The ABC Learning Collapse: Essay On Deficient Strategy And Risk Mitigation Omission.

In the year of 1988, ABC Developmental Learning Centres’, commonly known as ABC Learning, was established by Eddy Groves and his wife, Le Neve. In the same year, the company commenced its humble journey and it soon developed to become an international company famous in providing developmental and educational care for children, around the world. The initial growth of the company was in Australia, and then it started to expand beyond boundaries into New Zealand, the United Kingdom (UK) and the United States of America (USA) (Mitchell, 2020).

The company was enlisted in the Australian Securities Exchange (ASX) in 2001 and it success started to grow following that. By the year 2003, there were 43 childcare centres of the company in Australia alone. Following its listing in the ASX, the company commenced expanding exponentially through different types of mergers and acquisitions. In 2006, the company completed the acquisition of La Petite, the second largest childcare in the USA, and Busy Bees Group Ltd, the fifth largest childcare in the UK, which made it 15 times larger than its Australian business (Gallagher, 2017).

During April 2008, the company was forced to sell its childcare business of the USA to Morgan Stanley, and it used the proceeds from this sale for paying off the accumulated debt (Vaccari, 2018). It was put into receivership in October 2008 because of the lack of profitability of 40% of its centres. The company went into voluntary liquidation in November 2008 as the company was handed over to the administrator by its Board of Directors. It implies that there were many reasons which contributed to the collapse of a successful company like ABC Learning (Vaccari, 2018).

The main aim of this report is to investigate the major issues associated with the collapse of ABC Learning. The report specifically focuses on two key aspects associated with the collapse: deficient business strategy or rapidly expansion strategy, and omission of business risk mitigation. While discussing about these major issues, this report incorporates key auditing concepts in the discussion, such as risk-based auditing approach, auditing standards, auditing concepts and others.

The whole report is divided into certain key parts. The first part of the report introduces the topic by providing necessary information on ABC Learning collapse. The detailed methodology adopted to conduct the investigation of the collapse is discussed in the second part. The third part represents the findings of the report. This part includes the details on the reasons that contributed to the collapse of ABC Learning. The fourth part discusses about the implications of the findings. The last part provides the conclusions and recommendations based on the whole report.

Methodology can simply be regarded as the regulations, rules, patterns and method that should be considered when focusing on the main issues of the report. The adopted methodology is the key manner that should be followed properly to find the main issues associated with the collapse of ABC Learning. The methodology can either be qualitative or quantitative in order to collect the required data and information on the issues associated with the collapse. For this particular report, the methodology adopted is that of qualitative analysis in order to obtain the required information on the collapse of the company. It implies that this report obtain the required information about the company’s collapse from the secondary sources and the information obtained is of secondary nature (Yates & Leggett, 2016). The secondary sources from where the required information is obtained include journal articles, research papers, various internet resources, web resources, Australian Auditing Standards and others. Therefore, the information acquired from these secondary sources assures the reasonable level of understanding on the key issues and the information collected is in line with the objective of the report (Yates & Leggett, 2016).

Findings

There were many reasons which contributed to the collapse of ABC Learning and two of them are deficient business strategy or rapidly expansion strategy, and omission of business risk mitigation. Once, ABC Learning used to be the largest publicly listed childcare operator in the world. A net profit after tax of $52.3 million and a total revenue of $292.7 million were recorded by the company in the financial year 2004-2005, which made the company a highly profitable one. During the following six months ending 31 December 2005, the profit after tax and total revenues of the company were $38 million and $219.8 million respectively. At the end of the financial year of 2006, the shares of the company were trading at around $8.80 on the stock market. However, the price of its shares deteriorated to $0.54 in less than two years, and the Board of Directors placed it in the administrators’ hands (smh.com.au, 2022).

The market capitalization of ABC Learning was $4.1 billion. The total worth of the company was $296 million when the stock exchange suspended the trading of shares at $0.54. The root cause of the deterioration in its share price was an unexpected drop in profit by 42% to $37.1 million in the second half of 2007 and its incapacity of servicing its debt worth $1.8 billion. The development of the financial and economic problems due to the global financial crisis in 2008 eventually contributed to the collapse of the company (Ross, Sy & Tinker, 2012).

It was a sound vision of Eddy Groves to corporatize the childcare industry. Good demographic trends supported the industry, such increasing birth rate, growing number of working mothers, and others. His strategy to create economies of scale by bringing together a huge number of childcare centres operated well. However, he was determined to purchase as many childcare centres as he could, and as quickly as he could. Between the period of 2001 and 2005, an almost continuous stream of acquisition was made by him, which increased the number of ABC Learning’s childcare centres to 697 from 43. It was important to keep going at all cost irrespective of the prices paid to acquire those businesses. The acquisition of Peppercorn Childcare in 2004 was the biggest acquisition made by ABC Learning, in which 450 childcare centres were grabbed by the company for $340 million, a price that could not be refused by Michael Gordon, the founder of Peppercorn Childcare. At present, the approximate total worth of Michael Gordon is $180 million where Eddy Groves’ business was liquidated. It implies that a company is negatively affected by the expansion at any cost (sbs.com.au, 2022).

