Every parent wants a better future for their child and most are willing to make sacrifices to achieve this, but the reality in South Africa is that very few can afford to do so. With our consistently poor scoring in global benchmarking studies, it is no secret that the South African government school system is largely in tatters.
Curro is currently South Africa’s largest independent schooling operator offering a range of options for parents seeking feasible alternatives to public schooling. We discuss why we are positive about Curro’s prospects and believe its share is deeply undervalued.
Ready, aim, fire!
Curro is an entrepreneurial success story that began when a group of schoolteachers started offering classes in a local church hall. They went on to scrape together enough funding (including their personal life savings) to build the first Curro school campus in Durbanville, in the northern suburbs of Cape Town. Believing that they were onto a good thing, they secured a long-term capital partner in PSG, the Stellenbosch investment company.
Curro listed on the JSE in 2011, with a fantastical vision of building 80 schools for 80 000 students by 2020. Six rights issues later, raising R4.6 billion in new equity capital, Curro begins this decade with 76 schools and 63 000 learners.
Curro offers a range of schools to meet different income levels. The original business model was centred around a school for mid-to-upper income families, with average fees of R4 500 per month. Today, there are 38 500 students attending this type of school, compared to 10 000 learners in 2011.
More recently, increased learner numbers has largely come from a lower-fee model called Curro Academy. Fees at these schools range between R1 900 to R2 900 per month. The lower fees are achieved by having slightly larger classes, fewer academic options in higher grades and less ancillary facilities.
The collective matric pass rate at the Curro Academies is high, at 92.4% in 2019, compared to the national average of 81.3%. The success of this model is opening up a large new market of growth for Curro and there are now 13 of these Academies across the country.
The business of schools
Owning a school is capital intensive and a considerable amount of money is invested before there are any learners sitting behind desks. Thereafter, it costs the same to run a classroom with one child in it, as it does with 20.
The Curro school business model is planned around a “J-curve”, which shows the progression of schools through time. The business approximately covers its costs, including teachers and overheads, once it has 20 learners per class – regarded to be the breakeven point. Learner number 21 begins to generate a surplus to pay the capital providers, lenders and shareholders. Ideally, classes will reach 30 learners. If a school is able, it may add another class to that grade, however, it is then back in the position where it has two unprofitable classes of just 15 learners until it can attract another 10 learners to the grade, and so on.
As the school grows, more capital is spent on employing additional teachers, improving technology, or upgrading facilities. It is regarded reasonable to fund schools with a sizeable amount of debt to reduce the overall cost of funding. In recent years, Curro has relied more on debt than shareholder equity to fund its growth, which has led to higher interest payments that have been a drag on profit growth. Nevertheless, Curro initiated a dividend in 2018 – an indication of its maturing business model.
A slippery slope
We would be naïve to suggest that private schooling is not a discretionary household expenditure item – many South African families do not even have the means to keep their children in a government school. After years with little to no household income growth, mounting job losses, run-away electricity tariffs and municipal rates, and uncertainty about the future, households are particularly stretched.
Evidently, at the margin, this is not a positive environment for Curro’s revenues and any declines are magnified in profit declines as fixed costs must still be covered. In order for Curro to grow the number of learners at a school, it must first replace the child whose family has chosen to emigrate or drop out. This is made all the more difficult if the departing learner was in grade 10, which is not a common entry point for learners into a new school. Or, in the case of a family experiencing financial difficulties and if the learner is a good student, it may be prudent to offer the family a discount on fees as the incremental cost of a learner is low. Any additional fee revenue is positive, providing other families continue paying their fees in full.
The weak economy has resulted in a slower than expected growth rate in learner numbers at Curro schools. We believe these factors may continue to dampen growth, but there are clear indications that a reasonable level of increased learner numbers is somewhat assured over the next few years.
Learner numbers at key entry grades, one and eight, paint an encouraging future picture. The chart below shows that learner numbers in these grades are higher than subsequent grades. Grade eight enrolmentments, in particular, have increased significantly. If this trend continues and Curro can retain the majority of its students in these grades, the knock-on effect continues as successive years retain larger classes.
Historical performance provides a clear indication that profitability improves as average class sizes increase. As indicated below, the average number of learners increases predicatably as the school ages. Profitability consistently improves as the school grows.
Opportunity in a downward spiral
Because of the weak environment, now is a good time to buy schools. An organisation the size of Curro, with committed shareholders, access to capital and a valuable school management platform, is relatively well placed to weather the effects of weaker income growth and a stagnant economy.
However, this differs for ‘solo’ schools in the current environment, where single campus schools are not able to pool resources or streamline costs across campuses. Furthermore, management structures migrate with the cohorts of learners through the school, as parents invest in the school when their children are in attendance, but typically stop when their children leave the school. Consequently, there is seldom a long-term orientation in solo schools. In addition, if schools run into financial difficulty, this may result in the quality of education slipping, which in turn makes parents anxious. Students then leave, and the school finds itself in a negative spiral.
Curro has found an opportunity here, acquiring a number of established schools for less than what it would cost to build a new school and carry it to a break-even point. Curro then invests in facilities and staff, causing school confidence to improve and learners to remain and even return – all indications that are supportive of healthy returns on investment.
A digital future for schools
Falling prices for devices such as iPads and laptops are supporting a global trend towards digitally-enabled learning. This ranges from distance schooling for all grades, to digitally-enabled classrooms. The spectrum of impact that the internet and digital content is having on schools, is vast. There are many models across the world that are being trialed and, while we don’t know what will work best for South Africa, it is clear that the classroom of the future is very likely to look quite different to today.
Curro’s financial scale and breadth of operations are a strength when it comes to innovation. Launched in 2019, its DigiEd model provides learning through online tools and videos at lower cost than its traditional schools. It builds on content from its best teachers and subject matter experts across its schools. The DigiEd model is specifically designed to be an on-site learning model that maintains the social development of learners. Longer operating hours also ensure that children are safe and kept busy on campus during office hours for working parents. The model has been very successful to date and three new campuses will launch in 2020 with strong enrolments.
Patience will be rewarded
Curro’s overall shareholder returns are not particularly impressive at present. Investing in a host of new schools, including buying seven in the last year, has caused debt to increase faster than its operating profit. This has left investors negative, with the share price at a multi-year low.
To mitigate concerns, management have scaled back on investment plans, choosing to expand only into existing schools to accommodate the learner growth that is already ‘programmed’. It will also invest in recently acquired schools, spending money where learner growth is practically assured or where assets have been acquired inexpensively.
Given how schools are designed, it is no surprise that the current returns are low. Viewed as if it were one large school, Curro is currently operating at 70% capacity, which for a class of 30 learners, is 21 pupils. With the average age of a Curro developed school being 6.5 years, in school parlance this means that Curro is still in primary school. Therefore, it is simply too early to expect returns to be peaking.
Unless a better operator of independent schools steps into the picture (unlikely in our view) or learners are lost to emigration or unaffordability, today’s grade one Curro learner will be approaching matric in a decade’s time. Consequently, Curro classes will be fuller, its economics will be significantly better and shareholders with a long-term orientation will be richly rewarded for taking advantage of todays depressed share price.