China / Hong Kong Industry Focus

China Education Sector

Refer to important disclosures at the end of this report

DBS Group Research . Equity 12 Jul 2017

A young and robust force

• The abolishment of the one child policy coupled
HSI: 25,878
with parents’ ability and willingness to pay
ANALYST
provides strong tailwinds for the sector. Manyi LU
• Top-line growth to accelerate on the back of manyilu@dbs.com
capacity expansion and student number increases.
Dennis Lam +852 2971 1922
• New regulations to be neutral to the listed dennis_lam@dbs.com
companies
Recommendation & valuation
• Initiate coverage on the sector with top pick
Yuhua (6169 HK) Co mp an y Pric e M ark et T arg et R ec o m 1 8 F PE
Cap Pric e
Robust industry growth ahead driven by imbalance between HK $ HK $m HK $ x
demand and supply. Supported by the abolishment of the one China Maple Leaf
6.36 8,774 7.73 BUY 16.5
child policy and increasing household income in China, Chinese (1317 HK)
education institutions are entering a golden age with China Yuhua
2.61 7,835 3.23 BUY 14.5
increasing demand and low price sensitivity for quality Education (6169 HK)
education. The shortage of public education resources has Wisdom Education
2.71 5,530 3.17 BUY 15.9
given rise to the need for premium private schools. (6068 HK)
V irscend Education
4.88 15,083 4.97 HOLD 23.2
Student numbers the key revenue driver. Given the strong (1565 HK)
demand and availability of capital, we expect faster student
number growth for the listed companies, in line with the Source: Thomson Reuters, DBS Vickers
aggressive capacity expansion outside of home cities. Aside
from organic growth, we also expect more active M&As going
forward. All of which will lead to higher student numbers,
which is a key critical factor for the performance of education
stocks. In addition, the strong demand will reflect in rising
tuition rates, as current admission rates remain low (e.g.
Usually 7-8 students compete for 1 position).

New regulations to be neutral to listed companies. On the

regulatory front, new national regulations announced in Nov
16 gave more guidance as to the “for profit” and “non profit”
nature of education companies. We believe these regulations
to be overall neutral to the listed companies. They are likely to
retain their “non profit” status whilst extracting profits via a
variable interest entity (“VIE”) structure. The improved clarity
on this matter should remove investors’ some investors’
concerns.

Current valuation has not factored in the strong earnings

outlook. We initiate BUYs on Yuhua, Maple Leaf and Wisdom
given their c.25%+ earnings growth and reasonable valuations.
Aside from an inexpensive valuation, Yuhua faces lower
execution risks given a more conservative expansion pace.
Maple Leaf’s light asset, lower tier city focus underlies its
scalable, aggressive growth. Wisdom appears to be most
aggressive in M&A in pursuing its capacity expansion. Virscend
has a stellar brand name and strong growth rate but it is
probably already factored in the share price.

ASIAN INSIGHTS VICKERS SECURITIES

ed-TH / sa- CW
Industry Focus
China Education Sector

Table of Contents
Investment Summary 3 
I. Strong growth potential in China education market 4 
II. Risks and threats in the private education industry 16 
III. Outlook of key education segments 26 
IV. Listed company landscape in Hong Kong 35 
Stock Profiles 55 
China Maple Leaf (1317 HK) 55 
China Yuhua Education (6169 HK) 61 
Wisdom Education (6068 HK) 67 
Virscend Education (1565 HK) 73 

Appendix I: Critical factors study 79 

Appendix II. Case Study: Lessons learned from New Oriental 87 

Page 2

Investment Summary
Stellar industry growth outlook, thanks to growth in
demographics as well as parent’s increasing willingness and
capability to pay. We forecast education spending in China to
grow by a CAGR of 6.7% in the foreseeable future due to
multiple drivers. The end of the one-child policy should drive
student number growth. We also expect rising income to
support continued increase in household spending. Meanwhile,
with the fast development of private and international
education in China, parents are especially willing to pay for
quality education for their children. The total market value for
education and training is estimated to reach RMB 3 trillion by
2025 with most of them coming from K12 segments.
Main risks of private education are 1) management and
operational risks; and 2) uncertainties brought about by new
regulations. The New Oriental case (Appendix II) shows that
management integrity and unclear areas in VIE structure and
tax payment are vulnerable. While we believe the management
risk will not affect the industry much, we should still be
cautious about the uncertainties during the regulation
transition period.
Starting from 1 September 2017, new education regulations
require private schools to be classified as either “for-profit” or
“non-profit”. Details are yet to come but we do not expect
much, if any, negative impact on the industry.
All the companies listed in Hong Kong are likely to remain as
non-profit schools under new regulations. The impact of new
regulations are limited and we believe schools will remain as
they are in the next few years because 1) profits can be
generated and transferred through VIE structure regardless of
the type; 2) low possibility of gaining financial benefits after
turning into 'for-profit'; and 3) difficulties in the procedures of
applying to pursue profits.
Supply of land and teachers are two key expansion hurdles for
schools, but we believe there are enough resources for the
industry as a whole to realise its full market potential.
Different educational segments have different development
outlook, but we believe that non-compulsory stage schools
and after-school training are more attractive for investors.
Kindergartens will enjoy a higher student growth momentum
and better tuition pricing power in the coming years as the
result of baby boom and loose regulations. The after-school
training segment is benefitting from a series of market drivers,
including fast expansion and new technologies, making it the
favoured sector of investors.
Industry Focus
China Education Sector
Currently, four K12 school education providers listed in Hong
Kong have their own strengths while Virscend has a slightly
better growth outlook. Student number growth and gross
margin are the two most important earning drivers according
to our study of share price drivers (Appendix I). As a result,
regional and segment exposure, school quality and
management strategy are evaluated for the four listed schools
to explore their future student number growth trend.
Based in one of the most developed areas in China, Wisdom
has the best regional exposure driven by economic growth.
Yuhua and Maple Leaf are better positioned in their segment
exposures, while Virscend has high teaching quality and brand
value with outstanding student performance in examinations.
New footprints after IPO. With more funding resources,
recently listed education companies are expanding faster than
before. Among them, Virscend has the most aggressive plans
this year with asset-light models where the company co-
operates with third parties to secure land and buildings. In
contrast, Wisdom prefers to adopt an asset-heavy model with a
“2+2+2” expansion strategy. Yuhua is the most conservative
one for expansion in the next three years, focusing on high
schools and universities.
Strong earnings growth is expected for all companies. The
bottom-line growth is mainly driven by 1) revenue growth
driven by accelerated capacity expansion as well as tuition fee
hike; 2) improved gross margin where teacher’s salaries and
D&A expenses have a lower growth rate than tuition fees; and
3) stable SG&A expenses and decreasing finance costs as a
result of deleveraging.
Top pick Yuhua for its low risk, long-term growth and
reasonable valuations. We primarily used a DCF model for the
valuation where main assumptions are made for capital
expenditures and WACC. Overall, we think Virscend has a
better growth momentum over its peers. However, as its future
growth has already been reflected in its current price, our top
picks in this sector is Yuhua with more than 20% upside over
their current prices.
Page 3
Industry Focus
China Education Sector

I. Strong growth potential in China positive implications on the education sector in the coming
education market decade:

China's education industry is in its Golden Age with huge
expansion potential. In 2015, the total spending on education
from K12 schools to universities reached RMB 3.6 trillion
according to National Bureau of Statistics. Among this, RMB
2.9 trillion were from government spending, while the
remaining RMB 691 billion were from the private sector,
including tuition, donations and private investments with a y-o-
y growth of 8.2%. Despite the slowdown in China's economic
growth in recent years, education spending from both
households and the government has kept increasing at a
higher rate than GDP growth.
As government spending is usually not included in discussions
on consumption and investment, we will focus on the private
sector's education spending and take it as the education
market's revenue size. Tuition revenue is the largest part of the
education market, making up 63% of the total from 2012 to
2014 and reaching RMB 405 billion in 2014.
Education market size (RMB billion)
1. Demographics. The total number of students in China has
been declining in the past, but we expect a turnaround
due to relaxation of China’s one-child policy.
2. Ability to pay. We project continued strong growth in
Chinese household income to support growth in tuition
fees.
3. Parents’ willingness to pay. We expect continued increase
in penetration of private education due to Chinese
culture’s emphasis on education, desire to study abroad,
and difficulty in obtaining good education through the
public system. China’s education spending as a
percentage of GDP is also not high. These factors further
bolster private school student growth and tuition fee
increase.
Estimated education and training market size to reach
RMB 3 trillion by 2025

Based on the following analysis and assumptions, the total

Rmb bn
800 30% education market size, including spending on schools from
700
kindergartens to universities as well as training institutions, will
25% reach RMB 3 trillion by 2025, or an 89% increase from 2015
600
500 20% level of RMB 1.57 trillion and a 6.7% CAGR during the period.
400 15%
Total market size by 2025
300 10%
200
100 5%
Demographic 3 3 2 million
0 0%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

8 % of household
Wi llingness to pay R M B 2.97 trillion
i n come
Household Education Spending
Tuition revenue
Education spending growth Capability to pay R M B 111,888

Source: National Bureau of Statistics of PRC, DBS Vickers Source: DBS Vickers

The RMB 691 billion education spending excludes training
institutions, which is also a booming market in China. In 2015,
the total training market size was estimated to be RMB 882
billion by Tencent Education. The total education and training
market size would then be around RMB 1.57 trillion in 2015,
with 40% from school education and 60% from after-school
training.
Of the total market size, RMB 2.7 trillion will be from the 300
million K12 student market and RMB 920 billion or 34% will
be from K12 private school students. The strong growth
potential brings large development opportunities for private
education providers. K12 private schools will generate total
revenue of RMB 400 billion, of which RMB 300 billion are from
tuition income.

We also foresee strong growth due to upbeat drivers. We

analysed key drivers for education spending and they all have

Page 4
 Industry Focus
China Education Sector

A. Demographic: Growth boosted by the end of “One- Age distribution across population (million)
Child” era

The total number of students has been falling in China due to 2000 2015
the country’s ageing population. This trend has not dampened 95+ 95+
90-94 90-94
education spending, as spending growth per student has far 85-89 85-89
80-84 80-84
outstripped the fall in student numbers. However, a continued 75-79 75-79
70-74 70-74
decline in student numbers can pose an issue in the future. 65-69 65-69
60-64 60-64
Fortunately, we believe the relaxation of the one-child policy 55-59 55-59
will increase the number of students once again. 50-54 50-54
45-49 45-49
40-44 40-44
35-39 35-39
Without much room for further improvement of enrolment 30-34 30-34
25-29 25-29
ratio, student numbers are highly dependent on demographic 20-24 20-24
15-19 15-19
factors. This is especially true for primary to high school 10-14 10-14
5-9 5-9
students. The gross enrolment for compulsory stage school is 0-4 0-4
already as high as 103-104%. The ratio for high schools was (100) (50) 0 50 100 (100) 0 100
also high at 87% in 2015, which is already close to the Female (millions) Male (millions)
government's goal of 90% by 2020. The enrolment ratio of
universities, though appearing low at 37.5%, is also close to
the 2020 goal of 40%. Among all stages of schools, the Source: National Bureau of Statistics of PRC, DBS Vickers
enrolment ratio could only be further improved for
kindergartens. In 2015, the gross enrolment ratio for 3-year- Though not every couple choose to have their second child,
old children (who are three years below school-going age) was loosening birth control policy in China has helped the birth rate
75%, still 10% lower than the 85% target set in the recover. China's birth rate increased from 11.93% in 2011 to
“Thirteenth 5-year Plan” for education development. But even 12.95% in 2016, meaning 17 million new babies were born
if this is boosted up to 85%, the overall effect on total student during the year. At the same time, the percentage of children
numbers would be rather small. aged 0-4 as a percentage of total population increased steadily
from 5.05% in 2007 to 5.83% in 2015.
Gross enrolment ratio (%)
Birth rate and 0-4 age group percentage
%
120 % %
6.0 13.5
100
80 5.8 13.0
60 5.6
12.5
40 5.4
20 12.0
2010 2011 2012 2013 2014 5.2

5.0 11.5
Primary School (as of local school age population)
Middle School (as of 12-14 year old population) 4.8 11.0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2011
2012
2013
2014
2015
2016

High School (as of 15-18 year old population)

Kindergarten (as of 3 years before school age )
Universities (as of 18-22 year old population)
Source: Ministry of Education of PRC, DBS Vickers
From 2000 to 2015, the demographic chart of age distribution
in China turned from a pyramid-like shape to a shuttle-like
shape, reflecting the decreasing population in the younger age
group. The population under 20 decreased from 395.3 million
in 2000 to 302 million in 2015, though the total population
increased 8.5% from 1.27 to 1.37 billion in the same period.
0-4 as % of total popultaion (LHS)
Birth Rate % (RHS)
Source: National Bureau of Statistics of PRC, DBS Vickers
The “second child” was firstly allowed for couples meeting
certain requirements at the end of 2013 (e.g. at least one half
of the couple should be the “only-child” at home”). The policy
was loosened further to allow all couples to have their second
child in 2016, resulting in a more than 7% rise in birth rate
during that year.

Page 5
Industry Focus
China Education Sector

A research paper published in the Progress in Geography (vol
35, 2016), which is a journal of Chinese Academy of Science,
shows its prediction of the population age structure as affected
by the new demographic policy. In 2020, the population of 0-4
year olds will be 138 million or 72.5% higher than the 2015
level in the prediction model. The average population growth
rate was 0.61% from 2010 to 2015 and will double to 1.25%
from 2015 to 2020. The number of people under 20 as a
percentage of total population will increase to 25% from the
2015 level of 22% and will continue rise to 26.2% and 26.9%
in 2025 and 2030 respectively.
Driven by the increasing population, especially the young age
group, we are optimistic about student numbers in the next
ten years of baby boom era even without much improvement
in enrolment ratio. In 2015, there were 251 million students in
total from kindergartens to universities, or 82.9% of the total
302 million people under 20. The number of K12 students that
year was 224 million, or 89.2% of the total number of
students. With an expected enrolment ratio of 85% for 2025,
the total number of students should reach 332 million in that
year, out of which 300 million, or 90% are expected to be K12
students.

Population under 20 (million) Number of students (million)

mn mn
160 500 88%
140 400 86%
84%
120 300
82%
100 200
80%
80 100 78%
60 0 76%

2020E

2025E

2030E
2011

2012

2013

2014

2015
40
20
Total student number
0
0-4 5-9 10-14 15-19 Population under 20

2015 2020E 2025E 2030E Enrolment ratio (As of population under 20, RHS)

Source: Progress in Geography, DBS Vickers Source: National Bureau of Statistics of PRC, DBS Vickers

Total population prediction (million)

mn
1,550

1,500

1,450

1,400

1,350
2016 2018 2020 2022 2024 2026 2028 2030
Source: Progress in Geography, DBS Vickers

Page 6
 Industry Focus
China Education Sector

B. Parents’ capability to pay: Steady growth in Expected GDP growth in China

disposable income

The disposable income of all households in China increased 7%

steadily in the past few years. In 2016, the per capita
disposable income of all residents in China reached RMB
6%
23,821, representing an 8.4% nominal or 6.3% real growth y-
o-y. We are confident about the future growth trend,
supported by the per capita GDP growth and continuous 5%
urbanisation process in China.

Annual disposable income of all residents in China 4%

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026
30,000 18%
16% Expected GDP growth in China by DBS macro team
25,000
14% Per Capita GDP growth
20,000 12%
10% Source: DBS Vickers
15,000
8%
10,000 6% Urbanisation will also help with income growth. Urban
4%
residents, who now account for 56% of China's total
5,000 population, have a higher disposable income. In 2016, per
2%
capita disposable income of urban residents was RMB 33,616,
0 0%
or 2.7 times that of rural residents. The continuous
2009

2010

2011

2012

2013

2014

2015

2016

urbanisation would be another important driver of the increase

in income.
Disposable Income (LHS) growth rate (RHS)
Annual disposable income of urban residents in China
Source: National Bureau of Statistics of PRC, DBS Vickers

GDP growth to support further income expansion. The real 35,000 18%
growth rate of 6.3% is highly correlated with the GDP growth 30,000 16%
in China, between the 6.1% real per capita GDP growth and
25,000
6.7% total GDP growth in 2016. Given the 6.5% GDP growth 14%
target for 2017, 5% real growth in per capita disposable 20,000
12%
income could be well expected even if we place a discount on 15,000
the official data in China. 10%
10,000

Our macro team expects China’s GDP growth to average above 5,000 8%
5.5% in the next ten years, leading to a 5.1% CAGR in per 0 6%
capita GDP given the total population prediction as analysed in
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

the previous section. The per capita GDP will grow at a lower
rate from 2017 to 2020 as a result of fast-rising population, Disposable Income growth rate (RHS)
but will grow to RMB 87,925 in 2026 from the 2016 level of
RMB 53,461.
Source: National Bureau of Statistics of PRC, DBS Vickers

With similar growth level of per capita GDP, the per capita
disposable income could reach RMB 37,296 in 2025 or 56%
higher than the current level. The average household income
for a family of three would thus be RMB 111,888.

