As predicted in my last post – “What Nord Anglia Education’s Partnership With People Combine Mean For The K-12 Sector”, the event has re-invigorated the deal making discussion in the K-12 Sector. Over the last few days I would have interacted with dozen plus school promoters and potential investors. Based on my interactions – here is some Good News and some not so Good News.
First the Good News – There are enough number of credible players on either side of the deal. There are scaled up K-12 businesses run by reputed promoters who are looking to partner to further grow and scale. Also there are strong domestic and global operators with capital who are willing to add new schools to their portfolio.
Now the not so Good News. While there are willing parties on either side of the table, there are fundamental issues which can act as a spoil-sport to potential deals. I have summarized some of the key issues below:
Regulatory Requirement, Lack of Awareness has resulted in a situation where quality K-12 businesses cannot be easily transacted on.
CBSE and most state governments provide school licences only to not-for profit entities – Societies, Trusts, Section 8 Companies. By their nature these entities one needs to keep reinvesting any surplus generated from the business and cannot return it to the investors. Only in states like Maharashtra, Haryana one can run a purely international school under a for profit company.
To overcome this challenge most forward looking promoters have implemented the Opco-Propco-Manco (Operating Entity – Property Company – Management Company) structure. The Operating Entity is the not for profit entity with the education license. The Property and Management Company provides infrastructure and services to the Operating entity and thus create a conduit to generate returns for the investors.
There are other nuances around structuring and this topic needs a separate post for itself. Most promoters have not structured their k-12 business optimally making it difficult to transact on.
Lack of Strong Governance Framework
K-12 Businesses in India are mostly unorganized, run by promoters and in most cases don’t have very high standards of governance. In some cases a significant part of the business is off the books for multiple reasons, including:
a. To optimize on potential taxes
b. To monetize on excess demand for admissions
c. To overcome on regulatory restriction on fees
Not only the business is off the books, it is not uncommon for the promoters to demand value for part of the business which is off-books.
Investors’ specifically international investors would typically stay away from such businesses.
Gap in Valuation Expectation
While valuation gap is an issue which exist across sectors and businesses, the absence of listed companies or the relatively fewer number of transaction make it even more difficult for K-12 business. Market participants in general tend to use multiples of relatively similar sectors to start with and use arguments like regulatory issues, non-cyclical nature to increase or decrease the multiple depending on which side of the deal they are.
Additionally in cases where the real estate is also part of the deal apart from the school operations, the divergence between the business value and the the real-estate value is a major issue. We have seen cases where the real estate is extremely valuable but the operations will not generate commensurate surplus even in full capacity. In such cases the business needs to be restructured to make the deal viable for both parties.
Absence of Strong Deal Team In the Business
A K-12 promoter typically would not have exposure to all the nuances of deal making and relies on investment-bankers, lawyers and other advisors. The Investment Bankers primary objective is to close the transaction given their incentive structure. However in multiple cases promoters have expressed that they get squeezed by their own bankers.
Promoters need someone with deep expertise who can be part of their team, take care of their interest and at the same time program manage the entire process. Currently there is an absence of formal advisory support of this kind making it difficult to close deals.
We at LoEstro are attempting to bridge some of the gaps mentioned above. Leave us a comment below in case you need to talk.