PRIVATE EQUITY

IN INDIAN

EDUCATION SECTOR

Subject: Venture Capital

Submitted to: Prof Bhatia

Submitted by

Ruchi Jha 14Manoj Mahato 21Tejashree Rane 39Madhura Sabnis 42Varsha Sahani 43Namrata Vikam 57

Overview of the education sector in India:

The Market

The education sector in India has a wealth of opportunities for startups, created by factors

such as an inefficient public education system, a booming young population and a

bourgeoning middle class. The Indian Higher Education market in 2012 is estimated at $11bn

– is next only to the K12 segment in size with $13bn spent on importing education (amount

of money spent by Indians on foreign higher education degrees. With a median age of 25

years, India has over 550 million people below the age of 25 years. According to Census

figures, over 32 percent of the 1.1 billion populations is between the age group 0-14. This

means that the number of people in India needing primary and secondary education alone

exceeds the entire population of the USA. Since these students will be seeking higher

education in India over the next decade it illustrates the sheer size of the Indian education

market. Presently about11 million students are in the Higher Education system. This

represents just 11% of the of the 17-23 year old population. The government hopes to

increase this to at least 21% by 2017- a target which still falls short of the world average.

With the emergence of India as a knowledge-based economy, human capital has now become

its major strength. This has put the spotlight on severe inadequacies of India’s infrastructure

for delivery of education, particularly higher and vocational education. The cost of

educational services in India is one of the lowest in the world — less than one-sixth of the

global average. According to an Anand Rathi report, India’s education sector ranks among

the top 10 in value terms. Households account for about 35 percent of that spending, which is

higher compared with other countries.

Demand-Supply Gap

Indian society puts a premium on knowledge and its acquisition -spending on education has

figured as the single largest outlay for a middle class household after food and groceries.

With its rapidly expanding middle class, India’s private expenditure on education is set to

increase manifold.

India’s public expenditure on education (centre plus state expenditure) has ranged between

3.26 % and 3.85% from 2004-05 till 2009-10 and this needs to increase if it were to come at

par with the expenditure incurred by the developed economies. While there has been some

private investment in setting up educational institutions, there remains a glaring mismatch in

demand and supply, particularly in high quality institutions.

Example: only 1 out of 150 applicants get admission into the elite Indian Institutes of

Management (IIM’s) compared with the ratio of 1:10 for MIT. It is therefore not surprising

that an industry chamber has recently reported that 450,000 Indian students spend over USD

13 billion each year in acquiring higher education overseas.

To reduce the demand supply gap in school education, it has been proposed in the 12th FYP

(2012-17) to set up 6,000 schools at block level as model schools to benchmark excellence.

Of these, 2500 will be set up under Public Private Partnership. Further, easy availability of

education loans to students it has been proposed in Budget 2012-13 to set up a Credit

Guarantee Fund for this purpose.

Source: MHRD report titled “Analysis of budget expenditure on education (2007-08 to 2009-10)”

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. Experts estimate the opportunity in the Indian private education sector

will reach $70 billion by 2013, from $60 billion in 2012.

Trends in the Education Sector

Private Equity/ Venture Capital Investments in the Education Sector

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. 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.

Private Equity Deals in India in the Education Sector

Challenges facing the private equity investments in Indian education sector:

1. The not-for-profit diktat associated with private investment wherein no dividends can be

paid to the investor has traditionally discouraged private funds from flowing into the

educational sector.

2. The sector is over-regulated and sees rampant corruption as a large majority of private

institutions are owned by politicians making it more unattractive for the corporate or

private investor.

3. Privately run higher education institutes (HEI’s) choose not to affiliate to the system and

effectively escape the over-regulation but then have to overcome the burden of getting

industry acceptance as there are no regulations in place to recognize such HEIs that have

no accreditation.

4. The non-formal segment of the education sector lacks the necessary scale needed for it to

be an attractive investment opportunity.

5. In the K-12 segment, where there is currently tremendous underinvestment, there are

challenges in PE investing. Specifically, there are regulatory hurdles in this process and

this is often cited as the major impedance to free flow of PE funds. Some of these

concerns are:

Non-profit requirement for schools & colleges.

Requirement for certification/affiliation to boards like AICTE.

Restrictions on Foreign Investments in higher education.

General lack of clarity on what is allowed and what is not allowed.

Opportunities for PE firms in the Educational Sector in India

As outlined in the previous section the educational sector in India is fraught with challenges

in termsof it being free for private investment. These challenges however do not absolutely

exclude anyopportunity for investment and in this section we try to address the question of

what a PEfirm can actually do to get around or address these challenges to still capitalize on

the boomingeducation market in India. The primary challenge being the not-for-profit

regulation covering mostof the educational sector in India the central question is “How can a

PE firm address the Section 25 of the Companies Act?” This refers to the Government of

India (GOI) regulation that stipulates thatincome from entities that fall under Section 25

(which include educational trusts) “apply its profits, ifany, or other income in promoting its

objects, and to prohibit the payment of any dividend to itsmembers.” We believe that the

answer to this question lies in either finding a way to bypass theregulation, in investing

outside the scope of the regulation or simply taking “an option” on theregulation to change.

How can a PE firm bypass the not-for-profit regulation?

