China’s crackdown on online education could crush these 3 actions

Over the past year, many of China’s top online education actions have skyrocketed as more students took online classes during the pandemic. However, most of those stocks fell apart this year due to three main challenges.

1. Chinese regulators have cracked down on the industry. They claimed that educational companies used predatory sales tactics, put too much pressure on students, and exacerbated the wealth and education gap between rich and poor families. To address these issues, the Chinese Ministry of Education would like to create a dedicated government division to oversee all private education companies.
2. Many tech stocks have fallen in recent months as investors shifted from growth stocks to value stocks.
3. Persistent delisting threats in the United States have made Chinese tech stocks even less attractive.

These headwinds won’t abate anytime soon, so investors should avoid three stocks in particular – New oriental education (NYSE: EDU), NLP Education (NYSE: TAL), and Gaotu Techedu (NYSE: GOTU) – until China clarifies its plans for the education sector. Let’s find out more about them.

1. New oriental education

New Oriental Education was founded 28 years ago, making it one of the oldest education companies in China. It was also the first Chinese education company to go public in the United States in 2006, and remains a major player in terms of students and income. New Oriental operates language schools, learning centers and bookstores. Most of its income comes from its K-12 tutoring services, and it has expanded into online education services over the past six years.

New Oriental’s revenue growth looks decent. Its revenue grew 10% year-over-year in the first nine months of fiscal 2021, while the total number of students enrolled rose 18% to 9.44 million. But its adjusted net income was down 4%, mainly due to higher marketing spend and promotional offers.

It expects its revenue to increase by around 17% for the full year, while analysts expect its adjusted profit to decline by 3%. But next year, analysts expect its revenue and profits to grow 33% and 52% respectively, as more students enter a post-pandemic world.

Unfortunately, these estimates are no longer reliable due to regulatory challenges. It’s the best house in a bad neighborhood, but it still can’t be considered a good deal at 18 times the profits eventually.

2. NLP education

TAL was founded almost 18 years ago and went public in the United States in 2010. It also primarily provides after-school tutoring services to K-12 students.

TAL’s revenue grew 37% in fiscal 2021, which ended in February, and its adjusted net income grew more than 11 times year-over-year. But unlike New Oriental, which is still profitable, TAL remains unprofitable on a GAAP basis, and its net loss actually widened last year.

The average number of quarterly student registrations at TAL for long-term “normal-cost” courses increased 54% to 4.67 million for the full year. This growth, which excludes its promotional offers, was mainly driven by strong demand for its e-learning services.

Analysts expect TAL’s revenue to increase 37% this year and its adjusted profit to nearly quintupl. These are impressive growth rates for a stock that trades at just 16x futures earnings – but regulatory headwinds are still too intimidating to ignore.

In addition, short sellers have previously accused TAL of publishing fraudulent real estate transactions to boost its pre-tax profits. TAL has repeatedly dismissed the allegations, but the allegations could yet reappear and trigger further short-seller attacks on the company as regulators continue to strangle the industry.

3. Gaotu Techedu

Gaotu Techedu, formerly known as GSX Techedu, was also a popular target for short sellers, who claimed to have inflated its student and income numbers. The accusations sparked an SEC investigation against the company last October.

But at the same time, Gaotu has remained a popular growth stock for institutional investors like Archegos Capital. Gaotu initially resisted attacks from short sellers, but the collapse of Archegos Capital in late March torpedoed the stock. The sell-off, along with regulatory challenges and the market’s disgust for Chinese tech stocks, has caused Gaotu’s stock price to drop nearly 75% this year.

By comparison, New Oriental and TAL’s stock prices have fallen by around 60% and 70%, respectively, since the start of the year.

Gaotu was founded just seven years ago and went public in the United States in 2019. Unlike its older peers, it was built from the ground up as an online education company. It generates most of its billing from its K-12 students, but it also provides other online educational services for older students and adults.

Gaotu’s revenue soared 237% in fiscal 2020, but he ended the year with a net loss. Rising infrastructure costs, promotions and fierce competition all weighed on its results.

Analysts expect its revenue to grow 52% this year with a larger loss. Again, Gaotu shares may look cheap at twice this year’s sales, but they likely won’t attract any value-seeking investor.