Show me the money

Think of the potential in the Indian education sector and it’s easy to imagine long, winding queues of investors waiting eagerly with blank cheques. The numbers certainly seem to point that way — India has over half a billion people in the 0-24 year age group, all of whom need to be educated. Just 12.4% of students currently study beyond the school level.

If that number has to increase to 30% by 2020, the country will need another 800 universities and 35,000 colleges. And it’s not just higher education — virtually every segment in the education space presents a business opportunity, be it pre-school, K-12, colleges, test preparation or vocational training. Technopak estimates the opportunity in the Indian private education sector will reach $70 billion by 2013, from $60 billion in 2011.

That’s on paper. The reality is far more disappointing — private equity and venture capital investors have pumped in only $844 million over the past five years in the Indian education sector, according to VCCEdge, a research firm that tracks PE/VC investments (see: Low IQ). Granted, that’s not insignificant, but it’s certainly small compared with both, total PE investment in sectors like IT & ITES ($3.45 billion), banking and financial services ($6.2 billion) and pharma & healthcare ($2.48 billion) in the same period and the opportunity in the Indian private education sector. So, why is private equity in Indian education on such a steep learning curve?

Over-regulated

Look closer at the big picture, and investable opportunities in education are few and far between. Investors are holding back for a couple of significant reasons. Foremost of these are the regulations governing the core education segment of K-12 schools and colleges. “Education is one of the few sectors that are still in the throes of the Licence Raj and this has dampened the enthusiasm of private equity investors towards the sector,” says Gopal Jain, managing partner of the Mumbai-based Gaja Capital, an early investor in the education space.

After making its first investment of around Rs.4.5 crore in Educomp in 2005, the fund has invested in staffing company Teamlease (around Rs.100 crore along with ICICI ventures), test prep company Career Launcher (over Rs.30 crore), the Millennium Schools (part of Educomp) and the Indus Schools, which is part of Career Launcher (over Rs.20 crore).

“Since the direction and pace of reform in the education sector have been far from satisfactory, India is getting only a fraction of the capital that it should be attracting into education,” Jain adds.

The core education space — formal education covering K-12 schools and higher education institutions — is highly regulated. Government guidelines stipulate that these institutions can be run only as non-profit organisations under a society or trust. Any surplus generated by the trust or the society cannot be distributed as dividends and must instead be ploughed back into the institution.

Even in states that allow for-profit schools (such as Maharashtra and Haryana), getting approval from the education boards is a Herculean task. So, there’s little incentive for entrepreneurs and investors to enter the sector. “Education is a sector that is desperate for more investments but because we have gotten ourselves in the mindset that it has to be done for charity and not for profit, capacity building in the sector has suffered,” says Jacob Kurian, partner, New Silk Route Advisors. The PE has invested $30 million in Hyderabad-based Varsity Education Management, which provides operational and support services to educational institutes in Tamil Nadu, Andhra Pradesh and Maharastra among others.

It also makes little sense for investors to sink money into the core business, which holds the assets. “The challenge is that as an investor you cannot invest in a structure determined to be a non-profit organisation,” says Sandeep Aneja, managing director, Kaizen Private Equity, India’s first PE fund focused on the education sector. “What we invest in are companies that provide services to schools.”

Kaizen has made three investments since its 2009 launch — distance education provider Universal Solutions (Rs.35 crore), school management firm Altus Learning (Rs.25 crore) and Bengaluru-based daycare and playschool chain Your Kids Are Our Kids (Rs.20 crore). “The opportunities are driven by the quality and quantity gap across all segments,” Aneja adds. 

Typically, educational institutions run on a dual structure. The schools and colleges are run by trusts or societies. They then create subsidiaries that supply the land and building or offer ancillary services such as teacher training, maintaining IT and finance departments of the school, or managing the cafeteria and transportation of the institution, in return for a rental or management fees. Investors, in turn, pick up a stake in these subsidiary companies or the holding company that owns these entities. But that’s only if they can get over the bigger problem caused by over-regulation — corruption.

A dirty business?

The trouble with too many rules is that, often, it puts power in the hands of the wrong people. And investors believe this is particularly true in the case of the education business. “There is corruption in any sector that is over-regulated, and education is no different,” says New Silk Route’s Kurian. 

