Saturday, Jul 24th 2021

Our latest thoughts on the Chinese AST market


On Friday, Chinese education stocks plummeted on media reports that suggested that China may ban weekend and holiday after-school tutoring (AST) classes and convert academic tutoring institutions into non-profit organizations.

These reports - which remain unconfirmed but have circulated in multiple Chinese media outlets, including Caixin - in our view represent a meaningful step up from the event pattern that has impacted the sector year-to-date.

As a result, we’re currently re-evaluating our position in EDU and any other stocks for which there might be “read-through” or second-order implications from these most recent developments.

What happened

For more background on the recent macro developments in the Chinese AST market, please see the prior research we published on the space.

But in short, the most recent reports that circulated across Chinese media outlets have suggested that China may ban both weekend and holiday after-school tutoring (AST) classes, convert academic tutoring institutions into non-profit organizations, and prevent AST institutions from targeting or even raising capital from international markets.

If true, we believe this set of regulatory actions would represent a true black swan or extreme left tail outcome. In fact, in our scenario analyses, this outcome would most closely map to our acute downside case, which we had assigned a <5% probability to.

But what complicates the current situation further is that the takeaway from these recent reports is not cut and dry. The suggested set of regulatory outcomes seem to be fundamentally at odds with several other observable data points from both official and unofficial sources that we’ve tracked over recent weeks, including:

  • The Beijing Haidian Board of Education refuting earlier rumors that ASTs would not be allowed to offer classes during summer vacation
  • Messaging from a state-backed news outlet that cited the need for thoughtful solutions that don’t overcorrect and cause investors to lose confidence in the AST industry
  • EDU and TAL both reporting that they not having received official notifications regarding these industry changes, despite being the two largest players in the space
  • EDU recently refuting rumors of an internal company discussion of there being no classes on weekends and holidays beginning 2022
  • And finally, on the valuation front, current implied valuations that appear extraordinarily cheap and suggest an up/down skew that looks favorable from a strictly mathematical perspective

All this said, there are also several factors that seem to suggest that on net, the most recent reports should be viewed as credible and assigned precedence, including:

  • Recent reports being originated by multiple Chinese news outlets as opposed to US-based outlets with less reliable track records when it comes to exclusive Chinese news breaks
  • Caixin reportedly having received confirmation from staff members at the education departments of several local municipalities confirming receipt of new documents related to regulation
  • The absence of an official rebuttal from local municipalities on the latest round of media reports (which, while not required by any means, is something several municipalities have demonstrated a willingness to put forth in the past)

So where do we net out?

We’re still finalizing our views, but on net, we do believe that the Caixin reports are more credible than not, and deserve precedence when considering the path forward.

While valuations are now indeed extremely cheap and there are multiple conflicting factors that complicate the outlook suggested by recent reports, at the end of the day we believe everything needs to be weighed probabilistically against the key touchstones of fundamentals and core thesis drivers.

We will revert shortly with more details on the implied valuations at today’s levels, thoughts on the merits and drawbacks of various positioning possibilities, and our decision on the path forward from here.

Be sure to stay tuned in the app to keep fully up to date.

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