Buy & build ISSUE #11 THE PIE REVIEW

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1 Buy & build It s well known that demand for access to a global education is growing. But how has the involvement of private equity s big money, combined with education providers big growth ambitions, influenced the industry? Beckie Smith finds out. EVERYBODY, EVERYWHERE WITH capital is looking at the education sector, because it has these fundamentally attractive characteristics, declares Rupert Barclay, co-head of the education practice at Cairneagle Associates in the UK. Privately-funded education is a premium product with strong underlying demand driven by expanding middle classes and attractive long-term returns, he notes. The evidence to support this theory stacks up. A report published last year by Parthenon-EY found that mergers and acquisitions in education in emerging markets had increased sixfold since The report s co-author and Parthenon-EY managing director, Ashwin Assomull, predicted private equity funds around the world are about to become a lot more organised when looking at private education as an investment mode. There is now a crowded marketplace of investors keen to invest in all segments of the industry: in 2014, Baird Global Investment Banking identified 50 potential M&A opportunities in education across Europe alone and predicted a new wave of investment in for-profit education across the continent. Much of that activity is in domestic provision, but a significant proportion is in international. Baird s report singled out Cambridge Education Group whose acquisition by Bridgepoint in 2013 generated a 14.6x return on investment for previous owners Palamon Capital Partners as an indicator of the value this industry holds. International schools, language schools, pathway programme operators and private higher education providers are all riding the wave of aspirant middle classes in emerging economies looking to invest in their children s future. We re talking about hundreds of millions of people who suddenly have got significant disposable income, says Fergus Brownlee, president of CEG. That immediately creates, from a private provider perspective, opportunity. Private Equity 2.0 Private investment in international education has always existed, but it is undoubtedly gathering speed; it s only in the last decade that interest from private equity firms dedicated investment funds that inject capital into private businesses or buy out public ones has really materialised. Along with demographic changes and strong growth in the private sector, another reason private equity activity is only now gaining traction is the increasing scale of the assets available. Mainstream private equity funds have constraints to invest a certain amount of capital, so until a certain consolidation has occurred in the sector, it will be very difficult for them to play a role, comments Bruno Mourgue d Algue, CFO of the PE-backed European higher education group Galileo Global Education. Anything much below $10 million is pretty hard for private equity to do, agrees Ian Koxvold, head of education strategy at PricewaterhouseCoopers, noting that private equity firms that invest in smaller businesses are the exception rather than the rule. And shifting business models have also played a role in the changing nature of investment trends, he adds: Five years ago there were a lot of private businesses owned by complex shareholder structures four founders clubbing together, for example, or not-for-profits. Over the last five years a lot of those businesses have cleaned themselves up and become more transactable, i.e. owned by a single majority shareholder, with a few tag-alongs. And it s a lot easier to do a deal then. In the international school space, it s for these reasons that large companies like GEMS Education and Nord Anglia Education are among only a handful of education providers that were part of what Barclay calls Private Equity 1.0 coming from a relatively narrow group of savvy early investors, primarily out of the US, who realised that international education was an interesting space. ISSUE #11 THE PIE REVIEW 37

2 HOW TO FUTURE-PROOF EDUCTION? PHOTO: NORD ANGLIA PHOTO: THE PIE NEWS Dubai-based GEMS, which sold a 25 per cent stake to the UAE s largest private equity fund, Abraaj, in 2007 (which has since exited), is one of the world s largest K-12 groups with 91 schools across 13 countries; while Hong Kong-headquartered Nord Anglia, bought by private equity fund Baring Asia in 2008, has 42 schools in 15 countries. Six came through the acquisition of WCL Group, another PE-backed group, in 2013; and a further six from Meritas in But the sector is now welcoming a second wave of capital as investors crunch the numbers international schools are set to nearly double in the next decade to 16,000, generating an annual $89 billion, according to observational body, the International Schools Council. The UAE alone accounts for more than half a million enrolments, and private equity is helping to drive growth: in the last two years, Gulf