China's growing middle class will stop at nothing to give its children the best possible start in life – and education is the key.
Increasingly, this doesn't just mean finding the right public school or even shelling out big money for an elite international education. A range of online providers are seeing the possibility in offering lessons, tutoring and other educational resources online.
Underlining this point, online education platform Zuoyebang said on Wednesday it had closed its $350 million series D funding round, led by New York-based tech-focused hedge fund Coatue Management.
The company, which provides everything from one-on-one tutoring to in-depth courses for children from kindergarten age up to 12th grade (K-12), was already a unicorn, according to Chinese research body E-Commerce Research Centre.
Beijing-headquartered Zuoyebang raised some $235 million in earlier funding rounds from the likes of Sequoia, GGV, Tiger Fund, H Capital, Legend Capital and Xiang He Capital, according to a statement on Zuoyebang's official WeChat account.
Zuoyebang, which claims 70 million monthly active users, is one of a host of companies which see vast opportunity in China's education sector. The potential is obvious given China's huge population, economic growth and hunger for learning – but corporate valuations have been growing in lock-step with a flood of funding into the sector, and lingering concern remains over how and when online education companies will develop a profitable business model.
According to UN statistics, China has 220 million children aged 14 or below today; while this figure is expected to slip as the country's population ages, the market potential will remain strong in the years to come.
Chinese research house Zhiyan.org believes the online after-school education market will enjoy revenue of about Rmb1 trillion ($149.4 billion) by 2020, up from RMB 240 billion now. Taking in other segments such as professional training and international schools, it expects private education revenue to hit Rmb3 trillion over the same period.
Given the rapid growth of information technology expanding internet coverage, the prospects for online education look rosy.
“We expect multiple unicorns to be born in China’s online education space,” Huang Yungang, a partner at Chinese venture capital fund Source Code Capital, told FinanceAsia in a telephone interview.
“Over the past few months, many [existing and potential] limited partners asked about online education investment in China,” said the fundraising head of a Chinese US dollar-denominated venture capital fund.
In the past month, 13 startups have announced funding rounds. They include a $500 million series D round for VIPKID, a company offering online English lessons with native English-speaking teachers, which FinanceAsia last year named as one of 10 start-ups to watch. Meanwhile Hai Feng Education sealed a $100 million series-C, backed by Source Code.
To be sure, online education in China has been in the spotlight for some years now, experiencing both a funding boom in 2015 and then a pullback in the number of deals as investors focused on a smaller number of larger companies.
Data provided by Chinese online education thinktank Investedu.cn shows total fundraising via unlisted instruments – private equity and venture capital funds – in the first half of this year has already topped 80% of the total recorded for the whole of 2017.
“We expect the online education industry to experience explosive growth in the coming ten years,” Source Code’s Huang said. The market was worth some 53.97% more in 2017 than in 2016, E-Commerce Research Centre data shows.
The flood of capital into the space has, not surprisingly, sparked concerns about stretched valuations.
“But like with beer, having the proper amount of bubbles makes it taste better,” Huang said. “As long as there is plenty of room for the industry to further expand, and the target firm has potential to grow, we can stand overvaluation to a reasonable extent.”
He argued that smart money would always be able to identify smart startup teams at a smart time for a smart price.
Investors whose interest is piqued by the growth of online education will need to drill down into the different sectors involved – from pre-primary to professional training.
But a clear winner, according to date provided by Investedu.com, is K-12 education, which is in the top three sectors both for number of deals and size of funding. In particular, investors are backing companies that provide one-on-one after-school tutoring.
“Online K12 education is rigid demand, we believe the market is still in the early stage of development, and the growth potential is enormous,” Huang noted.
Parents, especially in poorer and more remote parts of the country, see online tuition as a way of accessing better resources than are found in a public system that struggles with a mismatch in demand and resources.
“Online platforms will optimise individual teachers' productivity, release unlimited resources from countable teachers, and break the geographical bounds,” Huang noted, adding that companies able to expand fast to cover most lower tier cities would be very attractive.
Start-ups targeting even younger children are another potential goldmine; after all, Chinese parents stress the importance of not allowing their children to fall behind at the educational starting line.
And this push for high-quality pre-primary education isn't just about the traditional test-oriented study; parents also want their children to learn about art, sport and even information technology.
“Platforms providing emerging courses, children programming course for instance, have great potential as well,” Huang noted.
... BUT WILL IT TURN A PROFIT?
One issue that may give investors pause for thought is the fact that, as in other nascent industries, few online education companies are yet turning a profit.
According to Investedu.cn, more than 70% of online education firms have delivered less than Rmb1 million in aggregated profits. In practice, most of these churning through investors' cash.
“There are two factors we consider to be helpful regarding the profitability issue,” the fundraising head told FinanceAsia.
One is customisation; the other is highly efficient deployment of staff: “The former highlights one-on-one tutoring, while the latter has strong technical support that helps cut the human resource cost. Both make it easier to drive up the user volume quickly.”
Despite concerns over valuation and profitability – not to mention the ever-present worries about China's changeable regulatory environment – capital continue to flow into the sector. It's attracting high-level talent, more mature investors and sparking innovation – with the latter particularly amplified online.
“Offline schools are cash cows indeed, but don’t forget the hefty investment in hardware such as infrastructure and human resource,” the fundraiser said. “Plus, getting regulatory approval could be very time consuming.”
“On the other hand, online platforms – the right ones – could leverage a relatively small amount of capital to achieve surprisingly good alpha for investors.”