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Brazil Education
May It Be Infinite While It Lasts
December 19, 2012 Shifting Focus Towards the Right Fundamentals
In a sector with such rich fundamentals supporting strong growth and
LatAm Team attractive returns, it is sad to see market debates restricted to a student loan
Gustavo Wigman program that lacks the administrative and economic structure to support it for
+55 (11) 3701-6302
gustavo.wigman@credit-suisse.com long. We strongly believe in the importance of student financing but do not
believe it changes dramatically the long-term supply-demand dynamics for
Clarissa Berman
+55 (11) 3701-6316 adult education. Scarcity of labor is placing increasing importance on
clarissa.berman@credit-suisse.com employee productivity, and as long as educators can prove their services can
Claudio Lensing enhance labor, the market will reward them and financing mechanisms
+55 (11) 3701-6333 (government supported or otherwise) will be available.
claudio.lensing@credit-suisse.com
Paulo Albano A New Way to Look at Education
+55 (11) 3701-6301
paulo.albano@credit-suisse.com Note that in the first paragraph we refer to adult education and not to
higher education. This simple change in scope increases addressable
market by ~130% and should be the new trend for private education
companies. The opportunities appear infinite but won’t last long for a large
share of education providers. The new competitive environment will demand
a level of scale and managerial skills that smaller players lack, fostering
consolidation in the sector. For those who survive, rewards are noteworthy.
Widening the Valuation Peer Group
Unlike other research houses, we include education (and health care) under
the umbrella of consumer goods and retail. We understand their nuances
but believe they all compete for the same resource: the pockets of the
Brazilian consumer. In addition to the typical valuation benchmark to health
care, we detail our view on relative attractiveness to retail, which we believe
is a better proxy for the sector and supports higher upside for the sector.
DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. FOR OTHER IMPORTANT
DISCLOSURES, visit www.credit-suisse.com/ research disclosures or call +1 (877) 291-2683. U.S. Disclosure: Credit Suisse does and seeks
to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest
that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
December 19, 2012
Table of contents
Executive Summary .......................................................................................................... 03
Employability should gradually become the sector’s benchmark of quality, and employers will likely have a greater
say in defining curriculae. We also see the focus of sector discussions moving towards an amplified addressable
market, with format and content flexibility becoming key success factors for what lies beyond FIES.
Government Support: Student Loans - FIES(ta) or FIES(co)? .......................................... 13
It is undeniable that FIES provides the sector with short-term momentum. Yet, we believe that the most important
question is what lies beyond the program.
Long-Term Intrinsic Drivers: Dissecting Growth Levers .................................................... 21
Education is structurally poised to outperform other sectors in growth, which is historically a key driver of above-
average TRS generation. To fully realize Brazil’s growth potential, winners will need to demonstrate format and
content flexibility, expand beyond traditional regions and create a successful track-record of M&A capabilities.
Valuation Framework: Dissecting Value Drivers ............................................................... 31
Fair valuation levels for the education sector have come into the spotlight after the recent outperformance. We
argue that, on a relative basis compared to other consumer sectors, multiples deserve to trade at a premium owing
to factors such as stronger and less volatile earnings growth.
Companies Section .......................................................................................................... 34
New in This Report
We include the education debate in our broader consumer coverage to maintain consistency across our
forecasts for consumer spending categories.
We explored our CS consumer database for insights into education spending patterns across the
student life cycle, which supplied the granularity needed to explore trends on a micro level.
We take a comprehensive approach to analyzing the intrinsic value drivers of the education sector. Our
in-depth analysis of sector fundamentals point to a promising outlook, derived from other growth
drivers aside from growth in student-subsidized funding
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must be made exclusively based on information contained in the preliminary and final prospectuses. Investing in shares involves risks. The information
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Brazil Education: May It Be Infinite While It Lasts 2
December 19, 2012
Executive Summary
“Quality” is becoming a hot topic in education but there isn’t
much consensus on what it actually means. Social definition
aside, the essence of “quality” can be summarized to one simple
goal: employability of students. Unfortunately, achieving such
goal is far more complicated than simply financing their
diplomas. Employers complain new graduates are not prepared
for entry-level positions and the situation may get worse if
unstructured access to financing brings in less prepared
students. Many believe the sector enjoys “la FIES(ta)” and
underestimate the sector challenges. We agree with short-term
tailwinds but prefer to focus this report on the opportunities lying
beyond the “FIES(co)”.
Ask any young Brazilian about his or her aspirations, and and that has significant consequences for the outlook of
access to high-quality education will probably be at the economic growth. Hiring has become a critical issue for
top of the list. Besides the noticeable monetary return companies in Brazil, and the quest for talents should
for each additional year of schooling (see Exhibit 1), a make the problems and bottlenecks of Brazil’s post-
college degree is also perceived as a status symbol and secondary education more evident.
a sign of progress for families.
Ensuring that students get what they need to succeed
Despite the allure of education, the vast majority of in the labor market, that employers get the talent they
Brazil’s adult population have not reached post- are looking for, and that schools get the recognition
secondary education, either because they were forced (and rewards) for the service they provide is no trivial
to join the labor market earlier in their lives to support goal, especially in a scenario where college seats are
their families, because their educational foundation was being offered to students who often lack the primary
not sufficient for them to pass college-entrance exams, and secondary educational foundation needed to
or simply because supply (at affordable prices) was not successfully complete their post-secondary studies.
available when they reached college age. The number of
The federal government has set aggressive targets for
seats at public universities has always fallen short of
the growth of enrollments in post-secondary education,
potential demand, and it was not until the last decade
but the initiative alone does not guarantee that the
that the private sector started to increase capacity and
supply of qualified labor will expand as needed. Once
lower tuitions more aggressively.
students are in college, it is crucial to ensure that they
The sector is also gaining importance in economic develop the set of skills expected by employers and that
discussions. Improving the quality of Brazil’s they are placed in related fields of expertise. The key
professionals has become mandatory, since the problem in Brazil’s educational system is that educators
demographic evolution of the country is restricting the and employers do not share the same view on the
expansion of the labor market. Smaller pools of young necessary skills and competencies.
