|Shares Out. (in M):||40||P/E||19||0|
|Market Cap (in $M):||336||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||22||0|
Internationella Engelska Skolan, aka IES, is the largest independent operator of free schools in Sweden. 20%-owned and still operated by its visionary founder Barbara Bergstrom, IES has leveraged its differentiated culture to achieve higher quality education, generating a strong brand which translates into student demand, great unit economics and large room for growth. Because of high fixed costs and burdensome regulation the business of operating schools is tough. Very tough. I think the market not pricing IES as it deserves as a result.
The summary of the thesis is…
- With very few exceptions school education is tuition-free in Sweden, meaning that the decision driver for parents and students to pick a school is based on quality rather than price
- Unlike preschool and upper secondary school, middle-school – grades 4 to 9 – is compulsory in Sweden. Incidentally 32 of the 34 IES’s schools operate in the middle school segment
- The number of students enrolling in preschool and middle school have each increased at 2% CAGR since 2011 whereas enrollment in the upper secondary school has shrunk by 3% annually
- The middle school education providers are either municipal or independent schools, with 85% and 15% respective share. Independent schools are steadily taking share from munis capitalizing on better incentives to operate sustainably
- Barriers to entry to set and run school have increased amid an increasing regulatory burden
- The independent school arena is very fragmented and prone to consolidation itself, with ~90% subscale players operating just one school
- IES’s brand recognition and efficiency have positioned the company as the largest independent operator by far 15% share amongst independents. IES will continue to steadily take share
- Despite optically not cheap IES is just selling for 10x true earnings adjusting for the fact that more than 1/5th of its schools are still immature
- In addition to the growth in Sweden IES adds the optionality of further growth in Spain
- IES benefits from a unique educational culture that yields better quality and academic results
-The company has its founder and significant owner at the helm
Brief intro to education in Sweden
Until 1992 the providers of compulsory free education have traditionally been government schools either at the municipal or at the state level (Sami schools) to a lesser extent, most of them lacking the right incentives to run operations without demanding further government support. So in order to introduce competition the government implemented a school voucher reform – a state-funded, private alternative to the public system, where entrepreneurs can set up independent schools and receive government funding based on the number of students enrolled.
The two graphs below are self-explanatory and bring up the following facts. (1) The total number of students in compulsory schools shrank in the 2000s decade and then recovered from 2010 up till now, (2) The number of students enrolled in independent schools has grown every single year regardless whether the total student population has grown or not, and (3) Independent schools have remarkably taken share since the 1992 reform, moving from less than 2% to 15% share. I was just able to get official data up to 2016, but for the purpose the graphs do the work.
Interestingly the voucher system follows an equal-treatment policy under which the reimbursement amount per student is the same no matter whether the receiver is a municipal or independent school. Truly speaking there are some complementary items for students with special needs and other subsidies for things like extra activities or homework support and reimbursement rates widely vary depending on the school location – as an example the annual reimbursement per student can vary as much as ~90,000 Kr for a school based in a large city to more than 110,000 kr for a school based in a sparsely populated municipality. But you get the main point. No voucher discrimination between the state-owned and the independent schools.
So the government essentially sets the reimbursement rates per location at the beginning of every academic year. As the regulated voucher amounts per student basically eliminate the discretionary decision to exploit pricing power, it leaves independent operators the choice to grow earnings over time by attracting more students per school, opening new schools and /or becoming more efficient. Interestingly IES operates three of the ten largest compulsory schools and nine of the ten largest amongst the independent ones, has significantly more students per school vs. peers, opens more schools than competitors and is certainly more efficient.
Given the government sets the rates per student that each school receives, how have these rates evolved over time? Leaving aside location differences amongst schools the Swedish National Agency for Education shows the average reimbursement per student in compulsory schools has compounded at ~4% CAGR since 1992, well above Sweden’s inflation rate. For IES the average voucher per student currently sits at ~95,600Kr per annum, slightly below the national average (~97,000Kr) as a direct result of IES’s schools geographical mix.
On the cost side costs per student now sit above the voucher contribution and although total costs per student have “only” grown between 3-4% per annum since the 1992 amendment as opposed to the 4% annual growth in voucher, quite a few schools still face deficits – mostly muni schools but also some independents. Unsustainable deficits in some cases, which rhymes well with the story I just exposed of tens of muni schools going out of business over the last years. On the other hand, IES’s cost base is structurally lower than those of its independent counterparts for several reasons I will later describe. This is its recipe to be profitable and steadily take share.
Even briefer description of IES history and business model
Following the pass of the Independent School Reform in 1992 - whose main practical implication is the equal-treatment voucher-system – Barbara Bergstrom and a teaching colleague founded IES in 1993. In 1998 Barbara and her partner separated ways with Barbara remaining as the principal of the only school IES operated back then. A US-citizen who moved to Sweden and worked as a science teacher in a muni school, Barbara opened the first IES school when she saw the shortcomings of the muni schools in terms of quality of education and student grades. The graph below shows IES’s evolution in terms o number schools under management.