The Brazilian Market

(i) Overview of the Higher Education Sector in Brazil

According to information from the 2012 MEC/INEP Higher Education Census, Brazil is the fifth largest higher education market in the world and the largest higher education market in Latin America, with approximately 7.3 million enrolled students.

The education sector in Brazil is highly relevant to the country’s economy, due mainly to the size of our population. According to the results of the 2013 MEC/INEP Higher Education Census, Brazil had a total of 44.3 million students enrolled in Basic Education, including all of the categories of education within preschool, elementary school, high school, youth and adult education and vocational education. Of this total, 21.3 million students are in elementary school, 8.2 million are in high school and 7.5 million are in preschool, the three largest education sectors in the Brazilian market. Higher education, meanwhile, had a total of 7.3 million students enrolled in 2013.

Despite the growth in the number of students enrolled in Higher Education in recent years, only 17.8% of the Brazilian population aged 18-24 were enrolled in institutions of higher education in 2012, based on the results of the 2012 MEC/INEP Higher Education Census, which is well below the goal of 33% set by the Federal Government for 2020, indicating the potential for the continued growth of the higher education sector in Brazil.

Based on the information from the MEC/INEP, the sector of private classroom-based institutions presented a compound annual growth rate of 7.07% from 2000 to 2013, while the public sector grew by a rate of 5.5% per annum during the same period. With this, the private sector’s market share fell from 67.1% to 21% between 2000 and 2013, while the public sector saw its share drop from 32.9% to 28.8%. The charts below illustrate, respectively, (i) the increase in the number of enrolled students for classroom courses in the public and private sectors and (ii) the share of each sector in the total number of enrolled students in classroom courses from 2000 to 2013.

One of the main factors behind this growth was the change in the regulation of the sector in the 1990s. Prior to 1996, the higher education sector in Brazil was facing regulatory restrictions that hindered the expansion of higher education by private institutions, despite the lack of public investment at various levels of the sector. Following the December 1996 promulgation of the Law of National Education Guidelines and Bases, a variety of measures have been launched to encourage private investment in the higher education sector in Brazil. Some of the major initiatives include the easing of regulatory restrictions on the opening of courses and institutions and the legal regulation that allowed higher education institutions to be set up as for-profit businesses.

Currently, unlike the segment for basic education, higher education in Brazil is dominated by private institutions, capable of meeting the demand for higher education courses that is not being met by public institutions. While the public higher education institutions are directed to serve as centers of excellence and research, with extremely competitive admissions standards and a limited capacity for expansion, the private higher education institutions are focusing their attention on the professional requirements imposed by the labor market and they develop flexible programs to meet the needs of the working population.

(ii) Levers for growth in the sector

The higher education sector in Brazil has four levers of growth:

(iii) Distance Learning

Distance learning has arisen as an option to increase the penetration of higher education in Brazil, given its lower monthly tuition fees, which substantially increases the number of people with the purchasing power to enroll in these programs.

According to the survey conducted by the Brazilian Distance Learning Association (ABED), in 2008 there were approximately 2.6 million students enrolled in a distance education course in Brazil. According to the information released by the MEC/INEP for 2013, Distance Education was the fastest growing mode in the higher education market, with a compound annual growth rate of 35.15% for the period from 2002 to 2013, when there were approximately 1,2 million students enrolled in higher education distance learning courses in Brazil.

(iv) Increase in financing alternatives for students

The increase in financing alternatives for students, combined with the growth in the number of higher education institutions and courses targeting the middle and lower economic classes can be seen as opportunities to grow the number of enrollments in higher education in Brazil.

To encourage education in Brazil, some of the financing alternatives create tax and financial incentives for educational institutions that have enrolled students who are benefiting from certain government programs.

With access to this financing, the middle and lower economic classes, which historically have not had access to higher education, have been largely responsible for the increase in the number of enrolled students. These students are mostly adult professionals in search of better salaries and employment opportunities.

University for All Program ("PROUNI")

PROUNI was created in 2005 and provides exemption from certain federal taxes for revenue earned from undergraduate courses offered by institutions of higher education that provide a certain number of scholarships to the low-income students in their undergraduate and related courses. By providing tax breaks to for-profit institutions, PROUNI also played an important role in stimulating growth and private investment in the higher education sector, allowing for-profit institutions to offer courses at competitive prices, when compared to those offered by charitable organizations and non-profits.

Student Financing Program ("FIES")

The FIES was created in 1999 and provides financing for up to 100% of monthly tuition fees at the private higher education institutions that take part in the program and have received a positive ranking from the MEC.