adults are joining the working-age population (WAP)
Brazil Education: May It Be Infinite While It Lasts 3
December 19, 2012
Exhibit 1: Returns by Education Level increase Exponentially
Adjusted Income (R$ ‘000 / month) Total Income (R$ ‘000 / month)
5 6
Salaries increase for High College
students engaged in post- School 4
4 secondary studies and raise
exponentially for college 2
students and graduates
0
3 1 3 5 7 9 11 13 15 17 19
Years of Study
X
2 Average Occupancy Rate (%)
100
1 80
60
0
1 3 5 7 9 11 13 15 17 19 40
1 3 5 7 9 11 13 15 17 19
Years of Study Years of Study
Source: FGV, Credit Suisse Estimates
To make things worse, the vast majority of students have Private (unlisted) schools appeared less excited about the
no clue what the market conditions or requirements of long-term sustainability of the FIES program and
different professions are. Students usually choose dialogues centered on the risks of having the federal
courses without understanding whether there will be a government controlling the school’s receivables.
demand for their qualifications and often end up pursuing Speculations around further government intervention also
different careers after their graduation, triggering doubts popped up during meetings, which was not a surprise
about the return on the time and money invested in their given the recent “noises” in other sectors of the economy.
college degrees. It is true that a growing share of
Overall, the issues raised during conversations point to five
students are studying and working simultaneously and
key trends for private education players:
that their education choices are often related to their work
fields. That, however, should not be an excuse for 1. “Quality” should finally move from talk to action. In many
educators to avoid paying more attention to the key cases having a college degree evidences only the self-
priority of their clients: finding a good (or better) job! determination of the person who holds it, as simultaneously
managing work and studies is no small task, even at lower-
Clearly, we cannot provide definitive solutions for the
quality schools. Employers are not getting what they expect
challenges highlighted in this report. Our key goal is
from new graduates, and diplomas will lose value unless
simply to move discussions from enrollment growth to
this trend is reverted.
job placement and return on human capital invested,
which we believe are the fair metrics for evaluating 2. The addressable market should change from “higher
success and sustainability of the sector. education” to “adult education.” For several high-growth job
positions, a college degree is not even required, which
Over the past few weeks, we spoke with investors, industry
does not mean that these professionals do not need
consultants, corporations (employers), and schools about
continued education. Schools will need to get closer to
the most important topics they believe should be discussed
employers to spot these training niches, which could be as
in this report. Unsurprisingly, conversations with capital
(or even more) attractive than a traditional college degree.
market participants were focused on the implications of
FIES for short-term enrollment growth, as well as “fair 3. Flexibility is the name of the game. As the labor market
multiples” for the sector. should remain very tight, we expect a growing share of
students to keep studying and working simultaneously. The
As expected, employers were concerned with the poor
need to develop more flexible learning formats (and
skills of their new hires and suggested topics related to
content) is crucial for this public, and employers and
the quality of post-secondary education. It was also
education providers will need to solve this puzzle.
suggested that education players should expand scope
from higher education to adult education since a 4. From “knowledge generators” to “certifiers of
significant share of Brazilian adults lack the requirements, knowledge.” The internet has dramatically changed the way
the will or the need to pursue a college degree, but would knowledge is generated and shared across the world.
still benefit from further training. Fighting the trend of highly respectable universities
“dumping” their lectures free of charge on the web is
Brazil Education: May It Be Infinite While It Lasts 4
December 19, 2012
inglorious, and schools will need to learn how to use this attention to education quality should gain higher
content in their favor. Instead of focusing on knowledge importance.
generation, most private colleges will simply focus on
Perhaps the question should not be whether the goal is
ensuring that all this available knowledge is channeled to
achievable or not, but whether Brazil should pursue this
students in the best format possible (with few exceptions,
goal at all. The language and mathematical skills of
private players have not been creating much knowledge
college graduates is surprisingly low and has
anyway). Students will still need to be guided through their
deteriorated in the past decade as private players
studies and certified for the knowledge acquired, which
expanded capacity aggressively. New graduates agree
does not necessarily diminish the role education companies
with their employers that they lack what is needed for
play in the process.
entry-level positions. Pumping money into FIES and
5. Financing should become increasingly important. The forcing unprepared students into college does not seem
excitement surrounding FIES is understandable, but players to solve the problem, and the government’s cumulative
will likely diversify their sources of funding. Education is costs (or losses) could reach fairly high levels.
highly aspirational, and those who can afford it are already
“consuming” it. Marginal growth requires some sort of Marginal Students Learning Marginally Less
financial aid (grants, scholarships, or loans). The FIES has
been a gift to private players, who were able to move their The 2011 edition of Brazil’s National Household Survey
students with financial problems onto the government’s (PNAD), released in September 2012, shows that
balance sheet. However, we would not count on this “free teenagers are staying in school longer, which is
lunch” for long and expect players to find alternative ways contributing to a significant increase in the average
to finance their students. number of years of schooling of Brazil’s population.
Redefining Addressable Market Exhibit 3: Schooling Level of Brazilians Has Improved
Distribution of 15-to-64-year-old Brazilians according to schooling level, %
The back-of-the-envelope growth calculation circulating in
the market is fairly simple: Brazil is expected to have 23.9 Schooling Level 2000 2011
million 18-to-24-year-old adults by 2021, when the Illiterate 10% 9%
government plans to achieve a gross post-secondary Primary school (1-5 grade) 30% 15%
enrollment ratio of 50%, which sets Brazil’s college Primary school (6-9 grade) 28% 24%
universe at 11.9 million. The math is correct, and the Secondary education 24% 37%
implied annual growth rate of 6.1% in enrollments attracts
Post-secondary 8% 15%
investors. Although the sector has faced tuition deflation in
TOTAL 100% 100%
recent years, there are many who believe this negative
pressure ceases with the FIES removing the cost barrier for Source: IBGE
poorer students and lowering sensitivity to tuition inflation.