Capital, Fajr Capital, GFH Capital, Al Najah Education and Bahrain Mumtalakat Holding the investment arm of the Kingdom of Bahrain have all invested sizeable sums in international school operators. There are probably groups of investors people like HIG Capital, BXR, International School Partnerships looking to build international schools, estimates Barclay. The sector is therefore the perfect illustration for the onset of Private Equity 2.0, he says: a proliferating group of trade investors and PE firms all over the world looking to invest in their own countries and internationally. Though much investment is clearly driven by a desire to make money, investors and providers nevertheless understand education s inherent value. Brownlee says it s a great point for mankind that education is where the new middle classes are choosing to spend their money. And some have an explicit social mission alongside their business model. Last year, GEMS group executive director Dino Varkey called himself an advocate of whatever gets us to solving the education crisis as quickly and effectively as possible, emphasising that private provision is necessary to keep pace with demand. The group operates premium and lower-priced brands and estimating that BRICS countries will need 10,000 new schools every year works with governments to provide teacher training, aiming to train 250,000 teachers in a decade. Pathway to profit Pathway operators, enabling students to progress to university and working with university partners, are also generating huge interest from private capital as operators strive to reach new segments of the international student market. There is no strategy that is led by a desire to make acquisitions The last few years has seen the worldwide proliferation of such programmes, and a joint report by StudyPortals/Cambridge English last year gave a conservative estimate that the English-medium foundation programme market is worth an annual $825 million. Education giants which have had private equity investment, including INTO, CEG and Study Group, have grown exponentially through pathway provision. The biggest growth to date has been in the UK, Australia and the US, all continuing apace, but continental Europe is about to emerge in the spotlight thanks to growth in Englishtaught degrees, the report predicts. In the last couple of years Study Group and CEG have opened pathways in the Netherlands and Sweden, and more are sure to follow. 38 THE PIE REVIEW ISSUE #11

3 PHOTO: CEG Lorem ipsum dolor sit amet, consectetur adipiscing elit, sed do eiusmod tempor incididunt ut labore agna aliqua. Ut enim ad minim veniam, quis nostrud exercitation PHOTO: THE PIE NEWS ullamc velit esse cillum dolore eu fugiat nulla pariatur. Excepteur sint occaecat cupidatat non proident, sunt in culpa qui officia mollit anim id est laborum. Nord Anglia was among the first wave of international school operators to attract private equity funding (far left); while iae Global (left) is one of only a handful of PE-backed agencies. Bridgepoint-owned CEG has schools in Europe and the US (above); group president Fergus Brownlee with Lord Lieutenant of Cambridgeshire Hugh Duberly CBE, who presented CEG with the Queen s Award for Enterprise for achieving substantial growth in overseas trade in And more investors are keen to elbow in on this lucrative market. UK-based Oxford International Education Group, which signed its fifth pathway deal this year, sold a minority stake to Bowmark Capital in 2014 to further its growth plans, with pathway and sixth-form provision as central features. Other recent market competitors include Shorelight, established in 2013 with investment from Sterling Partners, and Edu- Co, a Baring Private Equity Asia-backed white label partner that develops university-branded foundation programmes. Part of pathways appeal to investors is the business model of on-campus delivery. The exciting thing for private equity is it s low capex relative to schools or universities since you re actually leveraging the infrastructure of the university campus that you partner with, notes Assomull at Parthenon-EY. The cost of buying is no small consideration, notes Brownlee. There s a lot of cost and risk around it with advisors and distraction of your own people, funding costs, etc. The cost of making acquisitions is one of the reasons CEG itself has famously bought only a handful of schools, adds Brownlee, who joined the company when it was bought by Palamon Capital in 2007 at which point the growth strategy was exactly the opposite. We bought a small, family company with the aim of building on it as a platform through acquisition. We discovered building was much easier and a better return from a financial perspective. Even without buying, CEG achieved compound annual revenue growth of 26 per cent during Palamon s ownership. When Palamon sold to Bridgepoint in 2013, it achieved an impressive multiple of 11 times EBITDA. Since the sale to Bridgepoint, CEG has bought six language schools and is in the market for more, says Brownlee, but will only buy if it s