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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-andmortar 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 : Asset Beta: 1.o0 35%

Risk free rate 8.33% Market risk premium: Cost of equity 8.50 %

16.83%

Long-term growth rate 4.0% Fees 2.s% 16.83 23%

Venture CA rate w/o fees Venture CA rate with fee

Quantitative valuation
2010 IBT Less Taxes Net Income Dep & Amort. Less Capital EXP FREE Cash flow Terminal value FCf +ter 36.55 56.04 84.63 109.29 56.39 19.74 36.65 0 0.00 2011E 86.22 30.18 56.04 0 0.00 2012E 130.20 45.57 84.63 0 0. 2013E 168.14 58.85 109.29 0 0.00 2014E 217.645 76.17 141.47 0 0.00 Termnal 226.34 79.22 147.12 0 0.00

36.65

56.o4

84,63

109.29

141.47 778.57 920.03

147.12

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
Investmen t ZenCap Blackgem 44 150 X12 vs. X16 Ownership 10% 25% Pre- Money Postmoney 396Crores 450 440 crores 600

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