?Education: a debt due from present to future generations,? as defined by George Peabody, an 18th century entrepreneur, banker and philanthropist.

Indians spend approximately $44.8 billion on education while the global education market is approximately $2 trillion. Approximately 26% or $11.5 billion of the industry in India is private and offers investment opportunities. Market growth across the Indian private education sector is in excess of 10% per annum and this sector is looking like a major opportunity over the next few years.

As per reports within the private equity and venture capital world, one of the hottest new segments where investors are now looking to invest in over the next six to eight months is the education sector. The sudden rise of popularity in this sector has come at a time when investors are looking to expand their investment options and cover different options that not only provide a good opportunity but also discover new possibilities.

?India?s education and training sector offers private institutions an estimated $40 billion market, with a potential 16% five-year CAGR,? says a report by CLSA Asia-Pacific Markets. According to another report by IDFC-SSKI, India?s current spend on education is at 5% of the average household income, with a CAGR of 8.6% versus consumption growth of 3.2% over 1995-2005. ?With an inefficient public education system, a growing young population, a bourgeoning middle class (with the intent and ability to spend) and the price discovery it has seen over the past decade, we expect 14% CAGR in private spends on education ($80 billion by 2012),? the IDFC report forecasts, using the $13 billion being spent annually by Indians on higher education overseas to highlight the ?pay power of the education-hungry Indians?.

While the growth potential within this segment is massive, like all investment opportunities, this one too comes with its own set of concerns and drawbacks. One of the primary concerns investors are currently battling is, the regulatory uncertainty surrounding the profit making ventures in the K-12 and higher education segment. Another concern expressed by investors is that of scalability, especially in the non-formal and vocational segments of the sector.

Vinay Pasricha of Wigan & Leigh College (India), a vocational education firm that has raised private equity funding, for instance, feels there is enough scope to create scale in unregulated segments of the industry, both within and outside India. ?Tell me a sector where you do not face regulatory uncertainty,? he asks, adding that ?Education, apart from healthcare, is the only mass growth opportunity that will continue to flourish during any economic downturn,? as mentioned by him in the Venture Intelligence report.

Why education

While education as an industry may be different form many others, as an investment opportunity it?s measured in much the same way. While one of the reasons for its sudden popularity is the fact that this segment is one of the few that are completely unaffected by a downturn, this segment also seems to be promising good returns to investors. One of the many reasons for this segment looking so attractive in India is, our nations undying hunger for education and knowledge, as well as an expected increase in spending power to fulfill these needs. An IDFC-SSKI report in Jauray 2009 indicated that they expect the consuming class – i.e. households with annual income higher than Rs 90,000, to grow from 28% of the total population in 2002 to 48% in 2010. The report expects 14% CAGR in private spends on education ($80 billion by 2012) with 13% CAGR for the formal education segments (K12 and professional segments) and 18% CAGR for the ?non-formal? segments.

A CLSA report also establishes the growing preference for private sector institutions. While just 7% of India?s over 10 lakh schools are privately owned, they already account for 40% of the country?s 219 million students enrolled. This is even though almost a 142 million children are not in the school system. In higher education, 77% of the 18,000 institutes are already privately owned.

With such projected spending patterns and revenue generating opportunities, it comes as no surprise that everyone who can get it wants a slice of the pie. So far, private equity and venture capital funds have already invested over $300 million spread over the last few years in education-related companies. Almost 25% of the investment amount in the sector has gone towards the e-learning segment.

In a recent poll conducted by Venture Intelligence, amongst 90 private equity firms, a whopping 80% of them admitted to be looking to invest in the education sector over the next six-eight months. This is not as surprising when one considers the growth opportunities that this segment provides, or that fact that it has an expected IRR of at least 30%.

Concerns

A continuation of the poll also showed that almost 50% of the fund houses were very concerned about the regulatory hurdles, and felt that this could impact the investment flow within the sector. Some of the key regulatory concerns that were highlighted in the survey are, non-profit requirement for schools and colleges, requirement for certification/affiliation to boards like AICTE, restrictions on foreign investments in higher education and a general lack of clarity on what is allowed and what is not allowed.

