New Oriental Education & Technology Group

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

New Oriental Education & Technology Group is a leading provider of private educational services in China, primarily focusing on test preparation, language training, and online education.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

New Oriental Education and Technology Group (EDU) has significantly shifted its business model to focus on non-academic tutoring after regulatory changes imposed in China.

Business Overview

New Oriental Education & Technology Group (EDU), previously a leading provider of private educational services in China, has undergone a significant transformation following regulatory changes targeting the after-school tutoring sector. The company now primarily operates as a non-academic tutoring and educational services provider. Let’s break down its current business:

Revenue Distribution

  • Educational Services and Test Preparation Courses: While test preparation remains a core offering, this segment is no longer the primary source of revenue. The company now offers test preparation primarily for overseas test, vocational training, and some professional skill education. These courses are offered in a variety of locations both online and in-person. The largest number of centers are in Beijing, and Shanghai.
  • Online Education Services: The company has expanded its online learning platforms, offering a range of courses. Most prominently, the company has the Koolearn platform. They offer courses to a number of universities, and also online content and interactive products.
  • Overseas Study Consulting Services: This segment provides counseling services and products to students wishing to study abroad.

The private education sector, especially after-school tutoring, has faced major headwinds due to regulatory scrutiny in China. The “Double Reduction” policy, which aimed to alleviate academic burden on students, drastically reshaped the industry by prohibiting for-profit tutoring related to core curriculum subjects. This caused a massive consolidation of the market, and forced the closure of a large number of private tutoring companies. As a result, the surviving businesses have had to re-evaluate their revenue models.

This disruption has forced companies to look at more innovative business practices. Many firms have expanded into non-curriculum tutoring, STEM fields, and professional training, along with an increased focus on international students looking to get into prestigious universities abroad.

Competitive Landscape

The Chinese education market is highly competitive, featuring many domestic and international players, however, as the government regulates more of the sector. The big players in education all have a national or international presence, and while local competitors are abundant, they are much smaller. In addition, many of the biggest schools are state owned and have the best reputation in many fields.

  • Domestic competitors that compete in specific niche markets or offer unique education or enrichment programs
  • International competitors that have a strong brand recognition and established international student markets

What Makes New Oriental Different

  • Established Brand: Despite a major restructuring, New Oriental still holds a large brand. Many still view it as a high-quality school. Many of the newer companies do not have that established prestige and recognition.
  • Online presence: The company already had established online infrastructure and programs, so they were in a better position to move more of their business online and adapt to the changes.
  • Large Network: Many physical centers are located in different regions in China.

Financials

EDU has seen a significant transformation in its business. Revenue has declined as it changes business model, however, profitability has risen.

Balance Sheet Health: 4/5

  • Liquidity: The company’s cash balance is $2.872 billion, while short-term debt is $216.1 million. This shows that they have enough cash and liquidity to fund their day to day operations. Therefore, they get a 5 rating.
  • Debt Levels: Total Debt (which includes long-term liabilities and other liabilities) is 4.227 billion, which is about 40% of their overall assets (10.533 billion). The company has relatively moderate levels of debt. For that they get a 4 rating.

Income Statement

  • Revenues: Revenues decreased by 6.8% over the fiscal year ended May 31, 2022 from the year prior. However, education services decreased by 19.4% while studying abroad rose 28% year on year. Revenues have been on the decline in the past few years as they transitioned from K-12 tutoring.
  • Margins: Gross profit has risen from 24% in 2021 to 47% in 2022. However, since SG&A has also risen, and other expenses have risen, net profit margin is around 2.6%, an increase from 2021.
  • Net income: While losses have narrowed substantially, with a gain of 28 million in 2022.

Cash Flow

  • Operating Activities: Net cash from operations was a positive 762 million in 2022, an improvement over previous years when it was negative.
  • Investing Activities: This segment is heavily negative in cash flow because the company was continuing its restructuring.
  • Financing Activities: Net cash is a negative 421 million due to large debt repayment.

As more information comes in, cash flow can be used to assess the long term viability and sustainability of the business.

Moat Analysis: 2/5

  • Intangible Assets: Although the brand name is recognizable, it does not create a true pricing power advantage. There are plenty of education companies in the region that will be able to do the same or similar things, thereby limiting its pricing power.
  • Switching Costs: Switching costs are low, most students can choose another company or service provider without much hassle or negative consequences.
  • Network Effects: Very little network effect, because it is not a business where adding other users to the platform or network increase overall profits or attractiveness.
  • Cost Advantage: Low levels of operational efficiencies and high fixed costs means there is very little cost advantage
  • Regulatory Moat: Government regulatory approvals are needed to teach specific curriculum, but those do not establish a moat, because they are able to be acquired by other companies in the market. In addition, the government has put in place strict regulations to limit profits in this area.

Moat Rating: 2/5: Overall there seems to be very little sources of competitive advantage, and even those are weak.

Risks That Could Harm the Moat

  • Regulatory Risk: Further changes to the regulatory environment could severely impair the business model, or the company’s current lines of business.
  • Economic Risk: If the Chinese economy falters, then families are less willing to spend on tutoring services.
  • Competitive Risk: Competitors in the region can quickly copy their style of business, as they do not have strong sources of competitive advantage.
  • Technology disruption: New technology may make the services the company provides obsolete.
  • Geopolitical Risk: The continued geopolitical tension has a large impact on Chinese businesses, and more scrutiny may come from the USA.

Business Resilience

  • The company has been able to change its business model fairly quickly, and seems to be headed in the right direction.
  • However, in the long term, it still needs to be seen whether the company can create a more durable source of competitive advantage.
  • The management team, after undergoing this massive restructuring, has a track record of quickly changing the business model. It is too early to ascertain how that will perform in the long term, but it is promising.

Understandability: 2/5

  • The business model is complex and has had many changes over the last few years. It can be hard to understand the new structure of business, and how it has shifted.
  • In addition, it may be hard to understand the impacts of the Chinese government on the regulations.

Overall, New Oriental has gone through an entire transformation from a tutoring company to a non-curriculum school. The company’s future is hard to know, but there are glimmers of good results in the latest reports.