Based on census data produced by the Brazilian
Statistics Bureau (IBGE), there have been notable
Exhibit 2: Quick Math for Sector Growth advancements in education this decade, especially
2011 2021 secondary and post-secondary education. Exhibit 3
shows that the percentage of people with a secondary
# Students (‘000) 6,345* 11,877 education rose 13 percentage points from 2000 to
2011 (from 24% to 37%), 7 percentage points for
Population 18-24 (‘000) 23,513 23,861 those with a post-secondary education (from 8% to
15%).
Gross Enrollment (%) 23 50
*5,352 under on-site courses and 993 under distance learning programs
Source: IBGE, MEC, INEP
Is it doable? This is a fair question since the government
has failed to meet the goals established for the first
National Plan for Education (PNE), announced in
2001: to reach 30% of net enrollments by 2010, when
the actual number was nearly half (17.3%). We agree
the “new” FIES is a game changer, but as Brazil moves
towards accomplishing such a questionable metric,
Brazil Education: May It Be Infinite While It Lasts 5
December 19, 2012
Exhibit 4: Percentage of Brazilians With full Literacy Skills Have Dropped in the Past Decade
Distribution of Brazil’s students according to their language and mathematical skills
Primary School Secondary School Post-Secondary
Literacy (6-9 grade) (10-12 grade) School
Levels
2001/02 2011 2001/02 2011 2001/02 2011
Illiterate 1% 1% 0% 0% 0% 0% Share of post-secondary students
considered “functional illiterate”
Rudimentary 26% 25% 10% 8% 2% 4% doubled in the past decade
Basic 51% 59% 42% 57% 21% 34%
Statistics of students with “complete”
Complete 22% 15% 49% 35% 76% 62% status on basic language and
mathematical skills also deteriorated
Source: Functional Literacy Indicator (INAF)
In terms of statistics, Brazil appears to be moving in the In sum, the data show that the effort put forth by
right direction. However, the Functional Literacy governments and the population to stay in school longer
Indicator (Inaf) published by the Paulo Montenegro and to strive for a post-secondary education has not
Institute (IPM) from 2001 to 2011 shows that the gain resulted in the expected gains in learning. New social
in terms of years of schooling has not yielded, in the strata are reaching higher educational levels but
same proportion, to gains in reading, writing, and probably do not have the means to reach the highest
mathematical skills, as seen in Exhibit 4. Comparing the literacy levels that were assured when this level of
first Inaf for 2001-2002 with the survey done in 2011, education was more elite. The search for a new quality
only in the first segment of primary education does one of schooling, especially in the public system, should be
see any gains in learning skills throughout the decade. accompanied by efforts to increase scale so that
For other levels of schooling, the percentage of people schools effectively fulfill the right to an education.
achieving the full set of skills expected to be developed
While the poor quality of primary and secondary
by the end of the primary education is actually lower.
education may offer attractive opportunities for the
Of all those who attended all years of primary school, private sector, particularly learning systems, the blame
the proportion of functional illiteracy (i.e., illiterate plus for lower quality indicators in tertiary education falls on
rudimentary literate) remained relatively stable the private sector, given that it has been the key driver
throughout the decade (between 26% and 27%). of post-secondary expansion in the past decade.
However, it is noteworthy that the proportion of people
As the rewards for proven (or at least perceived) quality
with the full skill set fell from 22% to 15%. A similar
increase over time, we believe private post-secondary
result is seen among Brazilians in general, whether or
educators will pay more attention to quality, which
not they have completed secondary school: there is a
should also start influencing growth decisions.
decrease in the percentage of people achieving a full
set of skills, from 49% to 35%. In other words, if on the
one hand there has been a significant expansion in the Labor Market Is Not Getting What It Wants
proportion of people reaching secondary school, on the Do students get what they need? Ask that same
other hand there has been a sharp decline in the level of question to employers, education providers, and
skills that this level of schooling manages to pass on to students and you will hear fundamentally different
the majority of students. answers. According to a global survey conducted by
The effect of the decline in skills acquired in the years McKinsey Global Institute (MGI), not even half of
of K-12 education is also reflected in the post- employers believe that recent graduates are adequately
secondary level. In this group, the previously observed prepared for entry-level positions. Interestingly, over 50
trend continues: the proportion of Brazilians reaching percent new graduates agree with their employers.
post-secondary school has grown, but the group’s Education providers, meanwhile, are much more
average performance has decreased. In fact, the optimistic: 72 percent of them believe new graduates
proportion of literate people with a full skill set fell 14 are ready for employment (Exhibit 5). The results are
percentage points (from 76% to 62%) in the period quite alarming, and we find it hard to believe that there
from 2001 to 2011. will be no consequence for schools.
Brazil Education: May It Be Infinite While It Lasts 6
December 19, 2012
Exhibit 5: Perception of Graduate Readiness for the Job Market by Country
Agreement that graduates/new hires are adequately prepared, % of respondents
83 87
83
77 -38 -32 -15 72
-40 -20 70 70
67 -37
61
-36 -25 55
53 49 50 51 45
-33 43 42
40
36
31
20
Morocco Brazil UK Mexico Germany USA Turkey India S. Arabia Employer and Avg New
Provider Avg Graduates
Provider perspective Employer perspective # Difference
Source: McKinsey Global Institute
A closer look at how employers regard specific skills of 2. Employers note a clear gap between what they need
new graduates is also very informative. MGI interviewed and what they get: evaluation of new hires’ competency
nearly three thousand employers and one thousand in each skill is notably lower than the importance they
education providers in nine different countries and asked assign to each.
them to assess the importance of 12 individual skills and 3. There is a wide gap between the perspectives of
to evaluate the general competency of their new hires in employers and education providers on the competence
each one of those skills. Their responses, summarized of new hires, particularly in theoretical and hands-on
in Exhibit 6, highlight a few interesting takeaways: training, problem solving, and computer literacy.
1. Compared with education providers, employers are 4. The gap between the perspectives of competence in
much clearer in their ranking of the relative importance Brazil is one of the highest among the nine countries
of various skills (education providers give similar weights analyzed.
across the board).