convinced it will add value. David Leigh, CEO of Study Group, agrees that while making bolt-on acquisitions ( replicating, if you like, the very business model that private equity employs ) can be a valuable way to grow an education company, there is no strategy that is led by a desire to make acquisitions. Study Group, which has been private equity-backed since 2006 by CHAMP Private Equity and then Providence Equity Partners has made just one acquisition in the last three years. Leigh s aim is to see Study Group teach 100,000 students, up from 73,000 in 2015 via its Embassy, Bellerbys, HE and pathway brands. But he counsels, I won t ask the board if we can buy a company simply to get to the 100,000 number, because I ve got an organic plan that can get there; but if something comes along the way that can give us a more accelerated way of getting there in a way that helps us with our strategy, then we ll look at it. Considered strategies A further reason to exercise caution during expansion is that companies that adopt too aggressive an acquisition strategy can quickly run into trouble as they struggle to integrate their subsidiaries. We are a service industry; we are not robots, we rely on a lot of human capital and that human capital is the hardest to integrate in a very short period of time, says Toby Chu, CEO of Canada-based CIBT Education Group. If a company buys, say, 13 schools in a three-year period, that is really a tall order to amalgamate, 13 owners with 13 different backgrounds and ethnic cultures and corporate cultures. For this reason, CIBT limits both the number and size of the schools it buys, aiming to add one a year. By taking time ISSUE #11 THE PIE REVIEW 39

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5 BUY AND BUILD to focus on integration, CIBT can build links between its subsidiaries, such as a pathway programme developed between its most recent purchase, ELT-focused Vancouver International College, and Sprott-Shaw College, a career and technical college which it bought in Luxembourg-based Galileo Global Education is another education colossus striving to build links within its network of 30 postsecondary institutions. Within a few weeks of acquiring French higher education group Studialis in 2015, its German university, Macromedia University of Applied Sciences, signed an agreement with new addition Paris School of Business to leverage the French institution s expertise while founding a new business school. Another benefit PE brings is business acumen. When Palamon bought CEG in 2007, the new management team injected into a private educational environment business techniques, business approaches and strategy, which is all people like me can contribute to the much more important educational values, says Brownlee. Investment in ELT Significant investment is also seeping into the language teaching industries, notably ELT. Most people who run a school are good at running a school. But selling a business? Totally different Individual English language schools, while generally too small to interest private equity firms, are nevertheless attracting investment from a number of sources as the sector undergoes a process of rapid consolidation. Industry veteran Kevin McNally, managing director of independently-owned Torquay International School in the UK, suggests consolidation of a fragmented market is inevitable and even desirable. It will lead to the professionalisation and commercialisation, in the positive sense of both words, of our industry and we will be taken more seriously by governments and other non-related bodies, he predicts. In the UK, there are currently up to an estimated 900 ELT schools, according to James Dixey, a specialist consultant who helps UK school owners to sell. He expects that number is set to tumble to around 300 in the next three to five years because of closures and sell-ups. In Canada, too, smaller schools are being picked off by major operators from Asia, Ireland and Australia aiming to consolidate portfolios and diversify into Canada and the US because you don t want to put all your eggs in one basket, notes Douglas Halladay, president of Canada-based Halladay Education Group, which also helps to sell schools. An entire industry operates around the buying and selling of businesses. Strategy consultancies such as Cairneagle provide valuable market knowledge and due diligence for investors. PHOTO: CAIRNEAGLE ASSOCIATES The economies of scale this provides to larger businesses lowering the proportional financial burden of administration, compliance and student recruitment and allowing providers to spread risk across multiple geographies favours larger schools. They can employ someone to deal with compliance and administration who can live and breathe it and do it really well and really efficiently and it only adds five per cent to the student fees rather than 20 per cent, notes Simon Cleaver, who this year sold his UK-based English language school brand, British Study Centres, to Real Experience Group. Brownlee at CEG agrees: acquiring scale, he says, gets you