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One K-12 Investment Banker's Prognosis: Five Reasons to Prepare for Generation Z!

Trace A. Urdan is a Managing Director of the investment banking firm Signal Hill.

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1. Buyouts alive and well in Pre-K

The private buyout market is moribund at the moment, not because asset prices are high, or because the private equity firms lack capital, but primarily because the basic business model of using debt to finance purchases (and then pay that debt down through cash generated by the business) is hamstrung by the frozen credit markets.
Yet notably, even in this environment, two large (by sector standards) deals have emerged in the Pre-K market: Bain Capital’s $1.3 billion buyout of Bright Horizons (NASDAQ: BFAM; Hold), and more recently, Morgan Stanley’s purchase of a controlling interest (60%) in ABC Learning’s U.S. business for $775 million. In our view, both of these transactions are examples of situations in which the short-term horizon of the public equity market is being exploited to advantage by the longer-term horizons of private equity firms.

2. Pre-K Market Has Softened

Enthusiasm for childcare stocks has waned over the past two years in what has been a low-growth phase in the market. Though the number of working-parent families and children in childcare fluctuates with the economy, the principal driver is the total population of children under five. The large childcare chains, including Bright Horizons, developed as the boomers’ children (Gen Y) entered the childcare market between 1978 and 1993. As those tots were replaced by the children of Gen X (such a small group they don’t even have their own letter!), the size of the market contracted. During this period larger chains consolidated and in order to grow, Bright Horizons had to both buy up smaller childcare chains, as well as expand into ancillary markets such as charter school management, for-profit K-8 schools, elder care, and most recently, college counseling.

3. Boomer Grandchildren are Here

We believe that the children of Generation Y (or perhaps more clearly the Boomers’ grandkids), should fuel the next phase of growth for the childcare market. The front end of Gen Y turned 30 in 2003 (average child-bearing age is 25, but we believe the core market of working women skews older) and the number of 30 year-olds from Gen Y does not peak until 2017. At the same time, the number of Boomers 62 or older has already begun to accelerate and peaks a mere four years later in 2021, representing what should be a point of peak crisis in the U.S. workforce. Technology and immigration will undoubtedly address some of the challenges faced by retiring Boomers, but we believe that the pressure on corporations to retain women in the workforce will be enormous, fueling demand for child care.

4. Emerging Opportunities

The timing and amount of consolidation in the childcare market is, we think, no accident. These businesses are being purchased at or close to their demographic nadir by some very smart investors, including Michael Milken’s Knowledge Universe in addition to Bain and Morgan Stanley, who recognize, we think, the steady and ever-increasing demand that is in store for high-quality childcare over the next 10-15 years. This is a time horizon that works for private money and not so well for public investment dollars. But while the mainstream market is focused on how to leverage aging baby boomers, this related boomlet is left, we think, relatively under-appreciated.

The implications for entrepreneurs and investors in the K-12 market are twofold. Firstly, the end of the echo boom tail in the process of exiting the K-12 market. The effects of this development have already been strongly felt in certain parts of the country such as the Northeast and Midwest, but ultimately should be a national phenomenon – offset only in part by Hispanic immigration in the West and Southwest. This inevitable demographic trend will most likely continue to drive consolidation among businesses marketing products and services to schools. At the same time of course, we are heading into a period of extended accelerating growth in the population of young children – and specifically young children with two working parents where the principal opportunity will likely be a consumer one.

5. A Consumerist Future

Speaking anecdotally, for unfortunately little hard survey data exists to describe the consumer education market, the movement of Boomer Children (Generation Y) through their K-12 years has inspired the advent of consumer involvement in education. Beginning perhaps with branded childcare choices in the 1980’s and extending into educational software, tutoring, test prep, and college counseling, parents have grown increasingly willing and accustomed to supplementing their child’s education out of their own pocket. Sylvan Learning has expanded the size of its average sale in recent years, in fact, by encouraging parents even to borrow money to fund their child’s tutoring from Sallie Mae much the same way they might borrow to fund a college education.

Bottom Line

The poor perception of the state of public education notwithstanding, we think the combination of more children (given the demographics) and more working parents (given the demands created by retiring boomers), combined with the public spending pressures created by more retirees, and a thinner wage-earning tax base to support public education spending on a per student basis, is likely to add up in general to even more pronounced consumerism in the education marketplace in the years to come.


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