New Oriental Education
-- >>> School's Out, And So Are Chinese Education Stocks
By now, I’m sure you’ve heard all about the rigors of China’s national sports system that snatches up supple young kids and grinds out Olympic champions. How these young athletes are isolated from their family and pushed to the brink by grim-faced coaches who focus solely on medals, not child welfare. Here’s a typical account from a Chinese gymnastics camp. Actually, this story predates the Beijing Olympics, but could easily run again with a few tweaks (and possibly has). And, while doping allegations against record-breaking swimmer Ye Shiwen are pure speculation at this stage, press coverage of her training regime hits on some familiar themes. The sub-headline in this story by Britain’s Daily Mail hammers it out: ‘How Chinese children are taken away from their families and brutalized into future Olympians’.
No doubt, being selected for China’s elite sports academies is the end of a carefree childhood. But non-athletes in China have it equally hard. From grade school onwards, students face intense pressure to succeed in standardized tests that can make or break their academic career. Flunk a test and you don’t get into a good middle or high school. That makes it harder to ace the university entrance exam. Aiming for overseas universities? More tests, more prep. At every step of the way, afterschool and weekend crammer classes await. Most parents dig deep to give their child (usually only one) the best chance at success, which is why education ranks second only to property in discretionary spending in China ($140 billion in 2011).
This should mean rich pickings for China’s for-profit education companies, several of which are listed on U.S. exchanges. Instead, they’re struggling to prop up crumbling share prices. The falls are precipitous: shares in New Oriental Education (EDU) are down 53% since the start of the year, slashing its market cap to $1.7 billion. New Oriental is China’s most famous tutoring school. Its founder Michael Yu was previously worth over $1 billion. Not any more. Over the same period, Ambow Education (AMBO), which coaches both university and grade-school students, has lost 60% of its stock value.
Many Chinese stocks have suffered sell-offs this year as it becomes clear that the economy is slowing down, perhaps more sharply than anticipated. But nobody seems to think that Chinese parents are about to stop paying for afterschool classes. You could argue that education is the last household expense to get the chop if times are tough. What ails these stocks is a lack of confidence in their bookkeeping. U.S. investors are running scared from Chinese stocks seen as tainted by accounting scandals. Last year it was ChinaCast Education, a scandal-ridden tutoring outfit. Now New Oriental and Ambow are in the dock of public opinion, accused of playing fast and loose with their profits (both deny the charges). Investors have begun class-action lawsuits, cheered on by short-sellers like Muddy Waters.
A structural problem also plagues education stocks. New Oriental said recently that it’s being investigated by the S.E.C. over its corporate structure, which has features common to many Chinese companies that listed on Nasdaq since 2000. Known as a V.I.E., it’s a way around China’s restrictions on foreign ownership in sectors like book publishing, online commerce and private education. Many private companies use it to list overseas, but it’s not watertight, says Paul Gillis, a professor of accounting at Peking University who blogs on this and other issues pertinent to investors in Chinese stocks. “It’s workaround to do what is prohibited under Chinese law.”
Which is fine, as long as companies don’t run into trouble and investors don’t expect Chinese courts to enforce proxy shareholder rights. So, right now, investors are spooked by the risk. But they also want exposure to China’s dynamic online economy, which means holding V.I.E.-structured stocks like Baidu and Sina. Gillis says the S.E.C. has pushed for greater disclosure of these structures so that investors understand what they’re buying. What used to be a brief passage in a prospectus now runs to five pages of legalese. Of course, this doesn’t protect investors from cases of outright fraud like ChinaCast. Nor does it solve the puzzle of what to do with illiquid Chinese stocks that are now worth less than their IPO price. Some may get taken private. Or delisted, which is even more embarrassing.
This raises a wider question about China’s transition to market capitalism. Why are entrepreneurs going overseas to raise capital when there’s so much sloshing around at home? The short answer is that China’s stock exchanges can’t keep up with the pace of private enterprise. Regulators operate an informal quota that restricts the number of domestic IPOs. “So many good companies want to list in China. They have the luxury to be selective,” says Xu Dingbo, associate dean at the China Europe International Business School in Beijing. For their part, domestic retail investors are fearful that too many IPOs will drag down the overall market. So they don’t mind when private companies go overseas, trying to get higher valuations by sating foreign demand for Chinese growth stories. Now that pipeline to Nasdaq has run dry. But China’s capital markets aren’t ready to pick up the slack.