In this article, I’m going to examine China Education Alliance and provide evidence that the company is inflating its financial statements. China Education Alliance (“CEU” or the “Company”) is an online distributor of educational material with a website that fails to work and receives minimal online traffic, company facilities that are empty and unused, egregious shareholder dilution for no sensible purpose, SAIC financial statements that don’t match SEC filings, a history of small no-name auditors, and suspiciously unreasonable margins.
This article summarizes key points that I have put together in a longer report available here.
Today, CEU trades at a market capitalization of $150 million and its shares are listed on the New York Stock Exchange. In actuality, the stock is worth little more than the $20 million of cash it raised in its 2009 secondary offering, if indeed that cash still resides in the company’s bank account.
To most clearly illustrate my evidence, I have compiled four videos to (i) demonstrate how the company’s websites do not function properly and are unlikely to be as profitable as the company claims and (ii) provide evidence that the company’s training center, which ostensibly generates more than 30% of the company’s revenue, is actually an empty, unfurnished and unused building.
In this article, I also provide SAIC filings that show that the company reported less than $1 million of revenue to the Chinese government in 2008, the year of the most recent filings available.
In addition, I compare CEU with three other Chinese online education providers: DL, CEDU and CAST. Of these companies, CEU is the only company with non-functioning payment methods on its websites. Of these companies, CEU is the only company with dozens of broken links and html errors on its websites. Of these companies, CEU is the only company without a top 4 auditor. In fact, CEU has had 4 different low quality auditors in the past 6 years. CEU receives less web traffic to its sites than the sites of DL, CEDU and CAST by a large margin. Yet investors are to believe that (i) CEU generates gross and EBIT margins that far outpace these comparable companies and (ii) CEU generates revenue that is greater than DL and within range of CEDU and CAST?
Video - Part 1: Core Website Has Non-Functioning Payment System
Video - Part 2: Further Website Errors and Comparison with a Comparable Website
Video - Part 3: More Broken Links, Irrelevant Content, and a Flaw with CEU’s Business Model
Video - Part 4: Evidence that the Company’s Training Center is Empty, Unfurnished and Unused
Our first video introduces the website and demonstrates that visitors cannot purchase products from the company’s website, despite the fact that CEU is primarily a provider of online education.
Our second video examines the company’s online educational game website www.pk1234567.com and demonstrates that it neither works nor generates revenue through online payment because the payment options for the game are non-functional. The second video also contrasts www.edu-chn.com with the properly functioning websites of China Distance Education Holdings (NYSE:DL), and shows how visitors can in fact purchase products from DL’s websites, whereas they cannot from CEU’s websites.
Our third video shows numerous broken links and faulty html on the edu-chn.com website, as well as examples of inappropriate, irrelevant and outdated content. It also explores a fundamental flaw with CEU’s business model: free test papers and examination material are readily available on the web, and it is unclear why students would pay for content, if in fact the site’s payment options were to be functional.
Our fourth video shows the results of our investigation into the Company’s training center (Heilongjiang Zhong He Education Training Center), which according to SEC filings provides more than 30% of the company’s revenue. Through video footage and more than 40 pictures, we provide evidence that the company’s training center is in fact an empty, unfurnished and unused building. We’re skeptical that this vacant building contributed $11 million of revenue in the first nine months of 2010 (in presentations, management has claimed that the Heilongjiang training center contributes 60% of total training center segment revenues, but even then, we’re equally skeptical that this empty, unfurnished center contributes $5-$6 million of revenue).
The company’s websites do not work, despite the fact that CEU is an online education provider and its websites are the company’s main revenue-generating assets. The websites have non-functioning payment methods and are full of broken links and HTML errors.
Numerous attempts to purchase products online yielded no success. All payment methods on the company’s websites led to error messages. We had multiple investigators call the phone numbers on the websites to try to purchase products. The numbers either led to recorded messages during business hours or the callers were told that the cards “could only be purchased on site in Heilongjiang”. On several calls, the operators answering the phones were not able to provide any information on where these sites were located, although one operator said that cards are “sold at book stores around schools in Harbin”. The cards could not be purchased over the phone.
Click here for a report from one of our investigators who tried to purchase the company’s products online and over the phone. The investigator is a resident of Harbin.
