Is the Education investment opportunity for real? – Aravind G.R

“Sorry, I don’t need any money right now”. No, this is not me shooing away pesky telemarketers, it’s the line I hear from the archetypical ‘Gyani Sirs’ who run education companies.

While the whole investment community has been upbeat about the education space for most part of the last decade, why aren’t we seeing as many deals? For both sides (i.e. investor & investee) the answer still lies in the quality of opportunities. By quality, I mean a combination of team, product/service and more importantly the valuation expectation.

From the potential investee’s perspective: “I don’t need any money”- because:

  1. My business is working capital positive- My students pay up almost the entire fee in advance when they enroll; whereas my expenses are deferred throughout the duration of that course.
  2. I’m not planning to invest much, even while I’m expanding (Well, ‘going national’ is the buzz word I use for expansion) since my plan is to employ franchisees who would cough up the capex.

(Comment: A large number of MBA test prep companies threw caution to the wind and accepted franchisees all over the place. An average franchisee has little skill to maintain the quality of delivery that the particular brand of test prep company is known for)

From the Investor’s perspective: I’m being extremely cautious & picky while investing because:

  1. I‘m not sure what works: While ‘me too’ models works in every other sector, models which are followed elsewhere in the world do not seem to work here. I can take calculated risks, but I’m yet to see successful models emerge out.
  2. I cannot stomach the valuation expectations: Last week a news article quoted some bankers saying that some promoters in the sector are expecting valuations as high as 40 times EBITDA. This creates two problems: The first one being, how do I justify this valuation to my investment committee. The second being ‘exits’- An M&A opportunity diminishes as soon as the company crosses  the 15-20 crore revenue mark, they just become too expensive (with asking rates at 80-100 Cr) for any Indian education company to buy.
  3. I don’t know how to handle a situation where ‘Gyani Sirs’ say that we are used to showing only 50% as ‘white’, our revenues are actually two times the number you see in our P&L statement.

Summary: The volume of investment activity will continue to be muted over the next couple of years. We believe the industry will make a natural progression towards maturity and only then will the activity mirror the potential the sector posseses.

Why we’re betting on offshore service providers to the e-learning industry- Aravind.G.R

Arguably, India’s best Venture Capital exit came from a company in the e-learning offshoring industry. UTI exited Excelsoft Technologies with 50X returns by selling 35% stake (acquired at $600K) to D E Shaw in 2008 at a whopping $31 mn, valuing the company at close to $75 mn. The company boasted a net profit margin of 50% on a top line of $11 mn in FY 08, which essentially meant that the company was valued at 7x times its top line. DE Shaw paid such a high valuation because of the enormous profit levels on the company’s product and the blistering pace of growth (last heard, they had doubled revenues to nearly $20-22 mn in 2010).

The education practice at Viedea has worked with companies in the e-learning offshoring space over the past few years and continues to witness high growth in this sector. The fact that e-learning players in India have one of the highest representations in the Deloitte Technology Fast 500 list bears testimony to this.

The shift to e-learning

The market for technology based learning solutions is rising at a phenomenal pace globally. There is an inherent shift in the learning methods adopted by companies in employee training from on-the-job & classroom based training to e-learning. IDC estimates e-learning adoption at 48%, in in-house training. The academic market too has graduated towards using instructional design based content. IDC research estimated the size of e-learning market at $16 bn in 2007, growing at 20.4% to reach $40 bn by 2012.

The market for outsourcing

Global training companies such as Skillsoft, ElementK, Accenture, Expertus Adayana, Intrepid, etc use Indian firms or their own captive centers in India, to outsource ‘non-core’ processes. Training providers focus on their core competencies like deployment, delivery and R&D in their domain. Other processes such as (1) content creation/design/conversion/repurposing; (2) technology tools to create, convert, deliver, host & support content and (3) Consulting & implementation support are outsourced too. Outsourced service providers include Tata Interactive, FCS, eMantras, Magic Software, Edutech, Hurix, LearningMate, Harbinger (products), etc.

Viedea estimates that revenues from e-learning offshoring industry in India stands at $500-600 mn (including captives).Value Notes, an Information & Research firm has estimated that the sector is set to grow at 20-30% a year.

Our take

We expect significant outbound and inbound M&A deal activity in the learning outsourcing space over the next 24 months as the value chain gets reorganized to cater to the high growth potential.

Frontline training companies will look to backward integrate by acquiring offshore e-learning solutions providers, thereby gaining greater control over output as well as better margins.

Established Indian offshore providers will look to acquire mid-sized training firms in US and Europe, thus leveraging their content and technology expertise to offer seamless training solutions to clients. We also anticipate PE participation in funding some of the acquisition activity in this space.

Education : The new holy grail for VC/PE’s- Aravind.G.R

Ask any VC in India these days what their top investment sectors are and more often than not you will hear ‘education’ and ‘healthcare’. ‘Recession proof’, ‘underdeveloped’ and ‘large addressable market’ are phrases that almost certainly ensue.

