- Recent regulations & policies in China have targeted after-school tutoring companies and K-12 school operators, and this negative investor sentiment has spilled over to the Chinese higher education segment.
- The Chinese higher education segment is perceived to come under less regulatory scrutiny as compared to the AST and K-12 segments, but there are still risks relating to M&A.
- China Education Group is valued by the market at consensus forward fiscal 2021 and 2022 normalized P/E multiples of 16.9 and 14.0 times, respectively.
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I have a Neutral rating for China Education Group Holdings Limited (OTCPK:CEGHF) [839:HK].
China Education Group's stock price has not fully recovered from the sell-down in its shares in late-July 2021, as there is still fear that the Chinese authorities might introduce new regulations & policies in the future which could affect China's higher education school operators. As an example, independent college conversion is one of the company's key M&A drivers, and certain Chinese provinces have put on hold the merger between independent colleges and vocational institutes a few months ago.
China Education Group's current valuation multiples are below historical averages, which compensates for the regulatory risks associated with the industry and the company. As such, I view a Hold or Neutral rating for China Education Group as fair.
Do note that there is limited trading in China Education Group's OTC shares as shown on the OTC Markets website. This likely implies that there is no active market maker for the company's shares traded on the OTC market with the CEGHF ticker. As such, it is advisable for readers to deal in China Education Group's shares listed on the Hong Kong Stock Exchange which can be traded via US brokerages such as Fidelity or Interactive Brokers instead. China Education Group's Hong Kong-listed shares are very liquid with an average daily trading value of close to $12 million in the last three months as per S&P Capital IQ data.
Listed on the Hong Kong Stock Exchange since December 2017, China Education Group calls itself "the largest listed higher education and vocational education group in China" with respect to student enrollment numbers on the company's corporate website.
The company operates 14 schools, of which 12 (including the recently acquired Chengdu Jincheng College in September 2021) are located in China. In its 1H FY 2021 (YE August 31) interim report, China Education Group also noted that it runs two other schools outside of China - "an accredited higher education institute in Sydney, Australia, and a US-UK dual degree awarding university in London, UK."
China Education Group's core higher education business in China contributed 74% of the company's revenue in the first half of fiscal 2021. The company's vocational education business in China and global or foreign education business segment accounted for the remaining 20% and 6% of its top line, respectively in the most recent interim period.
Spotlight On Regulations And Policies For The Chinese Education Sector
Any discussion of school operators in general or China Education Group specifically cannot ignore potential regulatory and policy risks.
China Education Group's stock price fell by as much as -46% from its 52-week high of HK$20.80 registered during intra-day trading on June 20, 2021 to HK$11.30 during the July 26, 2021 trading day, which represented a new one-year low. This came about as Reuters reported on the same day that the Chinese authorities imposed new regulations that "ban companies from making a profit from teaching core school subjects and offering classes on weekends or holidays", which is referred to as the After-School Tutoring or AST segment in China.
The regulatory crackdown on the Chinese AST segment of China's education sector is widely speculated to be linked to China's plans to deal with an ageing population issue and encourage Chinese parents to have more children, by reducing costs associated with raising children e.g. after-school tutoring fees. According to a May 14, 2021 article published by state media CGTN, the proportion of the Chinese population who are 60 years or older is expected to increase from 18.7% in 2020 to approximately 38% in two to three decades' time. In August 2021, China officially transitioned into a "three-child policy" with the relevant new laws coming into effect. The country had an one-child policy since 1980, before allowing Chinese people to have as much as two children starting in 2016.
The Chinese policymakers are not only targeting the AST segment in an attempt to boost child births in the country. An earlier June 17, 2021 Fitch Ratings article highlighted that "China’s State Council" planned to introduce new regulations in September 2021 which will "prohibit related-party transactions and the control of schools in compulsory education (kindergarten to K-12) via contractual agreements under variable interest entity."
As it stands now, the new regulations and policies have largely targeted the AST and K-12 segments of the Chinese education sector, which do not currently have any impact on China Education Group or any of its higher education peers. Nevertheless, the more intense regulatory scrutiny of Chinese education players in general have led to a sell-down in China Education Group's shares between June and July 2021 as highlighted earlier.
Notably, China Education Group's last traded share price of HK$13.42 as of September 30, 2021 represents a +19% premium over the company's 52-week low of HK$11.30, but the company's shares are still trading -35% below its 52-week high of HK$20.80 recorded in June this year. China Education Group's current share price level appears to be reasonable.