Page 7
Industry Focus
China Education Sector
C. Multiple factors to spur parents’ willingness to pay
and private school penetration
Aside from a rebound in student numbers and rising income
levels, we also expect private school penetration to increase for
multiple reasons. Chinese culture’s emphasis on education is
one. Rising demand for going abroad or innovative curriculums
is another. The difficulty in obtaining a good education
through the public system is also another driver. Lastly, China’s
government education expenditure as a percentage of GDP is
also not high when compared to developed markets. Together,
these factors bode well for private school penetration rate and
parents’ willingness to spend their rising incomes on private
education.
In 2016, per capita consumption in “Education, cultural and
recreation” reached RMB 1,915, representing 11.5% of total
per capita consumer spending of RMB 17,111, or 8.04% of
per capita disposable income. No further detailed breakdown
was disclosed by the official source, but in 2013, it reported
education cash spending as 7.5% of total cash consumption
expenditure of RMB 10,917, or 58.6% of the “Education,
cultural and recreation” segment. Also, local reports from
some provinces show that in general 60% of this segment is
consumption on education. Education is making up a larger
share of this segment, while other entertainment and cultural
spending are diminishing. If 60% of the segment spending was
from education in 2016, families on average would spend
6.7% of per capita consumption expenditure and 4.8% of
disposable income on education.
Consumption on education, culture and recreation
1,400 8%
1,200
6%
1,000
800
4%
600
400 2%
200
0 0%
2013 2014 2015 2016
Education spending (estimated as 60% of the segment)
(LHS)
As of disposable income (RHS)
As of consumption (RHS)
Source: Bureau of Statistics of PRC, DBS Vickers
Although China is still a developing country with relatively low
per-capita GDP, Chinese parents are extremely willing to spend
on their children’s education. When comparing several
countries’ per capita education spending as a percentage of
Page 8
total consumer expenditure using 2014 data, China has the
highest ratio of 6.4%, followed by Korea, another East Asian
country. The European countries, on the other hand, usually
have less than 1% spent on education. Various factors on both
demand and supply side help to explain Chinese parent’s
enthusiasm on education spending.
Education as of consumer spending
7 140,000
6 120,000
5 100,000
4 80,000
3 60,000
2 40,000
1 20,000
0 0
Hungary
Australia
Estonia
Poland
Ireland
Switzerland
Luxemburg
China
Germany
Slovenia
Greece
United States
Czech Rep.
Denmark
Spain
Sweden
Mexico
Education spending as of per capita consumer spending
% (LHS)
Per capita GDP (RHS)
Source: International Statistical Yearbook (by Bureau of Statistics of
PRC), DBS Vickers
Culture tradition plus modern features
Chinese and East Asian cultures highly value education.
“書中自有黃金屋 書中自有顏如玉” This Chinese proverb sums
up how Chinese culture highly values education. A good
example might be Chinese families living in the US. Even with
the same examinations and education system as US students,
Chinese parents still tend to pay more on education, both cash
and attention, driven by the strong Asian cultural tradition of
pursuing better education.
This is true not only for Amy Chua, who became famous for
her article Why Chinese Mothers Are Superior and her book
Battle Hymn of the Tiger Mother, but also for most Asian
families in the US. A survey by US Census Bureau in October
2015 shows that in all income groups except the “not-reported”
one, Asian parents are more willing to send their children to
expensive private schools than average US parents.
The survey included around 30,000 families of all races and
income groups with children attending K12 schools. When
asked whether they send their children to public or private
schools or a mix of both, Asian parents are more likely to send
their children to private schools, at all income levels. This is
especially true for the middle-class parents with an annual
income of US$20,000 to US$74,999. On average, only 5.2%
 Industry Focus
China Education Sector

of US parents at this income level send their children to private Monthly spending on education, by income group 2016
schools, but 7% of Asian parents do so.
100%
Families in US sending children to private schools only
80%

12%
60%
10%
40%
8%
20%
6%
0%
4%
under 100-300 300-500 500- 1000- Above
100 1000 2000 2000
2%
Under 5000 5000-10000 10001-15000
0% 15001-20000 20001-30000 Above 30000
Less than $20,000 to $75,000 and Not reported
$20,000 $74,999 over
Source: iResearch, DBS Vickers
All race Asian Only
Taking the average of each group range for both income level
Source: U.S Census Bureau, DBS Vickers and educational spending gives us a rough idea about the
percentage of monthly income a common family would spend
on education. If we exclude the lowest and highest income
In addition to the cultural tradition, the modern features of levels, the monthly education spending represents around 6-
post-80s parents reinforced their willingness to pay for 7% of monthly household income for families with a monthly
education. Currently, most parents with K12 children were income of RMB 5000 to RMB 30,000, which covers most urban
born in the 1970s and 1980s. According to a study by Chinese families. The spending ratio here is higher than the
iResearch, a famous consulting company in China, 41.3% of per capita education spending ratio of 4.8% as it includes only
them were post 80s while 47.9% were post 70s in 2016. families with K12 children and is calculated as household
average, while the national statistics data is averaged for all
In the future, the K12 education market will be mainly driven people.
by post 80s or even post 90s parents when the latter group are
in their 30s in the 2020s. Unlike parents born in 1960s and Percentage spent on education, by income group
1970s, one of the most important characteristics of these
young parents is that they themselves are the “only child” in 20%
their families. The typical family structure in the near future
would be 4-2-1 or 4-2-2: four grandparents, two parents, plus
one or two school-going age children. Both wealth and 15%
attention are concentrated – on the one hand, post 80s
parents no longer have to share their family wealth with
siblings; while on the other hand, the four grandparents now 10%
only have one grandchild or two grandchildren to look after,
making the children the centre of family focus.
5%
Because of the concentrated resources, young parents tend to
spend more on their children. The consumer spending survey
on education by iResearch shows that for each income group 0%
Under 5000- 10001- 15001- 20001- Above
in China, around 15-30% of families choose to spend 10% or 5000 10000 15000 20000 30000 30000
more of their monthly income on education. For the lowest
income group with less than RMB 5000 monthly income, 42% Source: iResearch, DBS Vickers
of families reported higher than RMB 300 education spending,
or at least 6% of their monthly income each month.

Page 9
Industry Focus
China Education Sector

We expect the percentage of education spending on Private school student numbers increased in the past ten years.
household income to carry into the near future with slight All levels of schools witnessed an increase in the number of
improvement at around 7-8%. South Korea, which shares the students from 2004 onwards. The total number of students in
same culture of spending on education but has more than all levels of private schools was around 38 million in 2015.
triple the per capita GDP of China, may provide a good
reference for China’s future education spending trend. Number of students in private schools in China (million)
In the long term, two effects may offset each other on the
spending ratio. On the one hand, parents tend to spend more mn
on education when their income improves. On the other hand, 25
the ratio may decrease as the denominator is also larger. Per
20
household education spending ratio in Korea fluctuated within
a narrow range of 6.5% to 8.4% in more than ten years in the
15
past and is close to China's level of education spending.
10
In 2016, the rate was at its lower end of 6.7% in Korea.
Considering that the rate is the average of all families, the rate 5
for families with school-age children only should actually be
higher. Plus, impacted by China’s economic and demographic 0

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015
growth, we reckon that China’s average education spending
rate for families with school-age children will move towards
the higher end of 8% in the future years. Kindergarten Primary School Middle School High School

Source: National Bureau of Statistics of PRC, DBS Vickers

Household education spending ratio in Korea
The ratio of student enrolment in private schools to total
9% students enrolled each year has also increased. This is especially
true for kindergartens. Private kindergartens make up of
65.4% of total kindergartens in China. The ratio has kept
increasing in the past years for schools at all levels. The
8% increase in new enrolment, indicates that private school
penetration rate is likely to rise in the future.

Private school enrolment as a percentage of total

7% enrolment in China

60%

50%
6% 40%
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

30%

20%
Source: Statistics Korea, DBS Vickers
10%

0%
Spending in private education is increasing with private
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

school revenue expected to reach RMB 400 billion in 2025

The fast growth in K12 education sector brings lots of All level Kindergarten Elementary
opportunities in both schools and extra-curricular training.
Middle High
Training institutions such as New Oriental and TAL have already
been listed in the US. Online education platforms are also
Source: Ministry of Education of PRC, DBS Vickers
developing very fast and many are seeking to be listed in the
A-share market. Private education is playing an increasingly China's average private school enrolment rate for all levels of
important role in China's education market. schools (excluding kindergartens) is around 10%, with
elementary schools at 7.2%, middle schools at 12.1% and
high schools at 11.8% in 2016. This is similar to the US private

Page 10
 Industry Focus
China Education Sector

enrolment ratio. However, unlike China, US private school
enrolment is in a downward trend driven by the rise of charter
schools. As China does not have a similar form of charter
school, its private school enrolment is unlikely to drop in the
near future but is expected to continue growing. However, we
do not see a sudden rise as the ratio is already near the current
US level.
Without a sharp rise in penetration rate, the growth in number
of private school students is already in a stabilising trend. The
growth rate of student numbers in private kindergartens,
primary schools, middle schools and high schools in 2015 was
8.3%, 5.9%, 3.3% and 2.8% respectively. With a slightly
higher penetration rate of 23% in 2025, there will be around
68 million students in private K12 schools by then.

Private school enrolment as a percentage of total in US Growth rate in private school student numbers
with forecast
60%
14%
50%
13% 40%
12% 30%
20%
11%
10%
10% 0%
9% -10%
-20%
8%
-30%
7% -40% 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015
6%
1995 2000 2005 2010 2015 2020 2025
Kindergarten Primary School
K12 average Kindergarten to grade 8
Middle School High School
grade 9-12

Source: Wind, DBS Vickers

Source: NCES, DBS Vickers
Average tuition fee is less than RMB 5,000 per year but the
According to Frost & Sullivan’s study, the penetration rate of
total spending might be much higher. In 2015, common
K12 private schools as calculated by the total student number
private schools, including those in rural areas or for children of
at schools is 18.3% for all levels of schools and will grow to
so-called “migrant workers” charged tuition fees ranging from
21.3% in 2020 with a 3% CAGR.
RMB 2,000-6,000 per year, while the tuition fees of premium
Penetration rate of private schools in China private schools, which are usually in cities and offer higher
quality education, were between RMB 10,000 and RMB
60% 200,000 per year (Frost & Sullivan). However, the total
spending may be a lot more than just tuition fees, including
50%
after-school training, English classes and/or summer and winter
40%
camps, etc.
30%
20%
10%
0%
2016E

2017E

2018E

2019E

2020E
2011

2012

2013

2014

2015

Preschool Overall
Middle School High School
Primary School

Source: Frost & Sullivan, DBS Vickers

Page 11
Industry Focus
China Education Sector

Average private school tuition fee in China in 2015, by There is still room for higher spending ratio on private
level education when compared to developed countries. In 2015,
Korean households spent around 17% of their household
9,000 income per student in private schools, which is around RMB
8,000 18,000. Assume a 15% spending ratio and RMB 90,000
household income for a family with a private school student,
7,000
the average spending per student would be RMB 13,500 and
6,000 the total market for private education would thus be RMB 920
5,000 billion by the end of 2025. The market value of China's private
4,000 education market should be even larger if it is to catch up with
Korean spending level.
3,000
2,000 Korea's spending on private education (RMB)
1,000
Rmb
0 18,100 21%
Kindergarten Primary Middle High School 20%
18,000
School School
17,900 20%
Source: Frost & Sullivan, DBS Vickers 19%
17,800
17,700 19%
The weighted average tuition fee for all levels of schools based 18%
17,600
on their student numbers was RMB 3,620 in 2015. A 2% 18%
17,500 17%
growth in CAGR would increase the average tuition fees for
17,400 17%
private K12 schools to RMB 4,413 in 2025, which means RMB 17,300 16%
300 billion in tuition revenue. If on average 75% of private 17,200 16%
school revenues are from tuition income, the total private 17,100 15%
school revenue will be RMB 400 billion by 2025, 117% higher 2010 2011 2012 2013 2014 2015
than the 2015 level of RMB 184 billion. Annual spending on private education per student (LHS)
As % of household income (RHS)
K12 private school revenue (RMB billion)
Source: Statistics Korea, DBS Vickers
Rmb bn
450 30%
400
25%
350
300 20%
250
15%
200
150 10%
100
5%
50
0 0%
2025F
2011A
2012A
2013A
2014A
2015A
2016E
2017E
2018E
2019E
2020E

Growth (16-20 forecasted by F&S, 25 by DBSV)

Source: Frost & Sullivan, DBS Vickers

Page 12
 Industry Focus
China Education Sector

Gaokao. International schools are a popular choice for these

Diversified demand beyond traditional Chinese school parents.
education

Traditional Chinese education has only one ultimate goal: to
help students succeed in the National College Entrance Exam,
or “Gaokao”. This is not only true for high schools, but for
junior level schools as well. It is not an easy target, when
limited university resources are required to serve a large
population. And it is especially difficult for students from
provinces with large populations such as Henan and Shandong.
They have to face great pressure and compete with millions of
fellow students in order to be admitted to ideal universities.
Every student in this education system aspires to get into one
of the two best universities in China - Tsinghua University or
Peking University. However, there is only a very slim chance of
getting into these two institutions. Students in many provinces
have to work very hard to get into universities. Typical high
school students in China have almost no spare time for sports
and hobbies. All their time is spent on endless homework and
exams.
The is only a very small number of international schools. In
2016, there were only 321 international private schools, or
0.28% of the total. Considering the tuition fee for
international schools is always 5-10 times of local schools, the
total revenue of private international schools should be around
1-2% of the total. Given the spike in demand, there is still
huge room for future market growth in this segment.
Private international schools have better growth potential to
meet the growing demand and enlarging market share.
Though 218 public schools also offer international programmes,
there are lots of limitations on public schools. For example,
from 2014, Beijing no longer allows new international
programmes offered by public schools to co-operate with
foreign schools. Also, the number of students in international
programmes is usually 20-30% of the school (e.g. usually 60-
300 new enrolments per year), which is very small in scale
compared to private international schools.

Admission rate of THU and PKU of some provinces 2016 Overseas students from China

Tota l stude nts '000

a tte nde d Admite d by Admission
600 30%
Provinc e Ga oka o 2016 THU a nd PKU ra te
Beijing 61,200 626 1.02% 500 25%
Shanghai 51,000 209 0.41%
400 20%
Zhejiang 307,400 348 0.11%
Jilin 148,000 157 0.11% 300 15%
Liaoning 218,200 212 0.10%
200 10%
Fujian 235,800 202 0.09%
Jiangsu 360,400 291 0.08% 100 5%
Hebei 423,100 281 0.07%
0 0%
Henan 820,000 426 0.05%
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

Anhui 509,900 250 0.05%

Sichuan 571,000 310 0.05%
Source: DBS Vickers
Rising demand for international higher education and better
quality in fundamental education. The international and
innovative curriculums are usually offered in international and
premium private schools with much higher-than-average
tuition fees. Parents’ increasing willingness to pay for
education is partly boosting demand.
1) International schools
An increasing number of parents intend to send their children
to overseas universities. There are more choices and it is now
easier to get admitted by good universities overseas. Even the
Ivy League has an admission rate of around 5%, much higher
than that of Tsinghua University or Peking University through
Overseas students (LHS) Growth rate (RHS)
Source: Ministry of Education of PRC, DBS Vickers
Both opportunities and challenges exist for international
schools. Total number of overseas students from China
reached 544,500 in 2016, increasing 4% y-o-y. The overseas
education market may not grow as fast as in previous years,
but will continue its growth trend at a stable rate, boosting
demand for international schools. However, students tend to
go overseas at an earlier stage. Students going to high schools
overseas grew from 17% in 2012 to 27% in 2015 according to
CCG’s survey. In 2015, applications for overseas high schools
increased by 53% y-o-y, according to New Oriental. The
overseas competitors bring challenges to international schools
in China, offsetting part of the market growth opportunities.

Page 13
Industry Focus
China Education Sector

2) Premium private schools Unlike primary and middle schools, public high schools
produce better results and have better qualities than private
For schools targets in “Gaokao”, some premium private schools. High schools are not under the compulsory education
schools are also gradually beating public schools in compulsory category and hence, at this stage private and public schools are
education stage. This is especially true in Tier 1 cities like in direct competition for students. Famous public high schools
Beijing and Shanghai. We expect this trend to expand to other with a longer history, better reputation and outstanding exam
regions as well when they become more developed. Unlike results are the most sought after. The “Four Best High Schools”
public primary and middle schools, which are under strict in Shanghai are all public high schools. We do not expect
regulations for student enrolment and course offerings, private private high schools to perform better their public counterparts
schools are much more flexible in these aspects. Private schools as the former lack a good track record of university admission.
can accept or reject students based on their own criteria but Similarly, private higher education is also less attractive
public schools have to accept all students assigned to them, compared to public universities.
regardless of the students' knowledge level. As private schools
have students from a more diverse background and often As demand for quality education is increasing, parents are
higher level of knowledge, they have the resources and more than willing to pay premium tuition fees. Unlike the free
feasibility to offer more flexible courses. education offered at public compulsory education schools and
the average annual tuition fee of around RMB 3,000 at all
In Shanghai, for example, premium private primary and middle private primary and middle schools, private international
schools are famous for their good performance in admission schools often charge RMB 30,000 to 50,000 per year. The
examinations for higher education. This attracts parents most welcomed premium private schools usually charge RMB
although their tuition fees are usually around RMB 10,000 to 20,000 to 30,000 per year. Even with such a high base, tuition
15,000 for one semester compared to the free public schools. fees are rising and still have room for further increase. In 2017,
For the top private primary schools, the admission rate could the highest rate of increase for tuition fees of international
be as low as 1/6 to 1/7. To secure a place in these primary schools in Shanghai is almost 180%.
schools, the children have to begin preparing themselves at the
kindergarten stage, which in turn boosts the demand for good Too many obstacles to obtaining good education through the
private kindergartens. public system, including insufficient public spending, limitation
of “Hukou” and rising housing prices compel parents to spend
The 2016 early-admission results of the so-called “Four Best more on private education
High Schools” in Shanghai indicates an overwhelming
advantage of private middle schools. With less than 20% of Apart from those who choose to attend private schools on
the total number of students, they make up nearly 80% of the their own volition, many others have no choice as it is
number of students admitted to the top 10 schools. extremely hard to obtain a place in good public schools.
Public spending on education is still low in China compared to
2016 Shanghai “Four Best High Schools” Early Admission other countries. In 2013, the total education spending in China
was 1.6% of total government spending, lower than most of
20 16 2 016 Ea rly From
the countries compared. Other Asian countries, such as
Ea rl y Admi s s i on pri va te
Admis s i on top 10 tota l s c ho ol Pe rc e nta ge
Singapore and Thailand, have an education spending ratio as
Shanghai High 235 208 185 89% high as 20%.
School
No.2 High 222 147 110 75% The per-pupil spending was even worse. In 2015, per capita
School of East
GDP of China was RMB 50,251 while the public expenditure
China Normal
University on primary education per pupil was RMB 11,273, or 22.4% of
High School 221 163 103 63% per capita GDP. This ratio was the lowest even when compared
Affiliated to with the data from 2013 for other Asian countries. It lagged
Fudan University behind some developing countries as well. The per capita
resource of public education is too limited to be easily
High School 235 118 90 76%
Affiliated to approached.
Shanghai
Jiaotong
University
Tota l 9 13 636 488 77%
Source: School Website, DBS Vickers

Page 14
 Industry Focus
China Education Sector

Education spending as of total government spending Sky-high residential prices near good public schools further
2013 exacerbate the situation. In China, places in public primary and
middle schools are assigned to students who live in housing
25% estates nearby. Sometimes, children in one estate are assigned
to very good schools while children just one block away are
20% assigned to ordinary schools.
Thus, the prices of properties in locations that are assigned to
15% good schools rise faster than those in the already overheated
Chinese real estate market. From August 2016 to January 2017,
10% in Xicheng District, Beijing, the average price of second-hand
properties increased by RMB 19,636 per square metre (sqm)
5% while that of school district properties increased by RMB
24,600 per square metre.
0%
New…

United…

South…

United…
Indonesia
Bangladesh
Singapore

Russia
Netherlands
Thailand

China
Italy
Australia

Spain
Egypt
Israel

India
Kazakhstan

Ukraine
Poland
Turkey

Czech Rep.

Still taking Beijing as an example, a study by THUPDI in 2015

indicated that the price premium of good-school-assigned
properties over nearby ordinary-school-assigned properties is
usually higher than 20%. The exception is Chaoyang district,
Source: International Statistical Yearbook (by Bureau of Statistics of where the premium is only 1.42% because there are no good
PRC) , DBS Vickers
public schools in this district.

Government expenditure per pupil on primary Price per sqm of properties with good schools assigned
education in 2013, as % of per capita GDP
Rmb '000
400 80,000

350 70,000
300 60,000
250 50,000
200 40,000
150
30,000
100
20,000
50
10,000
0
0
Australia

Indonesia
Hong Kong
Malaysia
Thailand
Korea

China
Japan

SriLanka
Pakistan
South

Xicheng Dongcheng Haidian Chaoyang

24.4% 21.5% 20.2% 1.4%

Source: THUPDI, DBS Vickers

Source: UNESCAP, DBS Vickers
Though not as high as in Beijing, parents in other cities also
“Hukou” system in China rejects non-local students from have to pay a great amount for a property that enhances their
public fundamental education. The basic requirement to get changes of getting their children into good public schools.
into a public school is to have “Hukou” or family registered in After considering the costs and benefits, many parents may
the city. This is not an easily obtained status, especially for Tier find private schools a more cost-efficient option.
1 cities. For example, in 2015, there were 21.70 million
residents in Beijing. Among them, 8.23 million or 37.9% do
not have their “Hukou” in Beijing and 687,000 are children
under 14. Hence, it would be very hard, if not impossible, to
enrol these children in public primary or middle schools in
Beijing.