Seeing that it’s impossible to purchase access to CEU educational materials via the Internet or by phone, we became skeptical that CEU could have a strong enough presence locally in Harbin to generate the revenue reported to the SEC. We hired an investigator to visit bookstores near schools in Harbin to search for these debit cards. Our investigator visited fifteen locations, none of which carried CEU learning cards. Of the fifteen bookstores visited, only two sold learning cards, and neither was for edu-chn.com. One was for a competitor we were not familiar with,www.taiqiedu.com, and the other one was for websites of DL. The other thirteen bookstores did not sell learning cards at all. The addresses and a picture of each visited bookstore can be seen in the PDF linked to below. Our full set of pictures of the bookstores are available at this Flickr account. As a result of our investigation, we do not believe that CEU has a strong enough presence either online or locally in Harbin to generate even a fraction of the revenue reported to the SEC.
Click here for the bookstore addresses and pictures.
To summarize, our investigators could not purchase learning cards on the Internet, over the phone, or in person.
These additional errors were encountered while trying to navigate edu-chn.com:
- The “Famed Instructors Test Paper Store” and the “Famous Schools’ Test Paper Store” could not be accessed due to an error screen.
- The online store (www.edu-chn.com/wssc/index.htm), which appears to sell merchandise unrelated to education, also does not work.
- The “Big Classroom of Famous Instructors” did not provide access to tutoring services. After viewing a profile, there is a link providing the company’s main phone line and a QQ messaging link that doesn’t work. The phone number supplied frequently goes unanswered during normal business hours from calls originated in China.
- Some free test material was available for download, but it frequently didn’t include answers to sample questions and/or was available on other sites free of formatting issues, leading us to believe that CEU is not the original creator of its free material.
- The websites featured irrelevant content – in our third video, we show that the website includes a personals ad by a 52-year old female seeking a husband.
- Web pages had stale content that have not been updated since late 2005.
A variety of online services monitor visitor traffic to websites and make that information available to the general public. We examined traffic reports from the most popular of these services, Alexa.com, as well as one of the most useful traffic information resources in China, chinarank.org.cn.
Both sites demonstrated low traffic to CEU’s websites. When we compared CEU websites to websites operated by DL and CEDU, we found CEU generates a tiny fraction of its competitors’ traffic, yet reports similar revenue.
We provide screenshots and more detailed analysis in our report, and the data shows the following:
- www.360ve.com and www.pk1234567.com show negligible traffic data on both Alexa and Chinarank.org.cn, and therefore likely receive minimal visits.
- www.edu-chn.com receives less than a hundredth of the traffic of the numerous websites of China Distance Online Education, a Deloitte-audited company which reported less revenue in 2009 than CEU.
- www.edu-chn.com received very low amounts of traffic on Alexa until early 2010, leading us to believe that the company began utilizing artificial traffic-generation methods when it saw that investors were becoming concerned about the minimal traffic to the company’s main revenue-generating website.
Below is a comparison of edu-chn.com’s traffic data when compared with 5 websites of DL.
The Heilongjiang Zhonghe Education Training Center is located at Building 39, High & New Technology Developing Zone, Sidao Street, Qianshan Road, Nangang District, Harbin, Postcode: 150080. This information can be found inexhibit 10.4 in the 10KSB filed in 2006.
The company has not moved its location since 2006. Here is disclosure from its 2006, 2007, 2008 and 2009 10Ks about the training center. As we can see, the company has described the training center as having “17 modern classrooms that has a capacity for 1,200 students” since its inception, and refers to it by the name “Heilongjiang Zhonghe Education Training Center”. Throughout SEC filings and in MD&A, the company consistently refers to a single training center that began operations in 2006.
According to documents filed with the SEC, in 2009 this 36,600 square foot facility generated $12.1 million of revenue at a 78.8% gross margin. Management, however, has claimed in conferences that this facility is only responsible for approximately 60% of segment revenue, with the other 40% coming from smaller satellite facilities. These claims conflict with disclosures in SEC filings, but even if we assume that only 60% of the segment’s revenue comes from the Heilongjiang Zhonghe Education Training Center, that’s gross income of $156 per square foot. Average rent for Class A office space in Manhattan is $71 per square foot per year. This amazing profitability is something we needed to understand better, so we hired an investigator to visit the school. We found that if CEU is able to generate $156 per square foot, they apparently don’t even need furniture to do it.
Our investigator took more than 45 photos, as well as video footage. What we found was a vacant, unfurnished building, with little sign of use. We have created a video that features our investigator’s photos and video footage, as well as general evidence for why the company’s training center is a façade.
Further details on the training facility are available in our longer report.
Financial Comparison with Competitors
Given the faulty website and the empty training facility, it remains impossible for us to understand how this business generates the same revenue, better margins, and higher earnings than its competitors with functional websites, national scopes, and utilized training facilities. We compared CEU to DL, CEDU, and ChinaCast Education Corporation (OTCPK:CAST). We chose not to look at New Oriental Education & Technology Group (NYSE:EDU) because we believe it is a fundamentally different business with a larger scale, but we do note that it has much lower margins than CEU. We also include the numbers for the Princeton Review (REVU), a popular US test-prep company with which US investors should be familiar. Its use as a comparison company may be limited, but we will let readers weigh the evidence on their own.