into a world where the contracts are bigger, which allows you to plan better, be more efficient, be more productive, and grow your business. M&A in mind Unlike large businesses or private equity firms, which are built with M&A in mind, few school owners know how to navigate a sale. Most people who run a school are good at running a school, and know how to sell a school to students, says Dixey. But selling it as a business to an investor? Totally different thing. Using a broker helps schools to ensure they get the best price and to keep a sale quiet until it s completed. Failure to do so can be the undoing of a business, cautions Dixey: Most people are terrified about their agents finding out that they re selling and then people lose confidence ISSUE #11 THE PIE REVIEW 41

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7 BUY AND BUILD and suddenly sales and bookings can [plummet]. Meanwhile, an entire industry operates around the buying and selling of businesses, ranging from companies such as Parthenon-EY and Cairneagle to firms that make discreet introductions to market experts, charging per hour for conversations held under confidentiality agreements. Insider knowledge is a valuable commodity, not least when it comes to finding potential buyers or assets. When UK-based sixth form college group Mander Portman Woodward went on the market in 2015, more than 20 groups were invited to bid, sourced by M&A experts DC Advisory, before it was sold to Kaplan for more than $100 million. Around half the transactions PwC looks at in this arena are off-market, Koxvold estimates a buyer and seller While some in the industry are positive about private equity invesment, others are emphatically not. Till Gins, owner of OISE school group, has said he would never sell to a private investor. engaging without an open process. PE firms often have a team of people scouting out businesses they re interested in buying in the future. This can sometimes take years to come to fruition, he says Sovereign Capital reportedly courted the stakeholders that came together to form Astrum Education Group for seven years before investing in And before buying, due diligence is another crucial part of the process. Usually businesses will employ one or two firms to carry out a thorough review of the commercial, financial and legal health (sometimes operational or regulatory too) of an asset. As part of its targeted due diligence (referred to as DD), Parthenon-EY, for example, will spend up to 10,000-15,000 just surveying the market to see if a business s claim of having a differentiated proposition holds true. [Vendors] often say they have a differentiated management team Our job is to test with buyers, be they students or whatever, whether or not it really is differentiated, explains managing director Matthew Robb. Koxvold notes that conducting DD on education businesses requires extremely in-depth knowledge of the sector. Why do investors hire specialist education, commercial DD? Fundamentally, investing in education businesses is really very difficult. It s incredibly niche-y, with some big macroeconomic and transformational drivers, he says. PwC looks at 27 different business models just within education, he says. Culture clash Of course, being bought out isn t an attractive proposition for everyone. Till Gins, owner of the 27-strong worldwide OISE group of language schools, says categorically that he would never sell to private equity, despite frequent interest from funds and other investors. Their aim to find ways of increasing shareholder values and exit routes to realise PHOTO: OISE the gains is, he contends, completely different, and probably at odds, with the aim of education, which is to constantly find better ways of helping the students to learn and achieve more on their course. I think it s very important in any business to live within your means, and that s what we do, he says. If you re in an environment where it s clearly stated that the owners are backed by capital so they can take bigger risks, they re putting people s lives at risk and jobs at risk. That s what people will hear. It s not conducive to people getting impassioned in what they re doing which education is about. Gins is by no means the only school owner who is resistant to the rising tide of private equity and concerned about the perceived short-termism of these investments. Countering this contention, Jeffrey Leeds, president of Leeds Equity in the US, whose investments in knowledge industries include a Increasing shareholder values is completely different and probably at odds with the aim of education minority stake in INTO, insists the fund s approach to investment is highly collaborative and its interest stemmed from INTO s very high standard of care for the international students it teaches. Similarly, Bowmark Capital, which owns a minority stake in OIEG and previously invested in what is now Inspiring Learning, listens to management teams, says partner Tom Shelford. When we sit with companies, one of the main questions we ask is: with no constraint of capital, how would you like to grow the business? he relates. Private equity ISSUE #11 THE PIE REVIEW 43

