Private Schools Prepare Chinese Students For Life-Altering Exam
Monday June 23, 6:20 pm ET
Miho Nagano
New Oriental knows that it takes three key ingredients to realize the Chinese dream: a college degree, English skills and an overseas MBA or Ph.D.
China's biggest private education provider also knows that today's Chinese parents will do almost anything to give the first two to their sons and daughters.
In China, only 12% of high school graduates can be accepted to a four-year college. In order to get into a prestigious university, students need to score high on a standardized test called gaokao, the single most important measurement of admission. If they do badly on the gaokao, many students -- often driven by parents -- won't hesitate to devote an entire year to studying in order to retake the exam.
Gaokao test takers and retakers, some 10 million students, are the latest targets of New Oriental Education & Technology Group (NYSE:EDU - News). The Beijing-based educational giant has been offering English training and classes for adults and children in 35 cities nationwide in China. It's now aggressively expanding into the gaokao test-prep business. New Oriental estimates the market at $10 billion.
Testing Is Destiny
"Gaokao is called the life-determining test," said Louis Hsieh, CFO of New Oriental. He says the test score at age 18 not only determines students' future career path and pay scale, but also how well their parents and grandparents could live in their golden years.
Due to China's one-child policy, "six adults, including parents and grandparents, are focusing on one child's future" Hsieh said.
In less than a year offering gaokao prep classes for English, math, Chinese, physics and other subjects, New Oriental has managed to get 8,000 students into gaokao prep. The company recently bought a Beijing boarding school, Mingshitang, which specializes in tutoring gaokao retakers.
Retaker parents might spend up to $2,000 a student per year for the prep, which is highly profitable.
But how can New Oriental, which established a strong brand as an English school, achieve high enrollment for non-English subjects such as physics and chemistry?
"If a student is a retaker, parents are already paranoid," Hsieh said. "They already trust us for English. They don't want to start with a brand-new name."
Hsieh says New Oriental contracted with one of the best science high schools in China to share science content materials.
Also, the timing was right. Recently, the Chinese government prohibited public-school teachers from teaching after-school gaokao prep on school property. The regulation helps New Oriental, says analyst Trace Urdan of Signal Hill.
New Oriental hired many of those public-school teachers as part-time gaokao instructors. Including them, the company added 1,700 employees in 24 cities in fiscal 2008.
Enrollment reached 1.3 million in 35 cities. Compare that with the biggest U.S. educator, Apollo (NasdaqGS:APOL - News), operator of the University of Phoenix, which has 300,000 students.
New Oriental has taken nearly 15 years to achieve 1 million students since Michael Minhong Yu, a former Peking University English teacher, opened the school in 1993. CFO Hsieh says New Oriental should reach 2 million students in the next three years.
But with rapid growth, how can the education giant maintain teacher quality and continue to recruit talent?
That's the biggest challenge, Hsieh says.
William Blair analyst Brandon Dobell agrees. "It's tough to find good teachers," he said. "If they are good, they could leave New Oriental and start their own schools."
Hsieh says New Oriental hires fewer than 1 in 10 applicants. The company says it only hires the best and brightest of Chinese who have earned overseas degrees, especially for classes that prepare students for English standardized tests like the TOEFL and the GRE, a measurement for admission to overseas colleges.
But that's not enough, Hsieh says. The school trains its teachers to be inspirational and possess an engaging and dynamic style. "They are like actors," Hsieh said, "very energetic and charismatic."
Star instructors teach students how to score high on English exams, and they send a message that fluency in English and a global perspective backed by overseas degrees are the tickets to the highest-paying jobs in today's China.
For those teachers, a class is typically filled with 400 students. No wonder overseas test prep is New Oriental's most profitable segment. Evaluations by students determine teacher bonuses. Out of 3,100 total teachers, the top 400 get stock options.
The best teachers get more classes and try to please students, while poor teachers leave. "That's exactly what we want," Hsieh said.
New Oriental's teaching style differs from U.S. rivals -- such as Princeton Review (NasdaqGM:REVU - News) and Kaplan, a unit of the Washington Post Co. (NYSE:WPO - News) -- that also teach test preparation. Princeton Review and Kaplan classes are quiet. Students often wear headphones, says analyst Dobell.
Signal Hill's Urdan hears rivals criticize New Oriental's method as not necessarily valid, but he says New Oriental has "a strong sense of what Chinese consumers want."
The company opened 19 schools and learning centers in 2007. This year, it's adding 60 schools and centers. Next year, it plans to add 45 schools and centers. Meanwhile, third-quarter marketing expenses jumped 90.8% compared with year-ago levels.
"Costs are going up tremendously," largely due to rising real estate costs and wage inflation, according to Shaun Rein of China Market Research. He says margins could be hit hard.
Operating margin in the third quarter was 21%, flat vs. the year-earlier quarter. Third-quarter EPS rose 32% to 29 cents, beating views by 6 cents. Revenue surged 47% to $48.1 million, above views. Student enrollments surged 35% to 268,400 during the quarter.
Olympics, Earthquake
The impact of the Beijing Olympics and the Sichuan earthquake could trim $2 million in revenue from Q1, the summer quarter, says analyst Mark Marostica of Piper Jaffray. The summer quarter usually generates more than 35% of New Oriental's revenue.
Still, New Oriental is optimistic. It costs about $500,000 to set up a school. But to set up children's learning centers, which are satellite branches in local areas offering mostly English classes for kids, the cost is one-fifth that. "We pay them off in six months," Hsieh said.
At those small learning centers, teachers don't have to be showmen, analyst Urdan says. Unlike star teachers, they are mostly part-time.
In China, founder Yu is known as the godfather of English education. New Oriental alums are now working at many major U.S. companies, and when they return to China, they send their children to New Oriental, Hsieh says.
The goal is to become a partner with those children from age 5 to 30, he says.
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