Southeast Asia education: Top of the class?

Creador has its eye on a turnaround opportunity. A few weeks ago the India and Southeast Asia-focused PE firm teamed up with Malaysia-listed IT service provider SMRT Holdings and offered to buy struggling medical training school Masterkill Education. Together they want to refashion the business into an education group of high quality.

"When we look at potential deals, one aspect that we assess is the prospect of value creation and Masterskill is no exception. While this is not a typical deal for us, the risks are relatively low and the business has significant growth potential," says Kevin Loh, managing director at Creador.

The private equity firm is also getting in at a reasonable price. The consortium has agreed to pay about $20 million for a 30.75% stake in Masterskill and Creador alone purchased a further 19.26% interest for no more than $12 million. This values the entire company at not much more than the sum of its net assets.

Masterskill is in distress because Malaysia's medical education sector as a whole is under pressure. The problems date back 10 years to a time when there was a shortage of degree spaces at public universities in medical sciences. Additional licenses were issued to private operators and the capacity ballooned.

A number of private equity firms sought to ride this wave of expansion. According to AVCJ Research, four investments were completed in medical and healthcare training between 2004 and 2010; the three disclosed deals saw MYR170 million ($47 million) deployed. CIMB Private Equity, Khazanah Nasional, Ethos Capital and Capital Advisor Partners all put capital to work.

Back from the brink?

Crescent Point and Quilvest backed Masterskill and the company listed in 2010. Despite efforts at diversifiation, it slipped into the red three years ago as the oversupply of university places ate into enrolment fees. Ironically, there remains unmet demand for nurses in Malaysia: hospitals should have one nurse for every two beds but many institutions do not operate at this level.

"The key challenge is hospitals want high quality nurses," Loh says. "In Malaysia, nursing students must undergo practical training before they graduate and start work. In the past, due to insufficient teaching facilities in hospitals, many students were not able to complete practical training and so they are unemployable."

It is a vicious circle - the obstacles to employment have resulted in fewer people wanting to become nurses - and Creador hopes to ameliorate the impact by improving nursing curricula and forming partnerships between hospital and schools to ensure students receive the appropriate training. If successful, the strategy could prove lucrative, but other private equity firms may be reluctant to follow.

The problems experienced by Malaysia's medical schools encapsulate the risk that comes with a single-market strategy: overconcentration, particularly in an area like education that is often heavily influenced by regulation, exposes investors to a large potential downside. As such, there is a trend among private equity firms to pursue education opportunities that can achieve scale by crossing borders. This is easier in some areas than in others.

"The principal attraction of Southeast Asia's education sector is the high level of fragmentation," says Luke Pais, partner and ASEAN leader at E&Y. "Much like India and China, populations are still growing but families have started getting smaller and parents are willing to spend more on their children, especially on education. They are lured by schools brands. That's what the PE firms need to focus on."

According to Al Masah Capital, a MENA-focused alternative investment firm, government expenditure on education accounted for 3.7% of total GDP across Indonesia, Malaysia, Thailand, Vietnam, Singapore and Philippines in 2010. This is far lower than developed markets, with the US and the UK on 5.6% and 6.3%, respectively. Although there are no specific figures, private sector is said to have comfortably outstripped the state contribution in Southeast Asia.

Based on gross enrolment rates at each level for each country, the region's school-age population stood at 128 million as of April 2014, nearly twice that of the US. A total of 97 million students were attending public schools while the rest received private education, Al Masah noted. Rising income levels are credited with driving demand for better schools with world-class infrastructure and international curricula.

The private equity opportunity is not uniform across the region. In Singapore, for example, the education system is tightly controlled by the government, so there are few openings. Countries like Malaysia are far more welcoming, recognizing the role private capital can play in improving service quality, especially in the higher education sector.

Addressable markets

Sandeep Aneja, founder and managing director of education-focused GP Kaizen Private Equity, says that investment potential in Southeast Asia depends on two factors: the level of household income and whether the native language is English. The likes of Malaysia, Indonesia, Vietnam and Thailand fall into the latter category, so providing English-language training programs make more sense in these markets than elsewhere.

