The ideal investment opportunity is one that offers tremendous potential return on investment, and that not many people know about… yet. By this measure, we submit that there are many compelling investment opportunities in the emerging education and training industry.
In light of the “e-learning” explosion that has occurred over the past few years, we suspect that most venture capitalists are at least somewhat familiar with this aspect of the education industry. Some may also be aware of the few, but prominent, investments made by VCs in for-profit school management companies (e.g., Edison Schools). But there is much more to the story. We hope that this article will serve to introduce members of the venture capital community to the range of exciting opportunities that exist throughout the industry.
More Than e-Learning
Spanning from “cradle to grave,” the education and training industry covers a full range of educational products and services delivered through both traditional and technology-based distribution channels. It includes such distinct elements as early childhood education, K-12 schools, higher education, corporate training and lifelong learning, among others. KnowledgeQuest tracks investments in four major sectors – Schools, Services, Products and Internet-based Education – as well as more than 16 sub-sectors.
Broadly defined, the education industry represents an $815 billion market,1 second only to health care as a percentage of U.S. gross domestic product. The for-profit sector of the industry – which is of most interest to venture investors – has grown rapidly for most of the 1990s, both in absolute terms and as a percentage of total education expenditures. Perhaps more important is the fact that industry trends support continued growth even as the economy softens.
Industry Is Large and Growing
Over the last decade, the education industry has achieved substantial magnitude and vitality, as defined by the following four metrics:
Expenditures: While U.S. education and training represents an $815 billion market, global education expenditure is estimated at over $2 trillion.2 In 2000, the for-profit portion of the U.S. education industry earned revenues totaling $105 billion, roughly 13% of the total.3 This represents 10% growth over 1999 revenues of $95.8 billion.
Institutions and People: In K-12, the U.S. education system encompasses roughly 120,000 schools, 14,000 school districts, 3.1 million teachers, 53 million students and 23 million families.4 In higher education, the market includes 15 million college students, 3,706 institutions, 1.6 million administrators and 1 million professors.5 Combined, this creates a market of over 100 million people in the U.S. alone.
Equity Investment: During the 1990s, 350 private equity firms made investments totaling $6 billion in 401 education companies.6 Over that period, total private equity investment in the education industry experienced an average annual growth rate of 64%. Even in the midst of recent market volatility, private equity investment in education and training has remained healthy. In 2000, private equity investment reached a record $2.7 billion.7
Public Market Capitalization: According to Eduventures, a leading industry research firm, there are 75 publicly traded U.S. education companies with a total market capitalization of more than $56 billion.8 In addition, a record eight education companies made initial public offerings in 1999, followed by another 10 in 2000. An index of the 14 publicly held education and training companies covered by Credit Suisse First Boston generated a return of 83.7% in 2000, relative to 10.1% for the S&P 500 and 39.3% for the NASDAQ Composite. While this index excludes many small-cap companies that would dampen aggregate performance, it effectively illustrates the industry’s potential.
The growing potential of the education and training industry is driven by at least seven trends that we and other analysts have identified:
1. Increasing Value of Education in the “Knowledge Economy.” One projection suggested that, by 2000, 85% of the nation’s jobs would require education or training above the high school level, compared with 65% at the beginning of the 1990s and 40% in 1950.9 The wage gap between those with a high school diploma and those with a college degree also has expanded significantly: in 1980, the pay difference was 50%; by 1998, it had ballooned to 111% and it is still expanding.10 In this information-driven global economy, “knowledge workers” are essential, making better preparatory education and constant re-education the linchpins of future success.
2. Technology Drives Changes in Education and Training. We suspect that this readership recognizes the far-reaching impact of technology as a transformative force in the global economy. What you may not know is the degree to which this trend impacts all sectors of education. Most prominently, the e-learning industry alone is projected to be an estimated $40 billion market in 2005, with a five-year growth rate of approximately 42%.11 Corporations use technology to provide just-in-time, just-what-you-need learning opportunities to their employees. But technology also is penetrating the public school market – perhaps the most change-resistant sector – at a rapid pace: now, most public schools (96%) and more than half of the nation’s classrooms (51%) have access to the Internet, up from 35% and 3%, respectively, in 1994.12
3. Importance of Education as a National Policy Issue. Education is consistently the top domestic social policy concern of Americans, beating out other core issues such as the economy, health care and Social Security. In a recent Gallup poll, 50% of Americans said that education should be a “top priority” for the Bush administration, higher than any other issue tested.13 This public sentiment likely will lead to continued increases in federal and state funding for educational initiatives, much of which is available to private companies. We believe the national conversation about education reform albeit rhetoric-filled and often polarizing creates a political climate that supports experimentation and allows innovative ideas to emerge and flourish.
