Education – Should It Be A Commercial Enterprise?

The last few days headlines from China on their education sector has captured the attention of the world.  And it should.  When $100bn of market value of the Chinese companies in the sector is wiped out in a matter of days – there is something to pause and think some very basic questions.

Just like India, there is Negative List for Foreign Direct Investment in China…
China has had a long standing policy which prohibit foreign investors from investing in certain sectors of the economy – defence, mining, agriculture, media, publication, etc.  The policy for some other sectors (telecommunication, call centre, etc) is in the form of Sino-Foreign JV where Chinese have to have control of the enterprise. Even in these sectors which are partly deregulated, it is hard for foreign ventures to get the licenses.  Therefore, for the past 20 years a concept of Variable Interest Entity (VIE) has been used in the global capital markets to have Chinese companies get access to foreign capital and foreign investors to have participation in the fast growing though prohibited sectors for the foreigners.  

…However, Foreigners have found a VIE Structure to Participate in such sectors
In concept, the founder in China who has a company (“Chinese Company”) with requisite licenses and business in say education sector (after school enrichment).  He also forms a company in offshore jurisdiction (normally British Virgin Island (“BVI”) called “Offshore Company”).  The Offshore Company has a 100% subsidiary in China – WOFE (wholly owned foreign enterprise).  The WOFE enters into a VIE contract with the Chinese Company to acquire the same at a fixed cost subject to deregulations in the sector and in the meantime the WOFE shall benefit from service fee which shall basically be any profits that the Chinese Company makes doing its business.  In return, WOFE provides financial advances to the Chinese Company to pursue its business.  The WOFE, under US GAAP, consolidates the financials of the Chinese Company, and Offshore Company consolidates the WOFE and is able to raise capital by listing on the NYSE / HKSE or other similar exchanges globally.

Education Sectors has been beneficiary of foreign capital…

The education sector – mainly after school enrichment classes – have grown immensely in the last two decades.  The hyper competitive job market, one child policy, increasing income of middle class and availability of information technology infrastructure have created an enviable industry tailwind.  The market was estimated to be $130bn in 2020 and was growing at a healthy clip of 16% CAGR since 2015. 

The proliferation of tutoring centres have attracted foreign capital and some of the largest companies have seen their stock reach new heights in 2019 making their founders billionaires. Many of the largest companies have done IPO on NYSE, HKSE, etc. and have raised more capital with follow on offering.  The rise of their shares had been phenomenal -  but perhaps has attracted attention at the government level which is seeking social harmony with financial stability.

…But was severely impacted as it was affecting social harmony and stability

With the rise in the sector growth increased the cost of education which created more pressure on household spending causing further decline in population growth when China is struggling with ageing population due to historical one-child rule. The government came down heavily on the sector.  While murmurs of such intervention has been there from the beginning of 2021, the crackdown came two weeks back when the policy papers were reported in public causing a $100bn wipe out of market value of the listed players.  On an average 80-90% decline was observed.  The changes in the stance is stark – from profit to non-profit, from deregulated pricing to government mandated pricing, from easy approval for establishment to control licensing and from access to capital market to being domestically held and kept so.

What does it mean for India

India, being a vociferous democratic set up, does not have the reputation of sudden changes in law for foreigners investing in India – it does have some issues which are fundamental to the education sector.  India has spent less on its education infrastructure since Independence and suffered from high rate of illiteracy causing the self-fulfilling cycle of sub optimal growth and slow rise of the middle class.  However, with deregulation and increasing affordability more private players have come into the education sector.  It does have similar outcomes – higher costs for education and pressure on household to substitute other needs for prioritizing education for their children.  The AST sector in India is open to foreign participation – which is increasing with the success (till 2021) of the Chinese experience for foreign investors.  Byju is the posterchild of this with its latest valuation over $15bn.  The experience of China is an opportunity for India – to have rules of engagement which shall stand test of times.  Opening the sector for profit for the normal schooling would only make it legitimate what is an acceptable practise anyways.  It would make the sector more professional, accountable and attract more capital which should mean availability of quality education.  Government may want to regulate the fee/pricing or at least provide a broad blue print  of pricing – given the basic need of education – the pricing power of the providers is immense.  However, what can and should be avoided is the sudden change in regulations as India cannot afford $100bn loss in a day.