Page 15
Industry Focus
China Education Sector
II. Risks and threats in the private education
industry
Although the sector is rich with opportunities, there are some
risks to be mindful of, especially the regulation risks. Also,
there are some potential hurdles such as the shortage of
teachers and physical constructions which may prevent the
market from fully exploring the potential. However, after
careful study, we believe that these risks can be mitigated and
are controllable.
To have a better understanding about the risk factors, we
conducted a detailed study on New Oriental (Appendix II) to
find out the reasons behind the short seller’s attack and share
price drops. New Oriental’s experience shows that 1) student
number growth; 2) management and operational integrity; and
3) education regulation and related VIE structure and tax
problems; are the three main risk factors for private education
institutions we should keep an eye on.
A. Business risks
Private schools’ business is less affected by the total industry
and population growth but more by their own management
and operations.
Student number may not grow as fast as expected. We built
our market size estimation based on a series of assumptions
over population and economic growth. There is a possibility
that inputs do not grow as fast as we expect. Out of these,
demographic change has the highest uncertainty as the true
effect of the “second child policy” is hard to evaluate. The
education market size will be much smaller if the student
number does not grow significantly in the coming years.
With the new demographic policy and the governments'
concerted efforts, student numbers are unlikely to drop further.
The worst scenario is zero growth in the near future. If the
student number remains stable at its 2015 level of 250 million,
the total education market size would be RMB 2.25 trillion by
2025, or 75% of the RMB 3 trillion we previously estimated. It
is still a large market, with a 3.7% CAGR during 2015 to 2025.
What’s more, the negative impact on private schools, especially
the premium ones are very limited. Past experience shows that,
even though the total number of students kept dropping, the
private schools were in high demand with increasing student
numbers. For example, in the past several years, the yearly
enrolment of middle school students has been decreasing on
the national level while that of private schools kept the upward
trend. Though many public schools have been shut down due
to declining student numbers, their private peers are hardly
affected.
Page 16
Middle school enrolment (thousand), private vs total
'000 '000
16,000 1,750
15,500 1,700
15,000
1,650
14,500
1,600
14,000
13,500 1,550
13,000 1,500
2012 2013 2014 2015
Total middle school (RHS) Private middle school
Source: Ministry of Education, DBS Vickers
Private schools' management problems affect their reputation
and market share. Though similar “university admission
cheating cases” of New Oriental are unlikely to affect most
private schools targeting on “Gaokao”, they may still face
some problems on other aspects of management and
operations.
For private kindergartens, there is quite a lot of news regarding
child abuse cases. For example, children were beaten by
teachers or fed with rotten fruits. All these cases occurred in
private kindergartens. As there are not many requirements and
regulations on kindergarten teachers, common private
kindergartens or even some premium ones are very likely to
hire non-qualified teachers to cut their costs. Insufficient
government supervision has worsened the problem.
For other levels of schools, especially universities, the most
commonly encountered problem is their bogus qualifications.
For example, in 2013, 100 private universities were uncovered
by the media as “fake universities”. They did not gain the
approval for operating a higher education institution from the
government, could not provide students with bachelor’s
degrees and should not enrol any students while they post lots
of fake advertisements online to cheat students and parents.
Even the leading private schools can also face management
problems at times. For example, Virscend, a Hong Kong-listed
private school operator in Sichuan, has experienced some
disputes with its employees. Three hundred Virscend teachers
hired from local public schools went on strike in 2009 as they
were not satisfied with their welfare package.
 Industry Focus
China Education Sector

Such operational risks are hard to avoid. However, they are not
new problems and existed from Day 1 of the industry
development. The negative impact has already been reflected
in the previous growth of the industry.
category of education, e.g. they must have experience in
operating schools overseas. Foreign Ownership Restriction
requires the foreign portion of the total investment in a Sino-
Foreign joint venture private school to be below 50% with
approvals gained at provincial level.

B. Regulation risks
Regulations are stricter at the compulsory education stage, but
no big negative influences are expected. There are two main
regulations affecting private education: regulations on foreign
investments, which affect schools incorporated offshore or
partner with foreign schools; and regulations on education
guiding all private schools.
1) Laws and regulations relating to foreign investments
Foreign investments in compulsory education are strictly
prohibited. They are however allowed to invest in
kindergartens and high schools, subject to certain qualification
requirements and foreign ownership restrictions to run a joint
venture with Chinese partners. Qualification Requirement
means that the foreign investor must have relevant
qualification and experience at the same level and in the same
Currently, listed companies use VIE structure and a series of
contractual arrangements to avoid restrictions on foreign
investors. Some schools are also making effort to meet the
qualification requirement so that they can directly control the
schools without contractual arrangements should the
regulations be relaxed someday. For example, Wisdom plans to
co-operate with Dewey College in Canada and open a new
school in Canada. Maple Leaf is also proactively seeking
opportunities to expand abroad. By doing so, they meet the
qualification requirements of operating schools overseas and
can run their high schools directly as long as the foreign
ownership restrictions are loosened.
Maple Leaf, as well as all the other listed companies which
operate as foreign investors, applies their own methods to
avoid the restrictions on foreign investments.

Maple Leaf dealing with regulations over foreign investors

School type Elementary & Middle
Limits Prohibited from foreign investment
Solution Operated and held by Dalian Science
and Education and Dalian Educational
Group, which are onshore companies,
controlled by ML through Contractual
Arrangements
Comments
Source: Company, DBS Vickers
Foreign National Schools
Needs approval from provincial
authorities
Owns two foreign national schools
through the Founder (qualified foreign
investor)
Founder will continue to be the owner
until provincial authorities approval
The group want to change the owner
from Founder to the company, but not
approved by authorities yet by IPO
Preschools and high schools
Not regulated by Foreign Investment
Catalog, but prohibit from operating
independently. Need to meet Qualification
Requirement (QR) and Foreign Ownership
Restriction to run JV
Dalian Maple Leaf High School set as
Sino-Foreign JV before the regulation
came out, other schools are wholly-
owned by Founder's Sister and controlled
by company through Contractual
Arrangements
ML did meet "QR" when IPO. It now has
its first school overseas and has strategy
of overseas expansion, preparing to meet
the QR

2) Laws and regulations on private education
The regulation trend is to loosen regulations on private
education and encourage investments, but compulsory
education schools are more closely supervised. In 1995, under
the Education Law of PRC, no organisation or individual was
allowed to establish or operate a school or any other
educational institutions for profit-making purposes. In 2002,
the Law for Promoting Private Education also stated that
private education was for the good of the public. From then till
now, the private schools cannot pursue profits, but could have
some “Reasonable Returns”.
In November 2016, the Amendment to the Law for Promoting
Private Education was promulgated and shall come into force
on 1 September 2017. Under new regulations, schools can be
either “for-profit” or “non-profit” at their own discretion.
However, the schools engaged in compulsory education should
remain to be non-profit.
As details regarding to the tuition, enrolment and tax at
provincial level are not completely published yet, there might
be possible negative influences brought about by the provincial
level policies. For example, Hailiang Education, which is listed in
the US (NASDAQ: HLG) has encountered admission problems
in its Zhejiang Zhuji High School in 2013. Zhejiang province

Page 17
Industry Focus
China Education Sector

published a regulation on the private school admission of the Maple Leaf Company Structure
number of non-local students, e.g. private high schools cannot
admit more than ten students from a non-local city without
Maple Leaf
prior approval. Two hundred new high school students were
required to withdraw their enrolment as a result of the new 100% 95%
policy. Service fee
Dalian Maple Leaf
Beipeng Software
Though the National Medium and Long Term Education High School
Reform and Development Plan (2010-2020) raised the goal to Service
clear the discrimination policies on private education, the Service fee Service
situation has not really improved under the current regulation 5%
framework. We expect the discrimination policies to be Founder Founder's Sister
completely cleared under the new regulations, but should also
be cautious about the uncertainties of new policies. A detailed 100%
study on how regulations could affect the decision-making 100%
process of schools is conducted in the next part of this section.

Private school types under current and new regulations

Foreign National China Holdco and
Curre nt Ne w Schools Subsidiaries
Schools whose sponsors make donations For-profit
to the establishment of the schools
Schools whose sponsors do not require Non-profit (Compulsory
reasonable returns stage schools must fall in Source: Company report, DBS Vickers
Schools whose sponsors require this category)
reasonable returns

Source: DBS Vickers

Overall, we do not think that the new regulations will bring a

negative impact on primary and middle schools, especially the
listed ones. On the one hand, the regulations are actually
loosening instead of tightening as they begin to allow for-
profit schools in non-compulsory education and have clear
guidance on juridical persons. On the other hand, the listed
education companies have already taken the VIE structure to
meet the requirement for foreign investments. The same
structure can also be used to deliver dividends through a series
of contractual arrangements.

Maple Leaf, for example, uses four contractual arrangements

to control its PRC Holdco and subsidiaries and operate through
its wholly owned PRC subsidiary Beipeng Software. The
structure helped the company to avoid the restrictions of the
new regulation, e.g. it is not acting as a profit-generating
school, but Beipeng, a software company, receives services fees
and generates profits.

Page 18
 Industry Focus
China Education Sector

Contractual Arrangement of Maple Leaf C. Details of new regulations and related decision making
process
Conte nts Goa l
Exc l usi ve Beipeng Software has the Maple Leaf operates as a On 7 November 2016, the main regulation on private
Ma na ge me nt exclusive rights to provide holding company, education in China, The Law for Promoting Private Education
Consul ta n c y all intellectual property receives dividends and
was amended (“The Amendment”) and will be in effect from 1
a nd Busi ne ss services to Maple Leaf other distributions from
Coope ra ti on schools, Maple Leaf Beipeng. Dividends from September 2017. The main purpose for the amendment is to
Agre e me n ts schools pay services fees Beipeng depend on the set different categories of schools, e.g. for-profit and non-
(100% of net income after service fee received. profit, and manage them accordingly. We believe that the
deducting reserve) to Maple Leaf To receive impact of the new regulations on the listed schools will be
Beipeng benefits through Beipeng limited.
Ca l l Opti o n The Founder's Sister If current government
Agre e me n ts agreed call option for the approval policy for foreign Highlights of the change
Maple Leaf to gain national schools become
part/all of equity interests clear, Maple Leaf can Together with The Amendment, three related documents
in PRC Holdcos (currently consider to wholly own about the details have also been published: Opinions of the
100% owned by her) for the company by State Council on Encouraging and Promoting Private Education
nil consideration or the themselves (“Opinions”) (國務院關於鼓勵社會力量興辦教育促進民辦教育
min amount permitted
健康發展的若干意見), Implementation Rules for Classified
(Founder's sister return
the amount of purchase if
Registration of Private Schools (“Registration Rules”) (民辦學校
not 0) 分類登記實施細則) and Implementation Rules for Supervision
Equi ty Pl e dge Founder's sister to pledge To guarantee and Management of For-profit Private Schools (“Supervision
Agre e me n ts all equity interests in PRC performance of the Rules”) (營利性民辦學校監督管理實施細則). The amendment
Holdcos to Beipeng obligations of PRC and the detailed rules (or so-called “1+3”) offers a framework
Holdcos under the first
and guidance of the coming changes.
two contractual
arrangements
Changes are made in seven main aspects while the core is the
Powe rs of Founder's sister Maple Leaf and its wholly
Attorne y appointed Beipeng as her owned PRC subsidiary
categorised management and differentiated policies:
attorney to appoint Beipeng have the ability
directors and vote on her to exercise effective 1) Improve the control of China Communist Party (“CCP”) in
behalf on matters of PRC control over PRC Holdco private schools
Holdco through shareholder
votes Unsurprisingly, the Chinese government wants to ensure the
leadership of CCP in private schools. A new act was added in
Source: Company Report, DBS Vickers the Amendment to emphasise on CCP’s role in private schools.
What’s more, the Supervision Rules require for-profit schools to
have “two-direction entry” in their school board and CCP
Other listed K12 education providers also take similar VIE
organisation leaders according to the item 20, e.g. the leader
structure and contractual arrangements to control their
of the CCP organisation of a school should also be a member
onshore companies and generate earnings. The new
in the school board or senior management team.
regulations will have little influence on their earnings and
dividend payout of compulsory stage schools. The only risk of 2) Establish the legal system to manage different categories
this structure is the legal risk of VIE structure, which is rather
small. This is the core of the Amendment. Private schools in non-
compulsory education stage are now allowed to pursue profits.
The ambiguous saying of “reasonable returns” is deleted.
Schools are now clearly classified as “non-profit” or “for-profit”
and managed accordingly.

3) Further ensure the interests of sponsors

Sponsors can choose to be non-profit or for-profit according to

their own situation. Though the assets of the sponsors are
already “donated to the society for public good”, The
Amendment clearly added that the sponsors can participate in

Page 19
Industry Focus
China Education Sector
the management and operations of the school according to
the school’s charters.
4) Further improve teachers' welfare
Unlike teachers in public schools who are generally treated as
civil servants, their peers in private schools usually do not enjoy
the same benefits. To improve the treatment of teachers, The
Amendment further encourages private schools to pay
pensions for their employees.
5) More support from the government
The Amendment emphasises on the equal legal status of
private and public schools. Private schools can receive support
in the aspects of land, tax, finance, etc. regardless whether
they are for-profit or not. However, the extent of support
would be different to show the government’s encouragement
of non-profit schools. For example, the government grants and
finance awards are only available to non-profits schools.
6) Further establish operation and management systems
Under the new regulation, private schools are required to set
up boards or councils to deal with their decision-making
process and to have related supervision systems.
7) Stable transition period
The second revision of The Amendment raised a three-year
transition period. In the final version, however, the “three-year
period” was deleted. It is to give schools more flexibility and a
longer transition period. The transition period could last for a
few years without clear deadlines to ensure stable operation of
schools.
Impacts and uncertainties
In general, we do not think the listed companies will be
substantially impacted by the core changes in regulations.
Under the current regulation framework, all private schools are
non-profit regardless of requiring “reasonable returns” or not.
Listed schools are generating earnings and paying dividends
through VIE structures even when none of them are allowed to
pursue profits. There are no negative impacts on profit taking
as long as their VIE structures are in use.
Actually, a recent case between Yaxing Company and Ambow
Education reflects the Supreme Court’s positive attitude over
VIE structure in education companies, giving us more comfort
on the VIE arrangements.
Things will remain unchanged for quite a while. Apart from the
“1+3” regulations at the national level, many details such as
tax and tuition policies have yet to be determined at the
provincial level. The legislation process to making everything
clear could take as long as a few years. Schools also need time
Page 20
to determine their category and obtain approval. The whole
process might be long with lots of government work. The time
frame may also vary from province to province. We will have to
wait for some time before everything is well-settled under the
new regulations.
In the coming years, schools should pay attention to local
regulations in three aspects: 1) tax and land policies; 2) details
on how non-profit should be registered; and 3) if the school
turns itself into for-profit, what is the process, at what costs
and conditions, etc.
To be or not to be, that is the question
Based on the current information, we believe that it is highly
likely that all listed companies remain what they are as non-
profit schools for their K12 schools. Though details are yet to
come, the decision-making process is mainly based on two
questions: how large is the financial benefits brought by the
for-profit type and how difficult is the transition process, with
the summaries of factors as below:
Factors for decision-making: non-profit, or for-profit
Non-profit For profi t
Fina nc e
Tax No tax Discounted tax rate
Tuition Government approval More pricing power
(current situation)
Minor factors Same as public No government grants
(land use and school
government grants)
Non-fi na nc e
Registration Registration before Potential spin-off of
tax exemption licenses and assets
Management Corporte management
with enhanced CCP
leadership
Source: DBS Vickers
Tax and tuition are the main considerations on the finance side.
When considering whether to transfer their schools to for-
profit type, companies tend to think about the costs and
benefits on their revenues. Generally speaking, for-profit
schools could have more pricing power in determining tuitions
while they also have to pay higher taxes and receive no
government grants. We conducted a scenario study to
understand under what circumstances the schools would
choose to be for-profit.
Take Maple Leaf as an example. It reported total tuition
revenue of RMB 695m in FY16, among which 60% is from
kindergarten and high schools. As we focus on the tuition
revenue only, we only take into account the tax rate on the
tuition income, rather than the tax paid by WOFE or other
 Industry Focus
China Education Sector

subsidiaries. Using the PBT margin of 39% and tax rate on As a result, though there are different combinations of tax
tuition of 0% in FY16, we derived the PAT from tuition of RMB rates and tuition fee hikes, 0% tax rate and 0-5% tuition rise
273m for Maple Leaf, compared to its total PAT of RMB 308m would be more likely to happen if Maple Leaf chooses to
over the same period. The second step is a scenario study with register its high schools as non-profit while 15% tax rate and
different combinations of tax rate and growth in average 10-15% tuition rise are more likely to apply if for-profit
tuition level of non-compulsory stage school students. We kept category is chosen. The outcome shows that chances for-profit
the tax and tuition level for primary and middle schools schools to generate better finance outcomes are small. A
unchanged as we want to isolate the potential impacts of non- similar conclusion could be reached for other schools as well
compulsory stage schools only. The result is shown in the though they have different exposure in non-compulsory stage
following table: schools, profit margin, effective tax rates and tuition growth
rates.
Tax and tuition combination, Maple Leaf FY16
Tax and tuition combination
Ma pl e Le a f For-profit school tax rate
Tuition 273.0 0% 5% 10% 15% 20% Wi s d o m (b a s e d o n 1 H 1 7 re s u l ts )
increase in 0% 273.0 264.8 256.6 248.4 240.2 For-profit school tax rate
non- 5% 281.3 272.6 264.0 255.4 246.8 Tuition 9 7 .7 0% 5% 10% 15% 20%
compulsory 10% 289.5 280.4 271.4 262.4 253.3 increase in 0% 97.7 96.3 95.0 93.6 92.3
stage 15% 297.7 288.2 278.8 269.4 259.9 non- 5% 99.0 97.6 96.2 94.8 93.3
schools compulsory 10% 100.4 98.9 97.4 95.9 94.4
20% 305.9 296.0 286.2 276.3 266.5
stage 15% 101.7 100.2 98.6 97.1 95.5
schools 20% 103.1 101.5 99.8 98.2 96.6
Likely situation if Likely situation if
choose to be choose to be
non-profit for-profit Yuhu a For-profit school tax rate
Tuition 31 2.5 0% 5% 10% 15% 20%
Source: DBS Vickers increase in 0% 312.5 303.4 294.2 285.0 275.8
non- 5% 321.7 312.1 302.4 292.8 283.2
compulsory 10% 330.9 320.8 310.7 300.6 290.5
Theoretically speaking, schools could choose to be for-profit as stage 15% 340.0 329.5 318.9 308.4 297.8
long as the benefits brought by tuition rise outweigh the schools 20% 349.2 338.2 327.2 316.2 305.2
additional costs of tax rise. For example, if the average tax rate
for Maple Leaf non-compulsory stage schools increases to 15% Vi rs c e nd For-profit school tax rate
as they pursue profit, the final outcome would still be better Tuition 319.7 0% 5% 10% 15% 20%
off if their average tuition could increase by 20% or more. In increase in 0% 319.7 312.0 304.3 296.6 288.9
reality, however, it is very unlikely for schools to raise their non- 5% 327.4 319.3 311.2 303.1 295.1
tuition at such a sharp rate in the short term, especially when compulsory 10% 335.1 326.6 318.1 309.7 301.2
the tuition fee hike is usually imposed on new enrolled stage schools 15% 342.8 333.9 325.1 316.2 307.4
students only. As an international school, we reckon that a 10- 20% 350.4 341.2 332.0 322.8 313.5
15% y-o-y increase in tuition fees is more likely to happen if
the pricing regulations are further loosened. Source: DBS Vickers

Similarly, the governments are also unlikely to ban any kind of

tuition fee hike for non-profit schools. A more likely pricing
scenario for non-profit schools is to remain where it is – tuition
fee rise subjected to school application and government
approval. Historical trend shows that a yearly growth of 0-5%
in tuition level is quite sustainable. Maple Leaf, for example,
increased its average tuition fee for high schools and
kindergartens by 4.3% and 2.7% respectively in FY16.
For tax, a 40-50% discount could be expected on the current
level of corporate income tax in China of 25%, which gives a
10-15% tax rate of for-profit school income. The non-profit
schools will remain tax exempt as their public peers.
Under the new regulation, for-profit schools are not entitled to
government grants and enjoy fewer benefits in land use rights.
However, as the government grants are small in number and
the land problem is easily solved through the “asset-light
model” co-operation with third parties, they will not be major
factors in the decision-making process. As of FY16, the
government grants received by the four companies were less
than 1% of their revenues and almost negligible.

