Gaba tries to break free of English teaching's gangster reputation

English-teaching school Gaba is to IPO on Mothers on Dec 1. The company will be offering 14,200 shares at 265,000 yen, giving the company a market cap of 11.39 billion yen. The company in its current form was created in June 1994 through a management buy-out. It expects to record sales of 7.75 billion yen and net profit of 808 million yen through December this year, quite a turn-around from 2005, which saw sales of 5.52 billion yen and net profit of minus 2.87 billion yen, thus resulting in a notional PER of -3.7.

Actually, with such negative numbers last year, I am surprised that Gaba didn't wait an extra year to go public, so that the PER would look normal. But I presume that with the extent of the turnaround, management expects that shareholders will look forward for similar results in coming years, rather than looking at what is in the past.Given the current downwards trend in stock market IPOs, as well as removal of shareholder tax breaks, maybe they're right in taking the risk. This could well be their best chance to do a reasonably priced IPO for some time to come.

Anyway, while the Gaba folks are no doubt excited about the prospect of being able to tap public funds, I believe that it will be difficult for the company to maintain a decent stock price going forward. The reason for this is less a reflection of Gaba, although the school comes in for plenty of criticism from the English teacher fraternity for its low salaries, and more due to the problematic nature of the English teaching sector in Japan in general. While I won't name names, several of the biggest schools in the nation are rumored to be on the verge of bankruptcy, and for one school in particular, the losses are so great, one wonders how it stays afloat.

You would think that the English teaching business, known as "Eikaiwa," in Japan would be good. The Nikkei says that the industry is worth about 700 billion yen a year, of which 280 billion yen, or 40%, represents English language schools for adults. Students are obviously paying high rates and the top four companies operate 1,500 branches between them. Nova for example has 600+ schools, GEOS has 500+, and Aeon and ECC about 500 together. No one seems to know just how many adult learners of English there really are in Japan, but it's safe to say it is a lot. The numbers indicate somewhere about 2 million-3 million people at any one time, with the average student paying out about 100,000 yen a year in fees.

Unfortunately, the industry has acquired an almost yakuza reputation over the last few years, due to the heavy-handed sales tactics used by some schools. There are numerous stories in the media and Internet about people on the street being accosted by "catch sales" people, who pressure their prospects to sign up for lessons then accompany them down to the nearest ATM to make the first payment. This has resulted in some recent high profile consumer protection court cases against even major companies who in the past have been reluctant to give refunds.

Catch sales is a financially productive technique for those schools which are good at it and I was told by an insider that one well-known operator has just four schools and 200 (not a typo) sales people! Needless to say, they do well commercially and will no doubt be interested in the results of Gaba's IPO. The same person also told me that another large school is most likely connected to a large consumer finance firm and so while it loses money each year, the value of the student loans allows the finance firm to keep the school afloat. The average student loan is apparently large enough to take several years to pay off.

It isn't just the students that are getting stiffed either. English teaching is now considered by most foreigners in Japan as a low-paying temporary job and an industry which doesn't mind hiring unqualified workers. The schools may deny it, but anonymously English teachers claim to be getting as little as 1,400 yen for a 40-minute class (actually these were ex-Gaba teachers) and with a complex scheduling system, new teachers are unlikely to make much more than 250,000 yen per month. Further, since 40-minute classes mean that teachers are not working a full week, they are classified as part-timers, thus freeing the schools (not just Gaba) of the usual social insurance and other obligations that workers in other sectors enjoy as a matter of course.

It seems that the spread between 8,000 yen/lesson (factoring in text books and other costs) charged to students and 1,400 yen/lesson paid to teachers would result in a pretty good profit margin for the schools. So one wonders why they find it difficult to make money. In fact, Gaba has proven that you can do it, so I can only assume that either mismanagement or inability to respond to changing competition and demographics are the real reasons for poor results in other firms.

Indeed, the insider says that he thinks lack of IT and business efficiency, mainly due to the old fashioned autocratic management, are the major contributing factors. As an example, he mentions that despite the usually juicy profits of a catch sales organization, one such autocratically run school, Nippon NCB, the nation's 10th largest English school at the time, went bankrupt in January of this year.

Perhaps it is a bit much to blame just the schools for the woes of the English teaching sector in Japan. Clearly the education system has a part to play. The simple fact is that many Japanese kids learn early to hate English. In middle and high schools around the nation, the hardest exam is English. The curriculum focuses on rote learning of what essentially is not a logical language, and the rigidity of the system thus offers little of the incentive that most foreign language learners gain when opening what should be a magical door to other cultures and worlds.

In addition to the education hurdles, Japanese kids and their parents seem to have gotten soft about their desire to use English as a tool to get ahead. According to a report by Deutsche Bank published in September this year, just 1.5% of Japanese university students go on to study abroad, extremely low by international standards. In South Korea, the number is more like 12% and in fact South Korea, despite having only 1/3 of the population of Japan, spends about triple the amount on English education for its kids than the Japanese do.

Against this background, Gaba is probably doing about as well as is necessary for a young firm trying to muscle its way into a mature or even declining industry. By using IT and unpopular but effective hard-nosed cost cutting, they have found a way to produce a net profit that approaches 10% — about what is typical for a service industry business in Japan.

The only other way I could see another firm do as well or better than this would be to discover some way of making subliminal learning work — or to use the business as a front for some more lucrative downstream business, such as loan sharking or high-pressure sales of other services. In any case, if Gaba's IPO goes well, I'm sure that we will be seeing a lot more "eikaiwa" IPOs (one of the big four is rumored to have one in the works) coming out over the next couple of years.

Terrie Lloyd writes a weekly newsletter for entrepreneurs and business people about business and political opportunities in Japan. You can find the newsletter at www.terrie.com. For further contact with Terrie, email him at terrie.lloyd@daijob.com.