Taking SPACs to School

Publicly-listed education companies often sit uncomfortably between the demands of financial stakeholders on one side and commercial challenges of working with school systems, parents, government regulators and students on the other. Perhaps this is why education investment bankers are paid to be optimistic.

Consider the recent flurry of announcements for the creation of education SPACs–or “special purpose acquisition companies”–since the beginning of the year that promise to boost the industry profile and create new excitement for investors in publicly traded Edtech companies. [1] Ironically this follows closely on the heels of more and more education companies exiting the public markets, usually as a way to sell themselves to private investors.  These exits include some of the most formidable players in the education world, such as Pluralsight–which after only a couple of years announced its delisting and sale to to Vista–as well as Laureate, Apollo Education, Zovio, Nord Anglia, Renaissance (which recently acquired NearPod as a private company) and McGraw Hill, to name a few.

What do they know?

I Want My Public Offering

Part of the challenge with going public, and raising a ton of money in the process, is that shareholders want financial returns.  They might have some patience but generally it doesn’t last.  To make them happy, companies often need to develop a few things quickly:

  1. Better IP, products and services
  2. Larger scale through new or expanded markets (why raise so much new capital?)
  3. A larger pool of smart talent to drive it forward

In the education sector, where companies can operate within highly regulated school segments or credentialed markets that require social or employer validation, this can be tricky.  The pressure on public companies to grow in sequential financial quarters can either be a positive catalyst for innovation or a death spiral toward unsustainable and low quality ventures. We’ve already witnessed what has happened to growing networks of physical, capital intensive assets (schools or learning centers) that provide accredited products in higher education over the past two decades: they usually don’t remain public companies. This is particularly true for companies operating on a global scale, which brings its own baggage of regulatory hurdles, local competition and demand shocks.

Is this time different?

With e-learning pushed ahead of schedule from the pandemic, there is hope that edtech businesses, SaaS platforms focused on direct to consumer (“DTC”) delivery, and every possible iteration of the “Netflix/Amazon/Disney of education” genre will succeed as public companies in this “$1 Trillion Digital Market“. After all, these companies should not need to carry large amounts of physical assets and heavy capital costs on their balance sheets (marketing spend is another matter). Yet whether they can sustain themselves as public companies, under the usual shareholder pressure and relatively longer timeline for education products and services to make a sustainable impact on profitability at scale, is an open question.

Education SPACs: A New Lesson Learned?

Which brings us to SPACs.  Matt Levine at Bloomberg Money offers the most insightful roundup on SPACs: what they are, how they are evolving, how they can circumvent the highly regulated IPO process, who benefits from the financial engineering process, and what it all means.

I have a few specific questions: do education SPACs promise to benefit the education sector in terms of student access, affordability, and outcomes? We know that SPACs will provide an alternative path to public markets, which are lacking for the education sector. In a recent Forbes article, “BMO estimates there are six times more education companies large enough to go public than just 10 years ago. In 2010, BMO determined there were 16 education companies with more than $500 million of enterprise value. Today, the figure has swelled above 100.” The M&A opportunity is undoubtedly immense. But who will benefit [2]? 

To date, we only have one example of an education SPAC that has actually completed an acquisition:  Meten EdtechX.

Here it is:

The company, sponsored by EdTEchX (which has another SPAC ready to go, EdTechX Holdings II) has been a horror show for post-acquisition shareholders, currently down 76% from its acquisition price. As someone who has worked closely with China for decades, I was a bit skeptical about the company’s ability to (a) differentiate itself in a crowded English training market (b) sustain student growth metrics online, in additional to centers and (c) grow into its steep valuation of $535 million at acquisition (market cap is current $127m). Covid-19 was clearly unfortunate timing for the company, but that hasn’t stopped many other Chinese online tutoring companies from thriving over the 2020 period. I could be wrong about the Meten SPAC, as there are many companies facing the same challenges, so perhaps it is a matter of time. But there is also a Chinese idiom that comes to mind concerning its SPAC offering: adding legs to a snake (画蛇添足).

Will SPACs improve?

It turns out that there are a few technical reasons related to the SPAC structure itself that may have compounded the problem.  In a revealing interview with the sponsors, Meten, a China-based platform, was considered a difficult sell to US investors. It also had a number of European PIPE (private investments in public companies) investors which reduced liquidity and increased volatility in the traded shares. Future SPACs could certainly remedy this, both in terms of how they are financial structured and in the selection of acquisition targets.