Southeast Asia's education sector is worth $110 billion per year, compared with $1.43 trillion in the US and $133 billion in India, Aneja estimates. Kaizen is currently raising its second fund, which has a target of $120 million; 40% of this has been earmarked for deployment in Southeast Asia.

While Malaysia continues to generate a number of opportunities, particularly in private colleges and institutions in the eastern part of the country, early childcare is emerging as an investment thesis in Indonesia, Malaysia and Thailand. There is also rising demand in the K-12 schooling and vocational education spaces.

Omar Lodhi, partner and regional head of East Asia at The Abraaj Group, sees similar opportunities arising from the young generation. Following investments in Dubai's GEMS Education and Egypt's CIRA - both K-12 education services providers - the private equity firm took a stake in Singapore-based English language teaching operator Orca Global. Last year it invested in KPN Academy, a Thailand out-of-school education provider that focuses on music training.

"With its attractive demographics, we are active in the education space throughout Southeast Asia, including after school tutoring, enrichment centers and K-12 schooling. We are looking at investments across the entire spectrum, with a focus on leveraging our past K-12 school experience to build a regional scaled platform serving a student diaspora at multiple tuition price points," says Lodhi.

This strategy involves taking Orca Global and KPN Academy out of their local markets and into new ones. KPN Academy has already made headway, partnering with Thai public schools to roll out music programs. It is part of a government effort to improve the quality of existing curricula and give children a more all-rounded education experience. Abraaj hopes to replicate this approach elsewhere.

"In countries such as Indonesia and Vietnam, and to some extent Malaysia and Thailand, the affordability criteria must be taken into account. Given lower income levels vis-à-vis a market like Singapore, education offerings need to be more affordable. However, these are much larger markets in terms of population," says Lodhi.

There are various ways of addressing the affordability issue. In the Philippines and Vietnam, for example, the governments want subsidies granted to oil companies to be reallocated to infrastructure and education. However, the initiatives lack clarity.

"It is still a question of which segment of the market the government plans to furnish with more subsidies. Oftentimes, it prioritizes providing a basic level of education for students," says E&Y's Pais.

In this context, the return for PE is likely to be lower if cost of education is government-controlled. Traditionally, the premium segment - chiefly international education - has been the most attractive for investors. E&Y's Pais expects to see a lot of private capital targeting pre-school education and English language learning centers; both are premium and work in multiple markets.

This dynamic exists largely because the regulatory framework is minimal compared to K-12 schooling where cross-border expansion has been less visible. In Indonesia, the Philippines and Thailand, foreign ownership is banned in areas related to the national curriculum. However, it is possible to get exposure to the space through partnerships with local players.
A second consideration is the sheer cost of developing K-12 facilities.

Expansion plans

In contrast, language learning and childcare have seen plenty of greenfield investments. Navis Capital Partners first invested in Wall Street Institute (WSI) in 2006 when the franchise was limited to Thailand. The PE firm took the business into Indonesia in 2007, committing about $1.5 million, and it now provides English-language training to over 8,000 students. International education group Pearson bought the Indonesia arm in 2012, securing a 10x return for Navis.

"It is easier to make greenfield investments in language teaching centers, or even in early childcare centers. These are ‘extra or supplementary classes,' not mainstream or fundamental courses that are taught in schools, colleges or universities. Those decisions on mainstream education choices are very important decisions. But if students decide to learn English as an extra language, that's much more a discretionary decision," says Nick Bloy, co-managing partner at Navis.

Expansion opportunities also exist in the college and university space. The private equity investor would add places and courses to institutions that have a good reputation, slowly increasing the business margin.

However, good deals in tertiary education are scarce in Southeast Asia and difficult to access. The sellers have often spent years building up a brand and so they do not consider exit options with a commercial mindset: they want a fair price from a buyer of good standing and with solid plans for the business. Relationship-building is crucial. Conversely, it is immensely challenging to turn around a college that is beleaguered by a bad reputation.