This industry poses certain challenges to investors and if one is to make an investment in this sector some of the things they should be aware of would surround the scalability of the venture. Most of the institutes are small or medium sized at the moment, and majority of the entrepreneurs who have entered this field have done more so in a feel good and charitable sense. Therefore, one must be convinced that the fund they are investing via is doing so in companies, which are not so afraid of scaling up. However, in this sector, like the health care sector, a long-term approach is most advisable for one to gain the maximum out of their investment. The regulatory issues associated with investing, acquiring trusts, extracting returns, and exiting are significant and investors would be advised to retain legal counsel with prior experience in dealing with these issues early in the diligence process. Another area, which investors should look into, is if the company being invested in is over ambitious and tries to cover larger geographical areas, since they often stretch themselves too thin to maintain the standard of quality.

As far as the K-12 sector is concerned, regulations disallow any form of direct investments, leaving this sector highly underdeveloped as of now. A majority of the states do not recognise higher education institutes, which are privately run, unless they are a non-profit organisation. Coupled with a lack of real estate and good staff, this $20 billion industry shows very low returns or growth and is as of now a highly restricted area for investors.

Investment options

While there are many concerns this industry faces, not to mention the parallel education system run by teachers in their homes in the form of tuition, which makes this high growth industry look bleak, this segment too is not without its own unique way of functioning. One of the most common practices within the sector, that allows investments to happen and profits to be made, is the setting up of a non-profit organisation, which runs the institute.

This NPO becomes the face of the institute and gets the required approvals, certification, enrolls students, collects the fees, etc. The investors, apart form the NPO, also set up the required infrastructure, staff, uniforms, curriculums, etc. to get the place running and functional. These too provide a revenue-generating opportunity in the form of rent, fees, etc. This enables investors to invest in the company, which has set up the trust that runs the education institutes, thereby profiting from the industry, even though in a round-a-about-manner.

With private equity funds now looking to invest into our education sector, investors with deep pockets who are looking for an emerging market to tap now have a lovely opportunity of doing so. While the mutual fund industry has no fund specifically investing in this sector, their only exposure comes via buying the shares of publicly listed e-learning companies. This segment does have the unique ability to function and do well irrespective of the market downturn and an economic slowdown like this itself is an opportunity to invest here. Higher education is one of the few sectors that respond positively to the economic slowdown. Data from the prior and current recessions in the US have shown that enrolments in higher education institutes see a spike during such periods. This growth in enrolment is driven by the low opportunity cost that a downturn creates for professionals to re-tool and re-skill. In India, the counter-cyclical nature of higher education should also exist as banks continue to provide collateral-free credit to fund professional education, thus further driving down the opportunity cost.

?In the current uncertain economic environment, the attractive and predictable rates of return of the education industry, is serving as a magnet for PE investors,? points out Arun Natarajan, CEO of Venture Intelligence. ?In fact, in another poll, which we had done at the end of 2008 among PE investors, education had received thrice as many votes as the next favourite sector in terms of attractiveness for investments in 2009,? Natarajan added.

The education industry in India is one of the most important to our nation yet least talked about as in investment. This is ironical given not just the numbers and importance of the sector but also given the fact that the corporate world and education are so closely connected. While philanthropists have in the past set up many schools or chains of schools even across our nation, the fact that education is not being looked at as an industry that will be judged and monetarily perform as per its standard, delivery and effectiveness is a heartening sign of the things to come. Current private equity funds are looking to make the most of the healthcare and education sectors in growing countries like India and China.

Investors who may have never even considered investing in a school should now seriously evaluate this segment as an investment opportunity and follow the money trail, whilst being careful of the dangers this sector faces.

Thus, as Mahatma Gandhi said, ?Education not only moulds the new generation, but reflects a society?s fundamental assumptions about itself and the individuals which compose it.?

High rates of return

•Across sectors, EBIT margin ranges from a low 15% to over 40%. The IRR for these businesses can be in excess of 30%

Favorable pricing

• Partly driven by the supply/demand imbalance, price growth in more attractive sectors is higher than inflation

Revenue predictability

•Revenue predictability: In sectors such as private education, multiyear enrolment and knowledge of attrition rates allow firms to better predict their revenue streams

Scalability

•Insufficient supply and overwhelming demand offer opportunities for operational scale growth and top-line growth

Negative working capital

•Negative working capital: Student fees are collected annually or semiannually prior to actual enrolment, while costs are incurred over a period of time

Counter-cyclicality

•Counter-cyclicality: Enrolment in sectors such as tertiary education improves as the economy worsens. Increase in unemployment can result in an increase in enrolment