On one hand, the higher education segment is not expected to play an important role in parents' decisions to have more children, as compared to the AST and K-12 segments. In contrast, China's higher education segment should receive greater policy support from the Chinese government instead in theory. The higher education enrollment rate for China has doubled to 54% in the past 10 years, but still remains significantly below the 70% average for developed nations. Furthermore, an increase in the higher education enrollment rate in China going forward could encourage more families to have children, as their kids will have a higher probability of being enrolled in higher education institutions and securing better-paying jobs in their adult lives.
On the other hand, regulatory risks can come in many forms. I will touch on potential risks related to China Education Group's future acquisitions in the next section.
All Eyes On M&A As A Key Growth Driver And Associated Regulatory Risks
Mergers or Acquisitions (M&A) have traditionally been the key means of growth for higher education companies, including China Education Group. This is because China's ageing population & low number of child births translate into modest organic growth prospects, and it is not easy to obtain regulatory approvals to build new schools as well.
When China Education Group was first listed on the Hong Kong Stock Exchange at the end of 2017, the company merely operated two schools in the country in Jiangxi and Guangdong. As highlighted in the "Company Description" section of this article, China Education Group currently runs 12 schools in China. Of the 10 new schools added to its portfolio between 2018 and 2021 year-to-date, nine of them were acquired from external parties.
It is noteworthy that a significant number of China Education Group's M&A opportunities were sourced from independent college conversions. In a September 2020 HSBC (HSBC) research report on China's education industry, independent colleges are defined as "a kind of undergraduate institution that is mainly funded by social entities or individuals" that "pay a fee to partner with public universities in exchange for the use of their brands."
In the company's recent 1H FY 2021 interim report, China Education Group highlighted that it "has strategically acquired three high-quality independent colleges". The company also noted in the interim report that the acquisitions were done based on the rationale that the Chinese regulators "have directed that the conversion of independent colleges into full private universities is a top priority in the establishment of higher education institutions." These three colleges were subsequently converted into private universities, which justified China Education Group's earlier strategic acquisitions.
But there is no certainty that independent college conversions will continue to be a key source of China Education Group's future M&A pipeline and help to boost its inorganic growth prospects.
A June 9, 2021 Global Times (Chinese state media) news article mentioned that the education departments in a few provinces in Eastern China "will suspend a plan to merge independent colleges and vocational institutes", as certain parents were concerned that independent colleges "will become ordinary higher vocational schools" post-merger and "reduce the competitiveness of students in the job market."
The above-mentioned is a very good illustration of how fast regulations and policies in China's education industry can change, especially since education is a topic very close to the hearts of ordinary folks in the country. It will not surprise anyone if the future growth plans of China Education Group or any of its peers are impacted by changes to existing rules & regulations as highlighted above. This explains why China Education Group's shares have yet to return to the highs it saw in June 2021.
The market currently values China Education Group at 16.9 times consensus forward FY 2021 normalized P/E and 14.0 times consensus forward FY 2022 normalized P/E, based on its stock price of HK$13.42 as of September 30, 2021 and market consensus data sourced from S&P Capital IQ. This represents a discount to the stock's three-year mean consensus forward next twelve months' P/E multiple of 21.4 times.
I have decided that a Neutral or Hold rating for China Education Group is reasonable, as the upside potential associated with its attractive valuations (as compared to historical averages) are offset by the risks relating to new regulations & policies that are negative for Chinese higher education school operators.
The key risk factors for China Education Group include new rules imposed in China that target the higher education segment in China specifically, and a slower pace of mergers & acquisitions going forward which lowers the future inorganic growth expectations for the company.
As I mentioned at the beginning of this article, China Education Group's OTC shares have not traded actively in the past, likely due to the absence of any market makers. Investors are advised to consider trading in China Education Group's more liquid Hong Kong-listed shares with US brokers offering access to key international equity markets as a better alternative to the company's OTC shares.
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This article was written by
The Value Pendulum is an Asian equity market specialist with over a decade of experience on both the buy and sell sides.
He is the author of the investing group Asia Value & Moat Stocks, providing ideas for value investors seeking investment opportunities listed in Asia, with a particular focus on the Hong Kong market. He hunts for deep value balance sheet bargains and wide moat stocks and provides a range of watch lists with monthly updates within his investing group.
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