Two winners from the pandemic fallout

I admit to enjoying some aspects of Victoria’s COVID-19 lockdown. More time with immediate family, walks in parks and a generally simpler life have been highlights.

A lowlight has been watching the effects of online schooling. With home-based learning the norm, many kids have been stuck on electronic devices throughout the day – often a tiring experience.

Some kids inevitably jump to another device in the afternoon to play video games or communicate with friends. There were few other choices at the peak of Victoria’s Stage-four restrictions and 23-hours-a-day lockdown.

Worse, kids get stuck on devices at night watching YouTube or TikTok videos. Or using multiple devices to watch videos and text friends simultaneously.

There’s surely a future business opportunity providing services to help kids break their device addiction. A bit like the boom in tattoo removalists after the tattoo craze.

Another opportunity is extra learning services. There’s no doubt many kids will fall behind because some schools has poor online teaching facilities and digital skills. Or because some kids have slackened off and escaped their teacher’s attention in online schooling.

I worry that even just a year of online tuition could affect overall learning, particularly for secondary-school kids, and create other problems, such as device addiction.

Then there are health issues. Kids glued to devices all day must be physically and mentally damaging in the long run. Somebody needs to start a chain of gyms just for teenagers!

The pandemic has also accelerated cybersecurity and online-content threats for kids. The graphic suicide video that did the rounds on TikTok is a sign of things to come.

More kids spending more hours on devices – even when school returns to normal, nationwide – is inevitable. Sadly, that’s where society is headed.

Still, every problem is an opportunity.

Here are two companies well placed to benefit. Both suit experienced investors who understand the risks of microcap stocks.

1. Family Zone Cyber Safety (FZO)

I first mentioned the provider of cybersecurity services in the Switzer Report in August 2019, noting the stock looked interesting after recent share-price falls.

Family Zone fell from about 35 cents at the time of that report to 9 cents at the peak of the share market sell-off in March 2020. It has since rallied to 54 cents.

To recap, Family Zone listed on ASX in August 2016 through an $11-million float at 20 cents a share. It hovered around $1 in October 2017, such was the interest in the emerging tech company.

Family Zone has developed a clever software platform that enables schools and parents to keep kids safe online, anywhere and at any time, on an internet-connected device.

The technology helps schools filter out inappropriate content and thus meet their compliance requirements. Parents in that school community can use the platform after school for free (for their kids), or pay for a premium service that allows other controls to be added.

Family Zone is growing quickly. It ended FY20 with 2,456 school clients and 1.31 million students using the technology – up 70% on a year earlier. Student volumes grew 33% in the first eight weeks of FY21 alone, the company said in its latest investor update.

That’s not surprising given the number of extra hours kids have spent online during the pandemic and the need to protect them from cyber threats.

Family Zone’s technology has global application. About three quarters of its school client base is in the United States. The company’s market penetration in the US is less than 2%.

However, exponential growth in schools and users is yet to be felt fully in Family Zone’s sales. FY20 revenue of $5.09 million compares to the FY19 figure of $4.18 million.

Family Zone lost $17.2 million in FY20 as it invested in scaling the business. With emerging tech companies, it pays to focus on growth in user numbers, at least at the start.

On that measure, Family Zone is performing strongly as more schools – and thus many more parents and students – use its technology. The rapid uptake suggests the company’s technology has strong user benefits and is highly scalable.

Cybersafety technology at schools is mission-critical software. Family Zone has a clever model of linking schools and parents to the company via its platform. That should make its technology “sticky” because once a school has embedded it in its community, it is hard to change software providers. In turn, that should provide recurring revenue and margin growth.

Longer term, Family Zone has good prospects as more schools offer more learning online (as a backup to face-to-face classes) and invest more in protecting their students from cyber threats.

Chart 1: Family Zone Cyber Safety

Source: ASX

2. Kip McGrath Education Centres (KME)

I’ve followed the franchiser of after-school tuition services for years but eventually lost interest. In spite of its potential, the company had too many false starts, underperforming the share market for much of the previous decade.

Kip McGrath started to gets its mojo back in 2018, rallying from about 50 cents at the start of that year to a 52-week high of $1.65. The stock tumbled to 80 cents during the March sell-off and now trades at $1.20.

The online-learning boom could be the making of Kip McGrath. A company that for years relied on “shopfront” learning services looks far more interesting as an edtech play.

Kip McGrath’s share price “broke out” of price resistance in September after a few months of sideways consolidation. Chartists often favour this pattern, believing the spike is the start of a price uptrend.

However, Kip McGrath’s FY20 revenue rose only 5.3% to $17.1 million and underlying earnings (EBITDA) were flat at $5.2 million.

The company also gave a mixed investor update in August. COVID-19 had hurt its second-half franchisee fees because of the drop in student enrolments and attendance rates.

The highlight was the jump in online lessons at Kip McGrath, with growth in June 2020 up almost 300%, year on year (albeit off a low base).

Online learning will boost the company’s margins and profitability because it charges franchises the same percentage rate, regardless of the learning model.

The easing of COVID-19 restrictions over the next few months (even in Victoria!) should help Kip McGrath in three ways. First, there should be a recovery in Australian and New Zealand lesson numbers when more students can physically attend tutorials. Kip McGrath said  lessons were at 80% of pre-COVID volumes in August.

The bounce-back should be even greater in markets such as the United Kingdom, where Kip McGrath operates. The company says it expects all regions it trades in to “see improvements in coming months with lockdowns easing and normality resuming”.

The second benefit is parents seeking additional learning services to help their kids catch up on lost learning during the pandemic. Kip McGrath has had an increase in online leads for tuition from “parents concerned about the progress of their children” – presumably because of home-based school learning.

Third, COVID-19 has accelerated the move to online learning and its community acceptance. Having watched their kids learn online, many parents realise digital platforms will become a bigger part of the learning mix (preferably, in moderation).

For time-poor parents, online tuition – and the time it saves in commuting to Kip McGrath shopfronts and waiting for kids – is another benefit.

It won’t be all smooth sailing for the company. My hunch is parents will initially want their kids to return to face-to-face tutorials at Kip McGrath, rather than online lessons.

Lower migration in Australia is another factor. Some cultures are known for investing heavily in after-school tutorials for their kids. Witness the growth of Kumon overseas.

Moreover, economic strains from COVID-19 could make it harder for parents to afford additional tutorials for their kids, even if they believe they are needed.

For all the short-term challenges, Australia’s tutoring market remains highly fragmented and online tutoring has many years of growth ahead. Prospective franchisees could find online tutorials far more appealing because they reduce rent and other overheads.

That’s good news for Kip McGrath and other corporate-owned tutors that can provide additional online learning at scale, or blend face-to-face and digital teaching.

And most of all, help kids who have fallen behind in their schooling this year, catch up.

Chart 2: Kip McGrath Education Centres (KME)

Source: ASX