Get Yourself An Education

15 September, 2008

Education tops my list of emerging sectors to bet on in the Indian economy, But…

Before we get past the “but”, consider this:

Demand growth assured for the next few decades

As a service driven economy, India needs to spend as much on developing a pool of skilled and semi-skilled manpower as China has spent on developing its physical infrastructure. For India’s middle class, children’s education is already the top priority among discretionary spending items. Over the years, the remaining 75% of India’s population will start reaching income levels at which they are able to spend on private schools and supplementary education services. Servicing this need will take lakhs more schools, tens of thousands of tutorial centers and scores of vocational training institutes.

Already growing fast and getting organised

Even if you look beyond the fast growing public stocks – Educomp and Everonn, there is a clutch of reasonably scaled up (annual sales of Rs.50 crores or more) and fast growing private companies in the tutoring and exam preparation segments – Career Launcher, Mahesh Tutorials, FIITJEE, IMS, TIME etc. These companies are growing at 50% p.a. or more, some have raised their first round of PE capital and a few are priming to launch their IPOs as soon as market conditions improve.

Pricing power and brand value

In general the Indian consumer is notoriously price-conscious, but in the education sector consumers (or their parents) are usually willing to pay a significant premium for brands that have earned their trust. Hence, the sector is unlikely to become commoditised. Good brands truly have long term value as they will allow healthy margins to be sustained.

Negative working capital cycle

Most education companies charge their course fees in advance. Hence a fast pace of growth provides them with cash to fund growth, rather than compelling them to raise working capital debt/equity. Within the segment of supplementary education services, most companies have asset light business models that further boost their return on capital. Whatever be your screening limits on financial ratios, the best education companies will sail past them.

Domestic consumption led, relatively immune to macro economic shocks

While no sector in the economy can be completely immune to the effects of inflation, it is hard to imagine an education company going bust because of oil spikes, an India-Pakistan war or a fiscal crisis. To that effect, an investment in education is fairly secure from macro-economic or geo-political shocks.

So why isn’t education already attracting a large chunk of the PE investments flowing into India? That’s what comes after the “but” …

A. Socialist hang-ups

A royal pain in the “but”. The regulatory framework around formal education (K12 schools and colleges) dates from an era when it was considered a sin to make money. Consequently, it is extremely difficult for a company to invest directly in the formal education sector. Notionally, the sector is run by the government and by not-for-profit trusts. In reality, many politician-controlled trusts and less-than-scrupulous entrepreneurs have found “innovative” ways to turn their educational institutes into cash cows, while the rigmarole of regulation keeps out institutional investors, scrupulous entrepreneurs and many earnest educators.

When the telecom sector was first thrown open to private competition, the socialists worried about exploitative capitalists driving up the price of telecom. In reality, the relentless pressure of free market competition has driven down telecom rates to less than a tenth of what they used to be and has provided mobile connectivity to more rural users and to more first time users (auto drivers, dhobis, domestic help etc) in the last ten years than the government monopoly provided in the preceding fifty.

In education as well, free market competition combined with transparent regulations will improve quality and provide education options to a far wider base of people. Once capital is allowed to make an honest return, the sector will be able to attract and productively utilise billions of dollars of capital. No doubt, the government will continue to play a critical role in providing education opportunities to those that cannot afford to pay for them, but that will not exclude private sector involvement.

Public opinion is moving the powers that be slowly and surely towards deregulation of the sector and an end to this “monopoly of the unscrupulous”. For the country’s sake, one hopes it will be sooner rather than later.

B. Scale

Supplementary education (tutorial classes, exam preparation, IT training, soft skills training) is a much smaller segment than formal education. Until this point, most of the PE deals in education have happened in supplementary education companies and have hence been small deals – sub $25 million. Within the next 2-3 years, these PE-funded companies will scale up enough to either list or raise larger rounds of PE capital. Only then will the sector start attracting more banking coverage and attention from the bigger PE players.

The floodgates will truly open only when the formal education sector is deregulated. Once that happens, the sector will likely start competing with the infrastructure sector in terms of deal size and total investment attracted.

For now, keep watching what the early birds in education investing – SAIF Partners (Veta and ICA), Gaja Capital (Career Launcher), Helix Investments (Mahesh Tutorials), Zephyr Peacock (Wigan & Leigh), Tiger Capital (IIJT) – are up to. This is one bus you don’t want to miss.

 


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