HK/China Equity Long-Short

Osbert Tang, CFA

Equity Bottom-Up

We highlight that <a href="https://www.smartkarma.com/entities/china-east-education-holdings" target="_blank" data-smartkarma-citation="entities:27843:1" rel="noopener">China East Education (667 HK)</a>, given its focus on vocational training, is an off-target victim of the government's regulations on the Private Education Sector and the "Double Reduction" policies. We think it will ride on government's latest supportive measures on vocational training; and with its schools providing training in culinary arts, IT &amp; Internet Technology and auto services, China East will benefit from the shortage of skills workers in China. Also, unlike K-12 education, private participation in vocational education is very encouraged by the government. China East's good post-COVID recovery can be demonstrated by the sharp rebound in student number and stable tuition fees in 1H21. With 90% of students enrolling in long-term program, it has good revenue visibility. We like its sound financial position - Rmb3.5bn net cash, and consideration of shareholder value - bought back nearly 14m shares in Jul and Aug. While valuations are high in absolute terms, China East is clearly another interesting name in the sector after our preferred play <a href="https://www.smartkarma.com/entities/china-education-group-holdin" target="_blank" data-smartkarma-citation="entities:18218:1" rel="noopener">China Education Group (839 HK)</a>.

We highlight that China East Education (667 HK), given its focus on vocational training, is an off-target victim of the government's regulations on the Private Education Sector and the "Double Reduction" policies. We think it will ride on government's latest supportive measures on vocational training; and with its schools providing training in culinary arts, IT &amp; Internet Technology and auto services, China East will benefit from the shortage of skills workers in China. Also, unlike K-12 education, private participation in vocational education is very encouraged by the government. China East's good post-COVID recovery can be demonstrated by the sharp rebound in student number and stable tuition fees in 1H21. With 90% of students enrolling in long-term program, it has good revenue visibility. We like its sound financial position - Rmb3.5bn net cash, and consideration of shareholder value - bought back nearly 14m shares in Jul and Aug. While valuations are high in absolute terms, China East is clearly another interesting name in the sector after our preferred play China Education Group (839 HK).

China East Education (667 HK): Riding on Government's Push for Vocational Schools

Asset Allocation & Fund Positioning, Copley Fund Research

Steven Holden

Asset Allocation & Fund Positioning

Copley Fund Research

Copley Fund Research provide research and data on asset allocation among Global and Emerging Market equity funds.  The analysis details absolute and relative positioning across countries, sectors and industries together with highly granular data on single stock and single fund allocations.  The data is updated monthly with time series going back to January 2011.

Global Research - Analysis of 165 prominent Global equity funds, combined AUM $335bn
GEM Research - Analysis of 127 prominent global EM equity funds, combined AUM $250bn

Asset Allocation - Global and GEM Equity

Thematic (Sector/Industry)

We look in to the recent collapse of Consumer Discretionary allocations among active GEM managers.Consumer Discretionary allocations have dropped down to 3rd in the sector rankings among active EM managers.  Average weights stand at 14.1%, in line with the benchmark with just under half of the 247 managers in our analysis overweight the benchmark MSCI EM Index.  Over the period 10/31/2020 to 09/30/2021, average holding weights dropped by -4.99%, the most of any sector.Analysis of stock positioning changes over the same period reveals the bulk of the decline was caused by one stock, <a href="https://www.smartkarma.com/entities/alibaba-group-holding-ltd" target="_blank" data-smartkarma-citation="entities:787:1" rel="noopener">Alibaba Group (BABA US)</a>, with average holding weights falling by 4.04%, outflows of $2.26bn and 5.2% of funds closing positions.  Other contributors on the negative side were the educators, with <a href="https://www.smartkarma.com/entities/new-oriental-education-technology-group" target="_blank" data-smartkarma-citation="entities:32210:1" rel="noopener">New Oriental Education &amp; Technology Group (9901 HK)</a> and <a href="https://www.smartkarma.com/entities/tal-education-group" target="_blank" data-smartkarma-citation="entities:1124:1" rel="noopener">TAL Education (TAL US)</a> losing 18% and 12.6% of investors respectively.  Despite these closures, <a href="https://www.smartkarma.com/entities/alibaba-group-holding-ltd" target="_blank" data-smartkarma-citation="entities:787:1" rel="noopener">Alibaba Group (BABA US)</a> remains by far the most widely held stock in the sector, with 78.5% of funds holding a position at an average weight of 2.54%, though only 35.2% of managers are overweight the benchmark.  Widely held though it is, Alibaba's relevance in the sector has been hugely diminished.  At its peak, average holding weights in <a href="https://www.smartkarma.com/entities/alibaba-group-holding-ltd" target="_blank" data-smartkarma-citation="entities:787:1" rel="noopener">Alibaba Group (BABA US)</a> across the 247 active funds in our analysis stood at 6.57%.Analysis taken from our EM research, covering 247 active GEM funds with combined AUM of $500bn

