How to invest in Chinese education & avoid the pitfalls

Conrad Tsang founded Hong Kong-headquartered Strategic Year Holdings in 2015 which focuses on education investments.

Prior to founding Strategic Year Holdings, he spent 13 years at Baring Private Equity Asia and set up the firm's Beijing office. Before that, he was with Merrill Lynch Asia Pacific doing equity research, focusing on media and retail sectors.

The companies he has been involved over the years include Noah Education Holdings, Minsheng Education and Nord Anglia Education. Strategic Year Holdings has invested in Kasca Education.

We thought he was the right man to school us in investing in the education sector.

The following transcript has been edited for clarity and brevity

Q How much of your portfolio have you allocated to the education sector?

As far as Strategic Year Holdings is concerned, about two-thirds of our allocation is education related across Asia – education services, training services are in that category. I will maintain it like that because we like the sector.

It's a very resilient sector, even during economic downturns. Households will not likely cut down education spending on their children, that's why this sector, in a way, is a bit counter-cyclical. When economies are turning sour, even adults see the needs to equip themselves with more skills and more qualifications. We will continue to maintain the relative percentage of the allocation to the sector.

Q Is there any country in particular that you think is interesting?

Anywhere with a big consumer market is something we allocate more to; China for sure, plus a few other countries with a big population within Asia. I think China is tilting policy towards enabling working moms to be able to work more during the daytime so that they are encouraging more daycare centres and playgroups. They hope that through this encouragement, young parents are more willing to have children without worrying about who will take care of the kids after birth.

Q How do you spot a promising education company?

Generally, we like to have companies that have revenues already. They are not necessarily profitable on day one because you need to continue to invest, but we want to make sure that we see their path to profitability. At the end of the day, it's not the concept that works.

When times are not as good, like now in the private market, which is pretty quiet, investors and companies should actually focus more on cash-flow generating capability and profitability of the businesses.

Q Within the education sector, are there any promising sub-sectors?

The use of online learning in an offline environment and the resulting improvement in efficiency and cost-savings that lead to profitability is something that we are seeing being developed and should be developed across all age groups.

Personally, I do not subscribe to the fact that a company with an app or a website that is burning cash to acquire users, marketing advertisements to attract users and will be loss-making for years to come with no earning feasibility will eventually generate profits. There are companies like that all over Asia.

Having said that, there are companies that may start off with learning centres and schools offline, but because they use internet to reduce the number of physical teachers at every single location, for example, you save the cost of other teaching centres. We will be more interested in the prudent usage of internet or mobile to achieve cost-saving and efficiency.

Q What are your expected returns?

To execute our strategies, which take five to seven years, we are comfortable that we can achieve double-digit IRR (internal rates of return) on a consistent basis from earnings growth and M&A opportunities.

Through consistently investing in companies with scalable business models, the right management team, consistent revenue growth, we also help them with setting KPIs, executive management hiring and geographical expansion. We are not talking about a home run but what we are looking for is consistency in returns.

Q What are the risks of investing in education?

It happens occasionally; maybe the management has too rosy a growth trajectory, that's one factor. But in the case of China, what's more, common is actually policy change. It's something that's totally unexpected.

Until last year, kindergarten was a very hot sector in China. Some people were invested in it and some people were in the final stages of negotiation, until November last year, when the State Council issued a directive saying that they prohibit for-profit kindergarten from going public or being acquired by public companies.

That caught people by surprise because at the time, a lot of operators were investing heavily into high-end kindergartens to give good services to students. A lot of projects were put on hold and some of the operators were encouraged to turn their operation into non-profits.

When the industry is developing fast, I think regulators should be encouraged to keep in constant dialogue with practitioners and understand what their latest way of doing things are and to modify the regulations accordingly. I think that's true universally.

Q How do you determine when and how to exit?

Trade sale is one way to go, and IPO (initial public offering) of course when the market is buoyant. In some cases, when the exit window is not as favourable, then investors will need to engage in negotiations with companies about buybacks; but a buyback is a less desirable outcome because valuation is usually lower than via a third-party exit.

Q What’s your end-game in investing in education?

On the one hand, you generate commercial returns, on the other hand, you do something do good for the society. For high-quality education services, although they are not free, the key is, as long as the operator operates in a socially responsible fashion and that they provide high-quality services that justify the price they are charging, the consumers will be happy with that.