First High-School Education Group Readies $75 Million U.S. IPO

Summary

• First High-School Education Group has filed proposed terms for its U.S. IPO.
• The firm provides private high school instruction services in China.
• FHS has produced growing financial metrics but the IPO appears highly priced, so I'll watch it from the sidelines.
• Looking for more investing ideas like this one? Get them exclusively at IPO Edge. Learn More »

Quick Take

First High-School Education Group Co. (FHS) has filed to raise $75 million in an IPO of its ADSs representing underlying Class A ordinary shares, according to an F-1 registration statement.

The firm offers high school education and related services in China.

While FHS has produced positive financial results, Chinese education companies have been poor performers on U.S. markets and the IPO appears expensive, so I'll pass on the IPO.

Company & Technology

Kunming, China-based First High-School was founded to develop a network of private high school education campuses in Western China.

Management is headed by founder, Chairman and CEO Shaowei Zhang, who previously established the Kunming Qihang Education and Training School and Kunming Epoch Giant Tutorial School.

The company’s primary offerings include:

• 19 schools

• 14 high school programs

• 7 middle school programs

• 4 tutorial school programs

First High-School has received at least $32.6 million from investors including Longwater Topco, Visionsky Group, Long-Spring Education, Minglin Wu and Brightenwit Group.

The firm has focused on developing and maintaining close relationships with local governments, working with partners who contribute land and school facilities which the company operates.

The company markets its services via offline methods and word of mouth to maximize its school utilization rate.

FHS has operations in four provinces within China, as shown on the map below.

Selling and Marketing expenses as a percentage of total revenue have fluctuated as revenues have increased, as the figures below indicate:

Selling and Marketing	Expenses vs. Revenue
Period	Percentage
Nine Mos. Ended Sept. 30, 2020	2.2%
2019	1.4%
2018	2.2%

Click to enlarge

Source: Company registration statement

The Selling and Marketing efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Selling and Marketing spend, dropped to 10.8x in the most recent reporting period, as shown in the table below:

Selling and Marketing	Efficiency Rate
Period	Multiple
Nine Mos. Ended Sept. 30, 2020	10.8
2019	17.2

Click to enlarge

Source: Company registration statement

Market & Competition

According to a 2017 market research report by DBS Vickers Securities, it forecasted overall education spending market in China to grow by a CAGR 6.7% ‘in the foreseeable future due to multiple drivers:’

• End of one-child policy will increase student number growth

• Rising income to support continued increase in household spending

• Increased parent willingness to pay for education

The group expects the total market value for education and training to reach $474 billion by 2025, with the K-12 sector accounting for most of the demand.

Looking historically, the chart below shows the tremendous rise in education spending by households along with spending growth:

The company faces competition from other private high school operators as well as ably-run public schools.

Financial Performance

First High-School’s recent financial results can be summarized as follows:

• Growing topline revenue

• Increasing gross profit and gross margin

• Growing operating profit and margin

• Increased comprehensive income

• Sharply higher cash flow from operations

Below are relevant financial results derived from the firm’s registration statement:

Total Revenue
Period	Total Revenue	% Variance vs. Prior
Nine Mos. Ended Sept. 30, 2020	$ 41,574,000	30.6%
2019	$ 49,564,000	32.9%
2018	$ 37,307,059
Gross Profit (Loss)
Period	Gross Profit (Loss)	% Variance vs. Prior
Nine Mos. Ended Sept. 30, 2020	$ 13,457,000	51.8%
2019	$ 15,395,000	40.2%
2018	$ 10,978,529
Gross Margin
Period	Gross Margin
Nine Mos. Ended Sept. 30, 2020	32.37%
2019	31.06%
2018	29.43%
Operating Profit (Loss)
Period	Operating Profit (Loss)	Operating Margin
Nine Mos. Ended Sept. 30, 2020	$ 5,782,000	13.9%
2019	$ 5,746,000	11.6%
2018	$ (23,383,529)	-62.7%
Comprehensive Income (Loss)
Period	Comprehensive Income (Loss)
Nine Mos. Ended Sept. 30, 2020	$ 5,000,000
2019	$ 4,668,000
2018	$ (24,953,824)
Cash Flow From Operations
Period	Cash Flow From Operations
Nine Mos. Ended Sept. 30, 2020	$ 28,753,000
2019	$ 14,976,000
2018	$ 13,332,794
(Glossary Of Terms)

Click to enlarge

Source: Company registration statement

As of September 30, 2020, First High-School had $45 million in cash and $103 million in total liabilities.

Free cash flow during the twelve months ended September 30, 2020, was $16.3 million.

IPO Details

First High-School intends to raise $75 million in gross proceeds from an IPO of 7.5 million ADSs representing 22.5 million underlying Class A ordinary shares, offered at a proposed midpoint price of $10.00 per ADS.

Concurrent to the IPO, an external company has agreed to acquire $4.5 million of its Class A ordinary shares in a private placement at the IPO price, as adjusted.

Class A ordinary shareholders will have the right to one vote per share and the Class B shareholder, the founder, will be entitled to 20 votes per share.

The S&P 500 Index no longer admits firms with multiple classes of stock into its index.

Assuming a successful IPO, the company’s enterprise value at IPO would approximate $260 million, excluding the effects of underwriter over-allotment options.

Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 25.91%.

Management says it will use the net proceeds from the IPO as follows:

approximately 50% for establishing new schools and pursuing strategic acquisitions and investments;

approximately 20% for recruiting prominent teachers and training quality teachers, upgrading our standardized curriculum and investing in teaching methodology research;

approximately 10% for upgrading our information technology systems, building “smart campuses” and purchasing teaching equipment;

approximately 10% for making lease payments under certain sale and leaseback arrangement we entered into with a financing leasing company in August 2020; and

approximately 10% for funding our working capital and general corporate purposes.

Management’s presentation of the company roadshow is available here.

Listed bookrunners of the IPO are The Benchmark Company, AMTD, Valuable Capital, TF International, Maxim Group, Tiger Brokers, Boustead Securities, FUTU and Fosun Hani.

Commentary

First High-School is seeking U.S. investment to further its expansion plans in the offline private high school market in central and western China.

The firm’s financials show growth across major revenue metrics, net profit and strong operating cash flow growth.

Selling and Marketing expenses as a percentage of total revenue have been uneven; its Selling and Marketing efficiency rate has dropped to a still high 10.8x.

The market opportunity for providing private high school education services in China is large and expected to grow at a substantial rate as parents seek to provide their children with a better education than public schools can offer.

Like many Chinese firms seeking to tap U.S. markets, the firm operates within a VIE structure or Variable Interest Entity. U.S. investors would only have an interest in an offshore firm with contractual rights to the firm’s operational results but would not own the underlying assets.

This is a legal gray area that brings the risk of management changing the terms of the contractual agreement or the Chinese government altering the legality of such arrangements. Prospective investors in the IPO would need to factor in this important structural uncertainty.

The Benchmark Company is the lead left underwriter and IPOs led by the firm over the last 12-month period have generated an average return of negative (14.6%) since their IPO. This is a lower-tier performance for all major underwriters during the period.

As for valuation, compared to online oriented 17 Education, management is asking IPO investors to pay a Price/Sales premium of 137% YQ’s current valuation.

While FHS has produced enviable financial metrics, Chinese education IPOs have generally produced poor results for U.S. shareholders post-IPO for a variety of reasons, including regulatory changes and alleged financial improprieties.

The IPO appears excessively priced, so I'll pass on it.

Expected IPO Pricing Date: March 10, 2021

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[azbroker]

Anybody watching this one, has traded down to 9 m market cap but claims to still be making money?