Page 21
Industry Focus
China Education Sector

Government grants in FY16 Teacher’s average salary vs local average urban salary

RMB mn 160,000 160%

9 1.2%
140,000 140%
8
1.0% 120,000 120%
7
6 0.8% 100,000 100%
5 80,000 80%
0.6%
4 60,000 60%
3 0.4%
40,000 40%
2
0.2% 20,000 20%
1
0 0.0% 0 0%
Maple Leaf Wisdom Virsend Yuhua Maple Leaf Wisdom Virsend Yuhua
Teacher's salary (LHS) Local Average (LHS)
Government grants (LHS) as of revenue (RHS) Premium (RHS)

Source: Companies, DBS Vickers Source: Companies, DBS Vickers

Apart from the finance consideration, the complicated Registering as for-profit type seems more difficult to handle.
application and approval process may also keep schools from Firstly, spin-off would be a complicated problem. All of the
turning to for-profit type. The application and approval process four companies have some main campuses which are shared
for non-profit schools is already more troublesome than before, by different levels of schools as shown in the table below. They
while the for-profit ones are faced with even more difficult share one school licence for such a mixed campus. If they want
challenges in management and operations. to register their high school portion as for-profit, they first have
to get an additional school license for the high school part. At
The new regulations added a detailed requirement for tax the same time, assets should be also divided between the non-
exemption of non-profit schools. They must obtain approval profit and for-profit parts. It could be a difficult accounting
from the taxation authorities before enjoying tax exemption. process to count and divide assets like playgrounds, school
Currently, the taxation authorities have not published any buildings and dorms if they are shared by high school and
criteria for recognizing tax-exempted schools. However, the other level students in the same campus.
Ministry of Finance and State Administration of Taxation has
announced how the tax exemption qualification of non-profit High schools mixed with middle and primary schools
organisations should be recognised in the past. According to
Primary M iddle High
the announcement, only when the organisation’s employee
sc hool Sc hool school
salaries are lower than twice of the local average level could
M aple L eaf
they be exempted from the tax. If same rules are carried to Tianjin Taida Maple Leaf International School ✓ ✓ ✓
private schools, some may not be able to obtain the required Chongqing Maple Leaf International School ✓ ✓ ✓
approvals and may still have to pay tax even though they are Zhenjiang Maple Leaf International School ✓ ✓ ✓
registered as non-profit. Henan Maple Leaf International School ✓ ✓ ✓
Wisdom
When compared with the local average salary level for urban Dongguan Guangzheng Preparatory School ✓ ✓ ✓
employees at provincial level (nationwide average for Maple Dongguan Guangming School ✓ ✓
Leaf comparison), Maple Leaf and Virsend pay their teachers V irsc end
higher than twice the local average. If the tax-exemption Chengdu F oreign Languages School ✓ ✓
conditions on salaries are tighter than expected, they may have Chengdu Experimental Foreign Languages ✓ ✓
to adjust their salary policies slightly. Y uhua
Zhengzhou YuHua Elite School ✓ ✓
J iaozuo YuHua Elite School ✓ ✓ ✓

Source: Companies, DBS Vickers

Page 22
 Industry Focus
China Education Sector

For-profit schools are faced with one more regulation, the it is an international school. The ratios of the three local
Supervision Rules, than their non-profit peers. As this is the first curriculum schools are similar or just slightly lower than the
time for-profit school education is allowed in China, the average level.
government appears very cautious and would like to keep tight
control. Under the Supervision Rules, the requirement on CCP Statistics of teachers in listed K12 schools
control, CCP leadership in school board and political
Ma ple Le a f Virsc e nd Wisdom Yuhua
requirement on courses appear more than once. We are not
Teacher number in 2016 1,814 2,185 1,960 2,455
sure at what extent will these regulations be executed in real Student/teacher ratio in 10.66 12.84 16.22 12.48
life. However, the additional costs and less freedom in daily 2016 (K12 only)
management, especially for international schools, may prevent Total salary (RMB m) 268.0 217.6 197.5 181.2
schools from pursuing profits. As of total COGS 63% 62% 53% 48%
Average salary per 147,740 124,316 100,766 73,809
teacher per year
D. Potential expansion hurdles
Unlike other industries, schools do not need much raw Source: Company reports, DBS Vickers
materials or upstream suppliers to operate. The most important
supply-side factors are teachers, which determine their Supply of teachers sufficient to meet demand, but premium
education quality and reputation and construction of school schools hold the advantage in attracting good teachers. To
buildings, which in turn affect their capacity and ability to have 63 million K12 students in private schools means an
expand. The potential market value cannot be fully realized if increase of roughly 25 million in K12 student number in five
private schools cannot get these two key resources. years. The private schools need to hire 1.8 to 2 million new
teachers if they want to keep the ratio below 14.
Sufficient supply of teachers supports the exploration of
Graduates from normal schools are an important source of
the market, but quality remains a big concern, especially
teachers. The number of normal graduates does not show
for private kindergartens and higher education
large changes in the past few years. In 2015, the number of
normal graduates reached 556,587, including both bachelor’s
Average K12 student-to-teacher ratio in China vary from 12 to
degree and junior college diploma graduates. Assuming the
18 in different levels of schools. In 2015, primary schools had
yearly number remains the same, there will be 2.8 million fresh
the highest student-to-teacher ratio at 17.05, and that for
graduates in five years, already exceeding the 1.8 million
middle school was 12.41 and high school 14.01.
needed. Other sources of hiring include Master graduates,
Student-to-teacher ratio in China other university graduates, or experienced teachers from public
schools. The total supply would not be a limitation.
%
Number of graduates from normal schools (000)
18

17 '000
600
16
500
15
400
14
300
13
200
12
2010 2011 2012 2013 2014 2015
100
Primary School Middle School High School
0
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Source: Ministry of Education of PRC, DBS Vickers

Source: Ministry of Education of PRC, DBS Vickers

Private schools, especially those premium and international
ones, often have a lower-than-average ratio. The four listed
private schools had 10-16 student/teacher ratios for their K12
education in 2016. Maple Leaf has the lowest ratio at 10.66 as

Page 23
Industry Focus
China Education Sector

However, those premium private schools offering more Asset-light model results in faster expansion and less
competitive packages will be the biggest winners. Compared capital expenditure for famous brands
with public schools, teachers in private schools are faced with
Private schools have lower land and construction costs than
fewer regulations and limitations but also longer working
property developers. The other important input is construction
hours, greater pressures and fewer pension plans. In addition,
and land. Though varying largely from one school to another,
public teachers can enjoy a series of welfare and benefits as
they usually cost much lower than that for common property
local civil servants. Usually, only private schools paying higher
developers. Under new regulations, not-for-profit schools can
salaries can attract good teachers.
obtain free land as with public schools, and for-profit schools
can secure land at a discounted price.
As shown in the above table, the four listed private schools
offer RMB 70,000 to 140,000 on average per year to a teacher,
Per GFA construction cost is also lower as schools tend to have
which is more than double of that for a public school teacher.
a simpler building structure. While it costs RMB 3,000 to 4,000
Teacher’s salaries make up around 50% to 60% of their total
per square metre GFA for a common residential property in
costs, but in turn brings better quality and reputation to the
general, it costs around RMB 2,000 per square metre to
schools.
construct a school property. The cost level is similar for private
schools. For example, the costs for Weifang, Guang’an and
For universities, the student-to-teacher ratio is larger. They do
Yunfu campus of Wisdom Education is at RMB 1,300 to 2,300
not require as many teachers as the students are adults and do
per square metre.
not need teachers to keep an eye on them. However, the
quality of teachers is a big challenge for private universities.
Per GFA construction cost of schools
Compared to public universities, private universities have a
lower percentage of teachers with middle to senior academic
Rmb /sqm
qualifications. 2,500

Academic qualifications of full-time teachers 2015 2,000

1,500
45%
40% 1,000
35%
500
30%
25% 0
2007

2008

2009

2010

2011

2012

2013

2014

2015
20%
15% High School and Middle School
10% Primary School
Kindergarten
5%
0%
Source: Wind, DBS Vickers
Senior Sub-senior Middle Junior No-
ranking
Public universities Private universities

Source: Ministry of Education of PRC, DBS Vickers

Page 24
 Industry Focus
China Education Sector

Reputed schools are more likely to adopt asset-light models to

further lower their capital expenditure and accelerate
expansion. The asset-light model means that a school co-
operates with a partner who provides land and construction.
The school is responsible for daily operations and pays rents or
split its profits with the partner. The partner is usually a
property developer, local government or local enterprise. The
partners, especially local governments, are willing to pay to
attract reputed schools in PPP (Private-Public Partnership)
model. Compared with traditional asset-heavy model which
costs hundreds of millions of capital expenditure for a campus
of 5,000 – 10,000 capacity, it costs less than RMB 100 million
as capital expenditure in the asset-light model. The time frame
for recouping all investments is also shortened from 5-7 years
to 2-3 years. The PPP model works better in Tier 2 and Tier 3
cities as those governments have more incentives to attract
good education resources.

PPP example: Virscend with Panzhihua government

Co- Government build buildings and dormsm. Virscend

ope ra ti on rents and operates.
Re nts 20 years, first 3 years free. 8% of total tuition as rents
from the fourth year. Virscend has priority to buy or
renew rental contracts after 20 years.
Ope ra ti ng Government gives subsidies as to public schools
Subs idi e s according to the local students number
Equi pme nt RMB 10 million in 3 years
s ubs i di e s

Source: Company report, DBS Vickers

In summary, we believe that the upstream of supply chain

could well support the full exploration of the private education
market value with enough supply of teachers and low
construction costs. In this process, premium schools would be
the winners and acquire larger market shares with easier access
to good teachers and construction resources.

Page 25
Industry Focus
China Education Sector

III. Outlook of key education segments Number of kindergartens in China and growth

We believe that kindergartens and after-school trainings are '000

more attractive for investors. Kindergartens will enjoy a higher 250 12%
student growth momentum and better tuition pricing power in 10%
200
the coming years as the result of baby boom and loose 8%
regulations. After-school trainings benefit from a series of
150 6%
market drivers, including fast expansion and new technologies,
making it the favoured sector of investors. 100 4%
2%
A. Kindergarten
50
0%
Among all education segments, kindergarten is the first to
0 -2%
benefit from the end of one-child policy. After the easing of

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015
birth policy in 2016, the new birth peak will be from 2016 to
2019 when post-70s parents catch their last opportunity to
Number of kindergartens Growth rate (RHS)
have a second child, 80s parents have their second child and
post 90s have their first. Over 20 million newborns are
Source: Ministry of Education of PRC, DBS Vickers
expected annually in the peak years. As a result, there will be
great demand for kindergartens from 2019 to 2025. The total
number of kindergartens in China has been growing fast in the Number of kindergarten students in China
past few years. We believe that the trend will carry into the
future as the birth rate is rocketing rapidly from 2016 to 2019. mn
70 120%
Both population base and percentage of children going to 60 100%
kindergartens are increasing. Total number of kindergarten 50 80%
students in China was 42.6 million in 2015, 5.3% higher than 40
60%
the previous year. Typically, children from 3 to 5 years old go 30
to kindergartens in China. The population of 3-5 year olds are 20 40%
estimated from the total population and birth rate each year. 10 20%
Comparing the kindergarten student number with the 3-5 year 0 0%
2010A

2011A

2012A

2013A

2014A

2015A

2016E

2020E

old population, we found that not only the population base
have increased, but the percentage of kids going to
kindergartens has also improved a lot, from 62% in 2010 to
88% in 2015. We expect the school rate to further rise to
above 90%, as a target mentioned in the Outline of China’s
National Plan for Medium- and Long-Term Education Reform
and Development 2010-2020. With these two drivers, the total
number of kindergarten students is estimated to be around 65
million in 2025, or 8.3% CAGR from 2015 level.
2025E
Kindergarten students number (LHS)
3-5 year population (LHS)
Percentage (RHS)
Source: Ministry of Education of PRC, DBS Vickers
With the highest penetration rate, private education takes a
large share in the market. Kindergarten is the only segment in
K12 education where private schools take more than half of
students. The penetration rate reached 54% in 2015. The
number of private kindergartens accounts for over 60% of the
total number. The entry barrier for private education is low
because of 1) fewer regulation restrictions on obtaining
approvals and deciding tuition levels; and 2) lower
requirements for teachers as there is little or no exam pressure.

Page 26
 Industry Focus
China Education Sector

Number of private kindergartens in China

B. Compulsory Education (Primary and middle schools)

'000 Student number kept dropping as a result of previous tight

250 80%
70% demographic policy, but a turning point is in view. Total
200 students at school kept dropping in the last decade for both
60%
150 50% primary and middle schools. In 2015, there were 43 million
40% middle school students and 98 million primary school students
100 30% in total.
20%
50
10%
Unlike the decreasing new enrolment number of middle
0 0%
schools, that for primary schools ranged from 16.3 to 17.3
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
million in the past ten years. The total primary student number
showed signs of recovery from 2013. The downward trend
Number of Kindergatens
ended in 2014, with 0.8% and 2.3% annual growth in 2014
Number of private kindergartens
and 2015 respectively. We are optimistic that the trend will
As percentage
continue for another few years, supported by the new
Source: Ministry of Education of PRC, DBS Vickers demographic policy. The downward trend for enrolment and
total student number in middle schools can be expected to
Large room for potential tuition fee hike. Average tuition fees turn around from 2019, as a result of increasing primary school
increased in double-digit rate in the past five years. In 2014, graduates.
total tuition revenue reached RMB 98.2 billion or
approximately RMB 2,424 of each student for the total 40.5 Enrolment (000) and student number (million) of middle
million kindergarten students. The average tuition fee schools
increased by 25% from RMB 1,940 in 2014. The fast
increasing trend in tuition is likely to continue driven by the mn '000
booming demand. In 2025, we expect the average tuition fee 70 22
to grow to RMB 4,000 which gives total tuition revenue of 21
65 20
around RMB 260 billion. Private kindergartens are expected to
60 19
generate RMB 195 billion or 75% of total tuition assuming the
18
same tuition growth and 60% penetration rate in 2025.
55 17
Historically, the tuition revenue is around half of total revenue. 16
Other income sources include government spending, donations 50 15
and other income. The total kindergarten market value would 45 14
be around RMB 520 billion in 2025. 13
40 12
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

Average tuition of all kindergartens (RMB)

Students at school (LHS) New enrolment (RHS)

'000
45,000 16%
40,000 14% Source: Ministry of Education of PRC, DBS Vickers
35,000 12%
30,000
10%
25,000
8%
20,000
6%
15,000
10,000 4%
5,000 2%
0 0%
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

Kindergarten students (LHS) Growth rate (RHS)

Source: Ministry of Education of PRC, DBS Vickers

Page 27
Industry Focus
China Education Sector

Enrolment (000) and student number for primary schools Premium private schools make use of special features to
differentiate themselves from public schools. This would be a
mn '000 future development trend for private primary and middle
120 18 schools to meet different demands from parents and attract
115 more students to improve the penetration rate. Schools in
Shanghai have a good attempt on special featured education.
110 Some of the schools with special features approved are shown
105 17 in the table below:

100 Special features of premium private schools in Shanghai

95
Es ta b l i s h e d
90 16 Sc h o o l Na me Ti me Sp e c i a l Fe a tu re
Shanghai Dongzhan 2003 Morality e ducation
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

Primary School
YK Pao School 2007 Whole person education,
Students at school (LHS) New enrolment (RHS)
bi-lingual education,
family-like boarding,
Source: Ministry of Education of PRC, DBS Vickers happy e ducation
Tongji Unive rsity 2000 Science and technology
Average tuition level is low for private schools but that for Experimental School education
premium schools has kept increasing. The primary and middle Shanghai World Foreign 1993 Inte rnational education
school tuition is relatively low compared to that of Language Primary
kindergartens and high schools. Dropping from the 2014 level, School
they were at RMB 2,567 for primary schools and RMB 3,289 Shanghai Qibao Foreign 2005 New model of school-
for middle schools in 2015. The tuition fees for the large Language School family inte rgra tion
number of schools in rural areas or those with ordinary
qualities are low as they have to compete with free public Shanghai United 2003 Inte rnational school with
Inte rnational School fusion of Chinese and
schools. However, the premium schools in cities have kept
Inte rnational culture
increasing their tuition fees due to strong demand. In the
Shanghai Pinghe 1996 Globa l citizen education
future, we expect the average tuition fee to also improve Bilingual School
slightly as the total student number and demand begin to Shanghai Zhangjiang 2006 Science and technology
increase. Group Junior Middle innovation
School
Average tuition of private schools in China Dayi Foreign Langauge 2005 Art education
Primary School
Shanghai International 2001 Special English courses
9,000
Studies University
8,000
Bilingual School
7,000
6,000 Source: Development Report on Non-Government Education in China,
DBS Vickers
5,000
4,000
3,000 With the optimistic view supported by the turnaround in
2,000 student numbers, we are expecting small positive growth in
1,000 both student numbers and tuition levels for compulsory
0 education. 1% CAGR in average tuition, 3.5% and 2% CAGR
Kindergarten Primary Middle High School for student numbers in primary and middle schools respectively
School School and 10% private school penetration rate lead to total tuition
2014 2015 revenue of RMB 60 billion for 190 million students by 2025.
The figure is relatively small as 90% of the students who go to
Source: Frost & Sullivan, DBS Vickers public schools do not pay tuition.

