How to profit as Asia’s middle class starts the school run

Ask any parent what their long-term financial priorities are, and the top three will almost certainly consist of the following, in some order or other: pay the mortgage; put some money aside for retirement; and save up for the children’s education – be that university fees, private schooling, or piano and swimming lessons.

The desire to give your children the best start in life, and the tools to enjoy a better standard of living than your own, or to have opportunities that perhaps you didn’t, is a key ambition for most parents.

Perhaps nowhere is this desire felt more keenly than in nations where the middle class is just starting to make its mark. In these societies, a good education is still a passport to a better job, the sorts of opportunities a rural or factory labourer could never dream of, and a much higher standard of living.

When the benefits of a good education are so clear – as compared to life today in the West, with its swathes of unemployed graduates burdened with debts that will never be repaid – it makes sense that parents are more than willing to sacrifice a large portion of their own disposable income, effort and time to get the best education possible for their offspring.

That’s exactly what’s happening in emerging markets right now. As Asian economies have grown richer, both parents and politicians have been able to channel more money into education. In the last ten years, says Keith Bradsher in The New York Times, “China [has] doubled the number of colleges and universities to 2,409”.

These efforts have been helped by what Andres Oppenheimer, an Argentinian journalist studying Asia’s education systems, calls “a cultural respect for learning”. In Singapore, for example, pictures of teachers adorn local currencies and learning features in most government slogans. Study is seen as a glorious way to make a nation great.

Oppenheimer isn’t the first to notice this. Over the past ten years professional institutes, private colleges and Western universities have invested heavily in order to gain a foothold in the Asian education market. But there’s plenty of room for further expansion – the emerging-market education boom has only just begun.

Unsurprisingly, China is the focus for most investors. Nicholas Brummitt, managing director of the British-based International School Consultancy Group, tells Reuters there are now 338 international schools registered in mainland China, up from 22 in 2000.

Meanwhile, total student numbers have grown 25-fold. What’s driving this expansion? One reason is demographics. China is a relatively ‘old’ emerging market – the median age is 35, similar to Britain’s 37 and a lot higher than India’s 25. But China’s labour force is still expanding and is not expected to peak until 2015.

Urbanisation also plays a role. Around 270 million Chinese have moved from country to city in the last 20 years. Similar movements are well underway in other emerging Asian economies. As these countries shift from agrarian economies to industrialised nations with strong service sectors, young people need different, more specialised qualifications to succeed. Urbanisation creates intense competition for the growing numbers of ‘knowledge-based’ jobs often found in cities.

China’s education system is similar to our own in structure. Primary school lasts until the age of 12, with secondary school to the age of 18 (although school is only compulsory to the age of 14). State education is free, but parents have plenty of scope to opt out and go the fee-paying, private route. Those who can afford to often do.

That’s because China’s education system is also incredibly competitive, says Kopin Tan in Barron’s. “To be a student in China is to live under immense pressure. More than 230 million school-age kids make for quite a bit of competition.

Centuries of Confucianism hold up scholarly learning as the noblest calling, while decades of the one-child policy have spawned hopeful – and demanding – parents.” The stress culminates in the final year with “gaokao”, says Tan, a “gruelling nationwide exam” that decides if you’re among the few allowed into China’s most-coveted universities.

Foreign schools are a way around this stress, enabling students to avoid “the pressure cooker” of the gaokao, says Lucy Hornby of Reuters. The learning style is Western, based on students working out their own responses to challenges, rather than the traditional “mark-centric” Chinese system of memorising answers to questions.

While the merits of each system can be debated – that’s not our remit here – one thing that is certain is that learning the Western way in secondary school makes life easier for those Chinese students who end up studying at a foreign university, which is a handy fallback if you don’t make it into one of China’s top institutions.

There’s also a certain amount of “keeping up with the neighbours” going on, says Lilian Lin, a researcher with The Wall Street Journal’s Beijing Bureau. “If their child cannot get into a top Chinese university, parents would prefer to be able to say that they are studying at an impressive-sounding foreign one.”

With China’s population becoming ever more wealthy, there’s plenty of money to spend on education. And the one-child policy means there is a network of grandparents ready to help with the costs of training up the ‘little emperors’, as China’s current generation of youngsters are known.

Given the rapid growth so far, can investors expect more? There are now more than 184,000, mostly Chinese, students in these international schools. Considering that almost 29 million attend state primary or secondary school in the cities alone, there’s lots of potential for expansion.

We’re not just talking expensive, elite international schools either. The mass market institutions are another big growth area: many new private schools are being built in China’s less sophisticated ‘second tier’ cities.

As well as preparation for university, another big opportunity lies in higher education itself. In 2011, 340,000 Chinese students went to foreign universities, compared to just 140,000 in 2007. Almost half of those students go to America, while Britain gets around 20%.

As Asia has grown richer, total numbers of international students have swelled. The Organisation for Economic Co-operation and Development, a think tank, says there has been a 99% increase in student numbers since 2000, with 4.1 million students now studying abroad.

America, Britain and Australia are the most popular destinations, partly because most international students want to use the experience to improve their English. However, as Asian universities improve, Singapore and Hong Kong have become increasingly popular as destinations for international students too.

Western institutions have received their new Asian students with open arms. Foreign students pay full fees, unlike subsidised locals. It’s also a chance for universities to attract the best brains. Universities are so keen to attract foreign students they’re building campuses and creating affiliates in the source countries themselves.

