Chinese edtech firms’ $7.8b fundraising frenzy masks some hard truths on profitability

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China’s edtech sector, one of the biggest beneficiaries of the coronavirus-induced tech adoption, attracted several billions of dollars from bullish investors in 2020. These investments, though, are not risk-free as the edtech firms’ path to profitability still remains sketchy, given the top dollars they have to spend on customer acquisition, and user retention.

Edtech emerged as one of China’s most well-funded industries by private equity (PE) and venture capital (VC) investors in 2020. According to proprietary data compiled by DealStreetAsia Research &Analytics, there were at least 52 PE-VC transactions totaling about $7.8 billion in the Chinese edtech sector last year.

The biggest fundraiser, Yuanfudao, which operates live tutoring platforms and online homework services, garnered $3.2 billion across three funding rounds. Its last Series G1, G2 investments in October gave it a valuation of $15.5 billion and made it the world’s most valuable edtech decacorn — a company with a valuation of over $10 billion.

Zuoyebang, another K12 edtech giant in China, secured an aggregate of $2.35 billion across Series E and E+ rounds last year. The firm’s $1.6-billion-plus Series E+ round in December reportedly valued it at $10 billion.

Besides Yuanfudao and Zuoyebang, Huohua Siwei, also known as Spark EdTech, also completed more than one investment.

These edtech fundraisers, together with their PE-VC investors, are vying for a share of China’s burgeoning edtech market where the user base is projected to reach 446 million in 2021, according to a Chinese research firm iiMedia Research. The user base is poised to more than triple in five years, compared with 104 million in 2016.

Losses widen as costs increase

The dealmaking frenzy in the Chinese edtech sector, though, obscures some hard truths.

The fundraising comes amid increasingly fierce competition, with customer acquisition costs (CAC), and expenditures on marketing, and user retention hitting the roof.

A 2020 industry report from Chinese education specialist New Oriental indicates that the average CAC for online education institutions in the country stood at 3,000 yuan ($464.5). That’s more than triple that of offline players — 500-1,000 yuan. The CAC was the highest for one-on-one e-learning services — 5,000-15,000 yuan.

“Even with CAC being this high, we do not think competitors will step down any time soon given that the window for user acquisition may be limited. We believe the high CAC is a result of limited differentiation at the current stage,” Alex Liu, director & education analyst at brokerage firm China Renaissance Securities (HK), wrote in an email to DealStreetAsia.

“I expect competition to remain fierce in the next one to two years, but perhaps will ease in a three- to five-year horizon,” said Liu.

While unlisted companies are not obligated to disclose financial details, their publicly-traded counterparts have provided some degree of benchmark to comprehend the staggering marketing costs of the sector.

As US-listed GSX Techedu, an afterschool tutoring platform increased marketing costs six-fold in the third quarter of 2020 from a year earlier, the firm posted a 933-million-yuan loss, down from a small profit in the year-ago period.

Youdou, a US-listed online education subsidiary of internet firm NetEase, spent 1.15 billion yuan in marketing costs in the third quarter — four times larger than that in the same period of 2019. In the meantime, it generated a loss of 878 million yuan, widening by 242 million-yuan year-on-year.

The books of other US-listed Chinese edtech companies are no better. In the same quarter, Xueersi, the edtech unit of New York-listed Chinese after-school tutoring firm TAL Education, recorded its smallest quarterly revenue expansion. New Oriental, which also operates an edtech branch, saw its loss grow over 10 times to 758 million yuan.

The trend of splurging on marketing — ads on giant outdoor billboards, discounts, roping in new customers — means any chance of a profit is remote.

“The profitability roadmap [for edtechs] is still very unclear, but it’s unlikely that investors will allow such a low profitability period to linger much longer,” Liu wrote.

Massive market drives investor appetite

At least for now, PE-VC investors do not seem to be overly worried about how fast their Chinese edtech portfolios are burning through capital for a larger market share.

Some believe that China, the world’s biggest education market, could eventually accommodate a handful of major edtech players, each holding a market cap of $10-20 billion.