It is therefore generally considered easier to replicate the business model of English learning and childcare centers and build them into sustainable operating chains. The likes of Pearson, which was looking to expand in Southeast Asia when it picked up WSI Indonesia, make for logical trade sale buyers and they will only consider assets of meaningful size.

AVCJ Research has records of four exits in Southeast Asia's education sector over the past decade and there is a reasonably consistent theme of selling to strategic players. For example, in addition to Navis, Singapore-based Tembusu Growth Fund offloaded its stake in childcare centers operator Cherie Hearts to Australia-based G8 Education. Abraaj's Lodhi says notes that his firm's K-12 schooling investments would probably have to extend beyond the six-year holding period to ensure the required scale and impact is achieved.

Trade sales to domestic buyers represent another channel exit channel, particularly where an industry is undergoing consolidation. Creador brought in SMRT to help restructure Masterskill, and while the company will remain listed, opening up the possibility of a public market exit, the private equity firm will also consider strategic investors. Creador and SMRT are exploring potential synergies between Masterskill's Asia Metropolitan University and Cyberjaya University College of Medical Seiences (UCMS). The latter was restructured by SMRT and is now one of its subsidiaries.

"To turnaround or operate a business well we have to make sure we have the right management team is in place," says Creador's Loh. "That is why we chose to partner with SMRT - it has a strong education team with all the necessary capabilities, and it has successfully turned around another university in Malaysia."

SIDEBAR: Ed-tech - Expansion angle

Education technology in Southeast Asia has become a favorite of venture capital in recent years. A total of $33.6 million has been committed across 18 transactions in the past decade, but just since 2012, 12 deals have drawn $22 million, according to AVCJ Research. While some of these are pure online plays, there are also a number of online-to-offline (O2O) tutoring platform that connect teachers and students.

Last August, East Ventures backed Indonesia-based online private tutoring marketplace Ruangguru.com. The platform allows students to find teachers for after-school tuition in subjects ranging from mathematics to yoga. Ruanguru now has around one million of teachers, comprising both private and public school practitioners, and over 20 million students.

"Education is one of the areas Indonesia's middle class is willing to spend its money on," says Willson Cuaca, co-founder and managing partner at East Venture. "This kind of platform can scale up easily nationwide. The number of private teachers grew from 2,000 to 8,000 within six months. I think this could only happen in Indonesia; maybe Thailand or the Philippines as well, but certainly not Singapore or Malaysia because the populations are much smaller."

While there are at least four platforms trying to match teachers and students in Singapore, they have yet to receive VC backing. One of the reasons is the difficulties tied to taking these businesses cross-border. Cuaca explains that the technology is transferrable but the platforms rely on local teachers. "It is difficult because every country has its own learning methods. That's why when we considered investing in this type of start-up we focused on a big single market," he adds.

Market size is also a factor in determining the extent to which a business can become diversified, especially in the O2O space. For example, Ruangguru could feasibly acquire more users by branching out into areas such as providing guidance for students deciding on university applications.

However, from a pure online standpoint, cross-border can work. Pre-school, language learning and vocational training platforms have the potential to address the region as a whole, according to Sandeep Aneja, founder and managing director of education-focused GP Kaizen Private Equity. He sees this as a logical move for Singapore- or US-based start-ups that provide high-quality teaching curricula.

"For example, these online platforms could work with local players to games-based mathematics learning experiences for children or delivering specialized programs for training sales teams," Aneja says. "A lot of high-growth companies by nature have high turnover rate - around 30% of salespeople leave each year. The biggest problem is hiring and training and online solutions could be more efficient."

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• Topics
• Southeast Asia
• Buyouts
• Consumer
• Southeast Asia
• Education
• buyout
• Creador
• Abraaj Capital
• Kaizen
• Navis Management
• Growth capital