Today, you can study at Texas A&M in Qatar, Newcastle University in Malaysia or Monash University in South Africa. British universities now have 400,000 international students in foreign campuses.

The other element in this story is vocational training. Increasing numbers of graduates have led to extra competition. Unemployment rates among new college graduates jumped to nearly 30% in 2010 from 18% in 2001. As a result, an estimated 40% of recent graduates took part in extra training to enhance their English and IT skills.

These courses are also doing brisk business with those who haven’t been to university. It is estimated that 111 million 15 to 22-year-olds are enrolled in some form of vocational training. Thanks to these steady streams of demand, the private training market is forecasted to grow at 23% a year, say analysts at RedChip Research, to a value of $115bn by the end of 2013.

But what’s the best way to play this trend? The Western universities that are doing so well right now are generally non-profit institutions. Also, some parts of the industry, such as English teaching, have low barriers to entry, which may hit profit margins as the market matures. We look at the most promising parts of the sector – and how to play them – below.

The rise of the robots

The rise of the robot is making education even more important. Thanks to a wave of automation, driven by cheap sensors, increasing computer power and sophisticated artificial intelligence, humans will need to keep their skills up to date if they want to remain employable.

This might all sound a bit ‘sci-fi’, but the workplace has been similarly transformed before, says Kevin Kelly in Wired magazine. “Two hundred years ago, 70% of American workers lived on the farm. Today automation has eliminated all but 1% of their jobs.”

This second wave of automation will happen over a much shorter timeframe, says Kelly. First, machines will consolidate their gains in already-automated industries, such as factories, warehouses and fruit-picking. Then they will move to simple services. “Cleaning in offices and schools will be taken over by late-night robots”, while pharmacists will be replaced by “automated pill dispensers”.

Office workers aren’t safe. “We already have artificial intelligence in many of our machines” – such as word processors that automatically correct spellings – but soon “any job dealing with reams of paperwork will be taken over by bots”. The fact is “the rote tasks of any information-intensive job can be automated. It doesn’t matter if you are a doctor, lawyer, architect, reporter, or even programmer: the robot takeover will be epic”.

Sound scary? It shouldn’t. The first wave of automation created new careers that couldn’t have been imagined a century before. The same will happen this time, says Kelly. In 2050, “the highest-earning professions… will depend on automation and machines that have not been invented yet… we can’t see these jobs from here, because we can’t yet see the machines and technologies that will make them possible”. But we do know that these jobs will require a new set of skills, and offer opportunities for education and training.

The three stocks to snap up now

Investing in China is risky, so don’t bet all your money on one stock. New Oriental Education & Tech Group (NYSE: EDU) is the biggest supplier of private education in China and offers foreign language training, preparation for tests, after-school tutoring and educational software.

It is also making a big push into the fast-growing, high margin area of online teaching. The firm has also pushed beyond China’s biggest cities and established more than 500 learning centres in 50 second-tier cities.

The company is one of the purest plays on the education story, but be aware that, like many Chinese companies, New Oriental has been targeted by short-sellers, although it has so far defended itself more effectively than many other US-listed Chinese companies.

One short-seller, Andrew Left of Citron Research, later told Reuters: “I wrote about it, shorted it, and realised I was wrong, so I got out very quickly.” The company is currently involved in a dispute with another short-seller, Muddy Waters.

Another option to play the vocational training story, albeit still risky, is London-listed AEC Education (LSE: AEC). The group operates business and management training centres in Britain, Singapore and Malaysia. AEC taps into Asian demand for Western professional education by running courses accredited by British-based professional bodies.

For example, it offers courses from the Association of Chartered Certified Accountants (ACCA), and the CFA Institute. It also has tie-ups with British universities that allow it to provide their degree and postgraduate programmes through AEC centres in Asia.

In total, AEC has 14,000 students on its books, which brought in sales of £18m last year. It’s a tiny company, and not one to put your entire savings into. But it offers an attractive, speculative way to invest in Asia’s growing demand for education.

If you don’t fancy a small cap or a Chinese stock, you may prefer £1bn market cap Pearson (LSE: PSON). The publishing and education giant has a strong balance sheet and a 4% dividend yield.

Pearson share price

It’s not a pure play: around 17% of its sales come from Penguin, its publishing unit, and another 7% from the FT Group. However, many analysts believe the recent merger of Penguin with fellow publisher Random House is the first step of a strategy that will see the firm quit publishing to focus on learning.

Even if it doesn’t, Pearson still derives around 75% of sales, and an even higher proportion of profit, from education. Of that, around 43% comes from the American market, 25% is international and the remainder comes from support for professional and vocational studies.

The American private education sector is struggling, due to cuts in public spending. This was a key factor driving this week’s rare warning from Pearson that profits would fall a little shy of City hopes this year.

However, if anything this will increase Pearson’s efforts to build up its international education division. At present, the emerging-market side of this business accounts for around 15% of sales, but all the signs are that Pearson will focus more on these countries.

For example, John Fallon, the new chief executive, formerly headed up the international education unit. He has £1bn of cash to spend on acquisitions and recently made it clear which countries might be on his shopping list. “We’re still small in China relative to the size of the opportunity. You would say the same about Brazil and India.”

In November, the company launched an education tablet in India, which analysts at Natixis expect to drive Pearson’s sales in India by 30%. Moreover, “India could become a laboratory for Pearson’s geographic expansion in English-speaking countries (notably Africa)”. On a forward price/earnings ratio (p/e) of 14, Pearson isn’t cheap. But given it’s long-term growth prospects, it looks worth tucking away.

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