The innovative structures approach

Taking a cue from independent school-owners ‘extracting’ profits from trusts (schools and

HEIs) in the form of lease rentals and management fee, some players have taken the age-old

informal structure to the next level. The ‘innovative structures’ have emerged to break the

‘trust’ issue. The company creates a trust (a not-for-profit body) that runs the educational

institute at one level. It further creates a subsidiary that supplies land, services and

infrastructure to the trust in lieu of rental/ fees. In this way, the entity manages to unlock the

‘surplus’ and distribute it as dividends or use it to fund other ventures. This approach has the

benefit of possessing ample scale for it to be interesting for PE investment. Potential

acquisition candidates are however scarce and there is the ever present risk of this model

being struck down in this “socially sensitive” sector.

How can a PE firm invest outside the scope of the regulation?

Unlike in the K-12 segment wherein a school has to be affiliated to one board or the other for

its high-school graduates (10th and 12th grades) to be recognized as part of the formal

education system and eligible for further studies, it is possible to set up an HEI outside the

purview of University Grants Commission (UGC) regulations. The products of these

institutes (college graduates) do not have to conform to acceptance standards of the education

system but of the industry.

1. The ISB approach – Using the strength of brand and quality

As long as industry quarters perceive the products to be of superior quality, the HEI

can do without cumbersome affiliations and regulations. For example, ISB (Indian

School of Business, Hyderabad) is a venerated name in the industry corridors despite

it not being affiliated to any regulatory board. The diploma offered by ISB holds as

much (arguably more) value as any UGC-accredited certification.But importantly, this

status requires maintenance of world-class quality and strong industry

support,something that can only be achieved through significant investment of capital.

2. Tying up with a foreign institute

The above approach is however not possible for doctors, architects, lawyers and

pharmacists who according to the constitution have to be products of accredited

institutes to be able to practice professionally in India. The regulations however do

recognize a number of foreign degrees in the country, holders of which are indeed

allowed to practice professionally in India. Another avenue for PE investment in India

is to tie up with one of these foreign institutes and set up shop in India.

3. Going the non-formal way

Non-formal education though fragmented presents an attractive regulation-free

opportunity forinvestment. Spanning preschool to vocational training and including

peripherals like multimedia and books, this segment is growing equally fast due to the

imbalanced education supply-demand equation. The chart (see figure below) below

shows main players in the different non-formal segments.

4. Rolling it up

While scale is the main issue in the non-formal segment one way to deal with it is the

possibility to make multiple small acquisitions and rolling them up at a later stage.

Especially in the tuitions and tutorials space there is a possibility to combine multiple

small companies into one large company,push for efficiencies, build a brand and plan

an exit at a later stage.

PE Deals in India

1. Kaizen Private Equity

It is India’s first PE fund focused on the education sector. 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 day

care and playschool chain Your Kids Are Our Kids (Rs 20 crore).

2. Manipal University Learning

Manipal Universal Learning (MUL) has strong brand equity within the HE space through

Manipal University and Sikkim Manipal University (MUL sells services to the two Indian

universities within the Manipal Education group). While the Indian operations are at ~49%

of revenues, its international HE businesses dominate the topline (revenues primarily from

four institutes in Nepal, Dubai, Antiguaand Malaysia, run as private limited companies). Its

ability to attract capital has been based on astrong credibility of execution from its

management team. MUL also has branched outside of India making the investment more

geographically diverse, potentially also allowing for easier movement of funds within the

system. The other key differentiator of MUL is its ability to differentiate itself from other

institutions of learning. Its program offers cross region campus exchanges within its

system, much like the INSEAD model.

Given a strong brand position, it has been able to offer a number of different programs that

include vocational training as well as distance learning. It has also been able to tap into the

business sector and establish collaborations for training. Its attractiveness is based on its

diverse mix of educational offerings, competent management team, strong brand and risk

diversification.

IDFC Private Equity and Capital put in US$30m and US$40m respectively in May 2007. It

is one of the few formal players in the higher education sector that has made a name for

itself by being diversified and different.

3. Educomp

Another player that operates in the Preschool and K-12 segments is Educomp. This is a very

good example of how an innovative investment thesis can be formulated even in the highly

regulated K-12market by establishing a vehicle that caters to these markets. The graphic

below depicts the mechanism for how funds travel through the structure (see figure below).

For each owned school,Educomp Solutions forms a trust that runs the school’s operations

Educomp has two formed two subsidiaries –

1. Educomp Infrastructure (69.4% stake with Educomp Solutions) - owns the real estate and

leasesit out to the schools. Edu Infra gets:

i) Returns of 14.5% on capital employed in setting up schools

ii) 4.5% of annual tuition fee and

iii) One-time fee of Rs5m per school

2. Educomp School Management (68% stake with Educomp Solutions) provides IP/ content

and management services (content, delivery, canteen, transportation, text books etc) to the

schools.

In these examples, the PE investor has taken a novel approach to the regulatory hurdles that

beset the Indian education sector. We see a vast potential for investment but also the need for

straight forward investment mechanisms.

Bibliography

Reports/ Articles

1. India- Higher Education Sector (Opportunities for Private Players) – PWC

2. Private Equity in Education – Business Standard

3. Private equity – Outlook on PE in India’s Education sector

4.

http://www.firstpost.com/economy/indias-next-big-growth-bet-seriously-you-need-to-study-this-

171101.html

5.http://www.vccircle.com/content/kaizen-invests-46m-catamaran-accel-backed-education-firm-ace

6. IDFC SSKI & CSLA Education research report

7. http://business.outlookindia.com/article.aspx?282616