New Oriental: Privatization Bid On Tap?
I have to extend my sympathies to education services provider New Oriental (NYSE: EDU), which seems unable to earn any respect from US investors these days. The company has just reported earnings that look quite respectable to me, after being exonerated last year by the US securities regulator over potentially problematic accounting. And yet despite all that good news, investors have greeted this latest earnings report largely with indifference, leading me to speculate that New Oriental could soon join a growing list of US-traded Chinese firms to privatize. In this particular case, investors seem to have lost interest not only in New Oriental, but also in the Chinese educational services sector, which is being confronted by slowing growth, quality issues and intensifying competition. I’m not an expert on the sector, but a friend in the industry says one of the biggest issues is scalability. While tech companies, especially Internet firms, can often easily boost their scale with little extra costs, the same isn’t true for education firms. That’s because education is a product that requires large fixed costs like classrooms and teachers, which increase proportionally with growing student enrollments.
So all of that said, let’s take a quick look at New Oriental’s latest earnings report that shows its profit and revenue both grew by 25-28 percent in its latest reporting quarter. (company announcement) At the same time, the company also said its student enrollment dipped by 3 percent during that time, and its number of schools in operation fell by about 1.5 percent.
While some might say those latter declines look worrisome, others could argue they reflect New Oriental’s growing focus on quality over quantity. The fact that both its revenue and profits rose by healthy amounts despite the enrollment decline seems to prove that approach is working, with New Oriental reporting that its income from operations rose by 36 percent — even faster than its net profit growth. On top of all this relatively upbeat news, New Oriental also announced a program to buy back up to $50 million worth of its stock.
Despite all that, investors greeted New Oriental’s latest results and share buyback program announcement largely with indifference. The company’s shares initially jumped after the report came out, but later gave back all their gains and actually ended down 1 percent in Wednesday trade in New York.
This latest investor indifference reflects a broader theme that has seen shares of New Oriental and rival TAL Education (NYSE: XRS) languish over the last year. New Oriental shares briefly tanked last summer, losing more than half their value after it disclosed it was being investigated by the US Securities Exchange Commission for potential accounting irregularities. It was later exonerated of any wrongdoing, but its shares currently trade at more than 30 percent below their year-ago levels. TAL shares have struggled as well, now trading 20 percent below their year-ago levels as investors lose interest in the sector.
All of this leads me to my next point, which is that New Oriental may quite possibly be weighing a complete privatization of the company due to this lack of investor interest. The company’s market capitalization is still a bit high at nearly $3 billion, and it would no doubt have to offer at least a 10 percent premium to win shareholder approval of a privatization bid. But the company is also relatively cash rich, with around $800 million in cash and short-term investments. What’s more, private equity firms have shown a recent strong interest in helping to finance such privatizations, believing many US-listed Chinese companies are undervalued at their current prices.
We’ve already seen a number of similar privatization bids by similar firms for similar reasons, with IT services Camelot Information Systems (NYSE: CIS) making the latest such bid. (previous post) I suspect we’ll see New Oriental watch how its stock performs over the next 2 or 3 months, waiting to see if investors react more positively over that period. If they don’t, which seems very possible, I wouldn’t be surprised to see the company launch a privatization bid in the second half of the year.
Bottom line: New Oriental’s new share buyback program could presage a privatization offer if its stock doesn’t make significant gains over the next 2-3 months.
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