Let’s focus on education to try and understand where the real opportunity lies.India’s young population and the average Indian households’ propensity to spend heavily on education have been well documented. So are the systemic shortcomings and inefficiencies. The size of the education sector may not come as a surprise; considering each one of us has either spent or continues to spend on education. We estimate the Indian education sector’s market size at $50 bn annually. Except for some sub-segments, theoretically the sector is indeed recession proof. The sector continues to be heavily regulated, especially schooling and higher education; however, private firms have been extremely adept at circumventing antiquated regulations to create opportunities for themselves.

VC/PE investors naturally recognize the potential returns investing in this sector can offer. Based on proprietary research by our education sector team, we present a ‘below the hood’ peek into the sub-sectors that form the education pie.

1. School/College ManagementIf fund managers had their way, they would probably want to run a chain of schools (K12- Kindergarten to class 12) or colleges, with what ever focus (premium vs mid/low income) they deem fit. However, owing to regulatory & to some extent social obligations, schools and colleges in India have to be managed by a not-for profit entity (trust), thereby forcing ‘for profit’ enterprises to largely stay away from the ‘business’ of schools.

Recently we have seen investments by funds in pre-school chains and several private companies engaged in allied businesses taking ownership of school management. Some companies have worked their way around by differentiating the school ownership entity (trust) & school management entity which profits from land lease rentals, supply of IP, hardware, etc. However, we do not believe that school/college management is an attractive investment proposition for funds under the present regulatory conditions.

2. Information and Communication Technology (ICT) for Educational institutions:The ICT opportunity comprises technology solutions for learning, hardware, infrastructure, multimedia content, institution & student management systems, etc, for K12 and higher education.

The ICT business has matured, with strong competition between the established (mostly funded or listed!) players such as Educomp, Everonn,IL&FS ETS and NIIT. However, the addressable market is extremely large and there is an opportunity for atleast a few other players to occupy and service various niches in the space. Content on a standalone basis, we believe is difficult to sell to schools/students and most of the ICT/technology player’s have setup proprietary content development teams.
While ICT is an obviously large market opportunity, we believe that the key to scaling up is the ability to sell to government. Private schools may fetch higher margins, but the sheer volumes that government sale offers is vital for a private ICT player to scale up. Moreover, higher education, which has no nationwide common syllabus like ICSE/CBSE, is also largely untapped by ICT players and presents a potential opportunity.

3. Test prep and Tutorials: Test preparation coaching and tuitions have co-existed with traditional teaching and are an integral part of the Indian education system, especially in urban India. The apparent problem is scalability, especially with tuitions & test prep which tend to be built around individual(s) or at best limited to a particular region. Several test prep institutes such as Career Launcher and TIME have received PE funding. However, we believe that beyond a point scalability will become difficult for brick and mortar only model because of issues such as consistency of coaching, franchisee model pitfalls, real estate costs, etc.

Our hypothesis is that there is an opportunity for a nation wide test prep play through a strong blended model, combining brick and mortar with online delivery. While there is no success story yet to demonstrate this, with a clever combination of easy to use technology and good execution, we will witness a few success stories in this space in the coming years.

Online tuitions for school students we believe, is also catching up and scaling up is relatively easier. The nay-sayers can use statistical data about broadband penetration being low, but the absolute number of students using internet as a source of knowledge has gone up and there are only a limited number of tuition/coaching providers who are catering to them through the blended model.

4. Vocational Training: Nasscom and every other survey on the formal education system in India highlights the huge gap between employability and skill levels graduates in India possess across sectors. Be it IT, retail, financial services or BPO, companies spend huge amounts on training to make graduates productive after hiring them. The NIIT’s and Aptech’s have to a certain extent been successful in addressing the needs of the IT industry over the years. However, from English language training to financial analysis skills, the gap is still huge for the vocational training market.Recently, classroom based programs in English language training, BPO, Retail training, etc have been scaling up and have attracted investments as well. However, our hypothesis is that just like in the Tutorial/Test Prep space, a pure brick and mortar model will have scalability issues. A blended model with contact centers and online delivery (either web based on through VSAT networks) is more likely to scale up. Moreover, vocational training firms are now looking to tie up directly with universities and offer courses to students, which is also an interesting model to watch out for.Companies that have a placement services background seem to be in a better position here, including Edserve (recent IPO); nevertheless, the question of ‘recognized’ certifications needs to be addressed.

5. E-learning technology and content development: Within the outsourcing space, Indian companies have developed capabilities in development & consequently implementation of E-learning initiatives plus learning management systems (LMS) for corporate clients as well as educational institutions. The development and conversion of content for publishers & educational institutions, especially for the US market is also an opportunity that a few Indian companies like Excelsoft have targeted very successfully. These services are rendered mainly by small to mid size companies, but some of the big software vendors have strengthened these verticals lately. This space continues to be fragmented and smaller players may find it difficult to scale. However, mid sized players have high margins and good expertise and are well positioned to make inroads into markets outside theUS. We believe mid sized players in this space present a low risk investment opportunity for PE funds.

The sectors discussed above are not exhaustive; however, a majority of deals one is likely to see in the education space will fall into one of these buckets. As in any investment, the quality of the management team is probably the most critical factor, apart from the market opportunity they are addressing. For more information on education sector opportunities and interesting companies in the space, please contact Aravind G.R (aravind@viedea.com) or Deepak Srinath (deepak@viedea.com).

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