Jenney Lee, managing partner at global VC firm GGV Capital, said at the company’s recent Podcast Evolving for the Next Billion that edtech is not a “winner takes all” race because of the market’s different age groups, various study requirements, curriculums, and delivery formats, among other things.

“In each of these potential [edtech] categories, there could be leaders. I think the sector can sustain and hold several $10-20 billion market cap companies,” said Lee.

GGV, a backer of Chinese edtech firms Zuoyebang and Huohua Siwei, also has edtech portfolios across the US, Indonesia, and India.

Investors are generous, seeing how China maintained its lead in the development of innovative technologies to power traditional education. Statistics from global education intelligence platform HolonIQ shows that China accounted for over 60% of all PE-VC investments in education businesses around the world in 2020, followed by the United States at 15%, India at 14%, and Europe at 5%.

Eight out of the world’s 19 edtech unicorns, or private companies with a valuation of over $1 billion, are headquartered in China as of January 3, 2021, according to HolonIQ’s List of Global Edtech Unicorns. Collectively, global edtech unicorns have gathered more than $13.7 billion in financing over the last decade and are now valued at $64 billion in total.

This kind of patient capital has propelled Chinese edtech companies to reach a stunning level of valuations in recent months. At $10 billion in late December 2020, Zuoyebang saw its valuation jump over 53.8% in roughly six months compared to the previous valuation of $6.5 billion in late June.

Huohua Siwei, also known as Spark EdTech, just closed the third tranche of a Series E round one week earlier to hit a reported valuation of $1.5 billion, only six months after it achieved unicorn status with the completion of the round’s first tranche last August.

Their arch-rival Yuanfudao, backed by Tencent and Hillhouse Capital, almost doubled its valuation in less than seven months, from $7.8 million in March 2020 to$15.5 billion in October.

Space for tech-savvy latecomers

Also bolstering investor confidence in edtech companies is that they can leverage artificial intelligence (AI), machine learning, virtual reality (VR), and other advanced technologies.

These strengths, said GGV’s Lee, are part of an edtech company’s “early competitive moat” that gives them an edge to overtake traditionally offline-focused education brands.

“Among the companies that we have seen, the ones that have actually worked very well are [led by] cross-vertical CEOs,” said Lee, referring to Zuoyebang, which was part of Chinese search engine Baidu before its spin-off in 2015; and Huohua Siwei’s founder and CEO Mark Luo Jian, who previously served as CTO of classified advertising website Ganji.com.

Faith in China’s edtech future is strengthened with bets made by the market’s most active PE-VC investors, including Asia-focused Hillhouse Capital and its VC unit GL Ventures, IDG Capital, Sequoia Capital China, and smartphone maker Xiaomi’s co-founder Lei Jun-backed Shunwei Capital.

Besides that, a sizeable chunk of the capital inflows into the sector last year came from Tencent.

The Chinese gaming and social networking giant topped the investor list with participation in at least six edtech deals. Its newly added edtech portfolios include Yuanfudao and Huohua Siwei, as well as edtech Software-as-a-Service (SaaS) provider Empower Education Online (EEO), online art education platform Meishubao, and Golden Education, which focuses on financial courses.

With Tencent’s ubiquitous messaging app WeChat and QQ, these strategic investments are expected to help these emerging firms gain more traffic, reduce marketing costs, and make it easier for them to find a way to profitability.

Expand Table

Investment companyNo. of dealsTotal value of participated dealsLeadNon-lead
Tencent6$3,605 million42
Hillhouse Capital & GL Ventures5$3,743 million23
IDG Capital3$3,350 million03
Sequoia Capital China3$2,500 million03
Shunwei Capital3$46.7 million12

“We are in the second innings of edtech. It’s not like the first inning where we had a whiteboard, and we were trying to figure out which model works … I would say that all the different dimensions of how to get into the edtech market is pretty much laid out on the board,” said Lee.

Essentially, the sector is still very “numbers-driven,” said Lee. “The right thing to do is actually to think about all things on the first day, and to have a three-year, five-year, or even 10-year horizon to build up the entire go-to-market roadmap.”

While the investors still see the glass as half full, for the startups, the journey to profitability is a long road ahead.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.