The middle classes in emerging-markets economies are ambitious — but dissatisfied. As these national economies are growing, so are the salaries of middle-income earners. But many workers believe that their public services are not improving at the same pace. Such a sense of frustration sparked widespread public protests in Brazil last year. Private equity investors believe this dissatisfaction presents a golden opportunity for them.
“Governments are not very efficient in general,” opines Beatriz Amary, São Paulo–based head of the consumer sector for Actis, a London-headquartered private equity house specializing in emerging markets. “Moreover, they usually lack the management skills that are required for the business of education. Brazil is a great example of that.” Amary cites research from Brazilian bank Itaú Unibanco showing the cost of educating a student at 20,700 reais ($8,850) a year in public universities, more than three times the 6,800-real annual tuition at private institutions in the country.
Many Europeans who have grown up with government-sponsored services that are often high quality would dispute this claim. Yet even many advocates for state-provided public services acknowledge that emerging economies face particular issues that mature and democratic developed markets do not. “In emerging markets you have to deal with the inefficiencies of government, which sometimes include corruption,” says Amary. And even if emerging-markets governments are efficient, they can still face the problem of a lack of capacity. Demand is expanding so fast, say private equity investors, that they cannot keep up.
Elsewhere in the BRICS, Morgan Creek Capital Management, a $4 billion multiasset manager based in Chapel Hill, North Carolina, sees particular promise in the private provision of health care in China. It had previously invested in a private fund involved in Chinese business services and health care, which funded a hospital management company called Phoenix Healthcare Group, China’s largest private hospital group in terms of number of beds. Morgan Creek exited the investment through the company’s successful 2013 initial public offering. “China needs to do a lot of work on its health care system, so the government is going to increase spending on health care significantly,” says Mark Yusko, Morgan Creek’s chief investment officer and CEO.
Several private equity investors have also been attracted to opportunities in education. Bryce Fort, founding partner and head of the Nairobi, Kenya, office of Emerging Capital Partners (ECP), an Africa private equity specialist with committed capital of $1.4 billion, describes education as “definitely” the most promising area. Within this field, Fort sees the business case for universities, technical colleges and other forms of post-high-school training. “It’s a consumer-oriented business with a substantial imbalance between supply and demand, with demand higher than supply,” he says. “There’s negative working capital, because people pay for their tuition up front. And prices tend to grow faster than inflation.”
Ebitda margins in private education tend to be between the high 20s and high 30s in percentage terms, Fort says, and he expects such levels to prevail through much of Africa, where postsecondary training is taking off. Africans are prepared to cough up the money for education fees because they know how much of a difference training after high school — which in Africa tends to be concentrated in fields such as nursing, law and business — can make to their financial futures. According to Fort, the line of thinking among potential students is, “If I get into college, I will pay $2,000 or $3,000 a year for three years, but then I can get a job that will pay me $8,000 or $10,000 a year,” an annual salary that would fall comfortably in the upper middle class in major emerging-markets economies. African education thus provides a good internal rate of return for clients as well as providers, he says. ECP expects to announce its first education deal in Africa in the coming months, Fort adds.
However good the math of private provision of public services is in theory, private equity investors’ enthusiasm for it depends on the enthusiasm of the local government. And investors have a sense that many governments in Africa, Asia and Latin America are indeed keen on the idea. Amary notes that in Brazil, postsecondary education providers do not pay tax on profits as long as they provide scholarships, usually based on ability to pay, to 8 percent of students. The government also subsidizes some tuition.
Actis has invested in two Brazilian educational providers, paying about $100 million in each case for stakes of roughly 40 percent. The first company, Cruzeiro do Sul Educacional, educates some 65,000 students across multiple campuses. It is continuing to expand through acquisition, searching for the economies of scale that Amary believes are possible and desirable in this sector. The other investment is in CNA, a company that provides private English-language training. In the global EF English Proficiency Index, Brazil consistently scores below the other BRIC countries of China, India and Russia. That proficiency gap spells opportunity for CNA, and for Actis.
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