To date, more than 500,000 students have benefitted from the program, and an increasing number of higher education institutions in Brazil are covered by the program. Since 2005, the FIES has also offered financing to students who receive partial PROUNI scholarships that cover 50% of their higher education costs. Thus, these students are able to finance the other 50% of their higher education costs with a FIES loan.

Currently, FIES loans are granted in the following order of priority to: (i) students who receive a 50% scholarship from PROUNI; (ii) students who receive a complementary scholarship and are enrolled in courses considered priority by FIES (teaching degrees in chemistry, physics, mathematics and biology, as well as engineering, geology and other courses included in National Technical Course Catalogue); (iii) students who receive complementary scholarships and are enrolled in other courses; (iv) students enrolled in other higher educational institutions who adhered to PROUNI; and (v) other students enrolled in higher educational institutions that did not adhere to PROUNI.

For more information about PROUNI and FIES, see item 7.5 of the Reference Form.

Recent Changes

The FIES regulations recently changed in order to provide more benefits and make the program even more attractive to students, particularly those who intend to become teachers and doctors. The main changes were:

1. A reduction in interest rates from 6.5% to 3.4% per annum, compounded monthly at a rate of 0.27901%;

2. A reduction of 1% per month on the amount of debt held by teachers and doctors who choose to work in the public sector after graduation (teachers must work in basic public education and doctors in areas determined by the Ministry of Health);

3. Expanded terms. Currently, students have terms that are equivalent to three times the duration of the course, plus one year, to repay the financing. Previously, the term was equivalent to twice the duration of the course.

4. The possibility of students to apply for the FIES without the need for a guarantor in cases involving: students in degree courses, or students whose gross monthly family income is less than or equal to one and a half times the minimum wage or students who have been awarded partial PROUNI scholarships. To this end, the Guarantee Fund was created, which allows students to waive the presentation of a guarantor or joint surety.

5. The requirement, beginning in 2011, that freshman students (enrolling in the first semester) have taken the ENEM.

6. Varied financing percentages from 50% to 100%.

We believe that these changes will increase enrollment in undergraduate schools due to the improved conditions for students who cannot afford the cost of their education. Lower interest rates, coupled with longer term financing, should further boost enrollment, favoring the sector as a whole. In addition, as was mentioned above, the Government created a fund to guarantee student loans, which exempts the student from the need to provide a guarantor for their loan.

On September 13, 2013, Federal Revenue Office (RFB) Regulatory Instruction 1394 (IN 1394) was published, which revoked RFB Regulatory Instruction 456 of October 5, 2004 (IN 456). IN 1394 establishes the means of calculating tax exemption for higher educational institutions under the PROUNI program, tying the fiscal benefit to the ratio of effective occupation of the scholarships granted (POEB). This provision was already present in Law 11096 of January 13, 2005, as amended by Law 12431 of June 24, 2011, but had not been expressly regulated by IN 456.

For more information on the alterations introduced by IN 1394 and their potential impacts on our financial statements, see Items 3.3 and 7.5 of the Reference Form.

(v) Expansion of the segment composed of professionals who study

The prospect of career advancement and significant salary increases for professionals with college degrees are two key factors associated with the expansion of the higher education sector in Brazil. According to Hoper (OCDE), Brazil is one of the countries where holding a college degree makes the biggest difference in terms of salary, leading to an average increase of 250% for people with these diplomas.

In 2012, the number of students enrolled in Higher Education during the evening hours reached 3.75 million, representing nearly 64% of enrolled students.

We expect enrollment at institutions of higher education in Brazil to continue to grow as a result of certain factors, such as: (i) the prospect of career advancement; (ii) the significant increase in individual income for those who hold a college degree; (iii) the substantial, unmet and growing demand for skilled workers; and (iv) the growing availability of educational alternatives for Brazil’s middle and lower economic classes, due to the ongoing support from the Federal Government for private higher education and, specifically, private investments in higher education.

(vi) Consolidation of the Sector

In 2013, the 12 largest private, for-profit higher education institutions in Brazil (responsible for 39.3% of all private enrollment) registered approximately 2.14 million enrolled students, while the remaining private institutions (responsible for 60.7% of private enrollment) registered approximately 3.31 million enrolled students, according to data from Hoper Market Studies.

This high fragmentation provides opportunities for (i) gains in market share; and (ii) additional consolidation through mergers and acquisitions. While we have observed a significant acceleration in the consolidation process in the sector since 2007 as a result of the initial public offerings ("IPOs") seen in the sector and the increased interest of foreign companies, the education sector in Brazil is still quite fragmented.

