor has option but not obligation to put the bonds back to the $101 Interest rate Covenants Event of default Floating rate Interest will be 90 day BBSW plus 3.90% p.a. paid quarterly in arrears Yes (see below) Source: Preliminary Information Memorandum Failure to pay (i.e. non-payment of interest or principal on bank facility or senior unsecured bonds) Unrectified breach of senior unsecured bond covenant breach Cross-default to existing secured lender's covenants a) Subject to paragraph (b) below, the Issuer will not (and will ensure that any Guarantor will not) create or permit to subsist any Security Interest upon the whole or any part of its (or the Guarantor s) present or future assets or revenues other than a Permitted Security Interest. b) The Issuer or a Guarantor may create or permit to subsist a Security Interest (which is not a Permitted Security Interest) or a Security Interest may also be created or permitted to exist if, at the same time, either the same Security Interest as is granted by the Issuer or a Guarantor or such other security: i. securing the Issuer s or Guarantor s obligations to the Noteholders, equally and rateably in all respects so as to rank pari passu with the applicable Security Interest; or ii. as shall be approved by the Noteholders pursuant to the Meeting Provisions, is also granted in favour of the Noteholders in a manner that is satisfactory to the Trustee. Limitation on Debt Incurrence a) The Issuer will not (and will ensure that any Guarantor will not) incur or permit to subsist any new Financial Indebtedness after the Issue Date, unless, after giving pro-forma effect to the incurrence of such Financial Indebtedness and the application of the proceeds thereof, the Interest Cover Ratio is greater than 3.50:1. Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 10 of 17

11 Restricted Payments to Equity b) The Issuer will not (and will ensure that any Guarantor will not) declare or pay any dividend or make any other payment or distribution having the same effect ( Distribution ), or reduce, return, purchase, repay, cancel or redeem any of its share capital or buy back any of its shares ( Capital Reduction ) under Chapter 2J of the Corporations Act (or an equivalent provision under any legislation in another jurisdiction applicable to that Guarantor) except: i. where the recipient of the proceeds of such Distribution or Capital Reduction is the Issuer or a Guarantor; or ii. where the source of the funds to effect such Distribution or Capital Reduction has not been raised by way of Financial Indebtedness (or in a transaction or series of transactions having substantially the same effect), provided that, in any case, such Distribution is no greater than an amount lawfully permitted under applicable law. So long as an Event of Default is subsisting, the Issuer will not declare or pay a dividend or make any Distribution on any issued share in the Issuer, or pay any interest or other amounts in respect of any debt security issued which ranks behind the Notes in priority for payment of interest. Bondholders also benefit from cross default to existing bank covenants which include a Leverage Ratio and Interest Cover Ratio. The protection offered by the covenant package has a twofold benefit for bondholders. Firstly, collectively they ensure that GEM will have to balance its sources of capital when undertaking its acquisition strategy. The Negative Pledge set at a level below the publicly stated and historical average acquisition multiple means that GEM will not be able to debt fund its growth forecasts and will be required to utilise retained earnings and equity markets in addition to debt. We believe this is a prudent and appropriate protection for bondholders. Secondly, the covenants work to ensure the majority of the cash generated by GEM is kept within the business structure. Additionally, the senior nature and guarantee structure in place for the bonds means bondholders rank alongside regular creditors in a wind-up scenario. The senior secured lender receives a priority payment only in the event and all ongoing obligations for payment of coupons and principal are pari passu and will incur an Event of Default if not paid. The Information Memorandum contains the full terms and conditions, including the full covenant package for the offering for investors to review. Strengths With any acquisitive business, maintaining acquisition discipline is a key factor in the business sustainable success. GEM have displayed this discipline with its acquisitions to date which have been within their not more than 4 x EBIT mantra whilst investors will also gain some comfort from the discipline displayed by a number of the senior team when holding the same positions with S8 Limited and the companies public position on its acquisition multiple position. Further comfort for bondholders is found in the covenant package that will ensure that GEM will have to balance sources of capital to continue to fund its growth. GEM maintains a close watch on the performance of all its centres (at a centre level) with performance incentives in place which feed up the management line ensuring all centres are monitored against key performance benchmarks. These benchmarks are kept very simple at the centre level (concentrating on occupancy, wages and revenue against budget as well as wages as a % of revenue and parental debtors) to ensure they are easy to manage, monitor and rectify where necessary. GEM maintains a moderate level of leverage for a company of its size. Even allowing for debt raised under this issue the company will maintain a moderate level of gearing. Further, the company shareholders have shown an Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 11 of 17