Exhibit 6: Employers and Providers Do Not Agree on Competence Level of New Graduates
Rating of importance and competence of skills, %
Importance Employer rating of Provider rating of Perception gap for
competence and importance competence and importance competence levels Difference betweenemployer
Competence and provider competence
40 55 rating: country average
English proficiency 53 73 -15
Leadership 45 58 57 67 -12 UK 1
Basic math 49 60 59 71 -10
Germany 0
Theoretical training 50 69 -19
in discipline 63 73 Saudi
-8
Computer literacy 53 69 -16 Arabia
63 81
Creativity 50 63 62 72 -12 -11 Turkey
Written 49 63
communications 64 81 -14 -11 India
Problem solving 46 66 63 79 -17
-12 USA
Hands-on training 54 69
and discipline 69 79 -15
Oral communication 55 65 -10 -14 Morocco
73 81
Local language 65 73 73 77 -8 Brasil
-26
Teamwork 65 79 69 81 -4
-38 Mexico
Work Ethic 65 80 70 83 -5
-12
Source: McKinsey Global Institute
Brazil Education: May It Be Infinite While It Lasts 7December 19, 2012
Exhibit 7: Priorities of Education Providers
Rating from 1 (lowest) to 10 (highest)
Public Public open Private not Private for
Educational provider priorities rank
selective access for profit Profit
Attracting students 3 2 3 1 Clear focus
on top line
Generating sufficient revenues 9 8 6 2 momentum
Maintaining a relevant up-to-date curriculum 2 1 1 3
Attracting and retaining faculty/instructors 1 3 2 4
Helping students/graduates find employment 7 6 5 5
Increasing graduation and completion rates 5 4 4 6 Lack of focus
on student
Partnering with other education institutions 6 7 8 7 employability
Developing partnerships with companies 4 5 7 8
Low of focus
Reducing costs/increasing cost-effectiveness 10 9 9 9 on cost control
Supporting research 7 10 10 10
Source: McKinsey Global Institute
Going forward, a tighter labor market should encourage learning models to an ideal mix of the two. Current literature
employers to become more involved in the education of its actually suggests that a hybrid model of distance-learning
employees. The design of a curriculum that satisfies both and on-site classes supports student learning more
educators and employers is doable but will require more effectively than any other format. Web-based courses do a
intensive collaboration between them. Courses will not better job in giving students access to information, helping
necessarily fall under the “higher education” umbrella but will students master the subject matter, and in addressing a
be equally valuable to employers (and to employees). It is variety of learning styles. On the other hand, traditional
definitely a win-win partnership for both sides, and larger courses do a better job in strengthening group problem-
education players, in our view, are best positioned. All they solving and communication skills.
need to do is to approach employers and widen their target
market definition. Hybrid courses appear to provide the best of both worlds
and can help education companies (and the government) to
Emergence of a Hybrid Model lower operating costs. Prejudice regarding this channel is
likely to fade away as grades achieved by students prove to
Once the necessary skills are identified and agreed upon, be equal or even higher than those of students in traditional
the next challenge is for students to learn them. As the labor programs. Certification for both programs is the same, and
market should remain very tight in the years ahead, we employability should not differ. The “problem” for education
expect a growing share of students to keep studying and companies will be to offset the negative implications of
working simultaneously. The amount of hours that this lower average tuition with a higher number of enrollments.
implies is not reasonable, particularly in large metropolitan
areas where a significant amount of time is spent
The Need for Alternative Sources of Financing
commuting. The need to develop more flexible learning
formats is crucial for this public, and employers and In 2010, the government announced its new National
providers will need to solve this puzzle. Education Plan (PNE) and introduced the new structure of
FIES, triggering hopes for a strong acceleration in the
The good news is that the younger generation is addicted to growth of enrollments.
technology and considers online or distance-learning to be
as effective as traditional formats. Given that economics is We strongly support the development of financing
also a major factor limiting access to post-secondary mechanisms for student loans but do not believe FIES is the
education, upscaling distance-learning seems to be a cost- only or the final answer. In the following chapter we explore
in detail the key pillars of our skeptic view on FIES, but
effective way to provide the flexibility the labor market
Exhibit 8 illustrates our key concern: the program, as it is
needs.
structured today, will cost the government a significant
Going forward, we believe discussions will move from amount of money.
comparisons between pure traditional and pure distance-
Brazil Education: May It Be Infinite While It Lasts 8December 19, 2012
Exhibit 8: Understanding the Burden FIES Can Become for the Government
Key Premises Disbursement Schedule for Government and Students Consequences
We modeled a typical School Grace Estimated Recovery for 1 Contract of FIES
Amortization
Business Administration Years Period R$ thousand (net present value)
course, with 8 semesters
and tuition of R$500 per 20.6 4.8
month Months 0 48 66 222
15.8 5.2
FIES simulation assumes
full tuition financing, full Government 24.0 24.0 3.2
grace period (18 months) Accumulated 7.4
and amortization in 13 Disbursement
years (3x the length of (R$ ‘000)
the course + 1 year) 0.5
FIES currently offers Loan Built-in Loan Ex- Admin. Default Net Value
Student 37.4 Granted Subsidies Subsidies Expenses Costs Recovered
financing at 3.4% a.a.