We look in to the recent collapse of Consumer Discretionary allocations among active GEM managers.Consumer Discretionary allocations have dropped down to 3rd in the sector rankings among active EM managers.  Average weights stand at 14.1%, in line with the benchmark with just under half of the 247 managers in our analysis overweight the benchmark MSCI EM Index.  Over the period 10/31/2020 to 09/30/2021, average holding weights dropped by -4.99%, the most of any sector.Analysis of stock positioning changes over the same period reveals the bulk of the decline was caused by one stock, Alibaba Group (BABA US), with average holding weights falling by 4.04%, outflows of $2.26bn and 5.2% of funds closing positions.  Other contributors on the negative side were the educators, with New Oriental Education &amp; Technology Group (9901 HK) and TAL Education (TAL US) losing 18% and 12.6% of investors respectively.  Despite these closures, Alibaba Group (BABA US) remains by far the most widely held stock in the sector, with 78.5% of funds holding a position at an average weight of 2.54%, though only 35.2% of managers are overweight the benchmark.  Widely held though it is, Alibaba's relevance in the sector has been hugely diminished.  At its peak, average holding weights in Alibaba Group (BABA US) across the 247 active funds in our analysis stood at 6.57%.Analysis taken from our EM research, covering 247 active GEM funds with combined AUM of $500bn 

EM Consumer Discretionary:  Turbulent Times for Alibaba

In Sep, various ministries and local governments have announced detailed regulations or opinion-seeking drafts for the implementation of central government's "Double Reduction" Opinions. The areas that covered by these regulations range from the qualifications of tutors to the advance collection of tuition fees. While this should be anticipated, we think there is risk of regulatory overshoot which will put further pressure on the after-school tutoring companies like <a href="https://www.smartkarma.com/entities/new-oriental-education-technology-group" target="_blank" data-smartkarma-citation="entities:32210:1" rel="noopener">New Oriental Education &amp; Technology Group (9901 HK)</a>, <a href="https://www.smartkarma.com/entities/tal-education-group" target="_blank" data-smartkarma-citation="entities:1124:1" rel="noopener">TAL Education (TAL US)</a> and <a href="https://www.smartkarma.com/entities/gaotu-techedu-inc" target="_blank" data-smartkarma-citation="entities:28069:1" rel="noopener">Gaotu Techedu (GOTU US)</a>.We can see that the regulations are all targeted on off-campus after-school tutoring but not on the higher and vocational segment. In this regard, we believe <a href="https://www.smartkarma.com/entities/china-education-group-holdin" target="_blank" data-smartkarma-citation="entities:18218:1" rel="noopener">China Education Group (839 HK)</a>, which focused on higher education, and <a href="https://www.smartkarma.com/entities/china-east-education-holdings" target="_blank" data-smartkarma-citation="entities:27843:1" rel="noopener">China East Education (667 HK)</a>, which focused on vocational training, are better positioned in this wave of regulatory crackdown.

In Sep, various ministries and local governments have announced detailed regulations or opinion-seeking drafts for the implementation of central government's "Double Reduction" Opinions. The areas that covered by these regulations range from the qualifications of tutors to the advance collection of tuition fees. While this should be anticipated, we think there is risk of regulatory overshoot which will put further pressure on the after-school tutoring companies like New Oriental Education &amp; Technology Group (9901 HK), TAL Education (TAL US) and Gaotu Techedu (GOTU US).We can see that the regulations are all targeted on off-campus after-school tutoring but not on the higher and vocational segment. In this regard, we believe China Education Group (839 HK), which focused on higher education, and China East Education (667 HK), which focused on vocational training, are better positioned in this wave of regulatory crackdown.

China Private Education: More Regulations Rolled Out Backing "Double Reduction"

We take the recent newsflow on business development at <a href="https://www.smartkarma.com/entities/china-education-group-holdin" target="_blank" data-smartkarma-citation="entities:18218:1" rel="noopener">China Education Group (839 HK)</a> positively. While the market may still skeptical towards the company due to the sector's regulatory worries, CEG is standing in a better position than many of its peers given its focus on the vocational and higher education segment. In our view, the beaten-down performance of CEG's share price is not justified, and it is an interesting time to look at its long-term promising outlook now.   The 58% increase in approval higher education enrollment quota for 2021/2022 academic year, upside from contribution of the newly added Chengdu Jincheng College, support from banks and IFC through provisions of seven-year loan facilities at low pricing, rapid execution of M&amp;A and further potential pipeline acquisitions all lend support to CEG's business prospects amid a turbulent time. Our belief is that at 13.5x PER for FY22, CEG is inexpensively priced relative to growth.

We take the recent newsflow on business development at China Education Group (839 HK) positively. While the market may still skeptical towards the company due to the sector's regulatory worries, CEG is standing in a better position than many of its peers given its focus on the vocational and higher education segment. In our view, the beaten-down performance of CEG's share price is not justified, and it is an interesting time to look at its long-term promising outlook now.   The 58% increase in approval higher education enrollment quota for 2021/2022 academic year, upside from contribution of the newly added Chengdu Jincheng College, support from banks and IFC through provisions of seven-year loan facilities at low pricing, rapid execution of M&amp;A and further potential pipeline acquisitions all lend support to CEG's business prospects amid a turbulent time. Our belief is that at 13.5x PER for FY22, CEG is inexpensively priced relative to growth.

