Surya Tutoring

Qualitative Valuation
What was Suryas business concept?
How big was the market?
From Suryas point of view, what were the advantages of each
fund?
Were customers ready to purchase Suryas product?
What competition was Surya facing? Could it pre-empt future
entry?
Was it the right time to invest?
How long would it take for the product to be ready for
market?
 What were the major uncertainties? How could they be
addressed?
Could Suryas management team implement the opportunity?
Was the strategy consistent with the opportunity, uncertainty,
team, and exit strategy?
How much money did Surya need? Was it stageable?
How significant to a private equity deal was the weak
enforceability of contracts in India?
Why did ZenCap demand only one board seat of Five?
 Objectives
Identify the difference between the U.S and
India with respect to deal sourcing,
negotiation, and financial contracting.

Value a growth equity transaction in an

emerging economy, including financial,
contractual, and qualitative (social networks,
local knowledge, trust) aspects of the deal.
 Brief Summary of the major points of the
case (Synopsis)
Case Synopsis:
 Synopsis of the case
The case focuses on two major challenges in deal making in emerging market
economies (i) deal sourcing and (ii) negotiating in Private equity deal in India
In 2010 Surya Tutoring was a fast growing tutoring academy for High School
students aspiring to gain admission to the prestigious IIT.
Suryas CEO, R.K.Sharma, wanted to expand its reach beyond Kota (a city of 1
million people in the northern state of Rajasthan), which had become the
center of the IIT prep school industry and home to tens of thousands of
students studying for the rigorous IIT entrance examination.
Sharma knew there was vast untapped potential in teeming Indian
Metropolises of Mumbai, Chennai, Delhi and Bangalore, as well as in foreign
markets such as Dubai and Australia.
Sharma had received term sheets from two private equity firms willing to
finance Suryas expansion. By the end of the month he needed to decide
which to accept: the offer from big bulge bracket fund Blackgem, or the one
from ZenCap, a small Indian firm based in Mumbai, with which he had become
intimately familiar during the past year.
 Potential Business Opportunity

What is your view of Surya as a potential

business opportunity for a generic equity
investor? Justify your view with reason.
 Evaluation of Surya for Investment

Describe the business idea of Surya, market, value

proposition, customer acceptance, competition, timing,
uncertainties, management team, strategy, investment, deal
structure, and exit strategy.
 Business Idea
One of Indias leading test-prep schools
More than 22,000 studying annually to prepare for IIT entrance
exam.
About 1600 / 1700 Surya students secure admission in IITs with
10000 open seats.
At the time the case was written, there were only two listed
education companies on the Indian stock Exchanges (Exhibit 4)
However, many investors wanted to invest in education stocks
What is the education environment in India
What can we say about willingness of Indian Parents to pay large
sums to enroll their children in tutoring classes to increase their
odds of qualifying to enter prestigious public schools
 Market

Serves a market with excellent potential.

Engineering education is very highly regarded in India
India produces about 700000 Engineering graduates annually
and growing rapidly
Many parents wanted their children to study engineering IIT,
one of the best schools in the nation and also well known
internationally
Indian parents would make major sacrifices to ensure an
outstanding education for their children. Example, the Taxi
driver of Nisith Verma, who spends 80% of his monthly salary
for his sons tutoring
 Market (Cont.)

More than 500,000 students sat for the IIT entrance exam
every year to compete for 10,000 seats
Future demand for IIT enrollment (therefore tutoring services)
looked to remain strong because available seats in
engineering and other disciplines at the top schools had not
grown as fast as the population and the literacy rate, making
entrance to undergraduate schools much more competitive.
Demographics were also in Suryas favor: more than 30% of
Indias 2010 population was under 14 years of age, and rapidly
growing Indian middle class saw education as an aspirational
good.
 Value Proposition
Suryas value proposition was based on its high success rate- every
year its students claimed more than 15 % of the open seats at IIT
Key to this success was recruiting and retaining good faculty who
were also IIT grads.
This success rate was measurable, which was beneficial in attracting
teachers and students.
But it faced at least 2 risks in maintaining its advantage: first ,
increased competition could make it more difficult to place as many
Surya students at IIT, and second, expanding Surya would decrease
the percentage of its students who gained entrance even if the
academys overall placement numbers stayed constant
 Value Proposition (Cont.)
It generated enough cash not only to sustain itself but also to
continue to grow at its current pace.
To achieve higher growth, however, it would need more
money for capital investments that would enable it to open
centers and schools across the country and beyond.
It received to financing offers, one from ZenCap and the other
Blackgem
ZenCap, in addition to cash, offered connection that would
help expand the business, one idea was partnering with
technology companies (connected to ZenCap) to conduct
remote classes using video conferencing facilities around
India.
 Value Proposition (Cont.)

