China schools investment rush gets an A for effort

But can it deliver the results that investors are hoping for, given intense competition between operators and growing government efforts to regulate the sector?

Chinese education – can't live with it, can't live without it. Or, at least, it seems from an investment point of view as capital floods into the sector and investors also fret about how best to nurture and grow their projects and eventually exit their investments under tight state supervision.

To paraphrase the Greek philosopher Aristotle: Give me a child and I will show you the man or woman. So schooling is hardly an area where an authoritarian state like China would give private capital a free hand (they don't usually in the 'capitalist' West either). 

But it's not just that; competition for the right to teach China's new generations and to profit from that endeavour is also fierce.

"We are worried about our project, day and night,” one education investor, who declined to be named, told FinanceAsia.

And yet the money is pouring in, with five significant equity investments already this week. 

The biggest was Hillhouse Capital's $500 million bet on TAL Education, which raised its stake in TAL to 7%. Then there was Zhangmen, a Chinese online tutoring company, which raised $350 million in its first Series E fundraising from CMC Capital Group, CICC Alpha, China Investment Corporation, Haitong International and Genesis Capital. 

Zteng, an IQ-training company, got Rmb24 million ($3.5 million) from Huagai Capital and Partnership Fund. Others chose a more distinctive angle, such as kids programming education site Hetao101. It received an Rmb120 million ($17.8 million) fundraising from Hillhouse, XVC and Source Code Capital. Meanwhile, Acadsoc, a one-on-one English teaching site, said it completed a Series C fundraising from IDG Capital and Shenzhen Venture Capital.

DISCIPLINE POLICY

Education from pre-school or kindergarten age to school-leaving or pre-university age, naturally, faces strict supervision. But it's got stricter of late in China.

The first strike came in August last year when the Chinese Ministry of Justice issued a draft of new rules banning education companies from expanding via mergers, acquisitions or franchising.

That came as quite a shock for some newly setup education companies who had set their sights on expanding through M&A and attracting more investment for that very purpose. Nasdaq-listed RYB Education (since renamed GEH Education), for example, saw its share price drop by 10% in response to the news. 

Another Molotov cocktail fell in November when China's State Council effectively banned private companies running kindergartens from going public and barred listed companies from buying stakes in the kindergarten operators.

"A listed company may not invest in a for-profit kindergarten through stock market financing, and may not purchase for-profit kindergarten assets by issuing shares or paying cash," it announced. 

The regulation tightening was unexpected and hit the shares of all listed Chinese education companies.  

OVERSUBSCRIBED

There is also the danger of having too many education companies operating similar business models that rely on high volumes because not everyone can win that game. As more players join, it will get harder even in a country as big as China to get enough users and orders to keep the businesses running.

But some investors are undeterred and think there is scope to build a Chinese education unicorn.

“Zhangmen’s $250 million fundraising is using this logic,” one fund manager said. “They want to run even faster in one-on-one online tutoring and hope no one can ever catch up with them.”

Certainly, becoming an education business leader in China would result in huge amounts of traffic and potentially be very lucrative as more Chinese parents competed to give their children that extra edge in life.

CAREER PROSPECTS

But what of investors' exit strategies?

Beijing’s latest actions underline how the government is keen to promote greater inclusivity and to regulate school pricing rather than allow a Chinese-education profit-driven free-for-all.

And who can blame them?

So education investors will need to come up with more discerning ways to work within the rules to realise a profit in the sector. The prize could be massive but getting there will require cunning.  

And if they are to attract a trade buyer such as an Alibaba, Tencent or Baidu, say, and get their money out that way, they will have to first make sure they have built up sufficient scale and profitability.

Not everyone will be able to though.

 

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