Will they? [3]

What is most important to me is how SPACs can make a positive impact on the education and workforce sectors by raising capital and allocating it effectively–the main purpose of any IPO. I’m a strong advocate for public listings when they make sense. But education SPACs will only be as successful as their M&A selection which, in my view, will most likely be sustainable if they focus on achieving global scale. With a few exceptions US education markets are mature, saturated, filled with “me too” companies and probably not large enough to justify the rosy growth forecasts and large acquisition price tags that SPACs are contemplating. For many high-growth education ventures the US market is simply not going to supply enough runway. That means either acquire a global education platform at the start, or be prepared to build one under public scrutiny.

A few considerations:

1. Find and manage acquisitions at global scale to justify an initial SPAC valuation. SPACs tend to have large capital commitments at IPO (sponsors only get so many shots at this) and business plans should be sufficiently ambitious.  If you look at a number of SPACs in other industries such as the latest fintech example with Sofi, what is clear is that aggressive future capital raises will likely be used for international expansion. If US markets are crowded, a step-up in business scale to justify high valuations has to be found elsewhere.

A recent case is Nerdy, which backed by the TPG PACE SPAC and acquired at a multiple of 7.1x 2022 revenue of $198 million. In its recent filing with the SEC, the company cites the $1.3 trillion offline DTC market as potentially moving online (and hence a target for the company), as well a $5 trillion global TAM. It’s main asset–Varsity Tutors–is a strong US-based business expected to report $99 million in revenue for 2020. Can it double revenues by 2022 from greater online tutoring penetration in the US alone? What about beyond 2022? Nerdy seems to be talking a global game, but how transferable is its US tutoring model to emerging markets?

2. Use public market status to gain competitive advantage. A number of education multinationals such as EF Education have remained in private hands while achieving significant and sustainable (multi-decade) revenues. Whether a public listing would have helped EF is questionable. On the other hand, public companies such as Pearson experiences heavy public pressure every time its businesses run into difficulties around the world, including in the US. No doubt international growth has benefited from becoming a globally recognizable brand through its public status, which comes with constant coverage in the financial press and a team of global analysts writing about it. In fact, it is unclear to me whether the Pearson could ever have gained such a high-profile global presence without a public listing, which they are now trying to use in launching their next pivot towards a D2C digital learning platform.

Navigating public market status as an education provider is not easy. SPACs might seize on an opportunity to enhance their global brand, accelerate M&A activities, gain access relatively cheap capital and use their stock for further acquisitions. They trade that for intense shareholder and regulatory scrutiny when acquiring and integrating new businesses, and high expectations that they deliver accretive value constantly. By contrast, private education companies can take care of business outside the glare of markets, which can sometimes help when school children and government overseers are involved.  In short, public scrutiny cuts both ways: making more critical that education SPAC owners and sponsors have an eye to sustainability and the ability to finesse a public listing over the long-term. 

3. Get the potential shareholding and integration mix right. A public company is only as good as its shareholders and they will be very different from private sponsors within the venture capital and private equity club. The ability for a private VC-backed company with a small pool of strategic and supportive shareholders to transition to the public IPO jungle of global day traders and institutional pension funds is not an easy task, particularly in down markets. In the case of SPACs, which already have question marks about being less regulated prior to going public, ongoing transparency will matter even more. SPAC prices are already proving volatile, and these vehicles would also benefit from acquiring companies that can foster a growing, sustainable, global shareholder base over time, rather than a narrow, speculative one.

Does it make sense to have a large education SPAC listed in the US that focuses solely on China? Or solely on the US market? Can future education SPACs position themselves to dramatically impact education and career development around the world and meet their aggressive growth forecasts?

Traditional investment banks have their own problems with IPO mis-pricing and investor selection. Will SPACs prove any better?

Caveat emptor.

[1] SPACs are nothing new.  As a baby investment banker in Hong Kong during the 1990s I worked on a number of SPACs or shell company conversions which were referred to back then as “backdoor listings.” At the time these listings allowed large shareholders, such as provincial Chinese government agencies, to “inject” company assets (or multiple state assets) into public shell companies and thereby circumvent IPO regulations, accelerate promotional activities and avoid a lot of associated scrutiny.  Owners of the public shells did very well financially; shareholders, not so much. 

[2] Of course, rent seeking, which in this context can mean economic wealth obtained through shrewd or potentially manipulative use of a public listing, can exist with traditional IPOs and within the entire venture capital gravy train of financial rounds.  That said, SPAC world may have to fight against a particularly negative perceptions as its primary modus operandi is to list and secure investor returns faster than a traditional IPO.

[3] For the uninitiated, PIPEs are private investments in public equities. Since these investors buy substantial stakes in such companies there is less room for others to trade the shares, which usually creates a more volatile price environment. As an aside, Chinese public education listings in the US, including in the education sector, have a relatively poor track record. Why Meten’s weak debut should have come as a surprise is unclear.