There is little doubt that China’s record $1.7 billion invested in 44 edtech companies last year is helping to provide one of the world’s most dynamic education market with increased access quality learning and spurring a movement toward social impact investing. But in the competitive scramble for gaining market share at high cost and rapid speed—not to mention the rush for early investors to cash out—there are seeds of potential failure. In fact, many Chinese online education companies are already folding with only an estimated five percent of such firms earning a profit in 2015, despite an overall online market that exceeded $20 billion in sales. (All monetary figures in this piece are in US dollars.)
The latest test of public scrutiny is 51Talk, an online English language platform that uses teachers in the Philippines to conduct synchronous one-on-one classes with Chinese students through an Uber-inspired “shared economy” model. 51Talk recently filed for a small but high profile $45 million initial public offering in the U.S. (under its parent company China Online Education Group). But it is already facing “six suspicions” in a Chinese-language article at Whale Media. What’s so suspect? Its claim to be the “largest online education company in China” by using an unsourced research report as well as its own hand-picked measures for what is considered “largest”; its creative use of “gross billings” that reflect up-front cash paid by students without revealing average student retention levels in its courses; its accumulated losses ($50.5 million in 2015, $15.4 million in Q1 2016) based on heavy student acquisition costs as well as deferment of employee costs; and issues surrounding tax compliance, social welfare obligations and other financial issues.
Time, of course, will unravel this tangle of issues. Yet it’s worth noting that Chinese education companies have their own unique historical context. Here are a few points to remember.
China’s Early Market Entrants
First, China’s education market demographics, dating back to the turn of this century, will never be repeated, as primary enrollments are now declining. But between 2000 and 2012, the country saw a massive expansion in student enrollment; the number of K-12 students jumped from 233 million to 251 million, and higher-ed students increased from five million to more than 24 million.
This sudden growth created unprecedented demand for tutoring services, international student pathways, higher education and English language study. This meant that China’s early entrants benefited from substantial unmet demand, peak K-12 populations, a shortage of university seats, and mass urban affordability for items such as educational games, private schools, study-abroad programs, and the services that support them.
Second, despite this growth, China’s consumer education market remains remarkably difficult to quantify. Consider that the recognized education giant of China, New Oriental, claims a large share of TOEFL and related overseas test preparation, but only one to two percent market share in China’s aggregate after-school tutoring market. Now try to figure out the other 98 percent of addressable consumers supplied by over 75,000 firms in the English language segment alone, not to mention other after-school tutoring competitors.
The result is that China’s ill-defined, but super-sized market plays havoc on investor expectations. Several high-flying Chinese companies listed in the US have been severely cut down to size. Take, for example, Ambow Education which was whacked with questions over financial and governance issues; ChinaCast, the first satellite-based online education company, which was crippled by executive corruption allegations; ChinaEdu, an online higher education service provider, which pulled its moribund public listing in the US via merger after years of sluggish growth on top of its anemic size and a tightly regulated customer base; and one-time investor darling Beijing Jadebird, a joint venture between India’s Aptech and Peking University, which after many years has faded quietly into the woodwork.
This leads to the third point: companies that consolidated their market share and shrewdly utilized financial resources were able to emerge dominant in China by also extending their brands to new education segments. New Oriental’s launch of its popular online platform, Koolearn, extended its learning center network into online tutoring. TAL’s move into early-stage edtech investing seeks to leverage synergies with U.S. higher education companies such as Minerva and Knewton. NetDragonWebsoft’s pivot from multi-level gaming to learning games culminated in its offshore acquisition of diversified global K-12 education provider, Promethean. As a result, early investors in these companies enjoyed smart returns since their IPOs, as Figure 1 indicates. But they are outliers.
In Search of China’s Next Unicorn
Fourth, unlike the past decade, today’s new crop of existing and aspiring Chinese Unicorns (see Figure 2) emerge from a startup scene that is soaked with education-focused venture capital. There is good reason: China’s thriving consumer-facing learning market is now richer as well as more mobile, tech-savvy, and globally obsessed than ever before, ushering in new opportunities in areas such as English language tutoring, international credentialing, virtual reality, and learning-based games. This has led nearly all of China’s leading internet companies (including Alibaba and Tencent) to invest in direct-to-consumer edtech startups and subsidiaries (along with leaders from India, South Africa and Europe), as covered here on Educelerate.
I have previously argued that Asia is emerging as the world’s edtech laboratory with China at its center. And that companies that can harness the right technology, deliver consistent quality to China’s consumer-facing education sector, and maintain sustainable levels of returns to both investors and students, will be the world’s next education leaders.
But with high expectations comes the fall. Relatively few Chinese education companies have proven that they can handle the added investor and regulatory scrutiny that comes with being a public company, particularly in the US. This time around, at least we have history as a guide.