(R$ nominal). For the Accumulated
NPV calculation, we Disbursement
assumed a discount (R$ ‘000) 1 Contract 500k Contracts
0 1.1
rate of 8%
Administration costs 29.4
Student 27.7
were calculated as 3%
Indebtedness
a.a. of outstanding debt (R$ ‘000) R$ 13,100 R$ 6.6bn
We assume delinquency 3.0
0
per year per year
rate of 20%
Source: MEC, INEP, FNDE, Credit Suisse Research estimates
During our meetings with market participants to prepare element in Brazil’s educational and social policy and
the exercise summarized in Exhibit 8, the premise most solving financial constraints needs to be a priority.
frequently debated was the recovery ratio, which
Supporters of government subsidy can also argue that
measures the ratio of repayments to total outlays,
loans bring two additional indirect benefits to society: 1)
including administrative and loan default costs. Our
Lifetime earnings for those with a bachelor’s degree are
premises for recovery ratios were invariably lower than
significantly higher than those with only a high school
what our audience expected, but the picture is not
diploma and higher earnings translate into higher tax
materially different from what’s observed in a number of
collections; and 2) college graduates typically impose
loans programs offered in other countries.
less cost on the government from public assistance,
Whether or not government subsidy is excessive will crime, and other sources.
depend on the main objectives that the program is
To date, student loan debt and delinquency have not
intended to serve. While we see rationale for some
posed a significant fiscal burden on taxpayers. But while
element of subsidy in most loan programs, heavy
net costs are negative by current government
government built-in subsidies cannot always be justified.
accounting standards, and small relative to total
In situations where the central objective is to promote budgetary outlays, continued increases in default rates
student independence, the key goal of the loan would could pose a more substantial burden.
be simply to reduce the financial burden on students
during school years and to delay tuition payment until What Is Left for Growth?
after graduation, when payment is easier given the
expected enhancement of earnings brought by Growth Remains One of the Key Drivers of TRS
additional education. In these cases, the level of subsidy Empirical evidence shows that companies able to
may be seen as excessive and the goal should be near- consistently outperform their sectors and the economy
full loan recovery. Also, in that scenario, government in terms of top-line momentum carry a much higher
should outsource loan program to the private initiative. likelihood of delivering above-average total return to
shareholders (TRS) compared to companies that simply
Now, where loans are aimed directly at social targeting,
focus on margin enhancement (for more details, please
sizeable built-in subsidies are often justified. As in many
refer to the “growth drivers” chapter for a more
other developing countries, Brazil has a relatively low
comprehensive discussion). The Brazilian education
enrolment of poor and disadvantaged youth in post-
sector has proven to be no exception to this standard,
secondary education. Increasing the access among
with TRS clearly associated with increased top-line
these segments of the population has become a major
momentum, be it through renewed organic growth or
transformational M&A.
Brazil Education: May It Be Infinite While It Lasts 9December 19, 2012
Exhibit 9: Share Price Performance Tracks Top-Line Momentum Strong Consolidation Favoring Large Players
Indexed at 100 in Jan/09
The post-secondary education market went through a
450 significant and unsupervised expansion in the 2000s,
KROT outperforms on increased exposure to creating excess supply in the industry. After years of
400 distance learning and large exposure to FIES
pricing pressures triggered by a highly competitive
350 AEDU outperforms on environment, the wave of M&A observed since 2008
hopes that it will drive
300 sector consolidation finally improved the conduct of players in many regions.
250 After a decade of declining tuition prices, the dynamics in
2012 appear to suggest a reversal in the deflation trend.
200
Despite the pick-up in M&A, the sector remains
150
AEDU fragmented. Consolidation in the mid-sized assets cannot
100 be discarded. There are currently 1,573 small-to-
KROT
50 medium-size institutions (December 19, 2012
suggests. We actually believe that apparel sales are
Exhibit 10: Education and Retail Highly Correlated
near peak momentum and set to decelerate gradually
1 year forward P/E multiple
over the course of 1H13, when the recent pick-up in
food inflation starts impacting consumer budgets. On 26x
the flip side, the expanding penetration of financing
provides the education sector, already more resilient 22x
Apparel*
than retail by nature, a strong tailwind for organic top-
line momentum. From that perspective, education 18x
stocks now offer a better risk-reward than apparel and
should trade at a premium. 14x
Education**
In summary, we have a high-conviction basket going 10x
long the sector in general. Despite the nuances in their
strategic visions, the three players (AEDU, ESTC, and 6x
Nov-08 Nov-09 Nov-10 Nov-11 Nov-12
KROT) have consistent discourse and we believe all * Market cap weighted average of HGTX3, AMAR3, LREN3, ARZZ3
three are long-term winners. ** Market cap weighted average of AEDU3, ESTC3 and KROT3
Source: Bloomberg
A New Approach to Clustering and Analyzing Brazil’s Social Classes
Since the most common approach in Brazil to defining class distinctions (based on household income) could limit understanding of
demographic shifts in Brazil, we have decided to segment the population into ten equally sized groups. Instead of migrating people up as
income improves, we estimated income growth in each segment and analyzed that growth in conjunction with social demographics. We
ended up with one rich class, two poor classes, and the middle class divided into seven smaller subgroups. This higher granularity allows us
to understand consumption patterns and elasticity of demand in detail, particularly among the rapidly growing middle class. (For further
details on our CS Consumer Database, please refer to our March19 report entitled “The Only Constant Is Change”.)
Exhibit 11: Summary of population groups identified
$ INCOME $$$
Decile
X IX VIII VII VI V IV III II I
Avg Family Size
(# of persons) 3.03 3.10 3.17 3.20 3.36 3.44 3.42 3.42 3.47 3.41
# of children 1.32 1.29 1.24 1.23 1.30 1.35 1.30 1.31 1.31 1.30
% of woman as
household's reference 24 25 21 19 14 14 14 12 11 9
Years of study of
household's reference 4.7 5.3 5.8 5.9 6.6 7.6 8.3 9.1 10 12
Credit Card
Penetration 0.9% 3.6% 7.3% 12% 23% 35% 53% 73% 87% 98%
Average income
(R$/month) 393 696 948 1,195 1,484 1,864 2,368 3,131 4,596 11,745
Total Annual Education
Expenses (R$ Mn) 1,107 1,970 2,689 3,392 5,516 9,969 15,663 26,180 31,248 61,647
Education Expenses Breakdown (R$ Mn)
Regular Courses 156 300 442 597 1,118 1,844 4,001 8,169 9,865 19,824
Post Secondary 105 239 398 592 1,544 3,715 5,388 8,551 9,963 18,884
Other Courses
and Activities 183 363 546 752 1,255 2,357 3,733 6,000 7,634 16,558
School Books and
Technical Magazines 96 163 212 254 270 443 600 955 1,156 2,330
School Material 480 758 905 977 913 913 847 1,003 1,057 1,642
Others 88 147 189 223 416 700 1,095 1,502 1,574 2,411
Source: IBGE, CS Consumer database
Brazil Education: May It Be Infinite While It Lasts 11December 19, 2012
Exhibit 12: Cross sector comparison of our valuation framework
Education Apparel Retail Health Care
1 Growth for listed companies should With few exceptions of formats closer We foresee a period of lower growth
remain robust over the medium-term to maturity (e.g. Arezzo), we believe in new private healthcare members
driven by: (i) organic expansion, helped the apparel retail sector continues to due to: (i) already high penetration in
by FIES and increased affordability, (ii) offer attractive growth prospects the corporate segment and (ii)
increased penetration of distance- owing to decent room for selling area increasing prices for individual plans
learning, (iii) market share gains over expansion (especially for players that driven by high medical inflation.