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China Education Sector

Number of students in high schools

C. High Schools
(mn)
Student number is shrinking with no upward trend in the near 48 12%
future. Unlike compulsory stage schools, students have to sit 10%
for examinations to be admitted by high schools and bear the 46
8%
risk of failure. Though the admission rate is rising, the new 44 6%
enrolment as well as total student number of high schools is 4%
42
decreasing, mainly driven by the drop in the number of middle 2%
school students. In 2015, there were in total 40.4 million high 40 0%
school students nationwide, 3.2% down from 41.7 million in -2%
38
2014. As the number of students in middle schools has yet to -4%
turn upwards and the admission rate is already over 90% with 36 -6%

2025E
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
little room for further improvement, we do not expect the
number of students in high schools to increase in the coming
years, but the decreasing rate will be stabilising. In the longer
Student number Growth (RHS)
term (e.g. 8-10 years), however, the student number should
enjoy a slow growth.
Source: Ministry of Education of PRC, DBS Vickers
With the weak growth momentum, we estimate 45 million
high school students in 2025 with 1.1% CAGR, which
Largest potential of rising tuition exists for high schools. Private
indicates that roughly 90% of the 51 million primary students
schools can pursue profits for high schools and public schools
enrolled from 2013-2015 would continue their studies in high
can also have tuition income. High schools are the only type of
schools. 6 million of them will be in private schools with 13.5%
school whose tuition increased in 2015, 1.5% up from the
penetration rate assumed.
previous year at RMB 7,719. Under new regulations, the
growth rate could be higher if more private high schools
Admission rates of high schools in China
declare themselves as “for-profit”. The average tuition of
private high schools is very likely to be more than RMB 10,000
(mn)
by 2025, which will give private high schools around RMB 45
25 100%
billion in their tuition income.
20 80%
International schools and programmes can fully make use of
15 60% their strength. Though many international schools have primary
10 40% and middle school education, their strength on international
curriculum could be fully realised as the courses provided in
5 20% compulsory stage have to strictly fulfil certain requirements. As
a result, most international schools are focused on high school
0 0%
stage. Only 6.1% international schools have no high schools
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

and 42.1% have only high schools. High schools are the most
Middle school graduates (LHS)
important stage for international education as most students
High school enrolment (LHS) who plan to study abroad want to go overseas for universities.
Admission rate (RHS) The high schools will have more room to increase tuition fees
compared to international schools at other levels.
Source: Ministry of Education of PRC, DBS Vickers

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Industry Focus
China Education Sector

International school types

D. Higher Education

Primary There are two kinds of higher education institutions (HEI) in

and middle China: regular HEIs and adult HEIs. In 2015, there were in total
Primary, schools
6% 26.3 million undergraduate students in regular HEIs and 6.4
middle and
high million in adult HEIs. As the students in adult programmes
schools usually have a wide age range and are likely to be part-time,
37% Middle and we will focus on the undergraduate students in regular HEIs
high
only.
schools
14%
University student number accounts for 10.5% of the total 251
Only high million students in 2015. The number of students kept
schools
increasing in the past decades despite the dropping population,
43%
mainly driven by the continuous increase in the admission rate.
However, the growth rate started to stabilie when universities
began to turn their emphasis from increasing size to improving
quality. In 2016, the student number yearly growth was 2.7%,
Source: Center for China & Globalization, DBS Vickers down from double-digit growth ten years ago.

K12 Education Market Outlook by Segments in 2025
To wrap up, among the total 300 million K12 students
expected in China in 2025, 65 million are kindergarten
students, 190 million or 64% are in the compulsory education
stage while high schools have the least number of students of
around 45 million.
The admission rate has increased greatly in the past 20 years.
In 1990, only 27.3% of high school graduates could be
admitted by HEIs. In 2015, the rate achieved 92.5%, thanks to
the enlarging admission plans and the development of private
universities. Little room exists for further improvement of the
already above-90% admission rate. The birth peak will not
affect the universities in the next 20 years either.

The total private schools' tuition income of RMB 300 billion will University admission rate, %
be mainly generated from kindergartens, which contribute
RMB 195 billion. Compulsory stage schools and high schools %
each contribute RMB 60 and 45 billion respectively. 95

K12 education market summary 90

100% 85
90% 45 45
80% 80
60
70%
60%
190 75
50%
40%
195 70
30%
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

20%
10% 65
0% Source: Ministry of Education of PRC, DBS Vickers
Number of students Private school tuition
(million) revenue (RMB billion)
Kindergarten Compulsory Stage Schools High Schools Due to the lack of further catalysts in either population or
admission rate, we forecast the student number to increase at
Source: DBS Vickers a lower rate of 2% CAGR in the next decade, reaching 32
million in 2025.

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 Industry Focus
China Education Sector

University students number (million) and growth Student number (million) and penetration rate

mn mn
35 18% 35 35%
30 16% 30 30%
14% 25 25%
25
12% 20 20%
20 10%
15 15%
15 8%
10 10%
6%
10 5 5%
4%
5 2% 0 0%

2025E
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2020 E
0 0%
2025E
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

Public universities (LHS) Private universities (LHS)

Students at school (LHS) Growth rate (RHS)
Private as of total (RHS)

Source: Ministry of Education of PRC, DBS Vickers Source: Ministry of Education of PRC, Frost & Sullivan, DBS Vickers
Private universities experienced a high growing period before Private universities in general charge higher tuition fees than
2010 and currently have a penetration rate of 23.3%. Both public ones. They are usually 3-4 times of public universities'.
number of schools and number of students jumped sharply in Together with the enlarging scale, both ASP and total revenue
2008. Since then, the penetration rate as of student numbers of private universities have improved in past years. The total
kept growing steadily. In 2015, there were 734 private market size is forecast at RMB 200 billion by 2025, with ASP of
universities, 275 of them being independent institutions, which RMB 21,337or 41% higher than the 2015 level.
were established through co-operation with public universities.
The total number of students in private universities was 6.1 The potential drivers for increasing market size of private
million in 2015 and is predicted by Frost & Sullivan to be universities include 1) large room for improving the quality of
around 8.7 million with 27.2% penetration rate in 2020. teachers and teaching; 2) higher management levels with
better strategic views; 3) higher employment rate of graduates
Number of schools – Regular HEI in China
as more and more private schools focus on job skill training
instead of academic research.
3,000 35%
30% ASP and total revenue of private universities
2,500
25%
2,000
20% 250 6%
1,500
15% 200 5%
1,000 4%
10%
150
500 5% 3%
100
0 0% 2%
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

50 1%
0 0%
Public universities (LHS) Private universities (LHS)
2025F
2016E

2017E

2018E

2019E

2020E
2011

2012

2013

2014

2015

Private as of total (RHS)

ASP (RMB 000) (LHS)

Source: Ministry of Education of PRC, DBS Vickers Total Revenue (RMB billion) (LHS)
ASP Growth (RHS)

Source: Frost & Sullivan, DBS Vickers

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Industry Focus
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Sohu Education’s education consumer survey shows that

E. After-school trainings 83.2% of K12 students attend after-school training, especially
After-school training institutions play an important role in the those in Tier 1 cities. Over 65% attend more than one class.
education market. It overwhelmed school education and made
Number of after-school tutoring classes attended, 2015
up of 60% of the total education market in 2016. A wide
range of trainings are provided for students at different ages,
including K12 after-school tutoring, art and music, foreign
no class
languages, early education for 0-4 year-old children and job 1 class 17%
skill and IT trainings for university students. 17%

K12 after-school tutoring has the best development

opportunity among all kinds of trainings. Faced with great
pressure of Gaokao, parents of K12 students pay extreme 2 classes
attention to the K12 after-school tutoring. According to a 26%
study by The Chinese Society of Education (CSE), 80% of K12 more than
parents agree that the tutoring is important and 92.7% are 3 classes
19%
willing to pay over 20% of their household income on the
after-school tutoring. 3 classes
21%
Parent’s attitude towards K12 tutoring in 2016

How do parents agree with the importance of after-school tutoring

Source: Sohu Education, DBS Vickers
Disagree
Neutral 2%
9% The extreme high willingness to pay for tutoring, together with
Very the expected growth in student number, high participation rate
disagree and household income, will support the fast expansion of
1% after-school training in the coming years. We are expecting
Agree around RMB 2 trillion generated from this sector, which will be
57%
67% of the total RMB 3 trillion market with 9% CAGR.
Very agree
31%
Despite the industry drivers, there are also three specific drivers
that further boost the fast growth of the sector:

1) Easy-to-replicate model
Unlike traditional schools, training institutions can decide their
How much parents willing to pay on after-school tutoring course materials and teaching methods all by themselves and
Not much only need to rent offices and classrooms instead of building
willingness
to pay
independent campus. As a result, it is convenient for them to
20% of 7% expand across cities and provinces.
household
disposable
income Successful institutions like New Oriental and TAL wholly own
34% their schools and learning centres and manage them from the
central management. Their core team in Beijing is responsible
for course development and teacher training, thereby
As much as
possible standardising the teaching process and quality. Their local
50% of
household without teams can themselves focus on expanding market share
disposable upper limit without much dependence on good teachers. Their success
income 32%
model is easy to copy. Once the brand is established, they can
27%
easily enter other regions.

For example, New Oriental has 66 schools, 748 learning

Source: CSE, DBS Vickers
centres, 22 bookstores across 55 cities, which is unimaginable

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 Industry Focus
China Education Sector

in scale for full-time schools. The growth rate slowed down Parents’ choice of training types
from 2013 to 2015, but accelerated again in 2016.
90%
Number of New Oriental learning centres 80%
70%
Number of learning centres
60%
900 60%
50%
800 50%
40%
700
40% 30%
600
500 30% 20%
400 20% 10%
300 0%
10% After Interest Educational Online Others
200
0% school Classes books education
100 K12 tutoring and vedios
0 -10%
2015 2016
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

Number of learning centres Growth rate (RHS) Source: iResearch, DBS Vickers

A leading Chinese consulting company, CIConsulting, forecast

Source: Wind,DBS Vickers
higher than 20% annual growth in the K12 online education
tutoring sector from 2015 to 2020. The market size will more
2) Large potential in Tier 3 and Tier 4 cities than triple from RMB 35.9 billion in 2015 to RMB 110 billion in
Currently, leading training institutions have most of their 2020.
learning centres in Tier 1 and 2 cities. The top 10 training
institutions all have their headquarters in Tier 1 cities like Forecast on K12 online education market size
Beijing, Shanghai, Guangzhou and Shenzhen. On average,
80% of their learning centres are located in Tier 1 and 2 cities. RMB bn
120 28%

In Tier 3 and Tier 4 cities, the market participants are generally 100 27%
small ones with less than RMB 1 million in annual revenue.
26%
Plenty of M&A and large growth opportunities exist for the 80
leading players entering Tier 3 and Tier 4 cities. 25%
60
24%
3) New technology development
40
With the development of IT technology, online education has 23%
become increasingly popular among both students and 20 22%
investors these days. Compared with traditional offline
education, online education enables students to study at any 0 21%
time and place at their convenience. The new broadcast and 2015 2016E 2017E 2018E 2019E 2020E
VR technology make interactions between students and Market size (RMB billion) Growth rate (RHS)
teachers the same as in offline classrooms.

Source: CIConsulting, DBS Vickers

2016 saw fast development of online education sector.
iResearch’s survey on parents’ choice of after-school training
shows that though traditional offline K12 tutoring remains the
most chosen type, an increasing number of parents turn to
choose online tutoring for their children. The ratio of parents
choosing online education increased sharply to 52% in 2016
from 37% in the previous year.
With a promising future and fewer regulation limitations, after-
school trainings, especially online education and K12 tutoring,
continue to attract investors’ attention. The investment has
spiked to its peak since 2014. In 2016, there were 303 public
deals invested in education industry and mostly in after-school
trainings with a total deal size of RMB 15.5 billion. Though the
investment size has decreased from previous years, it remains a
hot investment topic with strong fundamentals.

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Industry Focus
China Education Sector

Number and size of investment in education

400
350
300
250
200
150
100
50
0
2011 2012 2013 2014 2015 2016
Number of investments
Size of investments (RMB 100 million)

Source: China News, DBS Vickers

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 Industry Focus
China Education Sector

IV. Listed company landscape in Hong Kong A. Regional exposure

Based in one of the most developed areas in China, we believe

There are currently four K12 school education providers listed
Wisdom has the best potential market driven by the economic
in Hong Kong. Overall, we think Virscend has a better growth
growth. Though not a very affluent area, Yuhua also has
momentum over its peers. However, as its future growth has
advantage in regional exposure mainly due to the regional
already been reflected in its current price, our top pick in this
demographic growth.
sector is Yuhua, followed by Maple Leaf and Wisdom.
All listed schools except Maple Leaf have very concentrated
Through a study on critical factors (Appendix I), we found that
presence in their home provinces of Guangdong, Henan and
student number and gross margin are the two most important
Sichuan. Independent exam and admission system at provincial
drivers for earnings. To find out the champion of the sector,
level might be one of the most important reasons. For the
we studied the student number growth by breaking it into
schools targeting on Gaokao and offering Chinese curriculum,
several factors.
their advantage in teaching methods and training of teachers
under local exam framework might not be easy to be
The ability of the sustainable student number growth in the
replicated in other regions. Also, as students have to attend
long-term is determined by the size of potential market and
Gaokao where their Hukou is located, K12 schools for Gaokao
how well companies could position themselves in the market.
tend to have local students within the province only. As a result,
Due to the industry nature, it is impossible to form a united
unlike Maple Leaf which operates 56 schools in 14 cities and
market of education in China. Each company has its own
ten provinces in China and admits students nationwide, other
separated potential market, which is mainly affected by its
K12 school education providers choose to limit most of their
regional and segment exposure. The quality and development
schools within their home provinces with local students.
strategy of the schools determine how much they can finally
get from the market by affecting their pricing power and
Regional exposure
expansion pace.
To ta l n u mb e r o f N u mb e r o f s c h o o l s
The table below shows how each of the company relatively sc ho o ls b y Se p H o me c i ty/ o u ts i d e h o me
performs in the factors affecting their growth with 4 2016 p ro vi n c e c i ty/p ro vi n c e
M a p l e Le a f 56 Da lia n 42
representing the best:
Vi r s c e n d 6 Sichua n 0
Wi s d o m 6 Gua ngdong 2
Long-term growth momentum Yu h u a 25 Hena n 0

International Source: Company report, DBS Vickers

Local schools school
V irsc en d W isd o m Y u h u a M ap le L eaf It is easy for schools to expand their presence into other
Regional exposure 2 4 3 3 regions using the asset-light model. The capital expenditure
Segment exposure 3 2 3 3 would be low and they could take advantage of the revenue
Quality of school 4 2 3 2
growth and build a nationwide reputation. Yuhua Education,
Management strategy 4 3 3 4
for example, has plans to expand its footprint outside of Henan
O v erall 13 11 12 12
in the future. Wisdom Education also plans to further expand
Source: DBS Vickers beyond Guangdong province.

With highly concentrated presence in their home provinces and

There are also two university education providers listed in Hong
having most students from local cities and towns, development
Kong recently. Minsheng Education operates four universities
of K12 schools in Virscend, Yuhua and Wisdom groups have
in Chongqing and Inner Mongolia, and was listed on March
high dependence on local population growth and income level.
2017. China New Higher Education, operating two universities
in Yunnan and Guizhou, listed on April 2017. We will look into
The home provinces for the three groups, Sichuan, Henan and
these two companies at a later stage.
Guangdong all have very large populations. In 2016, the
population for the three provinces were 82.6, 95.3 and 110
million respectively, representing 6%, 7% and 8% of China's
total population.

Page 35
Industry Focus
China Education Sector

Among the three provinces, Henan province has the largest Age group 0-14 as percentage of total population
growth potential in population of younger generation, giving
schools in Henan a better position in future student base. 22%
Schools in Sichuan, on the other hand, may have the least
advantage in the demographic side. Despite the already-large 20%
population base, Henan province reported higher-than-average 18%
birth rate from 2013 to 2016. The birth rate in Henan reached
13.3% in 2016 after the relaxation of demographic policy and 16%
is higher than the national level of 13%. Sichuan and 14%
Guangdong, on contrast, reported lower-than-average birth
rates in past years though was improving. In 2016, the birth 12%
rates were 10.5% in Sichuan and 11.9% Guangdong, up from 10%
10.3% and 11.1% in the previous year. With the growth in
birth rate remaining stable, the end of “One-Child Policy” did 8%
2011 2012 2013 2014 2015
not have a large impact in Sichuan in the past year.
Sichuan Guangdong Henan China
Birth rate in each province
Source: Bureau of Statistics of PRC, DBS Vickers
14%
Located in Pearl River Delta as one of the most developed
13% regions in China, Guangdong province has the highest income
level. In 2015, the per capita disposable income in Guangdong
12% reached RMB 27,859 and was 26.8% higher than the national
level of RMB 21,966. Sichuan and Henan reported similar level
11% of disposable income level in 2015 at around RMB 17,200.
Both provinces lagged behind the nationwide income level
10%
from 2013 to 2015.
9%
Per capita disposable income (000 RMB)
8%
2010 2011 2012 2013 2014 2015 2016 30
Sichuan Guangdong Henan China
25
Source: Bureau of Statistics of PRC, DBS Vickers
20
Henan province also beats others in the population structure.
15
Despite the ageing problems in China, the percentage of 0-14
year old population as a percentage of the total in Henan
10
remained high at around 21% and was in a slight upward
trend in the past years. The 0-14 population ratio in Sichuan 5
and Guangdong, however, was dropping from 2013 to 2015.
In 2016, the percentages in Sichuan and Guangdong were 0
15.9% and 16% respectively, down from 16.2% and 16.5% 2013 2014 2015
in 2015 and lower than the national level of 16.5%. Sichuan Guangdong Henan China

Source: Bureau of Statistics of PRC, DBS Vickers

Though the income levels are similar, Henan province may have
better market potential in education and schools over Sichuan
as residents in Henan tend to have a higher willingness to pay
for education and related services. From 2013 to 2015,
residents in Sichuan spent around 9% of their total
consumption expenditure on education, culture and recreation

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 Industry Focus
China Education Sector

activities. The spending ratio in Henan was a little bit higher at fundamental education stage. Though no projections were
around 10%. reported, the penetration rate in Guangdong was as high as
28.7% in 2015 compared with the national level of 18.3%.
Consumption in education, culture and recreation as a Central region of China, including Henan, also has quite high
percentage of total consumption expenditure penetration rate. In 2015, 22.1% of students in Central region
and 24.3% in Henan province in fundamental education stage
12% were enrolled in private schools. Private education in southwest
regions, however, has lower penetration rates than average.
11%
Private fundamental education penetration rate
10%

9% 28%
26%
8% 24%
22%
7%
20%
18%
6%
2013 2014 2015 16%
14%
Sichuan Guangdong Henan China
12%
10%
Source: Bureau of Statistics of PRC, DBS Vickers

2016E

2017E

2018E

2019E

2020E
2011

2012

2013

2014

2015
Historically, the economic growth rates in these three provinces
are highly correlated to the growth at the national level Central China South-West China China
although Sichuan province fluctuates more widely in its
nominal GDP growth. In recent years, Guangdong province Source: Frost & Sullivan, DBS Vickers
had higher-than-average economic growth. In 2016, Sichuan
and Henan also showed upward trend to outperform the
national GDP growth. In the near future, we have an optimistic As a result, Yuhua will benefit from the younger population
outlook for the economic growth and expect higher-than- distribution and higher birth rate in Henan, bringing them a
average GDP growth for all three provinces. larger base of students. Wisdom may benefit more from the
large educational market size brought by the high income level
Nominal GDP growth and high private education penetration rate in Guangdong. On
the other hand, Virscend may enjoy the least growth
25% momentum from the regional development.

20% With students from all over the country and schools in different
provinces, the future development of Maple Leaf will be more
15% affected by the economic and population growth at the
national level instead of the provincial level. The wide regional
10% and student exposure mitigates various risks at the regional
level, but also limits the upper side they could get from the
5%
fast-growing regions.

0%
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Sichuan Henan Guangdong China

Source: Bureau of Statistics of PRC, DBS Vickers

In line with the high income level, Guangdong province has an

extremely high private education penetration rate in

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Industry Focus
China Education Sector

company’s segment exposure by adding kindergarten business

B. Segment exposure
Currently, we believe Yuhua and Maple Leaf have better
position over Wisdom and Virscend in their segment exposures.
Two factors are considered under this part: 1) Higher
profitability from the non-compulsory stage education,
especially kindergartens and high schools; and 2) Higher
popularity among parents of schools covering the whole K12
chain.
to the group.
Among all K12 education providers, Maple Leaf has a better
position to seize the opportunity brought by the “second-child”
policy. Not only does it have a higher ratio of students in
kindergartens and primary schools currently, its future
expansion plan also involves a large number of early-age
schools.

