Growth in Infrastructure investment continues to be a trend that has been unaffected by all manner of challenges, including the ever increasing global (and regional) political and economic instability. New capital continues to enter the market place at an incredible rate, meaning competition has never been more intense. Traditional infrastructure assets are being purchased for EBITDA multiples, which can only be described as eye watering. Accordingly, the migration of infrastructure investors into new sectors has been unsurprisingly swift. Telecommunications assets can now almost be considered as true hybrids between private equity and infrastructure, while the the universal interest in healthcare suggests this sector will follow the same path in coming years.
So the question arises, what is the next big thing? A look at some of the key aspects of the education industry suggest this sector could be just that.
Traditionally a resolutely private equity playground, the core model around value generation in education is to:
- Amalgamate – a large number of private schools globally are either family owned or non-profit organisations
- Grow EBITDA organically by building additional capacity to serve the growing demand in private education as well as through fee increases and cost management
Recent, widely reported and high-profile education deals show that education can derive top end returns for private equity investors, but accordingly that pricing of international school groups is not for the faint of heart.
Such pricing naturally plays into the hands of infrastructure investors and their lower cost of capital. There are also a number of other characteristics of education businesses which provide food for thought on the topic of education as a future mainstream infrastructure asset class.
Yield and stable cash flows
While school businesses can be cash intensive where expansion capital expenditure (CapEx) needs are high, school businesses generally provide very predictable, stable cash flows given the beneficial working capital cycles: revenues are collected in advance at fixed times of the year and costs are easily budgeted for in advance with little variance. It is true that there is no effective long term contracting. Students can be locked in for as little as a term, but student retention is very high with average tenure spanning five to twelve years depending on the proportion of expatriate students. This is unlikely to change given the chronic underfunding of state education globally. This is especially true in premium private schools. It is interesting to note that enrolment numbers in secondary, and tertiary, education have exhibited stable secular growth since the Second World War across OECD economies, with there often being countercyclical volumetric behavior during recessions, a point which is further addressed in the following paragraph. In addition, long-term forecasts of student volumes are considerably more reliable than, for example, vehicle rotation for car parks or container numbers in ports. This is because the students of future decades are all already born, lending much greater confidence to long term projections that would be central to infrastructure investors’ financial models.
Furthermore, the need for education is generally unaffected by political and cultural changes and upheavals. Education businesses are also much less linked to economic cycles, due to there being reduced volumetric correlation to the economic cycle. People will view sending their children to school as an absolute base necessity. This is not the case in many core sectors such as those connected to transport.. There is no real alternative or the option to reduce consumption. The underperformance of certain high-profile infrastructure investments in “GDP-linked” businesses during the 2008-2009 downturn, such as some car parks, toll roads or ports, demonstrates how important an upside this factor is to education as an infrastructure investment.
Real asset backing
School businesses have traditionally favoured leasing rather than owning school properties for the obvious reason that rates of return on capital employed on property acquisitions can be better deployed on expansion CapEx or further acquisition of school businesses. This is true even when balanced off against the impact lease payments have on EBITDA, i.e. reducing this key measure of an education businesses value. Similarly, since school businesses are often acquired with properties already owned, cash has been raised by selling properties to deploy on expansion CapEx or further acquisition of school businesses.
The landscape may be changing. With widespread changes to taxation rules on disposals of companies owning properties, it is much more difficult to realise gains on property disposals without incurring significant tax charges. As a result, the economics may shift in favour of school businesses being property backed, at least to the extent of properties being already owned, with the related downside protection that arises as a result of a business having real asset backing.
Education businesses typically are not positively regulated in so far as there being regulation which guarantees minimum fee level. Concurrently, regulations limiting fee levels or fee increases also tend to be limited. Infrastructure investors will in any case be used to limits on price increases on core plus assets, in particular where businesses operate around concessions from local authorities who have an interest in keeping social services affordable; car parking is a good example. Limitations on fee increases can also be managed through structuring in the case of global school groups. This can be achieved with use of arm’s-length management service or royalty arrangement, though consideration should also be given to the fact that such arrangements also tend to generate an irrecoverable VAT cost. Additionally, there are generally no restrictions on inflation related price increases even in jurisdictions where price increases are subject to some control (notably the Middle East), so increasing school fees in line with inflation is almost always possible, provided that the quality of the education services, generally measured by student results and the level of pastoral care, can be maintained. It should be noted though that the possibility of increased regulation on fee increases is also always an ever-present factor as education, even in the private sector, can be a charged political topic. Governments have in the past used stricter limitations on fee increases as political currency.
Education businesses tend to have a wide geographical spread. Private education businesses are common in Africa, Latin American and Asia where there is very little currency harmonisation. It is difficult to hedge against the effects of such diverse currency risk. Hence, currency management does represent a challenge for the traditional infrastructure investor who is more used to limited currency risk. However, core plus investors will note that the above position is not vastly different from telecoms businesses (including fibre and data centres) where similar currency issues can arise.
Some aspects of education businesses will of course still prove to be a barrier or at the very least a challenge to any infrastructure investor looking to move into new territory. A few of the key ones are noted below.
As noted previously, state education machine does not provide any material competition in a significant majority of territories worldwide. Furthermore, globally consolidated school groups are still relatively limited, with only a few big players currently operating in the market. However, competition at a local level is key and is significant, even in developing countries. Competitive pressure can, however, be mitigated by operating in the premium school sub sector where brand is key. Schools with prestigious, well-respected brands are much more insulated from the effects of competition. As a result, international school businesses that are able to amalgamate only premium schools can limit the risk of competition to a certain extent.
Schools are not passive operations, in fact they require significant hands-on attention to thrive. Just like teaching, management of schools requires a specialist skill set, and it is necessary to have the capabilities to follow regular business best practices while simultaneously managing parents’ expectations and interests. It will come as no surprise to anyone that “customers” can be much more emotionally driven in relation to a “product” that involves their children. Reputational risk is a significant business consideration, and errors in judgement by management can very quickly have a financial impact. An infrastructure investor who is more used to passive assets may therefore struggle to secure or understand the management know-how to actively run a school business, though this of course would not stop minority investments. However, it is possible that infrastructure investors who are able to access relevant know-how from other arms of their investment platforms can bridge the knowledge gap, potentially with the help of appropriate external advisory support.
Latin American, the Middle East and Africa have up to now been of lesser interest to core plus infrastructure investors due to political risk. This is of course evolving, with the first two regions in particular seeing some notable recent infrastructure activity. While political risk can be mitigated through the use of local partners and to a certain extent is limited in the case of global school groups, consolidated school businesses that operate only in stable mature economies do not presently exist and therefore avoiding all political risk is not possible.
It would certainly be fair to say that education is unlikely to be high on infrastructure investors’ minds for the remainder of 2019. However, as the past few years has shown, change in attitudes occurs swiftly, and even more speedy is the subsequent deployment of capital into a new asset class deemed to be appropriate. Given the relentless increase in available infrastructure capital, the idea of education infra in 2020 and beyond seems entirely plausible.