China East Education Shifts Into Conservative Spending Mode

Key takeaways:

• China East Education has revealed it could take as long as 10 years to spend $233 million in remaining funds from its 2019 IPO earmarked for the development of five regional centers
• The company’s conservative spending mode may reflect caution as it awaits results from China’s ongoing overhaul of its private education sector

By Doug Young

What do you do when the outlook for your industry looks extremely murky due to a fast-changing regulatory environment?

Conserve cash. That appears to be the latest tactic at vocational schools operator China East Education Holdings Ltd. (0667.HK), whose latest stock exchange disclosure reveals it’s in no hurry to spend nearly half of the HK$2.9 billion ($630 million) that it raised from its blockbuster IPO in 2019.

China East Education isn’t the only educator holding on to its cash as Beijing rolls out a massive overhaul of the country’s private-sector education sector aimed at easing pressure on stressed-out primary students. Last week Youdao Inc. DAO revealed it was in discussions to sell its after-school tutoring services that account for about a quarter of its business.

No price was given since that deal is still in discussion. But based on a quarter of Youdao’s current market cap of $1.6 billion, the deal could potentially raise as much as $400 million to add to the company’s coffers.

Cash suddenly looks like king in the current education landscape as everyone waits to see how the sector fares under new central guidelines.

One certain thing is that the future landscape will be mostly devoid of after-school tutoring for primary school students since hours for such teaching are being hugely reduced to exclude previously popular times like weekends and holidays. What’s more, companies that offer such classes will have to change to non-profit status, which rules out any listed companies, explaining why Youdao is selling off that part of its business.

All that said, let’s zero in on China East Education’s latest moves as it tries to position itself to survive and even thrive in the new environment. We’ve previously written the company is well-positioned due to its focus on vocational education for adults, teaching skills like IT services and cooking, which are not part of the cleanup.

Still, the company could face some major new competition as many existing companies like Youdao pile into the adult education sector after jettisoning their tutoring for primary school students. Accordingly, China East Education may be slowing down some of its investment plans and holding on to its cash to see how things evolve over the next few years.

China East Education hinted at its new “go-slow” approach in its latest stock exchange filing on Tuesday, in which it disclosed a timeline for the first time for remaining proceeds from its 2019 IPO. Before that, the company had disclosed how it planned to spend the money, though without giving any timeframe.

The biggest chunk of its IPO proceeds, some 45%, was always earmarked for the establishment of five regional centers that would become launch pads for offering its courses in China’s smaller cities where competition was less fierce. The latest filing shows it is taking its time spending that part of its IPO proceeds, giving itself five to 10 years to spend the money. By comparison, it said it plans to spend the rest of its remaining IPO funds in the next three to five years.

Big Bucks

China East Education said in the new filing that the development of regional centers was earmarked to receive 1.9 billion yuan from its IPO proceeds. But it had only spent 417 million yuan of that as of June 30, meaning it still has 1.5 billion yuan left that it can now slowly spend over the next decade.

That figure is roughly half the 3.5 billion yuan that China East Education had in cash as of June 30, according to its interim report.

Investors might do well to look at education companies’ cash positions as the sector moves forward into such uncertain waters. In that regard, China East Education looks fairly well-positioned. The company is one of the few in its sector that is actually profitable, meaning it won’t be under huge pressure to use its cash simply to fund operations.

The interim report released in mid-September showed the company has largely rebounded from the pandemic that shut down most of its schools for a few months in the first half of 2020. Its revenue totaled 2 billion yuan ($310 million) in the first half of the year, up 32% from the first half of 2020. Perhaps more important, the latest figure was also up 10% from the first half of 2019, which is probably a better comparison since it was pre-pandemic.

The company’s school and student enrollment count were also both up about 12% year-on-year in the first half of 2021 to 218 schools and 143,348 students. Its net profit fell 4% to 233 million yuan. But its adjusted profit – which excludes deductions for stock grants to employees – was up 42% to 301 million yuan.

Despite all that, China East Education’s stock has been getting punished with the rest of the sector and has lost more than half of its value from a February peak. The company announced a HK$600 million share buyback in early July, which may have helped to stabilize the price during the tumultuous period. Still, its shares are down about 20% since it announced the buyback.

In valuation terms, the company commands a slight premium over many of its peers, probably reflecting its better position in the current environment. It currently trades at a price-to-earnings (P/E) ratio of 13, compared with 5 for industry leader New Oriental EDU. Hailiang Education HLG, which operates actual primary schools and thus shouldn’t be too affected by the changes, trades slightly lower than China East Education with a PE of 11.

China East Education also has a relatively strong price-to-sales (P/S) ratio of 3.6, ahead of Hailiang’s 2.8 and Youdao’s 1.9, but lower than New Oriental’s 4.3.

At the end of the day, the company should probably be commended for its cash-conservation stance at the moment while all the changes play out. But once the new landscape becomes clearer, investors will probably expect it to get more aggressive with its spending to protect and expand its position as new rivals start encroaching on its turf.