AVCJ Awards 2016: Deal of the Year - Large Cap: Golden Apple Education

Over the course of 12 months, the PAG Asia Capital team collectively spent over 1,000 nights in Chengdu as they sought to acquire control of Golden Apple Education Group, the leading branded kindergarten chain in the western China city. During this period they engaged in more than 600 negotiation sessions with approximately 100 creditors, finally securing a $200 million deal in August 2016. It is said to be the first sizeable foreign private equity-led buyout cum debt restructuring ever seen in China.

"Had it got to a formal bankruptcy process, it would have taken a long time to sort through the different claims and collateral, and the banks wouldn't see any cash for three years. It would also probably have meant a meaningful deterioration in the value of the asset, because the value is in the kindergarten franchise rather than its underlying assets," says David Wong, the PAG partner who led the deal. "The creditors didn't really know what to do and they hoped someone would come in and figure it out."

Distress dilemma

Golden Apple is longstanding business with 33 kindergartens and two primary schools, serving about 12,000 children. It is also cash generative and the fees represent a strong recurring source of income; the company saw compound annual growth of more than 20% in terms of revenue and EBTIDA over the last three years.

The problem was Golden Apple's parent company, Sichuan Harmony Group, a real estate developer that ran into severe liquidity issues and defaulted on its obligations to creditors in mid-2014. Harmony Group knew it needed to sell assets in order to service its debts, but it wasn't clear what could be sold: all the assets were enforced against and the creditors had different claims against various pieces of the group. Disputes had already broken out, resulting in creditors cross-freezing and cross-enforcing on assets. How could the company come up with a solution that satisfied all parties?

Having heard about the situation through one of the creditor banks, this was the question PAG sought to answer over those 12 months. The nature of the creditors was an added complication. In addition to 18 joint stock and city commercial banks, Harmony Group owed money to 80 non-bank creditors, including individuals, small loan companies and informal investment organizations of dubious legitimacy that pooled capital from hundreds of different people, many of them unsophisticated investors.

"Banks are normally more rational or institutional. They can sit down, discuss a situation, and form a committee that decides what to do. But with so many non-bank creditors involved - some of them people you wouldn't want to run into in the street - it is difficult to have a typical creditor committee workout process," Wong explains. "We had to negotiate with everyone all the time in the hope that we would end up with a position on which everyone could agree."

PAG ran these negotiations in conjunction with Harmony Group and the Sichuan Financial Asset Exchange. The restructuring saw the non-bank creditors take a meaningful haircut on their claims and get paid out completely, while the banks agreed to extend their existing facilities to Harmony Group with a view to achieving payment through the sale of other assets. Of the 50-plus large enterprises in Sichuan province that has defaulted on debt obligations in the last two years, Harmony Group is the only one to execute a market-oriented restructuring.

The next phase

Now in control of Golden Apple, PAG's plans for the asset involve broadening its service offering. While at present the company caters to children from kindergarten through grade six - the final year of primary level education - it wants to cover the entire spectrum to grade 12.

"We are building out that capability now with a school that has a capacity of 3,000. Hopefully we can capture more of the students that come out of our existing kindergarten and primary schools," Wong explains. "Parents are looking for one-stop solutions. If they participate in a single, wider program they don't have to worry about matriculation and entrance exams to qualify for the next level of school."

This does not come without risk. Kindergarten and high school in China are relatively open to foreign investment, but the years in between that comprise compulsory education are more closely controlled by government. Historically, there has been a preference for non-profit models, to the extent that private capital has been allowed in at all, but in recent years regulatory attitudes have loosened somewhat.

For PAG, the return on making the breakthrough could be considerable. Barriers to entry are higher than in the less regulated areas of education, so there is less private competition and therefore more of an opportunity to charge a premium for services. In addition, there are economies of scale that can be achieved in infrastructure and management by serving a wider range of ages in a single high-density urban area like Chengdu.

As to whether Golden Apple also represents a panacea in terms of private equity targeting debt restructuring situations, Wong is circumspect. While the mounting number of non-performing loans (NPLs) on the books of China's banks means more distressed assets will likely be made available to private investors, addressing the opportunity from an equity perspective requires a change in mindset.

"Non-performing asset (NPA) investment in China has historically involved buying the underlying collateral, which tends to be real estate," he says. "Little attention has been paid to franchise-based business that could potentially be carved out of NPAs - mainly because the people who work on these deals are credit guys rather than equity guys. I hope there will be more opportunities for us, but it's not easy identifying viable or valuable assets."

Pictured: Tim Morrison (right) of PAG Asia Capital receives the award from Simon de Young of Baker & McKenzie

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• Topics
• Greater China
• Buyouts
• Restructuring
• Consumer
• China
• Education
• PAG
• AVCJ Awards