However, it is evident that there is an even bigger opportunity set in the independent schools sector where the growth rate in the number of learners was four times that of public school learners in 2014. The likes of Curro (COH), Reddam and Advtech (ADH) are already taking advantage of this opportunity. The popularity of lifestyle estates, and mini-cities like Serengeti, Waterfall Estate and Century City, which already have COH schools as part of their offering, is another tailwind for the demand of schools in this sector.
When analysing an industry and the entities that operate in it, Porter’s Five Forces is a very useful tool. Porter’s Five forces dictates that an industry is not favourable for an entrant when there is a large degree of competition. There are a fair number of private schools and private school franchises that have entered the market in the last decade such as COH and Reddford. Despite this, there is a lot of runway for the industry to grow given the high growth rate in the number of independent school learners. Furthermore, the number of independent school learners only makes up 4.1% (figure 2) of the total number of SA learners. The global average sits at 25% 1 while the UK and the US independent school learners make up approximately 6.5%2 and 10%3 respectively. The World Bank has this number at 16%2 for Brazil in the primary school sector which could be a better proxy due to its developing – country qualities. This would suggest we still have some way to go until we reach a point of saturation in the SA independent school market.
In recent times, a large part of the public schooling system and its offering has failed to equip SA’s learner population with adequate skills to get into university and thrive in that particular environment, let alone pass matric. In most cases one is likely to find that SA public school learners continue to be taught the same curriculum and in the same fashion as the learners who attended school 20 years prior. In a world that changes every day – this may prove to be inadequate. In SA public schooling, the benchmark for mathematics is 30% – a subject that is at the core of problem solving skills. Parents therefore sit with the problem of finding a better option for their children.
n SA, your options as a parent are to put your child into a good public school which in most cases ends up being a former Model C school. These schools cost, on average, R28 000 per annum (after factoring in 6% school fee inflation), shown in figure 3. Even though these schools offer good quality education and a decent chance for your child to obtain a university entry, they are often full. Getting in is incredibly difficult unless of course your child is extremely talented and can get in on a sports, cultural or academic scholarship. Your other option is to try and get your child into a traditional private school. These schools usually have a good reputation; the backing of an established old boy/girl community (that has a vested interest in the school’s continued existence) and on most accounts are extremely well run. In this category your child will have an even better chance of obtaining a university entry (figure 3), however, the biggest challenge is the cost of the education. You would be paying in excess of R126 000 per annum, on average, if we exclude the boarding-only schools and assume 8% school fee inflation. Over a five year period this would amount to more than R600 000.
The likes of COH and Spark therefore play in a niche market where they combine the quality education of a private school with the affordability of a good former Model C school. In its Meridian and Curro Academy offering, COH’s tuition fees are, on average, R24 000 per annum whereas Spark schools are around R19 000 per annum. Although Spark only offers primary education, the hours that the children spend at school puts this figure into perspective. This niche market offers COH and Spark even more room to grow.
There is financial merit behind putting your money into private education. The magic behind this concept is the learner teacher ratio which feeds into what is referred to as the ‘J-curve’ in figure 4. When a school campus starts out it has a few leaners per class e.g. 10 learners per teacher and so at this stage it is still making a loss. As the years go by and more learners join the school it begins to break even and starts making a profit e.g. 15 learners per teacher. As the school starts reaching its capacity they start becoming very lucrative e.g. 22 learners per teacher. According to Curro, a school takes 10 years on average to reach full capacity. As the learner per teacher ratio increases so too does the EBITDA margin and COH estimates that it could achieve EBITDA margins in excess of 40% per school once a school is at full capacity. This is aided by school fee inflation which is targeted to stay above average core inflation by 200 basis points. Now take one of these campuses and multiply by 80 and in 15 years’ time you could be reaping massive returns.
The ROEs of such businesses are supressed however, as these campuses require a significant investment (R100m and more) in infrastructure. One also has to be very patient for these returns. ROEs will continue to be supressed as COH executes on its aggressive growth path by putting down approximately six campuses per year. Once the likes of COH, ADH and Reddam reach their long-term targets and decide to stop building more schools, their ROEs should begin to grow almost exponentially. As a better estimate of the financial merits of private schooling for an investor, ADH is already showing ROEs of 14% and this is while still pursuing an aggressive growth strategy by means of acquiring schools. ADH is still only utilising 66% of its ‘ultimate potential site capacity’4. At some point these companies will have to pay out large dividends to keep their ROEs high as they will begin to sit on too much cash even after paying for maintenance capital expenditure. It is quite possible for a single school campus to generate more than 20% IRR once at full capacity and let’s remember that a well-run school can last for more than 100 years. There is also potential for these private entities to partner with government. In the recent past there has been talk about government potentially offering subsidies for children going to the lower fee income private schools. This would boost the number of children going to private schools which could lead to a quicker realisation of the J-curve for the likes of COH, ADH and Reddam.
Like everything else in life, the private education sector, especially franchises, is not necessarily the land of milk and honey. There are some risks to this investment case. The system depends on there being a ready supply of high quality educators. This may not be the case if the aggressive expansion of COH, ADH and Reddham continues at its current rate, as there is a finite number of high quality educators. The laws of supply and demand dictate that when South Africa has a massive shortage of these educators they will be able to demand much higher salaries and fringe benefits and their salaries will have to increase by more than they are currently.
This means that the EBITDA margins spoken about earlier will have to decrease and the ROEs could follow.
There is also the real risk that government begins to clamp down on school fee increases as private education providers begin to make exorbitant margins and charge large tuition fee increases.
In the long run, competitors never leave high returns just lying around and one has to wonder if competition would leave EBITDA margins of 40% up for the taking. International competitors with enough capital to invest and service the large maintenance capex requirement would likely come onto our shores to participate in these returns.
With a historic PE multiple of 27 times, ADH is currently trading at a 68% premium to its long-term average and a 16% premium to its long-term relative PE to the SWIX. COH on the other hand still has very supressed earnings given its early stage in the business lifecycle and its aggressive growth path. A PE of 111 times is not necessarily a fair reflection on COH’s valuation but still indicates an expensive valuation.
Whatever current view asset managers may take of companies listed in the private education sector, it will certainly be an exciting and interesting sector to monitor over time as the dynamics of the industry unfold. If nothing else, one hopes that initiatives in private education will go a long way to improve much needed access to good quality education at affordable prices for many South Africans.