China schools deal puts RRJ at top of class

RRJ has made a big profit from cashing out of Chinese education company Tsingda eEDU alongside OCBC and Capvent, just ten months after investing.

Asia-focused private equity firm RRJ Capital has made a near-threefold return on its investment in Chinese private education company Tsingda eEDU in less than a year, a source familiar with the situation said, underscoring the soaring demand for private schools and supplementary education as the country’s middle class grows.

The private equity firm has sold its roughly 20% stake in Tsingda for about $140 million to a Chinese trust company. The sale values Tsingda at about $700 million, similar to China Maple Leaf Education, the first Chinese school operator to list in Hong Kong, the source told FinanceAsia.

Completion of the deal implies RRJ has nearly trebled its initial investment of $50 million in Tsingda made in February last year.

Singapore’s OCBC Bank and Zurich-headquartered investment fund Capvent have also sold their shareholding to the same buyer for a total consideration of about $70 million. The duo held roughly 10% of Tsingda before the deal closed.

As part of the transaction, Tsingda chairman Zhang Hui has also sold $65 million worth of shares to the buyer in order to repay all of the company’s debt. He will remain the controlling shareholder of Tsingda after the deal.

BoCom International was the sole advisor on the transaction.

PE fever

Tsingda’s soaring market value hinges upon the potential growth of Chinese private education companies, including international schools, private tutorial service providers and distance-learning course operators.

The education industry has been one of the hottest investment areas in China for venture capital and private equity funds in recent years because it can be very lucrative and education companies often operate with a simple, light asset structure, one private equity fund manager told FinanceAsia. Usually these schools do not own the properties upon which they operate, but rather lease them from third parties. These simple structures allow relatively easy exits through trade sales or initial public offerings.

Examples of venture capital and PE investments in education companies include Baring Asia Private Equity's purchase of Hong Kong-based international school operator Nord Anglia Education for $360 million in 2008. Subsequently Baring Asia sold 23% of its stake for $304 million through a New York listing in March 2014.

Based on the valuation of $1.33 billion at the time of Nord Anglia Education’s listing, Baring Asia made a stellar return of 367% over a course of six years, or an annualised return of 61%.

In a separate example, US-based venture capital firm Sequoia Capital was a pre-IPO investor in China Maple Leaf Education before its HK$962 million ($132 million) IPO in Hong Kong in November 2014.

Rising demand

Education companies are also attractive to private investors because of their strong growth potential in the rapidly expanding and vast Chinese market.

China Maple Leaf Education, which provides international pre-school to high school education in China, reported a four-fold increase in net profit to Rmb205 million ($31 million) for the financial year ended August 2015.

The stellar profit growth is partly attributed to the rapidly growing middle class. Richer Chinese families tend to send children to international schools to boost their hopes of getting into top overseas universities. In the latest financial year, about 90% of China Maple Leaf’s pupils came from middle-class families, according to the company’s annual report.

Beijing’s decision to abolish the decades-old one child policy late last year is also expected to have a direct positive impact on the prospects for the education industry in the long run as the number of children grows.

Getting around foreign investment rules

Tsingda’s stake sale was aimed, in part, at unwinding the variable interest entity (VIE) corporate structure it established to facilitate an attempt to list in the US in 2011, the source familiar with the deal told FinanceAsia.

Some Chinese companies adopt VIE structures to circumnavigate rules that prohibit foreign investment in certain sensitive industries in China, such as the internet, education and telecommunications.

Under a VIE structure foreign investors are not investing directly into the operating company but instead taking stakes in a holding company registered abroad. In this way they can retain a controlling equity stake in the operating company in China while complying with Beijing’s foreign investment rules.

For the same reason the structure is also adopted to help achieve offshore listings since China-registered companies in sensitive sectors are not allowed to introduce foreign investors. In a VIE structure, the listing entity is a holding company which does not own the underlying business, but has the right to all revenues generated by the business through contractual arranagements.

Internet giant Alibaba is one of the best-known Chinese companies to adopt the VIE structure, allowing it to list in New York despite already having foreign shareholders such as Yahoo and Softbank. In fact, most Chinese companies that trade on US exchanges, including Baidu, Sina and Tudou, have adopted the VIE structure.

Tsingda filed a listing application with the US Securities and Exchange Commission in 2011 but did not proceed with the listing. The application lapsed in 2014.

Since the company is no longer pushing ahead with an overseas listing, the source said it was able to simplify its corporate structure by parting with all foreign investors to remove the VIE.

A non-VIE strcuture will also facilitiate a public listing on domestic stock markets, which Tsingda is considering in the near future, the source added.

Tsingda offers supplementary educational courses for children from infancy up to the age of 18, via the internet and its franchised learning centres. It provides pre-recorded courses and runs a virtual online platform that allows interaction between teachers and pupils.

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