A Recession-Proof Investment in China

A PE investor describes a win in “the sector least exposed to the slowdown in GDP growth.”

As China’s growth slows, private equity investors are looking for “safe” opportunities, and one of the safest niches in China these days is education.

The country’s education market is huge—200 million K-12 students—and Chinese parents spend freely on their children’s education, even in a downturn. Spending on K-12 tutoring has been growing faster than the Chinese economy, which saw 6.9 percent growth in 2015, and reached about $66B in 2014, according to the TAL Education Group. Chinese households now spend 30 percent of their income on education, more than households in Korea (22 percent) or Japan (10 percent).

“On a scale of zero to 10, education is about a 9.5 when it comes to being a recession-resistant sector.” says Tom Clausen, managing partner and co-founder of Capvent, which focuses on consumer-driven and lifestyle investments in Asia.

Of course, there are sectors within sectors, and not all subsectors of education in China—or anywhere—produce above-market returns. One drawback the cost of building schools. Another is that it can take decades—well beyond the typical PE investment window—to build a reputation and start attracting the best and brightest (and wealthiest) students.

Another hurdle particular to China is government involvement. If a private school wants to accept any of the country’s 100 million Chinese students, it must bow to rules that regulate details down to the cafeteria menu.

In 2012, Capvent found a way around all these hurdles by investing in online education company Tsingda eEDU Corporation, which Clausen calls “the YouTube of education in China.” Tsingda streams supplementary educational videos that build on the core curriculum for students up to 18 years old, which they watch at home or at one of its learning centers. It has no schools to build—only a few buildings used for instructor training—and it has gained quick popularity.

“From an investment perspective, we loved that the service is highly scalable and very low cost for consumers—you don’t have to be a millionaire in China to use this service,” Clausen says. “It’s also an attractive option for students who live in the provinces and have not had access to high-quality content and teaching.”

Tsingda has been unaffected by China’s downturn. Revenue has grown 4.5x since 2012 and net profits are high due to the company’s asset-light nature and scalability. Demand is strong because parents want to prepare their children for the job market—and that priority only strengthens in times of economic turbulence.

Capvent and OCBC Bank—a group comprising a family of companies owned by Singapore’s longest-established local bank—together held a 10 percent stake in Tsingda and, in January 2016, they exited via a sale to a group of Chinese investors. The sale of their stake was reported at $70M—a 3x return.

Capvent is continuing to look at plays in the education space, particularly the supplemental education space, where the growth ceiling is high. The proportion of households with children enrolled in supplemental K-12 education is only 30-35 percent, compared to 70-90 percent in Korea. And in China, no single company dominates the market: none controls more than 1 percent of the total share and the top five share just 3 percent.

“The only thing holding us back is the fact that valuations in the space—really all spaces in China—continue to be very high,” Clausen says. “So you have to be a value-driven investor, especially in this recessionary environment.”