Caixin
Apr 03, 2019 10:00 AM
TECH TALK

Could Online Learning Stocks Contain the Next Alibaba?

Chinese online education firms are getting a lesson of their own these days, namely that foreign investors aren’t necessarily buying into their business model of bringing extracurricular learning to the masses. Their stocks in general have been pretty beaten down over the past year for a number of reasons.

Chief among those is regulatory uncertainty, as China’s education ministry gets set to potentially lower the yoke on this ambitious group of companies. Then there’s the issue of hype, since it’s hard to tell which of these companies are simply using run-of-the-mill technology and which have the kind of proprietary systems that could truly change their field.

I won’t pretend to know the answers to the technology question, since that’s something that requires a bit more knowhow and deep research than I’m currently capable of. But I’ll try to provide some of my own thoughts on the sector in general, starting with my view that there’s truly some room for big growth in this space for the company that gets it right.

Having lived in Greater China for more than a decade, I can say with a high degree of certainty that education here is one of the few places where people often take a “spare no expense” attitude — especially when it comes to their children. Hong Kong has taken this to an extreme, to the point where certain private tutors have attained celebrity status in the former British colony.

History has shown that trends in Hong Kong and Taiwan often eventually get adopted on the Chinese mainland, meaning it’s probably only a matter of time before the extracurricular education industry becomes a truly multibillion-dollar megalith. Much of that will be driven by new online technologies that allow for a wide array of classroom formats providing flexibility for everything from timing, level of individualized instruction and provision of services to any place with an internet connection.

But you wouldn’t know about the big potential from looking at stocks or financials of the young crop of Chinese specialists to list these past two years. The broader group has been shunned on Wall Street and in Hong Kong, despite posting respectable growth in terms of revenue and student numbers.

Shares for four of the five companies I studied are down sharply over the last year, by anywhere from 25% for Rise Education Cayman Ltd. and OneSmart International Education Group Ltd., to as much as 63% down for Puxin Ltd. The only company to escape that trend has been Koolearn Technology Holding Ltd., which was up around 8% midway through the Tuesday trading session. But that’s only because the company just listed its shares in Hong Kong last week, and Chinese shares in general have rallied sharply since then.

Real or imagined?

All that said, let’s look more closely at these companies’ financials, and also zoom in on the two bigger factors that have investors most concerned: the potential for regulation and also the quality of their technology.

In terms of growth, most of these firms are reporting revenue rising in the relatively strong double-digits, mostly from 25% to 45% annually. Student enrollment is growing at similar rates, mostly in the 30% to 50% range. Those numbers actually don’t look that impressive for such early-stage companies, which are still relatively small. The largest in terms of revenue, OneSmart, posted relatively modest annual revenue of about $430 million for all 2018.

But if China has taught me one thing, it’s that that strong double-digit growth is possible for some companies for many years, even after they become quite large. I once dismissed the rapid growth of the duo of Alibaba and Tencent as unsustainable, saying it would inevitably stop once they reached a certain size, say around $1 billion in annual revenue. But fast forward to the present, when Alibaba Group Holding Ltd. posted 40% revenue growth in its most recent quarter and Tencent Holdings Ltd. notched a respectable 28%, despite each already attaining huge scale of tens of billions of dollars in annual income.

Of course whether or not any of these companies can become a future Alibaba or Tencent is debatable. At the very least some of the best players should be able to post strong growth for the next decade, which could ultimately value them quite highly.

Then there are the two questions of regulation and technology. For the former, we know that new rules are on the way because the education minister said so on the sidelines of the annual National People’s Congress last month. The logic is quite clear, namely trying to tame an industry that is stealing the childhood from millions of young Chinese whose overzealous parents are forcing them to take extracurricular lessons in most of their waking hours outside of school.

I’ve seen this kind of regulation before, and it usually ends with shadier fringe companies being removed, with more mainstream ones left largely intact. That means that most of these big overseas-listed firms aren’t likely to suffer any major long-term damage from the regulation.

The technology issue is more of a question mark. An investment contact who delves into these things in more detail said that even his firm has found these companies tough to understand.

“We’ve looked at some of those, especially those that claim to use artificial intelligence and big data, and it is really hard to see what actually works,” he said. “That is the toughest thing to verify. Does the technology actually do what it says?”

At the end of the day I do believe there’s some nice money to be made in this space despite the currently weak investor sentiment, and that perhaps the next Alibaba-in-the-rough is just waiting to be found. But finding that next internet sensation will require some spadework from investors, and it’s quite possible the company with the right formula hasn’t even hit the market yet.

Doug Young has lived in Greater China for two decades, including a 10-year stint at Reuters, where he led China corporate news coverage. Send your questions or comments to DougYoung@caixin.com

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