China Education (839 HK): More Flows of Positive Development

Forensic Analyst

Jason Yap, CFA

Forensic Accounting

The “double reduction” crackdown on K9 after school tutoring ("AST") that covers primary and middle school curriculums has inflicted major pain on the USD38 billion industry. With the original aim of easing student pressure inside and outside school, it has led to unintended consequences of tutor layoffs, early lease terminations, and fresh anxiety among parents on how to occupy their children's available after school time.
The regulations also shook the confidence of AST investors and enterprises. Weak hands folded by shutting operations, filing for bankruptcy and/or exiting investments while industry leaders with a stronger cash position frown over the best approach to pivot operations.
For industry leaders like <a href="https://www.smartkarma.com/entities/new-oriental-education-tech-grp-adr" target="_blank" data-smartkarma-citation="entities:531:1" rel="noopener">New Oriental Education (EDU US)</a> and <a href="https://www.smartkarma.com/entities/tal-education-group" target="_blank" data-smartkarma-citation="entities:1124:1" rel="noopener">TAL Education (TAL US)</a>, revenues generated from K9 academic tutoring comprise between 50% to 80% of total revenues. Hence, there is a direct material impact on forward revenue and earnings.  In addition, they will incur one-time costs for, amongst others, staff severance, early lease terminations, and refund liabilities for K9 courses that can no longer be administered.  
In August 2021, Beijing education authorities <a href="https://www.caixinglobal.com/2021-08-16/cover-story-whats-next-for-chinas-after-school-tutoring-industry-101755589.html" target="_blank" rel="noopener">extended</a> an olive branch, highlighting that AST companies may switch to sectors that aren’t affected by the new regulations, such as high school tutoring, vocational education, all-round education and adopting hybrid business models. A similar stance might by adopted nationwide and signals (at least some) policy support for the embattled AST sector.
Using TAL Education as a bellwether for the AST sector, we examine the financial and accounting concerns that arise as a direct result of the new regulations. In addition, we analyse the recent exit of a key Convertible Notes investor, who has essentially capitulated in the face of execution uncertainties of TAL's pivot strategy.  Should other investors follow?

The “double reduction” crackdown on K9 after school tutoring ("AST") that covers primary and middle school curriculums has inflicted major pain on the USD38 billion industry. With the original aim of easing student pressure inside and outside school, it has led to unintended consequences of tutor layoffs, early lease terminations, and fresh anxiety among parents on how to occupy their children's available after school time.
The regulations also shook the confidence of AST investors and enterprises. Weak hands folded by shutting operations, filing for bankruptcy and/or exiting investments while industry leaders with a stronger cash position frown over the best approach to pivot operations.
For industry leaders like New Oriental Education (EDU US) and TAL Education (TAL US), revenues generated from K9 academic tutoring comprise between 50% to 80% of total revenues. Hence, there is a direct material impact on forward revenue and earnings.  In addition, they will incur one-time costs for, amongst others, staff severance, early lease terminations, and refund liabilities for K9 courses that can no longer be administered.  
In August 2021, Beijing education authorities extended an olive branch, highlighting that AST companies may switch to sectors that aren’t affected by the new regulations, such as high school tutoring, vocational education, all-round education and adopting hybrid business models. A similar stance might by adopted nationwide and signals (at least some) policy support for the embattled AST sector.
Using TAL Education as a bellwether for the AST sector, we examine the financial and accounting concerns that arise as a direct result of the new regulations. In addition, we analyse the recent exit of a key Convertible Notes investor, who has essentially capitulated in the face of execution uncertainties of TAL's pivot strategy.  Should other investors follow?

TAL Education - Key Investor Capitulates, Should the Rest Follow?

China

TAL Education Group provides educational services. The Company offers comprehensive tutoring services to students covering core academic subjects such as mathematics, English, Chinese, physics, chemistry, political science, history, and biology. TAL Education Group serves students in China.

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TAL Education (TAL US)

China East Education (667 HK): Riding on Government's Push for Vocational Schools

China East should benefit from the government's push on vocational education and its businesses have less regulatory risks. The net cash position...

Osbert Tang, CFA

EM Consumer Discretionary: Turbulent Times for Alibaba

We look in to the recent collapse of Consumer Discretionary allocations among active GEM managers, and find that Alibaba is the driving force...

Steven Holden

China Private Education: More Regulations Rolled Out Backing "Double Reduction"

More detailed regulations on after-school tutoring have been rolled out by various ministries and local governments in Sep. The higher education...

Osbert Tang, CFA

China Education (839 HK): More Flows of Positive Development

Good enrollment quota growth, confidence from banking community and IFC and rapid execution of M&As are driving FY22 outlook for CEG, and this...

Osbert Tang, CFA

TAL Education - Key Investor Capitulates, Should the Rest Follow?

The “double reduction” crackdown has inflicted major pain on the USD38 billion AST industry. Weak hands have folded but TAL strives to pivot....

Jason Yap, CFA

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