The rot starts early, thanks to the lack of transparency when it comes to land acquisition and licences. And that keeps away genuine entrepreneurs. “Politicians control virtually all higher education in India today,” says a PE investor who doesn’t want to be named. He says that most politicians incur virtually no cost in setting up an educational institution — they get the land from the government as a grant and often, builders are willing to construct the building for free in exchange for favours.

“People who can actually deliver good quality education are not controlling education. It is either people with real estate interest or political connection,” the PE investor adds.

The challenge for investors, then, is to find above-board entrepreneurs with business models that are scalable and have high levels of corporate governance. “When we start looking at those parameters, the number of entrepreneurs that are investable is not very large,” says Jayant Sinha, MD, Omidyar Networks India, which has invested Rs.19 crore along with Matrix Partners and Foundation Capital in preschool chain Tree House, employability assessment company Aspiring Minds and language training company English Helper. 

Regulation-related issues aren’t the only problems dogging investors in the education sector. Finding resources, cheap real estate and capital also have to be sorted out. “As with any infrastructure business, scaling up in education is a challenge because real estate prices in India are three times than what they should be,” says Gaja Capital’s Jain. Remember, setting up an educational institution doesn’t come cheap. While it can cost anywhere upward of Rs.50 crore to set up a school or college in a metro, even a tier 2 location won’t come for anything less than Rs.20 crore. And finding — and retaining — good teachers is a critical but hugely difficult task. 

 “Indian education has not been able to attract good talent because our teachers are relatively under-paid. Consequently, the quality of education suffers,” says Amit Kapoor, MD, Matrix Partners India, which has invested in Tree House (Rs.59 crore), Fiitjee (Rs.100 crore) and school management firm, Maharana Infra (Rs.50 crore).

Too much for too few

But it’s not as if the sector is all bad news. The informal space, which includes pre-school chains, tutorials and test prep companies, is free of government regulation and currently presents an $8-billion opportunity, with companies like Tree House, Fiitjee, Career Launcher and IMS seeing significant interest from private equity investors. Another area of investor interest is in companies that are helping to solve the employability problem.

“There is such a dearth of quality educational institutes that provide education in diverse fields with a focus on employability,” says Shivani Bhasin Sachdeva, CEO of private equity fund India Alternatives, which has invested Rs.28 crore in animation training company Frameboxx and Indian Institute of Financial Management. 

Every year, nearly 20 million youngsters join the workforce. But, according to a 2005 report by McKinsey, only 25% engineers, 15% finance graduates and less than 10% of the other graduates in India are employable; more recent studies by Aspiring Minds offer even more dismal figures. While that’s bad news for the nation, investors see it as an opportunity to catch a rising tide — they’re placing their bets on firms like NIIT, Indian Institute of Job Training, English Helper and Teamlease, which help in skills upgradation.

The scalability in this business, however, will depend on how many students become employable after doing the course. “To scale up vocational institutes, you have to provide students with jobs. If there are no jobs, the business is unlikely to scale,” says Kapoor of Matrix.

For investors, the education sector, despite the many hurdles, is too big an opportunity to ignore completely. They continue to take bets on entrepreneurs and business models that have managed to scale up (See: Pick and choose). Some have even managed to get pretty decent returns. Gaja Capital made a 20x return on its investment in Educomp; Helix made a 2.5x return on MT Educare and UTI Ventures made a killing with a 50x return on its Excelsoft investment.

Still, there’s too much money chasing too few companies, so the price to buy into the sector is climbing rapidly and companies are getting valuations they would not get in any other sector. For instance, preschool chain Tree House clocked revenue of Rs.77 crore and a profit of Rs.22 crore in FY12. While it’s remaining profitable by not investing in real estate (see story on page 76), the stock doesn’t come cheap, trading at a valuation of 31 times its FY12 earnings. The challenge for such companies will be to maintain profitability as they scale up operations.

“Private equity investments in education have driven up valuations tremendously and in some cases, unjustifiably,” says India Alternatives’ Sachdeva. “In some cases, private equity investments in smaller and unlisted companies are happening at valuations higher than what the market is paying for larger listed competitors.” But, as long as capacity trails demand in the sector, good businesses will continue to demand top dollar. What is needed to kickstart the education sector is partial deregulation, suggest some PE players — regulated prices, but guaranteed returns. But even that seems to be some time away. So it will be a while before investors can truly reap the rewards of an educated population.