All these imply that a poor strategic planning and inorganic expansion was one of the main reasons for the collapse of ABC Learning. Before undertaking the rapid international expansion, the senior management did not analyse the risks properly and it made the company a highly levered one. It can be regarded as a term used in business for explaining the organizational expansion through mergers and acquisitions, by the creation of leverage in the market on other organizations’ commodities. ABC Learning used this strategy to expand into the international markets (Deng, Jean & Sinkovics, 2018). Though various mergers and acquisitions, the company acquired many childcare centres in New Zealand, the USA, and the UK. The company had to take huge loans and at a point, the capability of the company to repay was surpassed by those loans. The company had to pay a huge price to expand its business in the USA and the UK. There was an increase in equity from $20 million to $1.7 billion. More threatening was the debt that the management used for financing the international acquisitions and total debt increased to $1.8 billion. The company was stunned by debt repayments, and it led to the sale of its whole UK subsidiary and 60% of the USA subsidiary. The last traded price of its share was $0.54 which is well below its highest share price of $8.62 (Vitale & Cull, 2018).

Deficient Business Strategy (Rapidly Expansion Strategy)

All these imply that ABC Learning adopted a very aggressive strategy to acquire new businesses and to expand into the international market. It was a poor strategy because the company did not consider the business risks involved with this strategy. The management of the company was open to accept the fact that this strategy was going to be pursued in the same manner. Since this strategy was too risky, it increased the total debts of the company and made the business a highly leveraged one.

The adoption of an aggressive and poor expansion and acquisition strategy of ABC Learning contributed to an increased number of business risks. The three key business risks developed from this strategy were the rapid expansion of market share, over-indebt and blinding investments in overseas.

ABC Learning had almost 2200 centres in four countries at its peak and it did not have any effective strategy handling this momentous and rapid growth. Acquisitions after acquisitions were pursued by the company, and its appetite to make more expansion by acquiring more childcare centres was increasing at the cost of increased debt (Muir & Salignac, 2017). The acquisitions of ABC Learning was getting larger which created the risk that the company would end up paying too much for the businesses or would be unable in integrating the newly acquired businesses. It implies that there was more and more debt of the company with every new business acquisition. Eventually, the company was no longer able in sustaining its rapid expansion strategy. In the presence of declining share price and closes inspection of its accounting books, it became clear that the true value of the company was substantially lower than previously thought.

In the year of 2005, the company raised additional capital through issuing shares to the public in order to finance its plan of domestic and international expansion. An enormous amount of money was borrowed by the company from the big four banks of Australia: National Australian Bank, Commonwealth Bank of Australia, Australian and New Zealand Banking Group Limited and Westpac Bank. As a result of the development of the global financial crisis in 2008, it was not able to refinance its huge debt, which contributed to the need to call the administrators (Gallagher, 2018).

 An aggressive expansion strategy was adopted by ABC Learning after becoming the leading company in the national market. The investors were not placed by the high level of debt and dilutive capital raising. As a result, the share prices of the company were negatively affected by the doubt that whether it could repeat its national achievements in the overseas markets of the USA and the UK (Hopkin, 2018).

 It implies that there were many business risks which were generated because of the adoption of the aggressive expansion and acquisition strategy, and the management of ABC Learning completely ignored these risks, and hence, the company did not develop and employ any framework or mechanism to manage its business risks. In addition, these business risks did not visualize in the financial statements of the company. As a result, the investors and other stakeholders of the company did not have a transparent view of the company’s actual financial performance and position, which exposed them to the risk of large losses in the future (Polinkevych et al., 2021).

The above discussed findings have certain key implications on auditing. The auditing standards of ASA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment (ASA 315) and ASA 330 The Auditor's Responses to Assessed Risks (ASA 330) are associated with the Risk-Based Audit Approach that the auditor designs and implements for focusing on the nature, timing and extent of the audit procedures on those areas which include high potential risk of material misstatement (auasb.gov.au, 2022). As a result, the auditor is required to obtain understanding on the entity and its business environment as this may facilitate the auditor in identifying the risks which may lead to material misstatement. It requires the auditor to consider three key elements of the audit risk model: Inherent risk, Control risk and Detection risk (Leitner, 2017).

As per ASA 315, inherent risk can be termed as the vulnerability of an assertion related to a class of transaction, disclosure or account balance to a misstatement that could be material either separately or when in combined with other misstatements, before taking into control of any associated controls (auasb.gov.au, 2022). ABC Learning’s adoption of an aggressive expansion and acquisition strategy contributed to the development of many inherent risk factors which the higher management completely ignored. ABC Learning had to borrow a huge amount of money from the banking institutions to finance its domestic and international business expansion, and it led to an abnormal increase in the company’s debt position. This is a key aspect which increased the inherent risk of the company because an increased debt position affected the company’s ability to make the interest payments on timely manner and to maintain compliance with the terms of debt. It increases the risk of underestimation of debts by incorrect classification or deliberately removing some portions of the debts. Therefore, the auditor should have raised a red flag in this area (Hooda, Bawa & Rana, 2018).

