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China Online Education (51Talk): This Is Not The China EdTech IPO We Have Been Looking For

I have written and tweeted extensively on the lack of publicly traded companies within the education sector here in the US (see or follow @cnyren). Despite generating 9% of US GDP, US public market investors have just two midcap publishing company stocks to consider (JW and HMHC), one small cap edtech pure play (NASDAQ:TWOU) and two near micro-caps (INST and CHGG). (There are also a handful of nano-cap penny stocks, as well.)

Of course, there are two other publishing giants lurking out there (McGraw-Hill and Cengage), but both remain private having had to work through bankruptcy reorganizations. And yes, there are still a half dozen other publicly traded for-profit higher education institutions (DV, CPLA, LOPE, STRA, APEI), but these are all basically dead stocks given the regulatory overhang (though APOL may help clear the market with its pending buyout).

While a few edtech start-ups have achieved mythical unicorn status (PluralSight, Age of Learning, Udacity), the most logical IPO candidates are established education software companies from a generation prior which all went private over the last 5 years and have yet to re-emerge: Blackboard, Renaissance Learning, Ellucian, and Edmentum.

Yet the IPO markets continue to be highly challenging to both unicorn start-ups (Twilio is really the only enterprise SaaS IPO this year?) and private equity-backed buyouts, and so it seems we will have to look abroad for new market issuances.

Indeed UK based publisher Pearson (LSE: PSO), international higher education play Laureate Education (a 2007 management buyout), and Swiss study abroad platform Education First (family held) remain the world's three largest education companies. But just one of these are publicly held (indeed, Learn Capital's Rob Hutter has highlighted how education represents $4.6 trillion of global spend, yet just $0.1 trillion of global market cap) and none of these are edtech pure plays. (Another Asia based school platofrm Nord Anglia has managed to hold on to a healthy $2.5 billion market cap after its March 2014 IPO).

And so, we have come to a place where a small online English language learning company out of China with $30 million of revenue could get Morgan Stanley and Credit Suisse to lead a tiny $45 million IPO (at the midpoint of the price range on its IPO prospectus) under a grandiose name, China Online Education (51Talk is its more obscure Chinese brand).

With its obscure brand and expected small cap status ($330 million under the midpoint of its price range), its not surprising this IPO has generated scant US market coverage (despite the white shoe bankers involved), but it looks like this is one which would benefit from some more careful scrutiny. A recent Mandarin language report from Whale Media highlighted "six suspicions", of which I have summarized several below:

  • The company's cash burn has increased dramatically with deferred revenue growing even greater while current liabilities alone now exceed total assets, questioning the sustainability of their business model
  • Deferred employee salaries and benefits are high and growing, already exceeding their cash balances suggesting they may be helping bridge operating cash flow issues on the backs of employees
  • VAT payable is growing and appears inaccurate, suggesting some tax compliance issues (an issue that I recall arose in K12's once contemplated acquisition of another language learning business in China some years ago)
  • Increases in gross margin may result less from price increases and more from customer forfeiture / expiration rates, which further highlights the company's less generous refund policies, in contrast to other players in China
  • To support their contention they are the largest industry player, they cite an unsourced and ill-defined Frost & Sullivan report, which reminds me of the edtech start-ups which lazily spout market sizing guestimates from a certain GSV report

During the mid-2000s asset bubble, there were a raft of China education IPOS in the US and their ADR carcasses and trapped cash remain (see OTC penny stocks like CAST, CEU, NED, CEDU, DL, and small caps like XUE, AMBO, ATAI). New Oriental (NYSE:EDU) and TAL Education (XRS) remain the rare exceptions to have maintained healthy billion dollar, mid-cap market capitalizations from that era. Here is hoping that China Online Education (51Talk) will not add to this sorry list.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.