K12 segment breakdown

Most of the Hong Kong-listed educational companies provide
school education in various segments from kindergartens to
high schools or universities. 35,000
30,000
Segment exposure summary 2016 by student number
25,000
Pri ma ry M i d d l e Hi g h 20,000
Ki n d e rg a rte n Sc h o o l Sc h o o l Sc h o o l Un i ve rs i ty
Ma ple 10.1% 30.3% 21.0% 38.5% 0.0% 15,000
Le a f 10,000
Yu h u a 5.7% 15.0% 16.3% 11.0% 52.0%
Vi rs c e n d 1.0% 8.1% 30.4% 17.8% 42.7% 5,000
Wi s d o m 0.0% 35.2% 39.4% 25.4% 0.0%
0
Source: Company report, DBS Vickers Maple Leaf Yuhua Virscend Wisdom

Kindergarten Primary School

The four companies all have more than half of their K12
students (e.g. excluding university) in compulsory education Middle School High School
stage. Maple Leaf has the lowest exposure in the compulsory
education at 51.3% while Wisdom has the highest exposure at Source: Company report, DBS Vickers
74.6%.
Gross margin does not differ much in K12 schools. Though
New school plans in 2017 (number of new schools) schools in compulsory education stages are faced with stricter
regulation limitations such as the requirement to be non-profit,
number of new schools
this would not be a big concern for all the listed companies.
5 Being the largest or leading players in their regions with well-
recognised teaching qualities, they charge high premiums over
4 the average tuition level even for compulsory stage schools.
Their gross margin of primary and middle schools are in the
3 similar level with that of kindergartens and high schools. As a
result, although those with more kindergartens could improve
2 their revenue with more students and fewer regulations on
tuition, they do not necessarily have better profitability.
1

0
Yuhua enjoys higher margin for its university exposure while
Maple Leaf Yuhua Virscend Wisdom Virscend the opposite. Yuhua and Virscend, with more than
40% of their total students in university, generates a different
Kindergarten Primary School Middle School High School
gross margin from their universities. In 2016, the university in
Yuhua achieved a gross margin of 63.3% while the group level
Source: Company report, DBS Vickers was 52%. Virscend, on the other hand, have higher capital
expenditure and depreciation expense in its university. The
In the coming years, Yuhua has plans only to enlarge its
salaries of their university teachers are also higher. The gross
capacity at high schools while others have expansion plans for
margin of their university was only around 30% compared to
schools in all stages from kindergarten to high schools. In 2017,
the group level of 47%.
Wisdom plans to open one new school covering all K12 grades.
Though the planned capacity for kindergarten would still be
small compared to the other grades, it diversifies the

Page 38

C. Quality of schools
Virscend has firm position with top 3 ranking among all high
schools in Sichuan with outstanding performance in Gaokao.
Yuhua is also one of the Tier 1 school brands with high local
recognition while Wisdom and Maple Leaf have weaker
performance in their own market.
For K12 school education providers, especially high schools, the
most important indicator measuring their quality is their
students’ performance in college admissions. Tier 1 universities
in China are the best universities which could admit students in
the first batch after Gaokao. For high schools which mainly
targets in Gaokao, their admission rates of Tier 1 universities in
China is an important factor to be considered by parents when
choosing schools.
As a group, the brand and reputation are established mainly by
the outstanding admission performance of its high schools. Its
primary and middle schools then attract students by giving
students a higher chance of getting admitted by these good
high schools in the same group.
Ratio of Students admitted by Tier 1 Universities
2014 2015 2016
Yuhua 17.7% 11.4% 14.2%
(211 and 985 universities only)
Henan Province 8.1% 8.2% 9.1%
Wisdom 18.4% 21.4% 23.2%
Guangdong Province 8.1% 9.6% 11.2%
Virscend 69.5% 77.4% 87.0%
Sichuan Province 5.3% 5.5% 5.4%
Source: Company report, DBS Vickers
Each province has its own exam and admission system in
Gaokao. As a result, the difficulty of entering Tier 1 universities
varies in different provinces. It is not fair to compare the
admission ratio across provinces. When compared with their
local level of Tier 1 university admission, all three companies
show better-than-average admission results for their high
schools. All of them show an upward trend in the Tier 1
admission rate from 2014 to 2016. Though Yuhua’s admission
ratio seems not so high compared to the provincial level, it
reflects the students ratio admitted by the top universities
which are classified as “211” or “985” only. It includes only a
small number of the Tier 1 universities.
Among them, Virscend has the highest relative performance
over the provincial average. Despite the fact that Sichuan
province had the lowest Tier 1 university admission rate in
China (even lower than that of Tibet) at 5.4% in 2016,
Virscend had 87% of its high school students admitted into
Tier 1 universities. What’s more, operating foreign language
Industry Focus
China Education Sector
high schools, Virscend is also famous for its bilingual and
international education. The admission result would be even
better if we include the more than 200 students who were
either admitted by overseas universities or exempted from
Gaokao and directly admitted by top Chinese universities.
Premium over provincial average admission rates (bps)
%
90 82
80 72
70 64
60
50
40
30
20 12 12
10 10
10 3 5
0
2014 2015 2016
Yuhua (211 and 985) Wisdom Virscend
Source: Company report, DBS Vickers
The outstanding performance of Virscend is mainly from
Chengdu Foreign Languages School. The admission rate of Tier
1 Universities of that school reached 82.1%, 83.8% and
90.9% from 2014 to 2016. It is the only private school among
all the 16 foreign language schools which could recommend
their students to top universities free from Gaokao. In the 2016
ranking of top 100 high schools in China by Yuantiku, an
online K12 training company, Chengdu Foreign Languages
School ranked 82 nationwide and third in Sichuan Province.
Almost all of the high schools on the ranking list are public
schools. Chengdu Foreign Languages School has strong
competitive advantage not only over its private peers, but also
over many public high schools.
Though good at sending students to top Canadian universities,
Maple Leaf’s competitive advantage is not very significant
among all international schools as US remains the most
popular destination. Maple Leaf provides international
curriculums and does not compete with others in Gaokao. In
2016, over 56% of its 1,422 high school graduates are
admitted by Top 100 universities ranked by Maple Leaf based
on international standards including University of Toronto, the
University of British Columbia and McGill University, etc. Eight
of them were admitted by top 10 universities including Imperial
College of London and University College of London. In 2017,
43 graduates received admissions from these two universities
up until now.
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Industry Focus
China Education Sector

With its expertise in Canadian curriculums (e.g. it offers both Initial employment rate
China and British Columbia high school diplomas in high
schools), most of its graduates choose Canada as their 100%
destination for undergraduate studies.
80%
To further achieve its goal of getting students into overseas
universities, Maple Leaf has built up relationships with a 60%
number of foreign universities. For example, it applied to be
40%
the Oxford exam centre and organised summer schools to
overseas universities. 20%

Maple Leaf graduates undergraduate destinations 2016 0%

2013 2014 2015
Yuhua
Switzerland Virscend (include further studies)
4%
USA China Average
8% UK
4%
Source: Company report, DBS Vickers

Australia
11%
Canada
73%

Source: Company report, DBS Vickers

For private universities, the key indicator of their qualities is the

employment rate of their graduates. Unlike public universities,
especially those top ones, students in private universities are
very unlikely to devote themselves to research or further
studies after graduation. Almost all private universities target at
job skill trainings and their ultimate goal is to help their
graduates get employed.

Two of the K12 education providers also run private

universities. Both of them reported a higher-than-average
initial employment rate from 2013 to 2015. However, despite a
slight improving national average in 2015, Yuhua reported
lower employment rate that year compared to the previous
levels. Though the 2015 level rose to 95% for Virscend, it may
be boosted by the number of students who chose to pursue
higher education as Virscend includes this group of students
into its employment statistics.

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 Industry Focus
China Education Sector

student number target, but they also have high incentive for
D. Strategies and management this. Also, Maple Leaf does not have a high criteria for selecting
students. To get as many students as possible, it admits
Suitable strategies help schools to increase their size and
students with different qualities. Students are divided into
student number as well as to focus on their competitive
different groups and taught accordingly after entering the
advantages to further raise the tuition level. Maple Leaf and
school. For example, students who do not speak very fluent
Virscend could get more benefits in these two aspects from
English will have extra English classes.
their current strategies.

Virscend: Enlarging market based on the good reputation of its

Maple Leaf: Expansion strategy matches with its strength in
high schools, advantages in English teaching
Tier 2 cities and non-compulsory stage education; more
attention on student number than quality
Virscend's main competitive advantage lies in the extremely
good reputation of its high schools. It not only outperforms
Maple Leaf’s current schools are mostly located in Tier 2 cities.
private schools in Sichuan, but also most of the public high
On the one hand, governments in Tier 2 cities are willing to
schools. Operating mainly foreign language schools, Virscend
pay more in the asset-light model to attract quality education
schools have advantages in teaching English over its public
resources. On the other hand, Maple Leaf itself has more
peers. While public middle schools in Chengdu have 4-6
competitive advantages in Tier 2 cities. In China, the
English classes per week, Virscend middle schools provide 14
mainstream of international education programme includes A-
English classes every week. It also offers courses for IELTS, SAT,
level, IB and AP courses. Maple Leaf, however, focuses on the
TOEFL or AP courses to attract students who want to study
BC programme in Canada. As the US remains the most wanted
overseas.
destination for Chinese students, Maple Leaf does not have
any advantage in Tier 1 cities where there are plenty of
The supply of Virscend school position is far less than the
international education resources.
demand. In 2016, the admission rate of Chengdu Foreign
Languages Schools was 25.2% for middle schools and 28.6%
At the moment, Maple Leaf only has one high school in Tier 1
for high school. The middle school admission rates were even
cities. The Shanghai Maple School has nearly 1,000 students.
lower at 7-8% in 2013 and 2014 as the school set higher
Lack of attractions of BC programme, too many IB schools in
hurdles for signing up for selection.
Shanghai and its poor location make the school not so
competitive in the international education market in Shanghai.
With more sources of funding after being listed, Virscend is
Situations are different in Tier 2 cities. Not only can they get
changing its strategy to enlarge its targeted market. In the past,
better location of land with lower costs, the BC courses
it only takes in the best students. Now, it relies on the brand
become much more attractive in places where the international
value of Chengdu Foreign Languages School to expand its
schools are still small in number. The company’s future
presence and also target on not-so-good students. Considering
expansion plan and school pipeline could well match its
its high brand value and strong demand among parents, the
strength in Tier 2 cities. All 14 new schools to be opened in
company should not worry about the student number in its
2017 in China are located in Tier 2 cities.
new campuses. The aggressive expansion strategy actually
helps the company to turn its reputation into cash.
International schools differentiate themselves better in non-
compulsory education stages as they do not have to follow the
Though university is one of their exposures, it is not the key
Chinese curriculum requirements. Maple Leaf recently adjusted
area of expansion in recent years. On contrast, Virscend has
its strategy to pay more emphasis on kindergartens. The
strategies to seize the opportunities in baby boom. In the next
company has an aggressive development plan to open one
five years, it plans to open another three kindergartens in
new kindergarten in each of its current cities in the next plan.
Chengdu. Also, it invested in an early-education institution in
The new strategy makes sense in the environment of new
2017 to expand its footprint into the education of 0-5 year-old
round of baby boom and kindergarten’s ability to generate
children. The investment diversified the companies’ segment
profit under new regulation.
exposure and enables it to take more and earlier benefits from
the increase in numbers of kids.
Another key driver of revenue is student number. Maple Leaf
has taken a series of methods to make its student number
Wisdom: “2+2+2” expansion strategy and focus on Chinese
meet its annual target. For example, the increase in student
curriculum from grade 1-12
enrolment is not only the job of the registration office. It is a
KPI for every employee. The employees, especially principals of
Wisdom uses a so-called “2+2+2” strategy in its expansion. In
each school are usually under great pressure to achieve the
each year, they expect two new schools to open, two to begin

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Industry Focus
China Education Sector

construction and another two to begin preparation. Currently
it does not have any exposure in kindergartens and the future
pipeline for new kindergarten capacity is also very small. In the
future, it will still mostly focus on the area that it is mostly
familiar with: primary, middle and high schools without large
expansion plan in kindergartens and no strategy in universities.
Meanwhile, though Dongguan Guangming School offers some
international courses in its high school, Wisdom does not want
to pay too much attention on the international education but
just to keep it as a diversification option.
In short, Wisdom takes the strategy to stay in the field that it is
traditionally good at. This lowers down the risk of failure, but
also lowers the potential benefit it could get from strong
demands for international education and kindergartens. Its
strategy of increasing two new schools each year makes the
cash flow and capital expense more stable, but the fixed
expansion pace may not best suit each year’s market
environment.
Yuhua: Expansion in university and high schools; features in
arts and international education; building stable and capable
teaching team through its own HR training system
Yuhua pays lots of attention to attrac and train talented young
teachers in its HR strategy. At the moment, the company does
not hire many experienced teachers from other schools. Instead,
they hire fresh graduates and train them using their own
training system. The fresh graduates could become capable
teachers with strong recognition of Yuhua in 3-5 years. Large
room for promotion is provided for these young teachers. The
principal-in-general for all K12 schools is only 29 when he was
promoted as a principal of a single school for the first time.
To retain the young teachers in the system longer, the
company offers large amounts of options with long vesting
period of 15-20 years. The KPI of teachers focuses on student
enrolment, stability, teaching quality and management.
Yuhua’s HR strategy brings a team of young and energetic
teachers with high loyalty to the company. Its training system
has also reduced its dependence on only a small number of
famous teachers. However, as the training cycle usually takes
several years, it may constrain the expansion of new schools. In
school year 2014/15 and 2015/16, no new schools were
opened because they did not have enough supply of good
teachers.

Unlike its peers, Yuhua’s strategy focuses a lot on its higher

education segment and takes a more balanced development
plan for its K12 and university segments. For example, it plans
to use 25% of its IPO proceeds or around RMB 320 million to
enlarge its university capacity. Meanwhile, it expects the
student enrolment in its university to increase by 2,000 each
year and reach at least 32,000 students in 2020, which is 28%
higher than the current level of 25,000. They are also
considering acquisitions of new universities. The university
expansion makes sense in Yuhua because the gross margin of
its university is much higher than other segments.

For K12 schools, Yuhua plans to focus on high schools in

recent years. Among its current 25 schools, only three are high
schools. Increasing capacity of high schools could give it higher
profitability by increasing exposure in non-compulsory stage
education. In the future, they are considering various methods
in expansion of K12 capacity, including M&A, building by
themselves or co-operating with third parties.
Compared with public schools in Henan, Yuhua’s high schools
have advantages in arts and international education and thus
offer more options for higher education. Many students are
admitted by famous art colleges like Beijing Film Academy and
Communication University of China. As art schools have lower
requirements on exam scores, it provides more opportunities
for students who are talented in Arts. With specialised classes
targeting universities in the US, Australia and Korea, around
20% of its graduates further their studies overseas each year.

Page 42

E. Expansion and execution risks
Execution risks exist in the process of expansion. In our view,
Yuhua has the lowest execution risk at the moment with the
most conservative expansion plan. Maple Leaf’s related risk can
also be reduced by its many years of experience in growing in
different cities. Wisdom and Virscend, which aggressively
expand in or outside of their provinces after listing, have
relatively higher execution risks.
The main hurdle of expansion of schools is to have enough
good teachers to maintain their teaching quality. A good
relationship with the government is not a big concern as all
companies choose to expand their schools in Tier 2 cities where
the governments are more than willing to attract good
education resources.
Maple Leaf: Rapid expansion supported by asset-light model;
limited execution risk due to the nature of international schools,
track record of expansion and logistic support system.
Having nearly 20,000 students by 2016, Maple Leaf targets to
double its student number to reach 40,000 in 2019/20 school
year with over 70 schools in its network. To achieve the
medium-term goal, Maple Leaf plans to open 15 new K12
schools and one foreign national school in school year 2017/18
in five cities in China, including Xi’an, Huzhou, Weifang,
Yancheng and Chongqing. The expected new capacity is 9,700,
with 7,600 from new schools and 2,100 from expansion of
current campus.
Maple Leaf annual capacity expansion
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
2015/16 2016/17 2017/18E 2018/19E
Acquisition Greenfield Expansion of existing capacity
Source: Company report, DBS Vickers
Industry Focus
China Education Sector
Locating its schools in Tier 2 cities in China makes it possible
for Maple Leaf to expand quickly with an asset-light model.
The group has a mix of its asset ownership, including 1)
Owned schools, which are on its balance sheet; 2) Leased
schools where properties are leased by third parties to Maple
Leaf; and 3) Joint Venture schools, where Maple Leaf operates
the school and the property owner receives a share of net
profit.
Among all its 62 current schools in 2017 (two of them are
international schools overseas) around half are owned by
Maple Leaf itself. The other half is off-balance sheet, with 23
leased schools and seven profit sharing schools.
Maple Leaf schools by asset type
Profit share
Leased
11%
37%
Owned
52%
Source: Company report, DBS Vickers
The execution risk is rather limited for Maple Leaf despite its
wide footprint and rapid expansion. As the ultimate goal for
Maple Leaf schools is to get students into overseas universities,
there is no need for them to adapt their teaching methods to
Gaokao system in different locations. Also, with a proven
record of operating in different cities in the past 20 years,
Maple Leaf has experience in running its business in multiple
locations. As long as it can continue to hire enough good
teachers, it would not be difficult to maintain high quality in
the expansion process.
Two factors help Maple Leaf to replicate its successful school
model from one city to another: the carefully designed
curriculum and the strong logistic support ability. For primary
and middle schools, local curriculums are provided with special
focus on English teaching. With the matured model in
curriculum and teaching methods, it is not difficult to set up
schools in different places. Also, it has established its own
logistic support chain, or so-called “secondary service”. The
Dalian Maple Leaf Science and Education Company was
founded to provide services such as on-campus market,
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Industry Focus
China Education Sector
uniforms, canteens, summer camps, etc. As a result, new
schools in new cities do not have to find their own logistic
service providers.
To ensure the supply of good teachers, Maple Leaf has
established full-time recruitment teams in Vancouver and
Dalian to recruit international and Chinese teachers. Compared
to other international schools, 25% of its teachers are
foreigners. The high ratio of foreign teachers gives Maple Leaf
a better position to recruit good foreign teachers as the
company makes it easier to deal with the campus culture. Also,
Maple Leaf helps its Chinese teachers to cope with foreign
staff and international teaching methods, making them more
committed and motivated.
Virscend: Accelerated expansion in 2017 in Sichuan province,
execution risk mainly lies in its lack of expansion experience
and tight timeline of constructions; support from local
government helps to mitigate the risk.
Unlike Maple Leaf which continued to expand to different
cities each year in the past, Virscend operates a total of six
schools including a kindergarten and a university in Chengdu
from 2007 to date. Compared to its historical record, it has a
very aggressive expansion plan this year to open a total of 13
new schools with 25,300 in capacity in 2017 as it has more
sources of financing after IPO. The company also plans to co-
operate with famous overseas schools to set up an
international school in Shenzhen or Hong Kong. The goal is to
make it the largest international school in Shenzhen and Hong
Kong. The plan is still in progress and needs at least another 2
to 3 years to complete.
The 13 new schools are located in seven campuses. Five of
them are located in Chengdu, while the other two are in
Zigong and Panzhihua cities in the same province. Having
established its name in the city and the province for many years,
there is almost no risk in operating its new campuses in the
same city. However, without much prior experience in
expansion, the main challenges for Virscend are 1) to get the
construction completed and licence approved in the short term;
and 2) to maintain its high teaching quality in new schools in
the long term.
For the later, fortunately, Virscend has trained a number of
experienced teachers and principals in the past years that could
help manage daily matters of new schools. Also, to support the
new school in Panzhihua, the local government promised to
relocate 160 experienced teachers from public schools.
Benefitting from the internal flexibility of teachers and sharing
of information, the new schools will continue to focus on
teaching methods to differentiate themselves.
Page 44
The management teams of new schools are ready to operate
now, but the construction will not be completed until June.
Only after the construction is completed can the school gain
approval to formally admit students. Virscend needs a lot of
government support to accelerate the approval process or
otherwise their new school will not be delivered timely this year.
Among the seven new campuses, only Wenjiang Campus is
built under an asset-heavy model. The expected investment for
this campus would be RMB 600-700 million. The campus in
Chengdu Hi-tech West District is an equity investment deal,
where Virscend takes a minority stake of 20% and its partner is
responsible for the daily operations. The rest are either leased
or based on profit sharing with partners. The partners include
local governments, property developers such as Vanke,
Fantasia and Longfor, and also local enterprises. The three
profit-sharing campuses include other parties which are
previously considered as non-controlling shareholders. As the
new regulations require all primary and middle schools to be
non-profit, the profits may be paid in the form of rentals upon
further discussion with their partners.
With good reputation and outstanding performance in
university admission, the utilisation of its new schools is likely
to reach 90% in three years. The enrolment is progressing well
up until now. There are far more students who have registered
for the new primary schools than the positions offered.
However, if they could not keep the high teaching level in
expansion and did not achieve expected exam performance
when the first batch of students sit for the exam in three years,
the new schools might not be as successful as its established
ones.
Virscend new campuses by asset type
Profit share
43%
Equity
Investment
14%
Leased
29% Owned
14%
Source: Company report, DBS Vickers
 Industry Focus
China Education Sector