small/medium players and (iv) have format flexibility) combined with
Drug spending remains the positive
continued consolidation through M&A. inflation-like SSS.
Growth highlight thanks to demographic trends.
Distance learning should be a tailwind Marginal ROICs for own-operated We see pricing power – and ultimately
for returns, given the scalability of the stores remains healthy at ~25% and ROIC – being channeled to service
2 operation and existing pent-up most players benefit from a young providers, given current tight supply
demand for the service. store base. Franchise returns, and low level of investments.
however, appear to be on a negative Increasing MLRs should weigh on
Maturation, as well as high marginal
trend, especially for Hering. payer’s returns.
returns for expansion work in favor of
Drugstores should enjoy sound
campi. Decreasing drop-out ratios Decreasing financial service returns
marginal ROIC given high levels of
ROIC remains a significant upside for ROIC. may impact Renner & Marisa.
fragmentation.
Despite the recent rally, we see With few exceptions, after a good We are structurally neutral on the
significant upside in our DCF’s, momentum in 2H12, we believe the healthcare sector due to case-specific
actually the highest among the sectors Brazilian apparel retail sector is reasons. After a non-eventful set of
under our coverage. currently fairly valued, with an average 3Q12 results, our DCF’s points to no
upside to DCFs close to zero. upside in most of the cases.
3 We believe that the largest (listed)
players will benefit disproportionally Marisa remains the only stock with The pocket of upside remains in the
from sector trends, offering equity significant upside compared to our drugstore space (we carry an OP
Upside to DCF investors robust upside. valuation. rating on RADL), as well as in Dasa.
Education sector multiples have re- The apparel sector is currently trading Aside from Dasa, multiples within the
rated much in line with apparel at above-average multiples, a healthcare sector are currently above-
retailers in the past year. Going reflection of good results posted by historical average.
forward, we expect the historical key players such as Renner and
Our neutral stance towards the sector
correlation with apparel to be reduced, Marisa during 2H12.
(and payers in particular) is based on
as the market translates stronger and
With deceleration in sight in 1H13, we the fact that the likely top line
4 more sustainable growth trends of the
believe current valuation levels will not deceleration that lies ahead is not
Trading Multiples education sector into higher trading
be sustained. incorporated into valuations.
multiples.
Technical indicators currently work Aside from Hering, short interest Technical indicators appear more
against the education sector, mainly levels of apparel retailers are generally relevant to Odontoprev, which carries
driven the its stark outperformance low given indications of a strong 4Q12 a high short interest level. Qualicorp,
compared to other domestic segments and an easy comp base. on the other hand, suffers currently
in the past 12 months. from a stark outperformance YTD and
5 Upcoming triggers include 4Q12
lack of positive S-T triggers.
Upcoming stock trigger is 1Q13 results and signs of decelerating
intake cycle. trends in the first half of 2013. Dasa remains the stock with potential
Technical Indicators positive momentum.
We remain broadly 5-8% above In general terms, 2013 consensus for Except for Qualicorp, we remain on
consensus in 2013 and 2014, but the the sector appears fair, with limited average 7% below consensus for
6 Street is slowly catching up towards a room for upside due to company- 2013 and see limited scope positive
more refreshed view of latest growth specific cases. revisions.
and margin trends.
Main focus remains on potential The only stock with risk for positive
We believe that among the group, negative revisions to credit operations earnings momentum is Dasa,
AEDU offers more limited room for from Renner and Marisa. depending on the pace of its
Consensus View positive earnings revisions. turnaround effort.
Source: Credit Suisse Research
Brazil Education: May It Be Infinite While It Lasts 12December 19, 2012
Government Support
Student Loans: FIES(ta) or FIES(co)?
Not surprisingly, the new structure for the FIES fueled hopes for
a rapid reacceleration in college enrollment growth. Increasing
access to financing is definitely positive but we are not big fans
of increasing dependence on the government. The costs
associated to FIES are high and the “social return” is often
questionable. Although ST goal is narrowed to college
penetration, the trend is to combine loans with higher
commitments to quality and employability of students, which
could cap sector profitability. FIES is irrefutably a positive ST
catalyst for the sector, but we see more attractive value pools
beyond this financing scheme.
As in most developing countries, the association highlighted in Exhibit 1 in the previous chapter, the
between college attendance rates and family income in returns on education in Brazil remain very attractive.
Brazil is quite strong: while in the U.S. the poorest 40%
The issues observed in the US student loan program
of the relevant age group (18 to 24 years old) represent
obviously trigger concern about the level of debt poorer
around 20% of the student body (vs. richest 20% with
students incur to acquire their post-secondary diploma.
