Private education offers a compelling investment case

Globally, governments allocate roughly 16% of annual revenue to education compared with South Africa’s 20%.

This is according to Victor Mupunga, research analyst at Old Mutual Wealth Private Client Securities, who says this points to a skewed cost structure rather than the actual amount spent on education, as many critics assume. “A recent paper by the International Monetary Fund echoed these findings, highlighting staff compensation as one reason for the South African government’s dismal delivery on its education investment.

The Department of Basic Education’s 2018/2019 annual report confirms that South Africa’s schooling system struggles with inefficiency, caused by high levels of grade repetition, low levels of learning achieved by those in school, and high dropout rates from grades 10 to 12.

The report goes on to say that late entry into school is also a challenge because crucial formative phases are missed and “by the time these children reach secondary school they are more likely to drop out of school due to family responsibilities, pregnancy or the pressure to find work.”

Damon Buss, equity analyst at Electus Fund Managers, agrees that private education makes for a compelling business model.

He cites the following competitive advantages:

Efficient scale: These are high fixed-cost businesses – for example, teachers are paid regardless of whether there are ten or 25 children in the class. This means there is high operational leverage. A competitor locating a private school near an existing private school is likely to result in unviable utilisation levels, with not enough enrolment at both schools. For this reason, a private school is unlikely to have direct competition in its immediate geographic area.

High regulatory costs: Buss says that based on his discussions with Curro, getting land rezoned for educational use can take more than three years and there are substantial regulations to be complied with. This makes it more difficult for new entrants to get into the market.

High switching costs: Once a child enters a private school, they are likely to complete their education at the same school to avoid potential disruption.

Buss says only about 4% of South Africans attend private school compared with the global average of about 13%. “Continuing urbanisation and growth of the South African middle class means these numbers can only increase over the medium- to long term.”

Mupunga agrees, saying the disparity between SA and other developing markets is even larger in secondary education. “There is a void to be filled.”

Read: How you can save tax on school fees
And: School fees: Is the upfront discount worth it?

He points out that the private school model is highly cash-generative. “Fees are paid at the start of the month, quarter or year, and bad debts tend to be very low. Moreover, learners tend to be at a school for many years, resulting in an annuity revenue stream with an expectation of some escalation every year, which all makes for a good business model.”

AdvTech

The AdvTech group provides primary, secondary and tertiary schooling and has a job placement business. “From an investment perspective, we typically like businesses with some diversification and AdvTech has a differentiated offering from a stage-of-life perspective,” says Mupunga. “The company also owns multiple differentiated brands, including the well-known Abbotts College, Varsity College, Rosebank College, Trinity House and Crawford schools.”

Mupunga adds that once the key criteria of a good location and appropriate cost structure have been met, it becomes a case of “bums on seats”.

“The operational leverage is high, and after a school breaks even, additional enrolments fall through to the profit line,” he says.

AdvTech has always been known for its high-end independent schools but has increased its focus on the mid-fee market segment, as the tough economic environment has seen scores of South African families move abroad. The company recently completed a significant investment drive, acquiring close to 50 schools in four years, essentially doubling the size of its schools’ division. “With these investments done, and an expected improvement on the economic front, we expect improved shareholder returns,” says Mupunga.

Looking at the mid-fee sector, the AdvTech group has a growing number of schools under the brand name Pinnacle Colleges, which has been reporting strong growth. This hedges the group to some extent against the current difficult economic environment.

Investments into the rest of Africa have also served to diversify the company’s assets.

Read: AdvTech’s Africa expansion boosts student numbers

“They have invested in the likes of Zambia [university] and Kenya [Crawford school in Nairobi and the Makini brand of schools], and over time we expect increased contribution to profitability from [the] rest of Africa,” says Mupunga.

Curro

Curro offers primary, secondary and tertiary education. One of the key differences from its competitors is that Curro has unbundled its tertiary offering in the form of Stadio Holdings, which is a major contributor to profits. Curro has also expanded its offering with the launch of DigiEd, a new tech-focused school model.

Mupunga says that in terms of growth, Curro remains more aggressive, leaning towards spending close to R2 billion in the next few  years. However, it has doubled the number of students in the last four years. At the end of June 2019, there were just over 57 000 learners spread across all schools.

Read: Curro to invest R223m in four new campuses

Curro has several models targeting different income bands:

• Select: these are premium private schools with annual fees ranging from R70 000 to R120 000 (roughly the same as the majority of AdvTech schools).
• Curro: the bulk of Curro schools fall under this brand, where annual fees range from R50 000 to R80 000.
• Meridian and Academy: these are basic private schools where annual fees range from R27 000 to R33 000. This is where Buss expects most of the growth to come from.

Curro has launched DigiEd schools in Cape Town and Johannesburg. These schools focus on 21st-century skills to prepare learners for the fourth industrial revolution through a project-based e-learning programme that puts the emphasis on science, mathematics and technology.

Challenges

Buss says the recent performances of both AdvTech and Curro have been “unsurprisingly weak”, given the macro-economic conditions in the country. “We expect this to remain the case until there are some structural improvements in the economy.”

He says two key factors impacting profit margins at both companies are affordability (hampered by macro-economic conditions) and emigration, which includes semigration, where families relocate to another city.

“If we compare the two companies, AdvTech’s return on invested capital has steadily declined over the last ten years from 33% in 2008 to 10% in 2018. An aggressive acquisition and expansion strategy in 2015 was the key driver of the decline in return on invested capital to below AdvTech’s cost of capital.”

Curro’s return on invested capital remains very low at 3.2% in 2018, due to the business still being in an aggressive growth phase.

Buss believes the Curro school model is superior to AdvTech’s because the lower average fees equate to a far bigger potential customer base and the centralised model with shared services makes it more profitable.