Wisdom: Moderate expansion in school numbers, but widely
spread out school location outside Guangdong may add
difficulties in management
Wisdom prefers to use the asset-heavy model for its future
expansion as they think it would benefit them in the long term
without sharing profits with other parties. As a result, its
expansion plan is not so aggressive as Maple Leaf and Virscend.
Currently, the group has six schools. three of them are located
in its home city of Dongguan. After 2014, three new campuses
were established in Huizhou, Panjin and Weifang respectively.
In addition, two new campuses are expected to open in
Guang’an and Yunfu in 2017 and 2018.
The Yunfu campus is previously scheduled to be opened in
September 2017. However, the open of Yunfu School is now
delayed to September 2018 as the local government and the
company reached an agreement to use another piece of land
for school construction. This makes Wisdom the only company
to miss its original new school plan in 2017.
Wisdom's new capacity plans by 2020
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0 expansion in K12 schools. Their main concern about the pace
Dongguan Huizhou Panjin Weifang Guang'an
Guangzheng
Current capacity Estimated capacity 2017/18
Target capacity
Source: Company report, DBS Vickers
necessarily work in schools located in provinces far away from
Guangdong with completely different teaching requirement,
exam system and regulatory environment. What’s more, the far
distance makes it harder for teachers to communicate. A
common practice for schools to open up new campuses nearby
is to send their experienced and well-trained teachers to new
campuses in the first few years to build up the brand and train
fresh-graduated teachers. This method is almost impossible for
Wisdom. Without support from experienced teachers in
established schools, Wisdom has to pay more attention to
recruit good teachers in different places.
Yuhua: Conservative expansion plan in accordance with its
trainings of teachers and has the least execution risks
By August 2016, Yuhua had 25 schools including one
university and 24 K12 schools in nine cities in Henan province.
It started to expand its footprint outside of Zhengzhou in 2011.
As one of the best private schools in Henan, the retention rate
is high in Yuhua system. About 80% to 90% of its primary and
middle school graduates choose to stay in Yuhua schools to
further their study. However, Yuhua only has three high
schools at the moment and could not meet the demands. The
admission rate of Zhengzhou Yuhua Elite School is low at 20%.
Driven by the high demand, Yuhua plans to enlarge its three
high school's capacity in the coming three years to keep more
students in the schools within the group. In addition, they are
considering opening new schools in neighbouring provinces
outside of Henan in three years’ time.
Yuhua plans to use more asset-light models to facilitate its
of expansion is still teachers. For example, no new schools
were opened in 2014 and 2015 because the company was not
comfortable about their new teacher supply back then. At the
moment, the teacher supply should be sufficient as its capacity
expansion is not too big..

In contrast to Virscend, Wisdom is conservative in increasing

the number of schools but chooses to build them in separated
locations. It plans to add around 35,500 capacity to both
existing and new campuses in three years. The new capacities
are distributed to six campuses in six different cities. Three of
them are located in Guangdong and the other three in
northeast, east and southeast part of China.

Its development plan is to establish campuses covering

different regions in China. However, the wide spread of
campus and long distance between each campus may bring
more difficulties to the management. The success experience in
operating schools in Guangdong province might not

Page 45
Industry Focus
China Education Sector

F. Earnings and growth forecasts tuition revenue, mainly from services like school bus transport,
uniforms and study tours.
1) Revenue and growth
Strong revenue growth outlook for all companies. Overall,
Driven by the high demand, the four companies all have plans
Virscend is expected to have the strongest revenue growth
to raise their tuition fees every few years. Usually, one hike in
until 2020, followed by Wisdom supported by its accelerated
tuition fees could continue to benefit the revenue level in the
expansion.
following 2-3 years as only new enrolled students are charged
the new rates. In 2017, we expect Virscend to have the most
The nature of the industry makes it easy to forecast the top-
increase in its average tuition as a new round of 20% tuition
line growth. A major portion of a school’s revenue comes from
increase started in 2015 for its new enrolled students. Also, the
tuition, which is decided by the number of students and the
company expects to benefit from the new educational
average tuition level. These two factors could be well
regulations and have more room to increase its high school
controlled and planned in advance by the leading players.
tuition after the expected loosening of pricing limitations. As
the tuition pricing regulations are developed at the provincial
Student number in all schools will increase at a higher pace. In
level, other schools may not benefit so much as they already
2017, with the more aggressive expansion plan after IPO, the
have relaxed pricing power at the moment.
three new listed companies are expected to have sharper rises
in their student numbers. With near 100% utilisation rate of Average spending per student (RMB thousand)
current schools, the expected increments in Wisdom and
Virscend are mainly boosted by the expansion of new school
(000)
capacities. The increment of student number in Yuhua, on the
50
other hand, is mainly boosted by further improvement in
45
utilisation rate.
40
Number of students 35
30
25
(000) 20
60
15
50 10
5
40 0
Maple Leaf Wisdom Virscend Yuhua
30
2015 2016 2017E
20
Source: Company report, DBS Vickers
10
Strong revenue growth is expected with the bright outlook of
0
the industry and growth in both quantity and price. In general,
Maple Leaf Wisdom Virscend Yuhua
we expect at least near 20% growth in revenue for the listed
2015 2016 1H17 2017E schools. Supported by the large expansion and tuition hike,
Virscend is expected to enjoy 39% growth in revenue this year,
Source: Company report, DBS Vickers which is the highest growth level in the industry landscape.

ASP level will also improve. The ASP of each school consists of
Based on Frost & Sullivan’s research, the total private education
average spending per student on both tuition and non-tuition
market is expected to generate RMB 325 billion revenue in
parts, including uniforms, books, boarding fees, etc. Yuhua
2020 compared with RMB 184.2 billion in 2015. The CAGR of
and Virscend generate all their revenue from tuition and
the private school is 12% from 2015 to 2020. As the leaders in
boarding fees, while Maple Leaf and Wisdom have more
the market with high quality and reputations, we forecast the
diversified sources of revenue. In 1H17, 83.3% and 67.4% of
four listed companies will enjoy higher revenue growth than
Maple Leaf and Wisdom’s revenue were from tuition and
the industry level before 2020. Double-digit annual growth in
boarding fees, with the rest from other services. Wisdom’s ASP
revenue could be well expected for the next three years.
level largely increased in 1H17 due to the increase in its non-

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 Industry Focus
China Education Sector

Revenue (RMB million) Deferred revenue vs revenue, Maple Leaf

Rmb mn Revenue
y1 Maple Leaf
1,400
1,100
1,200
1,000
1,000 900
800 800

600 700
600
400
500
200
400
0 300
Maple Leaf Wisdom Virscend Yuhua 300 500 700 900
Deferred revenue y0
2015 2016 2017E 1H17

Source: Company report, DBS Vickers

Source: Company report, DBS Vickers
Charging tuition fee once per semester, the deferred revenue
of Virscend represents 53-54% of revenue next year. The linear
Revenue growth forecast regression model predicts RMB 916 million as revenue for 2017
based on the RMB 480 million deferred revenue by the end of
45% 2016 compared to our estimation of RMB 1,148 million.
40% However, as the fiscal year of Virscend ends in December, its
2017 revenue should include the revenues from the 12 new
35%
schools opened in September, which is not yet charged and
30% reflected on the balance sheet. In other words, the new
25% schools are expected to bring 25% more revenue than the
20% original RMB 916 million.

15%
Deferred revenue, Virscend
10%
5% Revenue
y1 Virscend
0%
2015 2016 2017E 2018E 2019E 2020E 900

Maple Leaf Wisdom Virscend Yuhua 800

700
Source: Company report, DBS Vickers
600
In addition, schools usually charge tuition once or twice per
year and keep it on the balance sheet as deferred revenue. The 500
historical data shows high correlation between deferred
revenue and the revenue next year, giving us good reference 400
on revenue forecast. 300
300 350 400 450
With the longest listing history, Maple Leaf shows a perfect Deferred revenue y0
linear correlation between its deferred revenue and revenue
next year. Its deferred revenue represents 75-80% of revenue Source: Company report, DBS Vickers
next year. Based on the linear regression model and the
For Wisdom and Yuhua, not enough data points are available
deferred revenue of RMB 803 million in 2016, it gives us an
for similar analysis due to their short listing history. In 2014 and
estimation of RMB 1,010 million as revenue in 2017, close to
2015, the deferred revenue of Wisdom represents 40% of the
the RMB 1,014 million estimated from student number and
tuition level.

Page 47
Industry Focus
China Education Sector

revenue in the coming year. And that of Yuhua represents 75- Gross Margin
80% of the next year revenue.
55%
2) COGS and gross margin
Benefitting from lower teachers’ salaries, Yuhua is the only
company whose current gross margin is higher than 50%.
Other companies have around 47-48% GP margins. 50%

Major costs are teachers’ salaries and depreciation expenses. In

2016, these two costs added up to 60-70% of total costs for
45%
all schools. In the future, the depreciation costs may drop
because schools are more likely to adopt the asset-light model
for expansion. The percentage of teachers’ salaries is likely to
stay stable or increase as more teachers are hired with higher 40%
salaries. Maple Leaf Wisdom Virscend Yuhua
2015 2016 2017E 1H17
COGS breakdown 2016 (RMB million)

Source: Company report, DBS Vickers

500
450 3) Bottom-line growth items and profits
400 In terms of bottom-line growth, companies share similar
350 features in 1) low and stable SG&A expenses (excluding listing
expense); 2) decreasing finance costs as a result of
300
deleveraging. They differ in impacts on tax expense brought by
250
new regulations.
200
150 In general, all companies are expected to have strong profit
100 growth in coming years. After adjustments for the one-time
50 listing expense, with a higher than 40% net margin, Yuhua
0 again beats others in this respect. In contrast, Wisdom lagged
Maple Leaf Wisdom Virscend Yuhua behind others with 22% net margin in FY16.

Teachers' salary D&A expense Others

SG&A expenses as a percentage of revenue has been generally
stable in the past years excluding the impact of listing expenses.
Source: Company report, DBS Vickers Virscend and Yuhua have lower level of SG&A costs, which are
less than 10% of total revenue because they do not have to
The four companies had a similar gross margin level at around
pay as much marketing and advertising costs. The sharp
47% while Yuhua had a slightly higher margin at 52% in 2016.
increase in Yuhua’s SG&A expense is mainly due to the one-
New schools usually have lower margin as schools have to staff
time listing expense. With continued expansion into new
up ahead to prepare for the increasing student enrolment and
markets, Maple Leaf and Wisdom have relatively higher level of
ensure sufficient teaching facility and they often charge lower
SG&A expenses at around 15-18% of their revenues.
tuition fees for marketing purposes. However, benefitting from
rising revenues, decreasing depreciation expenses, economies
of scale and maturing of new schools, we believe the overall
gross margin for all companies will continue to improve in the
coming years.

Page 48

SG&A costs as of total revenue (%)
25%
20%
15%
10%
5%
0%
Maple Leaf Wisdom Virscend Yuhua
2015 2016 2017E 1H17
Source: Company report, DBS Vickers
Two expenses are likely to have major changes in the near
future: interest expense drop when newly listed companies
used IPO proceeds to repay their debt; tax expenses also
change due to the tax policy change under the new
educational regulations as well as the tax charged on the VIE
companies for listing. Because of the different current level of
leverage and tax, companies are affected to different extents.
Having more funding sources, finance costs drops largely after
listing. In the future, the main trend is a lighter and healthier
balance sheet and the leverage will increase only when there
are acquisitions. Maple Leaf, for example, had no debt in 2016
but 2/3 of its acquisition of the school in Singapore in FY2017
was funded by debt. Virscend and Wisdom both used parts of
their IPO proceeds to pay off debts and saw significant
decrease in their finance costs in recent years. Still, their
leverage level could rise should there be potential acquisition
opportunities.
Industry Focus
China Education Sector
Finance cost (RMB million)
120
100
80
60
40
20
0
Maple Leaf Wisdom Virscend Yuhua
2015 2016 2017E 1H17
Source: Company report, DBS Vickers
Effective tax rates change in different patterns. Schools in
Yuhua paid no tax in the past as they declare themselves as
“not requiring reasonable returns”. In the future, they have to
pay tax if they declare their high schools as “for-profit” under
the new regulations. Also, companies set their WFOE (wholly
foreign owned enterprise) in the VIE structure in Tibet for
listing. To encourage economic development in Tibet,
companies there pay a lower corporate tax rate of 9% in their
first three years. As a result, their WFOE companies pay 9% tax
rate for their service fee income even if their schools are non-
profit and do not have to pay tax. The detailed tax policy under
the new regulation framework has not been determined yet at
the provincial level, but due to the industry's nature of public
good, for-profit schools are still likely to enjoy a discounted tax
rate.
Wisdom has already declared to “require reasonable returns”
under current regulations and paid 27.4% as their effective tax
rate in 1H17. The company expects to pay lower tax rate of
20% for FY20 as its WFOE is also established in Tibet and
could enjoy tax deduction after their listing. The long-term tax
rate is expected to fall gradually to 10% as it wants to declare
itself as a “non-profit” school under new regulations.
Without similar drivers, the tax rate paid by Maple Leaf is
expected to remain stable at around 6% in 2017.
Page 49
Industry Focus
China Education Sector

Marginal tax rate G. Valuation comparison

Yuhua, Maple Leaf and Wisdom’s growth potential has yet to

30%
be priced in and thus offers strong potential upsides. In
contrast, with the highest valuation metrics, Virscend ‘s current
25%
share price has already fully reflected its future growth
20% momentum.

15% Our valuation is based on the DCF model. The key factors
impacting the valuation in the model include terminal growth
10% rate, free cash flow and WACC.

5% 1) Terminal growth
Terminal revenue growth rate of 3% is assigned for all
0% companies after 2030. The positive impacts brought by the
Maple Leaf Wisdom Virscend Yuhua
baby boom will gradually fade out in the 2030s when children
2015 2016 2017E 1H17 born in the late 2010s graduate from middle schools. The total
number of students will be stable or begin to decrease again in
Source: Company report, DBS Vickers the long term.

All the recent listed companies are expected to enjoy strong
growth in their net profits due to the strong top-line growth as
well as the declining finance costs.
Profit after tax (post adjustment) (RMB million)
Rmb mn
400
350
We believe the 3% terminal growth rate is sustainable. The
growth of revenue is driven by increase in student numbers
and the rise in tuition fees. It is not difficult for these two
factors together to generate a 3% growth. If the student
number decreases by 2%, a 5% rise in tuition could help to
stabilise the overall growth. Considering the inflation, GDP
growth level and parents’ willingness to pay for education, a
5% annual growth in tuition fees will be easy to achieve in the
distant future.

300 Breakdown of 3% terminal growth

250
200 Tuition fees growth
150
6%
100 -2%, 5%

50 5%
-1%, 4%
0
4%
Maple Leaf Wisdom Virscend Yuhua
(adjusted) (adjusted) 0%, 3%
3%
2015 2016 2017E 1H17 1%, 2%
2%
Source: Company report, DBS Vickers 2%, 1%
1%

0%
-3% -2% -1% 0% 1% 2% 3%
Student number growth

Source: DBS Vickers

Page 50
 Industry Focus
China Education Sector

2) Cash flow assumptions We believe Maple Leaf will have a capex level at 30% of its
total revenue in the next 5-6 years as a result of its
Higher capex level assumptions assigned to Maple Leaf and kindergarten expansion strategy. Thereafter, it will remain at
Wisdom in the long term because of 1) Maple Leaf’s smaller 25% of revenue. Similarly, the capex level for Wisdom,
class size and thus higher per capacity spending; 2) Wisdom’s Virscend and Yuhua are predicted to gradually drop to 30%,
asset-heavy model. We make assumptions on the percentage 25% and 20% of their revenues eventually.
of capital expenditure and working capital as of each year’s
revenue in the valuation model based on their expansion plans Wisdom may have a higher capex level than its peers due to
and historical levels. the difference in asset models. Maple Leaf and Virscend would
have higher capex level than Yuhua as the per-capacity costs of
In 2016, Virscend reported RMB 860 million in capital expansion tend to be higher in international schools or foreign
expenditure, which is 4% higher than its FY16 revenue. The language schools due to better equipment and smaller class
large amount of investment is related to its aggressive sizes.
expansion plan in 2017. For example, construction of its asset-
heavy Wenjiang campus, purchase of new equipment for its Maple Leaf is assumed to have a higher working capital level
asset-light schools and the maintainance and improvement of due to both historical records and its nature as an international
current school buildings and dorms. We expect its capex level school. Without many receivables, payables and inventories,
to gradually decrease with the full delivery of its new school the most important component in working capital of schools is
capacity. the deferred revenue.