As per ASA 315, control risk can be regarded as the risk that a material misstatement could take place in an assertion about a disclosure, account balance or class of transaction and that could be material either separately or when combined with other misstatements, will not be avoided, corrected or spotted, on a timely manner by the internal control system of the entity (auasb.gov.au, 2022). It can be seen from the findings part of the discussion that the management of ABC Learning did not consider the business risks associated with the adopted expansion strategy, and there was not any risk mitigation framework in the company to address the risks. In this context, it is noteworthy to mention that a risk management framework is an integral part of an entity’s internal control system as it helps in identifying and prioritizing the business risks based on their severity. It is also important to have a risk management framework to set the risk appetite of an entity. Since there was not any such framework in ABC Learning, there was a major expansion in the risk appetite of the company to acquire more and more childcare centres off the back of increasing debt. As a result, the senior management could not safeguard the company from being liquidated. In this way, the overall control risk of the company increased significantly, and the auditor failed to identify the same (Judd, Olsen & Stekelberg, 2017).

These findings also have implications on the work of the audit team members. It can be seen from the above discussion that ABC Learning was exposed to certain factors which increase the inherent and control risk of the company. It put the obligations on the audit team members to obtain adequate understanding of the company and its environment so that they could identify these risks factors effectively. Failure in effectively considering these risk factor could increase the audit risk due to the risk that a wrong audit opinion could be issued by the auditor on the financial statements of the company.

Since most of the issues are associated with the increased level of debt and ABC Learning’s inability to services these loans on a timely manner, a key responsibility of the audit team members was to audit the long-term interests bearing liabilities of the company. Two key assertions that should have been considered by the audit team members are classification and completeness. The assertion is completeness is important in this case because of the possibility that the senior management of ABC Learning could remove some portions of the long-term debt by recording the same in the subsequent period. This would reduce the amount of debt in current period, and thus, improving the overall leverage position of the company. The assertion is classification is important because of the likelihood that the management of the company could inappropriately classify the non-current liabilities as the current liabilities to show an improved financial position of the company.

Conclusions and Recommendations

The objective of this report is the identification and assessment of the main issues associated with the collapse of ABC Learning. This report focused on two key issues associated with the collapse of the company: deficient business strategy or rapidly expansion strategy, and omission of business risk mitigation.

The findings of the report shows that ABC Learning adopted an aggressive strategy to expand its childcare business both nationally and internationally by acquiring new childcare centres, and it was a sound strategy to ensure business expansion. However, the key aspect which led to its collapse was the consideration of the crucial factors associated with this strategy, such as consideration of the risk appetite, large reliance on debts and others. The key negative aspect associated with the large dependence on debt capital for financing the business expansion is that it may impair the company’s ability to service the debts and the same happened with ABC Learning as it had to sale a large part of its international business to repay the debts.

Another key aspect associated with the collapse of this company was the complete omission of business risk mitigation mechanism. The rapid expansion strategy as adopted by the company leads to the development of certain key business risks, such as difficulty in managing the rapid expansion in market share, over-indebt and blinding international investments. However, there was not any such framework in ABC Learning to manage these business risks. As a result, the senior management of the company failed to reflect the effect of these business risks in the financial statements and the investors were not provided with a transparent image of the company’s true financial performance and position. As a result, the investors and other key stakeholders had to incur huge losses because of their stakes in the business.

It is crucial to mention that the collapse of ABC Learning had some important implications for the auditing profession. The rapid business strategy and the absence of any risk mitigation framework increased the inherent risk and control risks respectively. Since ABC Learning financed its acquisitions with the help of debts, the amount of debts increased leading the likelihood of understating them to show a better financial health of the business. The control risk was increased because of the absence of a risk mitigation framework which is a key part of a company’s internal control. It would require the audit team members to obtain adequate understanding of the business and environment of ABC Learning so that these risk factors could be identified to assess the risk of material misstatements. On the basis of the whole report, some recommendations are provided below:

• The companies are needed to consider their risk appetite while adopting a rapid expansion strategy. Considering of the risk appetite would signal them when to stop as excessive use of this strategy by ignoring the relevant factors might lead to the collapse of the business.
• Another key important factor is the effective consideration of business risks associated with the expansion strategy. It can be seen that many business risks developed from the rapid expansion strategy of ABC Learning and these risks were left unaddressed by developing no framework of risk management. Therefore, companies with the rapid expansion strategy should have a risk management framework in place to identify and address the key business risks.
• It is also recommended not to solely use the debt capital for financing the expansions as excessive debts make the companies high leveraged and geared which eventually affect their ability to service these debts. Therefore, the recommendation is to maintain a balance between debt and equity capital for financing the business expansions.
• The recommendation for the audit team members is to ensure obtaining an adequate understanding of the client’s business and environment so that the factors contributing to the development of inherent risk and control risk can be effectively identified. Identification of these factors would help them in identifying the areas with higher risk of material misstatement. 

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