On the other hand, being connected with an international

firm Blackgem, could be an advantage, to Surya with regards
to its plans to open international centers such as Sri Lsanka,
Dubai
 Customer Acceptance

Surya had a strong record of success in its first eleven years,

which had established its name and credibility. In education
industry, an organization that does well early on can rely on its
brand for a long time.
 Current and future competition

Surya (market leader in a fragmented industry) was already

facing competition from private schools and online firms
Barrier to entry was low for future competitors little capital
was required to set-up new schools, and students had a
tendency to follow star teachers. Suryas brand and reputation
would some protection against future and current
competitors, but it faced the risk of teacher defection.
 Timing

In general, investors in entrepreneurial finance want to make

sure that the timing to launch the business will generate
returns compatible with the life of the fund. This was a moot
question in the case of Surya, which had a strong record of
sales, a proven product, and four years of cash flow positive
operation.
 Timing (Cont.)

Question: With only two listed education companies on the

Indian stock exchanges, if was the right time for a private
equity fund to invest in education firm.

However, investors believed in the Indian consumption story

and wanted to invest in education and healthcare because
these sectors were poised for growth. The timing was
promising also because the Indian Government was focused
on the education sector and was trying to open it for
international investment
 Uncertainties
Recruiting and retaining skilled teachers, especially as it was considering
expansion to other cities has become a major challenge for Surya
The other risk closely related to the previous one was the risk that it
would not be able to maintain its high success rate in student admission to
IIT.
A common risk for cash-based businesses in emerging markets is related
to poor record keeping. This is a significant drawback for a private equity
fund seeking to acquire small business : the fund may not be able to
efficiently monitor revenues especially if it has a minority share and does
not have easy access to information. Employee theft is a related problem.
An investor can mitigate that risk by installing a new chief financial officer,
but building trust will be important in any case. On that score ZenCap has
advantage over Blackgem.
 Management Team

The Founder Mr. Sharma, appears to be capable of running

the company, but a strong CFO was needed to manage growth
and improve company record-keeping.
The company had a total of 280 professors, 70 of whom were
graduates of IIT.
Sharma had not shared much equity with the rest of the team
He is willing to create a separate shareholder pool of equity to
be given to faculty and senior management> ZenCaps term
sheet provided for offering equity to faculty; Blackgemdid not.
 Strategy
Suryas strategy - grow physical presence in Kota, and it had
been successful.
However, when Sharma saw what his competitors were doing
he was motivated to increase Suryas presence across India
and in select International markets by opening bricks-and-
mortar centers and conducting classes using teleconferencing
or remote video.
Sharma did not need capital to continue with his current
strategy, nor was he looking for a buyout; his reason for
seeking additional capital was to respond to moves his
competitors were making. The motivation gave him
negotiation power with both private equity firms.
 Investment

Proposed investment smaller than typical for private equity

firms.
The company generates enough cash flow to sustain its
growth at the current pace, but to achieve higher growth it
needed to deploy more money in the form of capital for
opening centers and schools across the country, or seek
technology to enable lower-cost solutions.
Surya needed managerial and business development help to
expand its business and respond to its competitors
 Deal Structure