12 Risks ongoing propensity to provide equity support for the acquisition of additional centres as the need arises. Any further equity raisings over the life of these notes would serve to improve the level of gearing. Childcare and early childhood education is central to a number of key government policies (from both sides of politics) both in relation to childhood services and broader economic goals such as increased workplace participation. The importance of the sector to all levels of government is underlined by the $6 billion in Federal and State government expenditure on care and education in the 2012 financial year. The support of governments for the sector has made it an important basic pillar underpinning our economy which provides investor comfort that support for the sector, and in turn its key players will be ongoing as the Australian economy and families become increasingly reliant on the sector to achieve other broader goals. GEM is the largest private operator of childcare centres in a fractured Australian sector and the company maintains significant liquidity and ongoing shareholder support which places it in an enviable position when it comes to acquiring centres. As there is limited competition in the centre acquisition market from private managers and as well as limited appetite from the not-for-profit sector, GEM is able to cherry pick centres that both perform and fit with the company s existing centre portfolio. Despite being the largest private operator, GEM still only holds 4% of the market and this, combined with its successful multi-brand strategy ensures the group does not suffer negative sentiments around corporate childcare which may be the case with a larger single brand strategy. The fundamentals of the childcare industry remain very strong. Statistically Australian families continue to move towards two income households which helps drive the demand for childcare services and demographic fundamentals (including the ongoing baby boom following the introduction of the baby bonus) also remain a positive for the sector. The provision of child care is largely price inelastic in the modern Australian economy. An increase in fees above CPI is unlikely to have any effect to the parents decision to send, or not to send a child to day care. This is a result of the significant contribution governments make to funding (the ultimate change in any fee per child to the parent is small post government funding is applied), and the attachment parents and their child feel towards the individual providers of the care ie. the child care worker who has the direct relationship with their child. Further, any fee increase is unlikely to result in the removal of the child from care as most children in long day care are in place due to work commitments of the parents. Engaged shareholder base which has raised equity on a number of occasions historically to fund the acquisition of further centres. Whilst the addition of this funding should cover growth for the immediate future, we could expect to see further shareholder involvement in any growth which goes beyond the existing funding capabilities. The performance of individual child care centres is largely driven by occupancy rates. These rates are affected by the performance of the overall economy, and in particular unemployment rates. When unemployment rises significantly and for the longer term, occupancy levels can be expected to drop as one or more parents are in the home to provide child care. Offsetting this is the diversity of GEMs centres which are across several states and servicing various socio-economic and employment markets. As noted above the childcare industry enjoys significant government funding. Whilst this is a positive for the industry, it comes with the risk of a change in government priorities resulting in lower levels of funding. This risk is somewhat mitigated by the bi-partisan support to the basic principles of the funding of childcare through the Child Care Rebate and Child Care Benefit and the importance of the sector to the ongoing performance of the broader Australian economy. Along with the significant government support in the form of funding comes significant government regulation, changes to which can affect the performance of individual centres and the industry as a whole. The management, operational performance and business structures in place at GEM give investors some comfort in Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 12 of 17

13 the company s ability to deal with any changes in regulation. Further, any changes which significantly affect the financial performance of GEMs operations will be passed through to parents in the form of higher fees. Due to the importance of safe, affordable child care to the modern Australian family, and the growing view of it as an essential service of government to support the care and education of pre-school children the sector has become increasingly politicized over recent years. However we note that broadly the sector enjoys bi-partisan support and the industry, and its funding, is significantly embedded in the modern Australian economy. The child care industry is labour intensive, and while the industrial environment is largely benign, changes to the labour cost structure can have a negative impact on the financial performance of the industry. However, as with regulatory changes, any significant deterioration in profitability will likely result in an upward review of daily child care rates being passed through to parents. The close bond parents have with the individuals providing care to their child does provide the opportunity of parents moving centres with carers who chose to leave, however GEMs staff turnover rates remain low compared to the rest of the corporate sector. Incidents of centres stealing staff (and thus children) through higher pay offers are rare in the sector. The barriers to entry for the child care sector are relatively low which may lead to increased competition over time. In particular, the last year has seen the listing of Affinity Education Group, GEMs most direct ASX listed competitor. We note however that given the relatively small market share of both providers and the fragmented nature of the sector, there should be continued equity support for more than one listed child care provider. Conclusion GEM is a growing business in the largely fragmented market of child care services. With management s strong track record, both through previous GEM acquisitions and senior management s actions at S8 Ltd we expect this growth to continue in a sustainable way over the life of the bond. Maintaining a moderate level of debt, a good history of shareholder support and the acquisition discipline displayed by the company we expect to see the strong financial performance of the group underpin the ongoing performance of these bonds. Paying a floating rate of return of 90 day BBSW % for four years (with the potential to be repaid after two or three years at above par), the GEM senior unsecured floating rate bonds offer an opportunity for investors to lock in a high floating rate of return whilst diversifying into a very important sector to the modern Australian economy. Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 13 of 17

14 Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 14 of 17