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With technology evolving rapidly in education, investors are taking a closer look at how it will financially impact the global education market. Stephen Byrd and Josh Baer discuss.----- Transcript -----Stephen Byrd: Welcome to Thoughts on the Market. I'm Stephen Byrd, Morgan Stanley's Global Head of Sustainability Research. Josh Baer: And I'm Josh Baer from the U.S. Software Team. Stephen Byrd: On the special episode of the podcast will discuss the global education market. It's Friday, May 12th at 10 a.m. in New York. Stephen Byrd: Education is one of the most fragmented sectors globally, and right now it's in the midst of significant tech disruption and transformation. Add to this, a number of dynamically shifting regulatory and policy regimes and you have a complex set up. I wanted to sit down with my colleague Josh to delve into the intersection of the EdTech and the sustainability side of this multi-layered story. Stephen Byrd: So, Josh, let's start by giving a snapshot of global education technology, particularly in this post-COVID and rather uncertain macro context we're dealing with. What are some of the biggest challenges and key debates that you're following? Josh Baer: Thanks, Stephen. One way that I think about the different EdTech players in the market is through the markets that they serve. So in the context of education, that means early learning, K-12, higher ed, corporate skilling and lifelong learning. The key debates here come down to what it usually comes down to for equities, growth and margins. So on the growth side, there's several conversations that we're constantly having with investors. Some business models are exposed to academic enrollments as a driver. To what extent would a weaker macro with higher unemployment lead to stronger enrollments given their historical countercyclical trends? And enrollments have been pressured as current or potential students were attracted to the job market. And on the margin side, some of the companies that we follow in the EdTech space, they're the ones that were experiencing very rapid growth during COVID and investment mode to really capture that opportunity. And so investors debate the unit economics of some of these business models and really the trajectory of margins and free cash flow looking ahead. One other more topical debate, the impact of generative A.I. on education, and maybe we'll hit on that topic later. Josh Baer: Stephen, why do these debates matter from the point of view of ESG, environmental, social and governance perspective? Why should investors view global education through a sustainability lens? Stephen Byrd: Yeah Josh I'd say among sustainability focused investors, typically the number one topic that comes up within the education sector is inequality. So higher education is a key pillar of economic development, but social and economic problems can arise from limited access. Unequal access to education can perpetuate all forms of socioeconomic inequality. It can limit social mobility, and it can also exacerbate health and income disparities among demographic groups. It can also restrict the potential talent pool and diversity of backgrounds and ideas in different academic fields, leading to all kinds of negative economic implications for both growth and innovation. While progress has been made in increasing enrollment among underrepresented students, significant disparities remain in admission and graduation rates. For investors and public equities, I think one of the more useful tools in our note is a proprietary framework that measures sustainability impact. Now that tool is really primarily rooted in the United Nations Sustainable Development goal number four, which lays out targets in education. This framework is rooted in the premise that I mentioned earlier. The COVID-19 pandemic has exacerbated multiple challenges in education. So when we think about business models that we really like, we're focused on models that can improve the quality of student learning, enhance institutions' operations and increase access and affordability. And we think our stocks that we selected really do meet those objectives quite well. Stephen Byrd: Josh, what is the current size of the EdTech and education services markets and why invest now? Josh Baer: First, on the size of the market, we see global education spend of 6 trillion today going to 8 trillion in 2030. So that's a CAGR below the growth of GDP, but we do see faster growth in EdTech. So there's really compelling opportunities for consolidation in the fragmented education market broadly and for EdTech growing at a double digit CAGR, so much faster than the overall education market. Why invest in EdTech? Well, as just mentioned, EdTech addresses these very large markets. It's increasing its share of education spend because it's aligned to several secular trends. So I'm thinking about digital transformation of the entire education industry. The shift from in-person instructor led training to really more efficient or economic online or digital learning. And positives from this shift, as you mentioned, include better scalability, affordability, global access to really high quality education. These EdTech companies are aligned to corporate skilling, which are aligned to companies, strategic goals, digital transformation initiatives. And then from a stock perspective, there's really low investor sentiment broadly and of course, the exposure to ESG trends around inclusion, skilling, education, access. Josh Baer: And Stephen, what is the regulatory landscape around global education and EdTech, both in the U.S. and in other regions? Stephen Byrd: So education policy is not really featured heavily in recent sessions of Congress in the U.S., as it tends to develop at more local levels of government than really at the federal level. The federal government in the United States provides less than 10% of funding for K through 12 education, leaving most of regulation and funding to state and local governments. Now, that said, there have been a few large education policy focused bills enacted into law since the establishment of the U.S. Department of Education in the second half of the 20th century. The most recent was in 2015, when President Obama signed the Every Student Succeeds Act, which granted more autonomy to states to set standards for education that vary based on local needs. In Brazil, there's some really interesting developments that we're very focused on. The Ministry of Education began loosening the rules for distance learning in 2017 to compensate for the lack of public funding and affordability. This was a new modality that didn't depend on campuses and was much cheaper for students. So companies saw this as the next growth opportunity and started investing in digital expansion, especially after COVID-19 lockdowns forced the closure of campuses. Distance learning grew rapidly and surpassed the number of on campus enrollments in 2021. Despite the increase in addressable market, this potential cannibalizes is part of the demand for in-person learning and reduces average prices in the sector. Lastly, in Europe, the European Union has set seven key education targets that it is hoping to achieve by 2025. And by 2030 on education and training. Let me just walk through a couple of the big targets here. By 2025, the goal is to have at least 60% of recent graduates from vocational education and training, that should benefit from exposure to work based learning during their vocational education and training. By 2030, the goal is for less than 15% of 15 year olds to be low achievers in reading, mathematics and science, as well as less than 15% of eighth graders should be low achievers in computer and information literacy. Stephen Byrd: Josh, how are emerging technologies like artificial intelligence and virtual reality disrupting the education space, both in the classroom and in cyberspace? How do you assess their impact and what catalysts should investors watch closely? Josh Baer: Great question. Investors are hyper focused on all the generative A.I. hype, all the risks and opportunities for EdTech. And it's important to remember that all EdTech companies serve different markets and they have different business models and they provide varying services and value to all those different markets. And so there's a wide spectrum from risk to opportunity, and in actuality, I think many businesses will actually have both headwinds and tailwinds from A.I. At the core, the question is not, will generative A.I. change education and learning, but how will it change? And from the way it may change, from the way education content is created and consumed, to the experience of learning and teaching and testing and studying. And on one end of the spectrum, investors should also look for signs of disruption, disruption to the publisher model or tutoring services or solutions, look for signs of students that may meet their learning needs or studying needs with generative A.I. instead of existing solutions. But from an innovation perspective, I think investors should look for new entrants and incumbents to leverage generative A.I. to really enhance the future of education, from personalized and efficient content creation to more adaptive assessments and testing, to more customized learning experiences. And these existing platforms, they're the ones that own vast datasets, really rich taxonomies of learning and skills. And I think those are the ones that are well-positioned to use A.I. technology to vastly improve their capabilities and the education market. Investors can also look for a more direct revenue opportunities, as the EdTech platforms are the platforms that will be teaching and reskilling and upskilling the whole world on how to use these innovative technologies, today and in the future. Stephen Byrd: Josh, thanks for taking the time to talk. Josh Baer: Great speaking with you, Stephen. Stephen Byrd: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts, and share the podcast with a friend and colleague today.