Yvonne Fan, London School of Economics and Political Science
New Oriental Education and Technology Group Inc. (HKG:09901) — once a promising and well-ensconced industry bellwether with robust growth— has taken a devastating blow from China’s massive “Double-Reduction” crackdown on K-12 private educational firms in July 2021, leaving the company reeling and its investors fleeing. The sweeping regulation aligns with a broader national narrative of boosting birth rates to foster sustainable economic growth.
 “Double-Reduction” refers to the official regulation used to sanction Chinese private educational firms, which will be further explained below.
 “K-12” refers to “from kindergarten to 12th grade”.
Background and Analysis
Since March 2021, the Chinese authority has been implicitly signalling imminent regulatory actions on the private educational industry — one that it described as “hijacked by capital” — which depressed New Oriental Education’s stock performance. Before these negative implications, its stock had always been a market darling for alpha-seeking investors. As of February 2021, New Oriental Education had a 52-week high of HK$158.8 and a gigantic market capitalization of HK$233 billion(US$30 billion). To put it into perspective, the whole private education industry was worth HK$770 billion(US$99 billion) back then.
New Oriental Education was also backed by strong fundamentals (2020 fiscal year):
- Gross revenue was HK$27.9 billion, representing a YoY increase of 14.97%.
- Net income sky-rocketed by 72.7% to reach HK$3.2 billion.
- Gross margin was 55.6% and net profit margin was 11.6%.
The stellar performance of New Oriental Education in recent years stemmed from the booming private education sector in China, with lucrative opportunities pouring in. As Chinese society becomes increasingly shaped by hyper-competition in all facets of life, especially academics, the private education industry began to blossom. Via anxiety-inducing advertisements, New Oriental Education had successfully hooked anxious parents who were willing to plough their savings into exorbitant classes for their children, resulting in high price-setting ability. The Covid-19 Pandemic further accelerated the penetration and adoption of online learning platforms, thus boding well for the earnings of the private educational mogul once again.
Then came the “Double-Reduction” policy on 24th July 2021 by the Chinese administrative authority, which was an unprecedented swath of restrictions specifically targeting K-12 educational companies. The policy bars them from operating as for-profit firms or raising funds through Initial Public Offering, among a string of other earning-eroding restrictions. The main driver behind this is China’s incumbent priority to raise its dwindling birth rate that poses foreseeable obstacles to the long-term economic growth of the Chinese economy. By clamping down on K-12 firms and decimating their price-setting ability, it significantly reduces the cost of child-rearing — one of the pertinent concerns for couples — thus striving to encourage family planning and rescue the nation from potential economic stagnation in the future.
The repercussions of these stringent enforcements have threatened to upend the K-12 education industry, sending shockwaves through the stock market and devastating New Oriental Education. On the morning of 26th July 2021 (the first trading day after the release of new regulations), New Oriental Education’s stock plunged by 35.89% to HK$19.36, with a severely squeezed market capitalisation of HK$33.2 billion (US$4.27 billion). In fact, copies of the regulatory document had been circulated throughout social media on 23rd July, one day before the official release, resulting in a sudden plummet of New Oriental Education’s stock value by 50%, as jittery investors scrambled en masse to prevent further losses in a panic sell-off. As compared to its heyday in February when the stock price was high at HK$158.8, the current 52-week low of HK$13 suggests that on a whole, New Oriental Education’s share price has nosedived by a staggering 91.8%.
On 7th September 2021, the stock price of New Oriental Education recovered moderately from a record low of HK$13.00 to HK$18.30, with a current market capitalization of HK$31.3 billion (US$4.03 billion). With speculations that the worst regulatory crisis is over, many started bottom-fishing, thus leading to this mild price recovery. The re-bounce may also be attributed to the restoration of investor confidence, as the bulge bracket investment bank, Morgan Stanley, announced on 30th August that New Oriental Education is significantly undervalued at 60% of its intrinsic worth and exhibits high growth potential. Furthermore, many investors believe New Oriental Education, as well as other K-12 firms, have sufficient cash flows to expand their businesses and explore other uncharted waters, including the nascent vocational education sector, of which the Chinese government is in favour. Indeed, the current P/E (TTM) of 10.3 is a much more attractive deal than the P/E (TTM) of 72.6 at the end of February 2021. Nevertheless, substantial profit-reaping may only be viable in the long run, as restructuring efforts to comply with the regulatory overhaul and venture businesses in other related fields take time.
One vital takeaway is definitely about actively looking out for regulatory risk, no matter how invincible or surefire a company seems to be. In the short run, investing in New Oriental Education remains a fragile and unsavvy prospect as uncertainty and complexity abound. However, for brave souls wishing to pursue a higher risk premium, jumping on the bandwagon of bottom-fishing may be a value-investing strategy that generates a high return of investment in the long run — but they must exercise patience.