New Oriental Eyes Chip Design, China Liberal Chases Higher Education

Key Takeaways:

• New Oriental Education’s potential move into chip design is one of many major new initiatives as it tries to transform after last year’s private education sector cleanup
• The company’s move into chips, if it comes, could get a boost from recent strong government support for China’s chip sector

By Doug Young

We’ll begin the week with a couple of items from the embattled education sector, which has largely gone silent these days after a massive cleanup that saw many lose the lion’s share of their revenue. That’s left most companies trying to figure out how to move forward over these last few months. Many smaller names look set to shut down completely, while larger ones with more resources are trying to retrench by focusing on areas where they’re still allowed to do business.

On that front, a new report reveals that industry veteran New Oriental Education & Technology Group Inc.EDU may be preparing to dip its toe into semiconductors, which is about as hot right now as education is cold in terms of investor interest. Meantime, the much smaller China Liberal Education Holdings Ltd. CLEU has announced it’s close to sealing a deal to acquire two private universities.

To recap quickly, China’s private education sector was essentially barred from offering after-school tutoring services in core curriculum subjects to most elementary and high school students starting last September, under an overhaul known locally as “double reduction.” That dealt a huge blow to companies like New Oriental, which estimated that such courses for K-9 students accounted for 50% to 60% of its revenue in the last couple of years.

Actual elementary and high school operators, such as the now-privatizing Hailiang Education HLG, were also affected by new restrictions limiting their business. By comparison, operators of private adult vocational schools and universities appear to be among the least affected, though that could change at any moment.

Against that backdrop, we’ll begin with the latest move by New Oriental, which hasn’t released any quarterly financial reports for nearly a year now but is preparing to release results for the six months through last November on Tuesday after markets close in Hong Kong. Instead it has released a steady series of updates on the education cleanup, and last month said in a Hong Kong Stock Exchange filing it expects to report a loss of $800 million to $900 million for six months through November last year, reversing a $228.6 million profit for the year-ago period.

That warning shouldn’t come as a surprise, since previous media reports have said the company’s revenue plunged last year as it exited the K-9 education business. They also said it incurred a whopping 20 billion yuan ($3.16 billion) in costs related to laying off 60,000 employees and canceling leases for many of its classrooms.

To put that in perspective, in its last financial report a year ago the company said it had about $6 billion in cash, term deposits and short-term investments at the end of February 2021. So that means it most likely had to spend about half of that cash pile on costs associated with the cleanup.

While all that sounds quite negative, we could also be more positive and note that New Oriental should still have a war chest of roughly $3 billion left to try and reinvent itself. It’s been looking around at a broad array of options, and previous media reports said it had set up around 90 new companies since last July, from stationery and agricultural products sellers to artificial intelligence software developers.

Chip designer?

That brings us to the latest news, which has media saying the company has just set up a semiconductor chipmaker called Taiyuan Design Future Technology Co. Ltd., citing a national registry for new companies. The company has registered capital of 1 million yuan and will engage in the design, manufacture and sales of semiconductor microchips, according to the filing.

While this particular move may sound odd to a westerner, it actually makes some sense within China. The country is currently on a mission to build up its domestic chip industry, and urgency for the drive has increased over the last three years following U.S. steps to withhold important related technology from China’s chip sector.

Accordingly, huge amounts of government money have become available to anyone with even just a modicum of credibility entering the space. In this case, the new company is located in the interior city of Taiyuan, capital of the relatively backward Shanxi province that is better known for its coal production than high-tech prowess. That means the local government could very well heavily subsidize this particular venture to the tune of tens or even hundreds of millions of dollars if New Oriental decides to move forward with it.

Of course, microchips are quite a different business from education. But having built up a huge and very successful private education company before the clampdown, New Oriental has shown itself quite capable of building up a new business. So, we’ll have to wait and see how serious it is about that potential new direction.

We’ll close with the news from China Liberal Education, which is a relative education minnow with a market cap of just $12 million and annual revenue of about $5 million. The company provides software and other services mostly to universities, which, as we mentioned above, weren’t the focus of the latest reforms.

The company now looks set to play up that business by purchasing a couple of private universities with a combined 4,200 students for $60 million – five times its current market cap, according to an update issued last week of a deal first announced in early February. That deal is expected to close in May, which could sharply raise the company’s revenue.

Current price-to-book (P/B) ratios may be the best measure right now for comparing how investors see this group of companies, since revenue and profit have become quite volatile in the current climate. New Oriental currently trades at a lowly P/B of 0.5, which is roughly comparable to similarly veteran peer TAL Education TAL. China Liberal trades at a miniscule P/B of just 0.27, while the more tech-focused Gaotu Techedu GOTU is a relative investor favorite with a P/B of nearly 1.

Shares of China Liberal have rallied 8% since it first announced its plan to purchase the two universities, and New Oriental has rallied by an even stronger 20% from a 10-year low in late January. Such signals may hint that spring could be just around the quarter for this beaten-down sector, at least for companies that have the best prospects for survival.