45% of seats), in Brazil, the poorest 40% represent
Among the concerns is that the debt burden could
only 9% of the student body, while the richest quintile
distort graduates’ post schooling decisions and affect
fill 53% of college seats.
household consumption. Rising leverage among less
The traditional explanation for this income gradient in educated citizens should always be a concern, but since
college attendance is family budget constraints. As student debt theoretically composes only a small portion
public (free of charge) universities have not kept up with of an average college graduate’s lifetime earnings,
rising demand in Brazil, unprivileged students are left these effects are not so alarming.
with private schools and, as the attendance involves
In our view, debt is the ideal mechanism for financing
heavy “investments” (including the indirect cost of
college education, as it permits a student to internalize
deferred participation in the labor market) most lower-
the full costs of his human capital investment decisions.
income students that are unable to cover the costs with
As long as the return on investments remains in the
parental income choose not to attend college.
positive territory, and most people believe it will, we see
Education is considered an important investment in no reason to think that higher levels of student debt
human capital where benefits include higher represent a market failure that warrants intervention.
compensation, increased job security and better career
opportunities. Rational human capital investors
theoretically base their educational investment decision
on the tradeoffs between the costs and benefits of
attending an additional year of education and, as
Brazil Education: May It Be Infinite While It Lasts 13December 19, 2012
Exhibit 13: Reasons for Not Attending Post-Secondary Education
Percentage of respondents agreeing with the reason
Cost/need to work Cost + Value Cost+ lack of interest Cost + capacity
Reasons
US Brazil Mexico Turkey India S. Arabia UK Marocco Germany Overall
Could not afford 48 43 24 20 18 38 35 34 17 31
No time to study due to work 16 25 29 21 10 16 18 21 19 20
Not interested in more education 11 4 5 15 16 41 24 27 7 15
Did not think it would add value 13 10 8 21 21 22 13 11 7 13
No program for interests 11 16 10 13 7 15 12 8 12 12
Insufficient capacity 5 12 8 11 14 8 9 6 25 11
No offerings in area 12 5 14 9 8 17 10 10 12 11
Not accepted to program of choice 6 3 10 11 14 26 10 5 10 10
Salary won't change 7 5 6 20 5 10 10 0 10 8
Family did not allow 7 3 5 11 14 13 8 4 7 7
Can get employment otherwise 6 2 6 8 5 10 9 2 7 6
Source: McKinsey Global Institute
The points raised above are fair, as long as we assume As explored in the introductory chapter, quality of primary
students are reaching their college years prepared to and secondary education in Brazil’s public system is
succeed in their post-secondary studies. deplorable. An alarming share of students does not
complete their secondary studies, or conclude it without
Exhibit 14: Highest Growth Jobs in the US the very basic language and mathematical skills, which
compromise their learning during college. Returns from
New jobs
Occupation added
Growth Entry-Level human capital investments are often questionable and it
(%) Education Required
(x1000) may be optimal for some poor individuals not to attend
Registered Nurses 711,9 26 Associate's degree college, even if they could borrow to finance higher
Retail Salespersons 706,8 17 Less than high school education.
Home Health Aides 706,3 69 Less than high school Besides, a number of job positions do not require
Personal Care Aides 607,0 70 Less than high school college degree. Exhibit 14 ranks the 20 job positions
Office Clerks, General 489,5 17 High school diploma that are expected to grow the most in the US until
2020. Interestingly, only 4 require college or a higher
Food Preparation and Serving Workers 398,0 15 Less than high school
degree. For 10, not even a high school diploma is
Customer Service Reps 338,4 15 High school diploma
theoretically needed. We could not find a similar analysis
Tractor-Trailer-Truck Drivers 330,1 21 High school diploma for Brazil, but we do not believe the conclusion would be
Freight, Stock and Material Movers 319,1 15 Less than high school materially different.
Postsecondary Teachers 305,7 17 Doctoral degree
For those individuals, technical courses would be more
Nursing Aides and Attendants 302,0 20 Postsecondary award appropriate and the government is incentivizing this
Childcare Workers 262,0 20 High school diploma market with the “FIES Tecnico” (a student loan program
Accounting and Auditing 259,0 14 High school diploma companies can access to finance their employees’
Cashiers 250,2 7 Less than high school
technical education). Independently of financing, this
market should increase significantly and should impact
Elementary School Teachers 248,8 17 Bachelor's degree
the addressable market for college degrees. There is
Receptionists 248,5 24 High school diploma still a lot of prejudice on technical courses, as
Janitors and Cleaners 246,4 11 Less than high school highlighted in the previous chapter, but corporations
Groundskeeping Workers 240,8 21 Less than high school could change this perception quickly, simply by valuing
Sales Reps 223,4 16 High school diploma its new hires for what the knowledge the bring instead
of the diploma they carry.
Construction Laborers 212,4 21 Less than high school
Source: US Labor Bureau
Brazil Education: May It Be Infinite While It Lasts 14December 19, 2012
Should the Government Get Involved? Why not, for instance, have FIES restricted to students
who do not earn 2x the value of their tuitions? Again, we
If markets operated well, one should expect that the
have no ambition to move into political discussions but
outcome based on the human capital model is an
as strong believers in the value of education, we would
optimal equilibrium solution, and there is no need for
rather see FIES smaller, but sustainable, than as an
government intervention. Students and banks would
ambitious but short-lived program.
take into account the present value of future earning
streams and conclude, in most cases, that it far
surpasses the investments in education to be financed. Can FIES Act as a Sustainable Revolving Fund?
There are, however, several potential market Government-sponsored student loans programs are in
imperfections in higher education that may lead to place in some 70 countries and regions around the world
inefficient outcomes: with clear differences in the structure of the loan scheme.
1. Banks do not accept the students’ prospective human Schemes differ not only in the underlying objectives
capital as collateral: banks cannot sell the human capital in pursued, but also in such parameters as organizational
case of insolvency. In addition, banks have imperfect structure, sources of funding, student coverage, allocation
knowledge about the students’ efforts to complete the procedures and collection methods. However, one element
program and their academic ability to do so. that is common to almost all government-sponsored
programs: they are highly subsidized. Unlike commercial
2. Adverse selection drives up risk premium: students loans, a sizeable portion of the total loans outlay is not
who are more likely not to be able to repay their debt received back in repayment. This gap between
would be more interested in applying for a student loan. disbursements and loans recovery is driven by two
Banks therefore charge a risk premium, which elements, detailed below: 1) built-in interest rate subsidies,
discourages high ability students, as it entails that they and 2) inefficiencies in the scheme administration.
are cross-subsidizing the low ability students.
