In a recent meeting with IDP Education (IEL), we explored the opportunity for management to unlock significant value in the IELTS (International English Language Testing System) business.
IEL background. IEL has been operating for over 30 years and is a global leader in international education services. IEL also part owns IELTS, the world’s most popular high-stakes English language test.
IETLS. IETLS is the world’s leading high stakes English test, tests which are taken for life changing events ( e.g. university admission or government work visas). There are only a few large players in this market globally, given the high barriers to entry to operating such testing operations, which include:
(1) require an extensive globe distribution network given at home testing or remote testing is not allowed for security reasons (note - despite the push back, remote testing may be introduced down the track which also improve the economics for IELTS)
(2) academic integrity backing the tests, which must be globally relevant, culturally agnostic and provides consistent assessment; and
(3) the tests need to be recognised among universities, governments, and other stakeholders).
Industry growth. The industry is driven by long-term structural trends – international university enrolments in English speaking countries and work migration for governments. IELTS holds approximately 60% of the market share, with the remaining market consisting of non-for-profit operated TOEFL (Test of English as a Foreign Language) (#2 player globally), Pearson and British Council.
IETLS ownership. The intellectual property (test questions, exams etc.) is jointly owned by Cambridge University, British Council and IDP Education. British Council and IDP Education are the exclusive distributors of the test (set the price, sell, administer, and distribute) around the world and generate profits. Cambridge’s role is to prepare the test (content, questions, test integrity etc.) for which it earns a royalty fee per test.
British Council (BC) vs. IDP Education. BC is a charitable organisation which is part of the British government and funded by the government. BC has established activities in over 100 countries and is effectively mandated to spread the English language, society, and culture aspects. IETLS has become the largest commercial revenue generator for BC, which funds BC’s other activities (pay for charitable and non-commercial activities and reducing the need for government funding).
Despite the joint ownership of IETLS, at the day to day operating level, BC and IDP Education are competitors - effectively compete in all the global markets and sell the same exact product. This makes BC IDP Education’s largest competitor.
Pricing is largely stable in the industry and therefore market share / volumes are driven by tactical strategies such as location of the test centres (convenience / close to schools or universities) and having strong referral partners (prep schools, language schools). Generally, the markets where IDP Education competes directly with BC, IDP tends to have the higher market share (~50% on the product), with market share slowly increasing over the years.
What if the BC and IDP Education IELTS operations consolidated? Whilst the current operating model has worked well over the past 30 years, going forward it may be time to consider a more optimal single distributor model and optimise returns. Synergies opportunity are extensive given they sell the exact same product – distribution structures can be consolidated, one contact for referral agents, one set of trained examiners for the spoken component and general overhead costs. Therefore, there is a strong strategic rationale for restructuring the distribution arrangements. This does represent a meaningful medium-term opportunity.
It will require some restructuring and given it involves dealing with a quasi-government agency which can be very slow or hard to move on such significant matters (especially given IETLS provides significant revenue for the BC). However, the lock-downs due to COVID-19 (potential of a second global wave), budget pressure on the UK government (potential funding cuts to quasi-government agencies?) and internal financial pressures may be the motivation required for the BC to act. In our view, this is a glaringly obvious opportunity for all parties to come out of the COVID-19 in a stronger position.
Based on our discussions, we have attempted to quantify the benefits from this potential consolidation. We present the potential uplift in revenue and gross profit over a 10-year period (your typical DCF model timeframe) in the chart below. Suffice to say there is a significant opportunity to lift earnings (more than 30%) based on our estimates. Key assumptions: (1) minimum impact at the volume line, however we expect ongoing market share growth given improved relationship with referral partners due to size; (2) pricing improves by 100bps on our original estimates (which was between 2.5 to 3.0% p.a.); (3) significant uplift in margins from sites consolidation (especially BC’s less inferior sites), more volume pushed through existing centres and increasing use of technology (e.g. remote testing).
Source: Banyantree, Company
Very strong balance sheet and liquidity position. Coming into COVID-19, the Company had approx. $20m in net cash on the balance sheet and operating cost structure of approx. $21m per month. Recently the Company raised approx. $260m in new equity and secured a $175m working capital debt facility. The Company has also reduced its operating cost structure down to approx. $16m per month. This provides the Company with significant liquidity to trade through current disruption and potential second wave, in our view. This also puts the Company at a competitive advantage in terms of access to capital and could accelerate market share gains.
Global conditions are challenging for IDP Education at the moment, but there are opportunities available to the Company to unlock value and it has the balance sheet capacity to ride out the current downturn.
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