Below are financial figures for comparable companies as of June 30, 2010.
Unlike CEU, the comparable companies have functioning payment methods on their websites. Unlike CEU, the comparable companies have no broken links, faulty html, and outdated content from 5+ years ago. Unlike CEU, the comparable companies have top-4 auditors, whereas CEU has had 4 different low quality auditors in the past 6 years. The comparable companies’ websites receive far more traffic than CEU’s websites.
Despite these facts, CEU generates gross and EBIT margins that far outpace the comparable companies, according to SEC filings. CEU generates higher revenue than DL and within a reasonable range of CEDU’s and CAST’s sales figures, according to SEC filings.
We strongly believe that CEU’s SEC filings are fabricated.
CEU’s locally filed financial statements in China do not match its SEC financial statements. These local financial statements, which CEU must file with the Harbin branch of the Administration for Industry and Commerce (“AIC”), show that the online business generated revenue of less than $1 million in 2008. This corroborates our belief that CEU is mostly a hoax. 2008 was the most recent year for which we could access filings, as of our last inquiry on November 15.
Below are photocopies of the company’s AIC filings for 2008, 2007 and 2006 for CEU’s main operational subsidiary, Harbin Zhong He Li Da Education Technology, Inc. We provide filings in their original Chinese, as well as English translations of those filings.
2008 AIC Filings in Original Chinese
2008 AIC Filings in English Translation
2007 AIC Filings in Original Chinese
2007 AIC Filings in English Translation
2006 AIC Filings in Original Chinese
2006 AIC Filings in English Translation
According to SEC filings, the “Online Education” segment generated $22.2 million at 79.4% gross margins; “Training Center” generated $12.1 million of revenue in 2009 at 78.8% gross margins; and “Advertising Revenue” accounted for $2.6 million at 92.0% gross margins. For 2008, “Online Education” generated $16.7 million at 82.9% gross margins; “Training Center” generated $5.6 million of revenue at 65.4% gross margins; and “Advertising Revenue” accounted for $2.6 million at 93.0% gross margins.
Therefore, we should expect the 2008 AIC filings of Harbin Zhong He Li Da Education Technology, Inc. to show at least $16 million of revenue and $13 million of gross profit.
What we find is quite different. An excel summary is below:
High Auditor Turnover and Low Quality Auditors
Low quality auditors and high auditor turnover are both telltale signs of trouble. Repeated transitions from one low-quality auditor to another should be looked at with suspicion, especially considering all of the other red flags that we’ve identified in this article.
Below is the history of CEU’s auditors:
None of the above auditors are considered top 100 accounting firms, and all are small, non-reputable firms. CEU’s longest auditor relationship lasted 3 years. Why would management need a new accounting firm of subpar quality every few years?
It is difficult to believe that this company is valued at $150 million. It is an even sadder state of affairs that the company is listed on the New York Stock Exchange. There are dozens of red flags, any one of which should scare investors away. To recap, here are glaring issues:
- The company’s main revenue-generating website does not have a functioning payment system. Its online and mobile payment methods lead to error screens. One cannot purchase their products by calling them over the phone. Our investigators could not find their learning cards at any Harbin bookstores, despite visiting 15 locations.
- The company’s sites feature a multitude of error screens, broken links, faulty HTML, irrelevant content and outdated material.
- The website receives minimal traffic. Data sources show either little volume or suspicious traffic growth, or both.
- Comparable online education websites in China have properly functioning payment systems, no broken links, and a cleaner and more intuitive layout. Yet investors are to believe that CEU’s faulty website with a geographic scope limited to Harbin is generating the same revenue and better margins than functioning websites with a national scope.
- The training facility is supposedly generating outsize profits and margins, despite the fact that it is empty and unfurnished.
- AIC financial statements filed in China for the online business (ie. excluding the training center segment) showed revenue of less than $1 million in 2008. We believe that companies report accurate financial figures to their own government, whereas they report fabricated financial figures to the U.S. government and U.S. investors.
- The company generates suspiciously low interest income off of its ostensibly large cash balance. We believe that most of this cash does not exist.
- The company has had 4 low-quality auditors in the past 6 years. In contrast, the comparable Chinese education providers DL, CEDU and CAST all have top-4 auditors.
- The company raised cash at a discount to its stock price at the time of its equity offering and has done nothing with that cash. It already supposedly had $38 million of cash on its balance sheet prior to its unnecessary capital raise.
Disclosure: Short CEU