8 BUY AND BUILD CEG has famously only bought a handful of schools such as Intrax in San Francisco (pictured, remodelled as Stafford House School of English), choosing more often to build rather than buy. PHOTO: CAMBRIDGE EDUCATION GROUP was born in helping mid-market companies grow, and that is all we do. As for fears over asset-stripping, Mourgue d Algue at Galileo Global Education says its private equity backing from Providence is growth-focused by nature. We are a strategic group, we are on a strategic mission; we are here to stay forever and we re building a group that is sustainable. Shelford points out that taking references from other portfolio companies can offer insight into a company s culture. The great thing about PE is we ve already invested in lots of companies so you could find out exactly what we re like by asking one of [them], and I don t think nearly enough people do that. Nevertheless, there are challenges that come with growth. The danger for the big schools, the groups, is that they become amorphous, soulless masses, observes Cleaver. In Real Experience Group he s confident he found a buyer that will avoid this, but it s a concern many business owners have in mind when they come to sell. For Declan Millar, owner of High Schools International, (which places students in high school programmes in the UK, Ireland, Canada and the US) there s no question that he might sell. Absolutely everything is for sale, he says, but the decision would come down to the buyer as well as the price. It comes down to a service orientation, and [for] anyone interested in buying me, that would really have to be a primary criteria in order to be successful, he insists. He also stresses loyalty to staff and the sector: This high school business is actually a very small world, so it would have to be a company that was aware of that. Agents of change While consolidation of providers is well underway, the same is yet to be seen in the student recruitment landscape, which remains hugely fragmented. Many investors still struggle with the actual business structure of agencies the fact we don t deliver traditional educational services, notes Mark Lucas, director of global administration & global development at iae Global Group, one of South Korea s largest agencies. The group completed a merger with a Tokyo-based private equity firm New Horizon Capital in 2014, but owner OJ Kim said the search for a strategic partner lasted a decade. It is still among only a small number of agencies that have attracted private equity investment because there are not a lot of target businesses in the agency side that are attractive to PE investors ; most are small and difficult to value or leverage to further growth, says Lucas. However, iae is an example of investment interest gathering steam. In May, a Chinese private equity-led group of investors bought one of the country s largest education agencies, EIC, for a reported $692 million more than three times what its previous owners were reported to have paid for it in The 2013 acquisition of EIC by Luxembourg-based CVC Capital allowed the company to buy New Pathway, a counselling and test prep company in the US, the following year. The buyout solidified EIC s foothold in the US, marking What you re seeing is verticalisation, where the process is controlled by agents another trend of Chinese companies buying into the US and other popular study destinations. Earlier this year, Weiming Education Group, a private Chinese provider with 42 schools, recently offered more than $12 million for a University of Connecticut campus, with plans to turn it into an international school, though the deal was scuppered when the town of West Hartford bought the campus instead. And more successfully, New York Military Academy which boasts Donald Trump as an alum was bought this summer by a non-profit group backed by China-based SouFun Holdings for $15.8 million, after a bidding war with another Chinese-funded investor. Todd Maurer, an economist and managing partner of 3/1 Global Research, predicts it will become a pathway college or school for Chinese students. I think a lot of Chinese companies want a piece of that market themselves, he observes. After all, they re the source of many of the students in China, and if they can create a foothold in places like the United States, which I think we re in the early stages of seeing, then they will be also providing services to Chinese students outside of China. This is also becoming apparent in the UK, according to Dixey, who says he s had a lot of interest from both Chinese and Russian buyers in English language schools. He adds that the last three schools he s sold have received offers from overseas agencies. What you re seeing is verticalisation, where the whole process is controlled by the agents, he says. This verticalisation is just another form of consolidation in the sector a trend, we can be certain, isn t going to abate any time soon. 44 THE PIE REVIEW ISSUE #11