17 Education Becomes Latest China Stock To Soar as Investors Sniff for Bargains

Key Takeaways:

• 17 Education appears to be the latest U.S.-traded China concept stock to be attracting new investor interest, with the company’s shares soaring 70% over the last week
• Other Chinese companies showing similar major gains this month include Hello Group and Gaotu Techedu, reflecting improving sentiment toward the beaten-down group

By Doug Young

First it was the march of the China meme stocks, a group of small, obscure Chinese companies whose shares suddenly soared, and then crashed, earlier this year in a speculative trading frenzy. Now a 2.0 version of that phenomenon is emerging, only this time the latest big share gains for a new group of soaring U.S.-listed Chinese stocks may actually be sustainable.

Education services provider 17 Education & Technology Group Inc. YQ has become the latest stock to get caught up in the new buying frenzy. The company’s shares are up 70% over the last five days, including a 29% jump on Friday and another 32% gain on Monday.

Trading volume for the company’s American depositary shares (ADSs) was huge over those two days, with a combined 2.5 million ADSs changing hands. That compares with an average trading volume of around 100,000 ADSs on ordinary days, and equates to about 5% of the company’s stock changing hands over the two-day period.

We wrote about something similar two weeks ago when shares of dating app operator Hello Group Inc.MOMO soared nearly 30% in a single day on trading volume that was about 10 times its average after the company released a ho-hum financial report. The company’s stock is now up 56% since the results announcement, following another big rally the day after the initial jump.

We’ve noticed big jumps for other U.S.-listed Chinese companies recently following similar patterns of large gains over a day or two on heavy trading volume, despite no major news. Those include two other education companies Gaotu Techedu GOTU and iHuman IH, whose ADSs are up 95% and 41% over the last week. News app operator Qutoutiao QTT is up by a similarly strong 57% over the last two weeks.

So, what’s going on?

When we wrote about the big jump for Hello Group last week, we said the big gains probably reflect a major new investor taking a position in the company. Such investors are probably smaller institutional buyers, not big names like Morgan Stanley or Blackrock, which are largely prohibited from investing in these companies due to their small market values. What’s more, most of these new investors are probably limiting their stakes to below the 5% threshold above which a public disclosure is required.

That said, the next questions we should examine are why is this happening now, and will it continue?

The answer to the first seems directly tied to the extremely low valuations many of these companies now trade at, following huge declines in their shares over the last year and a half that sometimes wiped off more than 90% of their market value. Those declines were spurred by two major factors: regulatory crackdowns in China, especially in certain sectors like education; and U.S.-China frictions that saw the U.S. securities regulator threaten to kick more than 200 Chinese stocks off U.S. exchanges unless China allowed better access to those companies’ auditors.

Issues resolved

The two big issues overhanging most of these Chinese companies appear to be largely resolved now. Growing sign are emerging that China’s regulatory clampdowns of the last two years are largely finished, and that the government could even start to become friendlier to private companies in general as it tries to jumpstart the country’s sputtering economy.

At the same time, the de-listing threat appears to be rapidly fading following the August signing of an information-sharing deal between the U.S. and Chinese securities regulators giving the U.S. Securities and Exchange Commission (SEC) the access to Chinese companies it was seeking. That issue saw a major positive development late last week when the SEC’s accounting arm issued a progress report saying it had received “complete access” to the information it wanted in an initial round of company inspections in Hong Kong.

With those two overhangs rapidly receding, investors seem to be trying to guess which of these smaller, undervalued companies have the strongest finances, and are best positioned to bounce back. That brings us back to back to 17 Education, which is part of a broader group of educators that were subject of one of the harshest regulatory crackdowns last year.

The company listed at the end of 2020, not long before the crackdown that was rolled out in September last year and banned companies from offering after-school tutoring services in core curriculum areas to K-12 students. 17 Education announced at the start of this year that a whopping 94% of its revenue came from areas that were banned under the new rules.

As its business of providing customized tutoring services to K-12 students evaporated overnight, the company – like most of its peers – has shifted to a new business model. In this case, 17 Education is now targeting its services at school districts and educators rather than students, helping them in areas like class preparation and delivery, homework-related activities and academic assessment.

The new formula appears to be gaining some initial traction. The company’s latest quarterly report released two weeks ago shows its revenue tumbled 75% in the third quarter year-on-year to 124.6 million yuan ($17.9 million), as it lost its core K-12 business. But excluding that K-12 business, the latest revenue actually represented a more than six-fold jump from the 19.2 million yuan in revenue a year earlier for the non-K-12 business.

What’s more, 17 Education seems to be a relatively well company, at least based on its profitability. The company reported a non-GAAP profit of 8.3 million yuan in the third quarter, representing its fourth consecutive quarter of profitability on that basis. Its gross margin also showed huge improvement, rising to 74.5% in the latest period from 49.4% a year earlier.

Even after the recent big jump in its share price, 17 Education’s stock only trades at a price-to-sales (P/S) ratio of 0.55, which is far less than the 0.9 times for the similarly small iHuman and well below ratios of 1.8 and 2.3 for the much larger Gaotu and New Oriental Education EDU, respectively. With those kinds of positive company-specific and macro trends, it’s not a huge surprise why at least one major investor may see some big potential upside for 17 Education’s stock.