The Education Industry: 2018 September 2018 Jeffrey M. Silber Henry Sou Chien, CFA Business Services, Industrial Services and Education Analyst Senior Associate BMO Capital Markets Corp. BMO Capital Markets Corp. (212) 885-4063 (212) 885-4138 [email protected] [email protected] Refer to Appendix pages for Important Disclosures, including Analyst’s Certification. For Important Disclosures on the stocks discussed in this report, please go to http://equityresearch.bmogc.net/Member/company_disclosure.aspx. 05:00 ET~ Table of Contents Table of Contents .............................................................................................................................................. 1 Key Investment Considerations ........................................................................................................................ 3 Education Industry Overview ............................................................................................................................ 5 Size of the Education Industry ...................................................................................................................... 5 Investments and M&A Activity in the Education Industry ........................................................................... 7 Impact of Economic Cycles ......................................................................................................................... 12 Regulatory Overview .................................................................................................................................. 13 Education Industry Growth Drivers ............................................................................................................. 13 Risks ................................................................................................................................................................ 14 Early Child Care: A Small but Steady Market.................................................................................................. 16 U.S. Early Child Care Market Overview ....................................................................................................... 16 Growth Drivers ............................................................................................................................................ 19 Largest Childcare Providers ........................................................................................................................ 24 Merger and Acquisition Activity ................................................................................................................. 26 Risks ............................................................................................................................................................ 27 K-12 Education: Largest Opportunity, Though Risks Abound ........................................................................ 29 U.S. K-12 Market Overview ........................................................................................................................ 29 U.S. K-12 Schools Market ............................................................................................................................ 30 U.S. K-12 Instructional Materials Market.................................................................................................... 46 U.S. K-12 Testing and Assessment Market ................................................................................................ 54 U.S. Tutoring and Test Preparation Market ................................................................................................ 57 U.S. K-12 Technology Market ..................................................................................................................... 57 U.S. Professional Development Market ..................................................................................................... 63 Postsecondary Education: Tough Near Term, but Solid Long Term ............................................................... 67 U.S. Postsecondary Market Overview ........................................................................................................ 67 U.S. Postsecondary Schools Market ............................................................................................................ 68 U.S. For-Profit Postsecondary Schools – Enrollment Trends ...................................................................... 77 U.S. For-Profit Postsecondary Schools – Revenue Trends .......................................................................... 90 Military and Veterans Markets ................................................................................................................. 109 U.S. For-Profit Postsecondary Schools – Other Operating Factors ........................................................... 120 U.S. Postsecondary Schools—Legal and Regulatory Issues ..................................................................... 129 Key Rule Changes From the Obama Administration ............................................................................... 140 U.S. Online Postsecondary School Market ................................................................................................ 157 Characteristics of Superior For-Profit Postsecondary Schools .................................................................. 166 Postsecondary Schools: Valuation Trends ................................................................................................ 168 Study Abroad Programs ............................................................................................................................ 177 U.S. Postsecondary Instructional Materials Market ................................................................................. 183 U.S. Postsecondary Technology Market ................................................................................................... 192 U.S. Postsecondary Marketing and Recruiting ......................................................................................... 197 Corporate Training: Moving to Software-Driven Model ............................................................................... 202 U.S. Corporate Training Market Overview ................................................................................................ 202 Content Type ............................................................................................................................................. 205 Content Delivery Channels ....................................................................................................................... 208 Training Technology Providers ................................................................................................................. 209 EDUCATION AND TRAINING | Page 1 EDUCATION AND TRAINING | Page 2 Key Investment Considerations The U.S. private sector education market should see growth accelerate. This $122 billion industry— serving the childcare, K-12, postsecondary, and corporate training segments—is a small component (roughly 8.1%) of the estimated $1.5 trillion to be spent on education in the U.S. in 2018. However, we believe private sector education has had a major impact on how traditional providers operate (e.g., greater acceptance of online education). Although annual growth slowed earlier this decade—owing to economic and regulatory issues, among others—we believe growth rates are starting to recover, though not to mid- to high-single-digit rates seen in the sector’s heyday last decade. We project U.S. private sector education revenues will increase at a 2.7% compound annual growth rate (CAGR) over the next five years, reaching roughly $139 billion in 2023, and generating about 8.4% market share. We believe the industry has many underlying growth drivers. We are still bullish on the long-term prospects for all the subsectors within the education industry. We believe private sector education could gain positive momentum from factors such as increased recognition of the benefits of early childhood education, the growing importance of accountability and education reform, rising awareness of the advantage of more education for one’s lifetime earnings potential, and the expansion of addressable markets through technology (i.e., online learning). However, we caution investors that the sector does have some regulatory and related pressures even for those not directly serving government clients. Contrary to prior popular belief, the economy does matter. In our view, the past two downturns have shown us that the acyclical theory of education may have been incorrect. Anecdotal evidence shows some companies cut back somewhat on expanding their worksite childcare offerings, as recruiting and retention perks became less of a priority in a downturn. State and local budget pressures forced severe education funding cuts, limiting what had been growth for those serving K-12 public schools. Conversely, these same limitations halted some advances by not-for-profit postsecondary institutions (e.g., online expansion) and made them weaker competitors just when demand for programs—which tend to be countercyclical—increased. We note, however, the not-for-profit sector has regained much of the “share” lost in the Great Recession. Revenue for corporate training providers declined because, in many cases, this training was considered a discretionary expense. As the economic expansion