4. Increasing Number of Students and Teachers Throughout System. Total public and private elementary and secondary school enrollment reached a record of 53 million in fall 2000 and is projected to remain at these high levels through 2010.14 Well-reasoned estimates place the total demand for new K-12 teachers at 2-2.5 million between 1998 and 2008, averaging over 200,000 annually.”15 Enrollment in institutions of higher education also is expected to rise to 17.5 million by the year 2010, representing an increase of 22% from 1997.16 This growth in students and need for additional teachers across the system further enhances the demand for a wide range of educational products and services.
5. Opportunities in Early Childhood Education Spurred By New Brain Research. Research about early brain development has begun to unlock the mystery of how the human mind learns, discovering that neural connections formed by proper stimulation in the early years can have a significant impact on educational and personal achievement later in life. For example, a recent study demonstrated that children who receive early intervention are more likely to score higher on IQ, reading and math tests; be enrolled in or graduated from a four-year college; delay parenthood; and be gainfully employed.17 This environment, in our view, will continue to drive substantial new investments in early childhood education.
6. Education and Training Industry May Be Recession-proof. As the economy contracts, making jobs more scarce, individuals increasingly turn their time, attention and resources toward the pursuit of additional education and training. This “recession-proof” quality means that, as other industry segments contract with the economy, the education and training industry can actually enjoy continued expansion.
7. Education is Global. While we have focused mainly on education-related opportunities in the U.S., it is important to recognize that increasing globalization impacts the education industry as well. There are three types of global opportunities for investment: exporting U.S. products and services abroad; importing foreign products and services to the U.S.; and investing directly in foreign products and services being sold in foreign markets. Investments of all three types are occurring to an increasing extent, perhaps most often in the areas of language and business.
With such powerful macro-trends converging, we believe the education and training industry offers a host of interesting investment opportunities, with a full range of risk-reward profiles to suit virtually any investor. To assist readers in identifying these opportunities, we offer the following brief insights about this evolving market segment:
1. The Internet May Change Everything, but It Isn’t Everything. There is a myopia that often leads investors to discount anything that is not technology-driven, or for people to think of technology as a panacea to education’s problems. We caution against both tendencies. We see many promising business opportunities in non-technology sectors, such as worksite child care (e.g., Bright Horizons Family Solutions, ChildrenFirst), learning centers (e.g., Score!, Sylvan), privately managed schools (e.g., Edison, Mosaica, Nobel) and for-profit post-secondary schools (e.g., Apollo, Devry). We also believe that hybrid Internet/site-based models will play a prominent role in education in coming years.
2. Clear and Convincing Revenues. When evaluating Internet opportunities in education, we have adopted a basic litmus test for the first round of review: are revenues received directly for the core product or service being delivered? Essentially, this excludes advertising- or sponsorship-based business models, as well as those that expect to support a core product or service with ancillary e-commerce. Parents, schools and corporations have demonstrated a willingness to pay directly for products and services that are perceived to have significant value; too often, the ancillary revenue sources are asked to support a product or service that customers don’t value enough to pay for themselves. We also look for companies that can be successful from one or perhaps two core revenue streams. It often seems that projections of multiple significant revenue streams merely cover a weakness in the core business model.
3. Need for Whole Solutions. As has been the case in the business-to-business sector, we see an opportunity for companies that offer end-to-end solutions. These solutions should solve “big” problems – the bigger the better. For example, K-12 schools are in need of an integrated solution that addresses back office data management, curriculum and assessment tools, professional development, online file storage, connection to community/parents, Internet security and more. While individual companies with targeted solutions to real problems may provide excellent near-term investment opportunities, we believe that the companies that build (or string together through well-managed acquisitions) whole solutions present opportunities to achieve lasting market dominance.
4. K-12 Sector Holds Untapped Opportunity. At $372 billion,18 the K-12 sector represents the largest portion of the education and training industry. However, schools have been the slowest to warm up to for-profit entrants in the market, lagging significantly behind corporate training and post-secondary education. Although the K-12 sector presents unique challenges, it also holds enormous opportunities for those entrepreneurs able to communicate a clear value proposition. We believe that sentiment is slowly shifting to a greater focus on what works, irrespective of the solution’s source.
The combination of elements outlined in this article – size and growth of the industry, underlying macro-trends, and expected future developments – suggests that the coming decade will present excellent investment opportunities in the education and training industry for those willing to understand its complexities. By doing so, investors also enjoy a rare opportunity to participate in a social transformation with the power to impact the lives of millions. We encourage you to learn more about this exciting industry.
Jeffrey A. Fromm is President of KnowledgeQuest Ventures LLC, a New York-based investment banking and strategy consulting firm that focuses exclusively on the education industry.
Todd V. Kern is Vice President of KnowledgeQuest Ventures.