Both proposals were for minority deals, that left the founder
with majority share in the company
In the U.S., The private equity deals, the Private Equity fund /
investor typically acquires cash flow majority rights.
Most private equity deals in India / Emerging economies are
for minority stakes. First due to poor legal enforcement,
incentives are very difficult to provide with alternative
contractual agreements.
 Exit
Surya was already a leader in its industry, but there are also significant
growth opportunities.
Education in India was expected to consolidate at some point and Surya
was nicely positioned it could be both a target and an acquirer of
education companies. The company had also achieved some scale, so an
IPO was a possibility, especially with the lack of education deals available
in the market.
Question: Will an IPO appeal to Sharma? On one hand, there could be
some ego appeal to running a publicly listed company, but he clearly
wants to maintain control of Surya.
This objective can be achieved easily and especially in emerging markets
where publicly listed firms often have a controlling shareholder, generally
with a minority share.
 Quantitative Valuation
Based on the Pro forma financial provided in the case and certain
assumptions, please, perform a valuation of the company based on
DCF analysis.
Assumptions:
Marginal tax rate : 35%
Asset Beta: 1.o0
Risk free rate 8.33%
Market risk premium: 8.50 %
Cost of equity 16.83%
Long-term growth rate 4.0%
Fees 2.s%
Venture CA rate w/o fees 16.83
Venture CA rate with fee 23%
 Quantitative valuation
2010 2011E 2012E 2013E 2014E Termnal

IBT 56.39 86.22 130.20 168.14 217.645 226.34

Less Taxes 19.74 30.18 45.57 58.85 76.17 79.22

Net Income 36.65 56.04 84.63 109.29 141.47 147.12

Dep & 0 0 0 0 0 0
Amort.
Less Capital 0.00 0.00 0. 0.00 0.00 0.00
EXP
FREE Cash 36.65 56.o4 84,63 109.29 141.47 147.12
flow
Terminal 778.57
value
FCf +ter 36.55 56.04 84.63 109.29 920.03

DCF 489
 Valuation

Pro forma numbers are pre-money.

Enterprise value is a pre-money valuation.
Calculate the difference between this valuation and the
valuation implied in the term sheet for the two offers.
The terminal rate of return for the funds is much lower than
deals seen in the U.S.
 Offer comparison
Investment Ownership Pre- Money Post-money
ZenCap 44 10% 396Crores 440 crores

Blackgem 150 25% 450 600

X12 vs. X16

 tradeoffs

What other benefits were offered by the prospective

investor?

ZenCap: Local deal offered by a private equity firm that

understands the nuances of the Indian market.
Blackgem: A boiler plate deal from a reputable international
firm that may lack understanding of the cultural and legal
differences between India and the Western world.

There are two major differences between they way the equity
deals are done in India and in the U.S.
 Two Major themes

1) Difference in the way deals are sourced and negotiated in

emerging markets (India) and Western developed markets
(U.S.A) and most parts of Europe.

2) Tradeoff in choosing a private equity partner from two very

different companies with different combinations of financial,
strategic, reputational and local market capabilities.
 Deal Sourcing & negotiation
The main difference in the deal sourcing and negotiations of
ZenCap was its personal and cultural nature. Verma learned
about Surya in a very indirect way through his personal
network (over dinner, from his brother). He then used his
cultural and local community ties in Kota to begin building a
relationship with Sharma.
Despite the fact that sharma said he was not looking for
financing, Verma continued to leverage his Kota business and
family connections to provide advice and stay in touch with
him. When the opportunity to submit offer arose, ZenCap had
already built both a solid relationship and a deep
understanding of the business.
 One advantage that ZenCap offered was its local knowledge of
the Indian Market in general and the IIT education tutoring
business in particular.
ZenCap also had a record of helping small, local businesses
tap into other major markets in India, which was a good fit
with Sharmas expansion plans. Verma and founder of ZenCap
were from the same town and shared the same sub-cast as
sharma, so they were able to connect with him on a more
personal level. In addition, their business and family ties in
the area could help Sharma expand Suryas reach and
influence.
 ZenCap was quite different from Blackgem, the bulge bracket
firm. Blackgem was based in Mumbai, which was at least a ten
hour journey from Kota. The distant location was one obstacle
that kept Smith, the Blackgem partner, from visiting Kota or
any of Suryas school locations. Blackgem had a general
weakness in local market knowledge, but it offered better
brand recognition, a higher valuation and the opportunity to
satisfy Sharmas ambition to expand Suryas reach not only
throughout India but also abroad in Europe and other parts of
Asia.
Term Sheet