According to the Hoper Consulting Firm, it is expected that the competition among private higher education institutions will undergo significant changes, as new elements are inserted into the competitive landscape, including the competitive advantages that the larger institutions have in comparison to smaller institutions. These advantages may include economies of scale and cost savings from operational and administrative centralization, greater access to capital to finance investments and a greater ability to attract talented faculty and students.

(vii) Competition

The higher education sector in Brazil is highly fragmented and includes competition in all locations. We believe that the factors that influence competition in the higher education market include price, educational experience, institutional tradition, faculty, facilities, location and variety of courses, among other factors. Due to the fragmentation of the sector, we are facing different levels of competition, depending on the location of our units. According to the MEC, in 2013 there were 2,112 private and 304 public institutions of higher education in Brazil. We directly compete with for-profit and non-profit institutions of higher education and institutions offering alternatives to higher education. The smaller private institutions, which normally have only one unit, have less of an ability to attract and maintain experienced management and faculty. They also have limited resources for opening new units, developing and providing quality educational services and putting together courses of interest to the students. However, according to data from the Hoper Consulting Firm, in 2013 we were the eighth largest private university network in Brazil in terms of revenue.

The Company’s Market Share

The chart below shows the total number of students at the 12 largest for-profit private higher education institutions in Brazil.

(viii) New Trends in Higher Education - The Demand for Quality

Much as the Law of Basic Guidelines for Education of 1996 changed the panorama of education in Brazil, causing the migration from a tradition model of education with low competition to a model of mass education, with high competition and the entry of entities focused on profit, efficiency and productivity, the sector has experienced a new turning point in recent years. The key stakeholders in the development of Higher Education in Brazil, i.e. the employers, the students and the Government, are providing indications that a new educational component will become key to HEIs: the quality of the education being offered.

From the point of view of the labor market, there is a significant gap between the perception of employers and the educational institutions in relation to the preparation of graduates for the labor market. Data from McKinsey contained in the report Education to Employment: Designing a System that Works offer an accurate picture of how the labor market perceives that students have inadequate preparation for new positions in the labor market.

The chart above clearly shows that in Brazil there is not only a considerable gap between the perception of preparedness of the students from different countries, but that Brazil is behind other countries considered emerging, such as India, Mexico and Turkey. This fact is expected to lead the labor market to press the HEIs to offer a better quality education aligned with the demand from employers for better-prepared professionals.

In addition to employers, students have also realized that quality Higher Education can lead to social gains, with benefits to their quality of life. According to the study published by McKinsey, 59% of the Brazilian students interviewed believe that Higher Education increases their chances of entering into the labor market. This puts Brazil behind Saudi Arabia, but ahead of India, Germany, Mexico and Turkey.

The perception of value in Higher Education by students translates into a demand for HEIs that offer higher quality programs and courses, benefitting institutions capable of aggregating recognition, tradition and quality teaching to their brands. A survey released by Hoper in 2013 shows that quality-related issues are the main determining factors for 47.4% of students when choosing an educational institution.

Source: Hoper Market Studies.

In addition to students and employers, the Brazilian Government has also demonstrated its alignment with respect to the issue of quality in education. The quality of Brazilian education is among the main guidelines with respect to education in Brazil that have been established by the MEC for the next 10 years. In addition, the guidelines establish an increase in the coverage of the National Student Performance Examination (ENADE), which indicates greater concern about the supervision of educational institutions.

This demonstrates that the Government has been more active in its supervision of education in Brazil. As a precondition for offering the FIES, it began requiring that the CPC be above 3 (on a scale that goes from 1 to 5), with the risk of freezing new enrollment in courses with a CPC rating constantly equal to or below 2.

(ix) Growth of demand for education in our segment:

We believe the fact that only 17.8% of the population aged between 18 and 24 have access to higher education (according to the 2012 MEC/Inep Higher Education Census) constitutes a strong stimulus for the growth of enrollments in this segment.

In addition, the Federal Government’s National Education Plan has set a goal of expanding the 7.1 million students enrolled in higher education in 2011 (according to the 2011 MEC/Inep Higher Education Census), to 11 million by 2020 (according to the MEC’s 2011-2020 PNE). The main government mechanisms for encouraging this growth are the quota system for public institutions and the FIES for private institutions, which had already benefited more than 1 million students by on August 2013. In the fiscal year ended December 31, 2013, FIES resources accounted for 31% of our revenue.

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