3. Investments in education are risky: graduates could Defining And Estimating Loans Recovery
end up unemployed, structural shifts in the economy The financial stability of any loan program depends on the
could reduce the worth of the acquired human capital extent to which loans are recovered by the lending entity.
and there is considerable variation in the returns to Despite the alleged high returns on education investments,
schooling between individuals. a number of factors limit the full recovery of loans.
In situations where banks are not willing to provide First, lending conditions in government-sponsored loans
student loans, the government has to intervene in order schemes are typically softer than those on regular
to ensure that needy students can collect the funds to commercial loans, including below-market interest rates,
invest in their education. We do not believe, however, grace periods (during and after study completion) and
that governments should monopolize student financing. repayments that are rarely linked to inflation. The
The returns on education are high and potential combined effect of these built-in subsidies is amplified
financing agents understand it. What they lack is clarity where amortization periods are long, and they often are.
on the boundaries of their addressable market. Private A commonly used metric to analyze subsidies is the loan
players will unlikely reach the bottom of the pyramid, repayment ratio, which is defined as the ratio of required
which is where FIES should focus. Middle class repayments to the loan size received, both measured in
students, however, should be left for those more terms of present values. The repayment ratio, however,
experienced in the field, in our view. fails to show the extent of recovery to the loans fund.
Ideal Invest (one of the first private players in student Even if student loans were not subsidized, not all loaned
financing), for instance, finances students earning a sums would be recovered by the loan provider. The
minimum of 2x the value of the tuition to be financed. extent of shortfall depends on the level of administrative
Credit approval takes into account not only the student’s efficiency under which the loan program is run and the
collaterals, but also the likelihood of that student to level of loan default ratios observed among
succeed in the study area chosen and in the labor beneficiaries.
markets afterwards (based on a complex set of The recovery ratio is measured by the ratio of total
algorithms updated continuously as their client base repayments to total outlays, including administrative and
expands). Ideal Invest absorbs default risks, pay taxes loan default costs. In some cases, it also includes an
and has grown at healthy rates. Many others like them, additional element, which is the possibility of canceling
including Brazil’s large private banks, could increase individual repayment obligations for such including
their presence in this market if they were not facing disability, student academic performance and the
competition from the government.
Brazil Education: May It Be Infinite While It Lasts 15December 19, 2012
encouragement of graduates to enter skills-shortage
Exhibit 15: We Estimate FIES Recovery of 36%
occupations or public services.
Indexed, 100 = Loan granted
Less-than-complete repayment ratios are typically
23
explained by the five elements described below. The
first three are typically combined under one single driver, 25
“built-in subsidies”, given the difficulties to decompose
losses quantitatively among them. Exhibit 15 15
100
summarizes our estimates for the expected recovery 36
ratio for FIES, which we believe is generally neglected in
sector discussions. It is just an estimate, but highlight
the importance of keeping this potential loss in mind
Loan Built-in Administration Loan Loans
when discussion potential penetration of FIES. Granted Subsidy Costs Defaut Recovered
Elements
Factors limiting full recovery of student loans:
Source: FIES simulation, Credit Suisse Estimates
1. Interest Rate: the interest rate subsidy on loans is
arguably the most important factor accounting for lower Given low recovery ratio in almost all student loan
repayment ratios. Levels of subsidy differ across programs (and very heavy losses in many cases),
programs but they are usually driven by the same government subsidy should remain a continuing feature of
factors: low (or zero) interest payment during the length student loan schemes across the world. The widely held
of study, grace periods and zero (or negative) real view that student loans programs can act as revolving
interest rates. Interest rate charged on FIES is 3.4%, or funds, financing themselves through repayments from
385 bp below the Selic rate. earlier loans, is therefore a myth. Governments around
the world will need to keep injecting funds annually to
2. Repayment Periods: the loan repayment length and cover the losses from non-repayment leakages.
grace periods obviously impact repayment ratios. Ceteris
paribus, the longer is the designated repayment period, the Whether or not loan schemes should be subsidized
greater is the hidden grant to students. FIES grants 18 obviously depends on the main objectives that the loans
months of grace period after graduation and a repayment scheme is intended to serve. When targeted specifically
period of up to 4x the length of the course studied. at disadvantaged groups of students, programs
(particularly those substantially subsidized) can lead to
3. Rate of Inflation: the ongoing rate of inflation is an greater access of the poor to university education, thus
important driver of repayment ratio. As interest rates on contributing to social equity. However, in cases where the
student loans rarely reflect real rates of interest, they intended effect of student loans is to reduce the financial
end up pressuring repayment ratios downwards. burden during study and to delay tuition payment until
Nominal interest rate charged at FIES, 3.4%, does not after graduation, when payment is made easier by the
even cover current inflation levels. higher earnings that additional education brings to
4. Administration Costs: administrative costs include students, the level of built-in subsidies seem often
initial registration and processing costs, maintenance, and excessive and the goal should be to reach near-full loan
collection costs. Tracking mobile students can be extremely recovery. In that case, it might also be better to outsource
difficult, which raises administration costs further. Where loan administration to experts in the field.
loans schemes cover relatively few students and where the
average loan size is small, administration costs per head Results So Far Are Disappointing
are proportionally higher. We do not have data on FIES Unfortunately, very little has been written about the
administration costs but based on loan programs abroad, impacts and efficiencies of the government’s main
we estimate it in the range of 2 to 3%. programs for the education sector: the University for All
5. Loan Default: Repayment default is often regarded Program (ProUni) and the Fund for Post-Secondary
as the major factor for low loans recovery. Experience Student Loans (FIES). The best assessment we could
abroad suggests that this is not necessarily the case. find was an audit report prepared by the Brazilian
Built-in subsidies are considerably more important than General Accounting Office (TCU) in 2009, whose main
repayment default in many of the programs analyzed. objectives were: 1) to evaluate if the two programs were
The default rate observed in the “old” FIES reached fulfilling their objectives; and 2) to analyze if control
~20% during its last years. For the exercise illustrated mechanisms in place were sufficient to regulate the
in Exhibit 15, we considered 20%, although we believe reach of the programs.
it could be higher.
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