Maple Leaf and Yuhua had 18% and 16% of their revenue Maple Leaf, which charges tuition once per year, has a higher
level as capex in 2016, while Wisdom reported a higher level of level of change in working capital as its year-end deferred
capex representing 29% of its FY16 revenue. The capex level is revenue usually represents the annual tuition. The net change
in accordance with their asset models. In 2017, however, we in working capital was around 20-30% of revenue for Maple
are expecting a large increase in the capex level. In 1H17, both Leaf in 2014-2016. In the future, we expect it to gradually
Wisdom and Maple Leaf saw a large jump in their capex, stabilise at around 20% with the stabilisation of revenue
driven by M&A. Without much capacity expansion plans in growth.
recent years, Yuhua’s capex level is expected to catch up at a
later stage. The other three schools are predicted to have 10% of revenue
as change in working capital each year in the medium and long
In the longer term, the capex levels are expected to drop to a term. Among them, Wisdom and Virscend charges tuition
lower and stable level. The lower level of capex is a combined twice a year. Their deferred revenues by year-end are likely to
result of both a slowdown in capacity expansion and an be less than half of the total revenue. Virscend is expected to
increase in total revenue. generate higher working capital in the next three years
together with its expansion.
Capex as a percentage of revenue
Though Yuhua also charges tuition once a year, its working
capital level was low in 2015 and 2016. This is associated with
100%
lower revenue level and growth rate in the past. In the future,
90%
with the brighter revenue growth outlook, the change in
80%
working capital is likely to catch up with its peers in 2017-2020
70%
and finally stabilise at the 10% level.
60%
50%
40%
30%
20%
10%
2017E
2018E
2019E
2020E
2016A

2021F
2022F
2023F
2024F
2025F
2026F
2027F
2028F
2029F
2030F

Maple Leaf Wisdom Virscend Yuhua

Source: DBS Vickers

Page 51
Industry Focus
China Education Sector

Change in working capital as percentage of revenue Based on our previous assumptions and analysis, Yuhua, Maple
Leaf and Wisdom will have potential room of a rise in share
45% price. Though Virscend has the best cash flow projection, its
40% value is already fully reflected in its current share price. At the
35% moment, Yuhua has the highest potential upside followed by
30% Maple Leaf and Wisdom.
25%
Target price vs market price (June 30)
20%
15%
HK$
10%
10 25%
5%
20%
0% 8
15%
2014A
2015A
2016A
2017E
2018E
2019E
2020E
2021F
2022F
2023F
2024F
2025F
2026F
2027F
2028F
2029F
-5% 2030F 10%
6
5%
4 0%
Maple Leaf Wisdom Virscend Yuhua
-5%
2
Source: DBS Vickers -10%
0 -15%
Maple Leaf Wisdom Virscend Yuhua
3) WACC and target price
WACC of educational companies are largely affected by the Target price (LHS)
costs of equity because of their low leverage. By 1H17, all four Latest price (LHS)
companies had less than 10% of debt in their capital structure. Premium (discount) (RHS)
The low leverage level is likely to continue in the future as they
are all generating strong operational cash flows that can cover Source: DBS Vickers
their capital expenditure without much new borrowings. With
Scenario analysis has been done on WACC to lower down the
expectations of continuous deleveraging, we simply take the
impact of potential inaccuracy in beta. Even if the highest
equity costs of Yuhua, Maple Leaf and Virscend as their WACC.
WACC is taken, there is still more than 8% upside for Yuhua,
Capital structure by 1H17 which reinforces our confidence in this stock.

Sensitivity analysis on WACC

100%

%
10

8
50%
6

2
0%
0
Maple Leaf Wisdom Virscend Yuhua
Maple Leaf Wisdom Virscend Yuhua
Equity Debt WACC WACC-1% WACC-0.5% WACC used
WACC+0.5% WACC+1%
Source: DBS Vickers
Source: DBS Vickers
Some of the recently listed companies do not have a
meaningful beta as their tracking records are too short. As a
result, we temporarily use Maple Leaf’s 1.04 as our beta
assumption for Virscend and Yuhua. The WACC used for
valuation varies from 11.9% to 12.7% for the four companies.

Page 52
 Industry Focus
China Education Sector

4) Valuation metrics

We favour Maple Leaf and Yuhua over other stocks when

considering both valuation and growth potential.

Maple Leaf is quite undervalued for the moment. As an

international school with higher tuition hike potential, we
believe it should have higher valuation driven by the successful
experience in expansion nationwide and new strategy of
developing kindergartens.

Wisdom also has relatively low valuation with its current FY18
PE lower at 15.9x. Its valuation is expected to be adjusted, but
the upside may not be as high as Yuhua's because of the
weaker position in segment exposure and higher execution
risks in its expansion process.

Yuhua’s valuation is at 14.5x FY18PE at the lower end of its

peers and still has room for improvement to reflect its future
growth based on the accelerated growth in the future.

Virscend, on the other hand, is fully valued at its current

market price. Though we are very bullish in the company’s
earnings growth and profitability and believe the company
deserves a higher valuation than its peers, the current valuation
is already quite high. Its FY17 PE is at 40x, which is almost
double its peers'. Its FY18 PE is also the highest among peers.

Valuation metrics based on FY18 financials

M ark et p ric e J u ly 1 1
P/ B P/ sales P/ E F Y 1 7 y ield
Maple Leaf 3.0x 5.5x 16.5x 2.1%
Wisdom 2.6x 3.9x 15.9x 1.7%
V irscend 4.3x 8.5x 23.2x 1.2%
Yuhua 2.4x 7.1x 14.5x 1.9%
A v erag e 3.1x 6.3x 17.5x 1.8%
T arg et p ric e
P/ B P/ sales P/ E F Y 1 7 F y ield
Maple Leaf 3.7x 6.7x 20.4x 1.8%
Wisdom 3.0x 4.6x 18.4x 1.5%
V irscend 4.3x 8.7x 24.0x 1.4%
Yuhua 2.9x 8.7x 17.5x 1.6%
A v erag e 3.5x 7.2x 20.1x 1.6%

Source: DBS Vickers

Page 53
Industry Focus
China Education Sector

STOCK PROFILES

Page 54
China / Hong Kong Company Guide
China Maple Leaf Educational Systems
Version 1 | Bloomberg: 1317 HK Equity | Reuters: 1317.HK
Refer to important disclosures at the end of this report

DBS Group Research . Equity 12 Jul 2017

BUY (Initiate Coverage) Growth of international pathways

Last Traded Price ( 11 Jul 2017): HK$6.36 (HSI : 25,878) • Enhanced international exposure and focus on kindergartens
Price Target 12-mth: HK$7.73 (22% upside) to capture new opportunities
• Valuation is reasonable at 16x FY18F with room to further re-
Analyst
rate supported by strong earnings growth momentum of
Manyi LU
manyilu@dbs.com c.20%.
Dennis Lam +852 2971 1922 • Initiating coverage with BUY and HK$7.73 TP
dennis_lam@dbs.com
Strong growth to continue with nationwide and overseas expansion.
Price Relative China Maple Leaf Educational Systems (Maple Leaf) operates the
HK$ Relative Index
largest network of private international schools in China. We are
8.6
308 positive on the company’s ability to expand into the international
7.6
6.6 258 education market. Its strategy is (i) to increase international exposure to
5.6 208 enhance its school network; and (ii) focus in Tier 2 cities. The first
4.6
3.6
158 enables it to catch the trend of students going overseas at a younger
2.6
108 age while the second helps it to avoid the weakness of the British
1.6
Nov-14 May-15 Nov-15 May-16 Nov-16 May-17
58
Columbia (“BC”) curriculum in Tier 1 cities where International
China Maple Leaf Educational Systems (LHS) Baccalaureate (“IB”) and Advanced Placement (“AP”) curriculums are
Relative HSI (RHS)
more popular.
Forecasts and Valuation
FY Aug (RMB m) 2016A 2017F 2018F 2019F Where we differ: Our FY18-20F revenue estimates are slightly more
Turnover 830 1,014 1,356 1,628 bullish than consensus while EPS projections are in line with the market.
EBITDA 298 359 473 580 We are more optimistic about its future expansion and growth
Pre-tax Profit 326 394 474 585
potential driven by its (i) expansion strategy and exposure to the
Net Profit 308 371 446 538
Net Pft (Pre Ex) (core international school market; (ii) easy-to-scale business model with its
308 371 446 538 own logistic supply chain. We are more cautious on the growth in
profit)
Net Profit Gth (Pre-ex)
49.6 20.5 20.3 20.6
‘other income’ including rent from the school acquired in Singapore.
(%)
EPS (RMB) 0.23 0.28 0.33 0.40 Critical share price driver: We believe revenues will be boosted by
EPS (HK$) 0.27 0.32 0.38 0.46 growth in overseas schools, junior level schools and non-tuition related
EPS Gth (%) 35.3 20.1 20.3 20.6 segments. Maple Leaf’s 1H17 revenue grew 27.1% y-o-y to RMB 483m,
Diluted EPS (HK$) 0.27 0.32 0.38 0.46 driven by strong growth in these non-traditional core revenue
DPS (HK$) 0.11 0.14 0.17 0.20
BV Per Share (HK$) 1.71 1.88 2.09 2.33 generators in the past. We expect the company’s growth momentum
PE (X) 23.9 19.9 16.5 13.7 to continue and forecast 24% CAGR in 2016-2020 revenue led by an
P/Cash Flow (X) 13.8 10.5 7.1 6.8 increasing focus on kindergartens.
P/Free CF (X) 0.5 0.0 0.0 0.0
EV/EBITDA (X) 20.5 17.3 12.2 9.3 Valuation:
Net Div Yield (%) 1.7 2.2 2.7 3.2 Our TP of HK$7.73 is based on DCF valuation assuming 12.7% WACC,
P/Book Value (X) 3.7 3.4 3.1 2.7 and 3% terminal growth. Our TP implies 20.4x FY18F PE while the
Net Debt/Equity (X) CASH CASH CASH CASH stock is currently trading at 16.6x FY18F compared with the peer
ROAE (%) 16.0 17.4 19.0 20.5 average of 17.6x FY18F.
Earnings Rev (%): New New New
Key Risks to Our View:
Consensus EPS (RMB) 0.28 0.35 0.42
Other Broker Recs: B: 12 S: 0 H: 2
Weaker-than-expected increase in student numbers and tuition; legal
risk of lawsuit with its consultant Zhixin
Source of all data on this page: Company, DBSV, Thomson Reuters,
HKEX At A Glance
Issued Capital (m shrs) 1,379
Mkt. Cap (HK$m/US$m) 8,774 / 1,123
Major Shareholders
Jen Shu Liang Sherman (%) 53.8
Buena Vista Fund Management, LLC (%) 7.2
Free Float (%) 39.0
3m Avg. Daily Val. (US$m) 5.2
ICB Industry : Consumer Services / General Retailers

ASIAN INSIGHTS VICKERS SECURITIES

ed-JS/ sa- CW
Company Guide
China Maple Leaf Educational Systems

CRITICAL FACTORS TO WATCH Total Capacity

Critical Factors 57640
58,216

Raising capacity by proactively expanding its footprint in new 49,900 47640

cities. By 1H17, the company has 56 schools and 22,693 41,583 38240
students in total. By September 2017, Maple Leaf will open 14 33,267 30040
new schools in Tier 2 cities in China such as Yancheng, 24,950
26090

Weifang and Chongqing. The main deciding factor is the local 16,633
disposable income level. Maple Leaf schools are currently
8,317
located in Tier 2 and Tier 3 cities and the company has plans to
0
take advantage of the economic growth in Tier 1 cities like 2015A 2016A 2017F 2018F 2019F
 
Beijing and Shenzhen in the longer term. Meanwhile, Maple
Leaf plans to expand its current campus in Chongqing and Number of students
Tianjin in FY17/18, adding another 2,100 in capacity, or 5.5% 39,370 38,598.0

of FY17 level. 33,064.0

31,496
Acquisitions have accelerated in recent years. Besides building
23,216.0
new schools and enlarging existing schools, Maple Leaf 23,622
19,334.0
completed the acquisition of a 47.5% stake in Hainan National 15,748
16,078.0

Science Park Experimental School in Haikou city, the capital of

Hainan Island, in May 2017. This has increased Maple Leaf’s 7,874

student numbers by more than 3,000 with a potential for 0

further capacity expansion. Aside from domestic opportunities, 2015A 2016A 2017F 2018F 2019F
 
Maple Leaf is also proactively seeking overseas expansion
ASP
opportunities. In August 2016, the company acquired a school
in Singapore, with an initial capacity of up to 600 students. The 44,544
40,613.5
42,917.7 43,670.3
41,013.7 42,188.8

acquired school students will account for 10.6% of total

35,635
students in FY18.
26,726
Utilisation to improve from established international curriculum
and strengths in dual diploma programs. Student enrolments 17,817

are fast increasing driven by capacity expansion, which has

8,909
helped to improve utilisation. As at Mar 31, 2017, student
enrolments reached 22,693, representing 17.4% growth from 0

2016. The company’s rapid capacity expansion did not lower 2015A 2016A 2017F 2018F 2019F
 
Maple Leaf’s utilisation rate. Though Maple Leaf’s utilisation
Gross margin (%)
rate of 60-65% in recent years is relatively low compared to
48 48 47
47
some other schools, it has been improving. Maple Leaf’s 48.9 46

competitive advantage lies in bilingual education and dual 39.1

diplomas offered by its high schools. Students are able to

29.3
obtain high school diplomas from both the PRC and British
Columbia in Canada upon completing their programs. 19.6

Tuition level to rise as the average tuition level is low versus the 9.8

industry. In 2016, the average tuition level at all schools was 0.0
RMB 39,240 per year, 5% higher than RMB 37,483 in 2015. 2015A 2016A 2017F 2018F 2019F
The tuition fee is affordable for middle class families. To  
compare, 80% of international schools in China charged more Financing costs
than RMB 50,000 per year in 2016. The non-tuition revenues
12 11.1
including revenue from uniforms, books, and summer camps
10
etc, have also been growing rapidly by 8% CAGR during 2011
to 2016. In the longer term, there is little pricing pressure even 8 7.6
6.4
if the company raises high school tuition fees to between RMB 6
80k to 100k per year. We expect the average tuition level to 4
4.1

slightly drop in FY18 as a result of low tuition in new acquired

2
schools, but to pick up gradually afterwards.
0
0
2015A 2016A 2017F 2018F 2019F
 
Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

Page 56
 Company Guide
China Maple Leaf Educational Systems

Balance Sheet:
Balance sheet is healthy with low leverage and light asset Leverage & Asset Turnover (x)
model. In 2015 and 2016, the leverage ratio was near or equal 0.25 0.4
0.4
to zero. As at the end of 1H17, the company had a total of 0.20 0.4
RMB 433m in bank borrowings (gross gearing: 20%), mainly to 0.3

finance its acquisition in Singapore. We expect gross gearing 0.15 0.3

0.3
be lower than 20% in the coming years, at 15%/10% in 0.10 0.3
FY17/18. 0.3
0.05 0.2

Capital expenditure driven up by acquisition costs while capex 0.2

0.00 0.2
per-unit of capacity is low. 1H17 saw a significant increase in 2015A 2016A 2017F 2018F 2019F

capex to around RMB 400m compared with 1H16’s RMB Gross Debt to Equity (LHS) Asset Turnover (RHS)

Capital Expenditure
76.3m. The increase was mainly due to the RMB 330 m
RMBm
purchase of the campus in Singapore. We forecast capex levels 600.0

to be around RMB 500m each year from FY17 to FY19 to 500.0

support capacity expansion and potential acquisitions. 400.0

300.0
Share Price Drivers:
200.0
International education becoming more and more popular in
100.0
China. As a leading player in the international school market,
0.0
Maple Leaf is ready to leverage on the future boom of 2015A 2016A 2017F 2018F 2019F

international education with its wide presence in China, well- Capital Expenditure (-)

established brand and affordable tuition fees. ROE

20.0%

Potential M&A opportunities. It is likely that more acquisitions

will happen in the future as the company has an ambitious 15.0%

expansion plan supported by strong operating cash flows.

10.0%

Key Risks:
1. Weaker-than-expected growth in student numbers and 5.0%

tuition fees
0.0%
2. Legal risk with Zhixin 2015A 2016A 2017F 2018F 2019F

Maple Leaf has a dispute with its two consultants, Forward PE Band
(x)
Diangxianghui and Zhixin, on execution of options held by 28.9

them. This dispute caused a sudden collapse in Maple Leaf’s

23.9
+2sd: 23.3x
share price in July 2016. The dispute has been resolved with
Dingxianghui, however, the lawsuit with Zhixin is still in 18.9 +1sd: 18.6x
progress and Maple Leaf may have to pay for legal expenses.
13.9 Avg: 13.9x
The potential expense is not disclosed but the management
believe that the impact would not be material to the company. 8.9 ‐1sd: 9.1x

3.9 ‐2sd: 4.4x
Company Background Nov-14 May-15 Nov-15 May-16 Nov-16 May-17

Established in 1995 in Dalian, Maple Leaf operates China’s PB Band

leading independent, international school system and offers (x)
international education for students from preschool to high 4.8 +2sd: 4.86x
school. It operates the largest network of private international
3.8
schools in China and is also Canada’s first and largest offshore +1sd: 3.59x

school system. Its schools provide a western academic 2.8

Avg: 2.31x
orientation and preparation for admission to western 1.8
universities, especially the Canadian ones, blended with ‐1sd: 1.03x
Chinese educational traditions and culture. 0.8

-0.2
Nov-14 May-15 Nov-15 May-16 Nov-16 May-17

Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

Page 57
Company Guide
China Maple Leaf Educational Systems

Key Assumptions
FY Aug 2015A 2016A 2017F 2018F 2019F
Total Capacity 26,090.0 30,040.0 38,240.0 47,640.0 57,640.0
Number of students 16,078.0 19,334.0 23,216.0 33,064.0 38,598.0
ASP 40,613.5 42,917.7 43,670.3 41,013.7 42,188.8
Source: Company, DBS Vickers

Segmental Breakdown (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F
Revenues (RMB m)
Tuition fees 555 695 852 1,177 1,406
Textbook 28 34 43 55 67
Summer and winter
35 39 51 66 86
camps
Other Educational
31 36 13 58 69
Services
Others 4 26 55 0 0
Total 653 830 1,014 1,356 1,628

Source: Company, DBS Vickers

Income Statement (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F
Revenue 653 830 1,014 1,356 1,628
Cost of Goods Sold (354) (428) (524) (723) (859)
Gross Profit 299 402 489 633 769
Other Opng (Exp)/Inc (132) (149) (178) (237) (277)
Operating Profit 166 253 311 396 492
Other Non Opg (Exp)/Inc 45 52 73 70 76
Associates & JV Inc 0 0 0 0 0
Net Interest (Exp)/Inc 5 18 10 9 16
Dividend Income 0 3 0 0 0
Exceptional Gain/(Loss) 0 0 0 0 0
Pre-tax Profit 217 326 394 474 585
Tax (11) (18) (24) (28) (47)
Minority Interest 0 0 0 0 0
Preference Dividend 0 0 0 0 0
Net Profit 206 308 371 446 538
Net Profit before Except. 206 308 371 446 538
EBITDA 213 298 359 473 580
Growth
Revenue Gth (%) 20.9 27.1 22.2 33.8 20.1
EBITDA Gth (%) 38.3 40.2 20.4 31.7 22.5
Opg Profit Gth (%) 45.1 51.8 23.1 27.2 24.5
Net Profit Gth (%) 413.4 49.6 20.5 20.3 20.6
Margins & Ratio
Gross Margins (%) 45.7 48.4 48.3 46.7 47.2
Opg Profit Margin (%) 25.5 30.5 30.7 29.2 30.2
Net Profit Margin (%) 31.5 37.1 36.6 32.9 33.0
ROAE (%) 18.0 16.0 17.4 19.0 20.5
ROA (%) 8.5 10.2 10.2 10.2 10.7
ROCE (%) 10.2 12.3 12.6 13.9 15.7
Div Payout Ratio (%) 13.0 41.6 44.0 45.0 45.0
Net Interest Cover (x) NM NM NM NM NM
Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

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 Company Guide
China Maple Leaf Educational Systems

Interim Income Statement (RMB m)

FY Aug 1H2015 2H2015 1H2016 2H2016 1H2017

Revenue 300 353 380 450 483

Cost of Goods Sold (176) (178) (201) (227) (256)
Gross Profit 124 175 179 223 227
Other Oper. (Exp)/Inc (66) (66) (65) (84) (84)
Operating Profit 57 109 115 138 143
Other Non Opg (Exp)/Inc N/A N/A N/A N/A N/A
Associates & JV Inc N/A N/A N/A N/A N/A
Net Interest (Exp)/Inc 0 0 0 0 0
Exceptional Gain/(Loss) 0 0 0 0 0
Pre-tax Profit 57 109 115 138 143
Tax N/A N/A N/A N/A N/A
Minority Interest N/A N/A N/A N/A N/A
Net Profit 57 109 115 138 143
Net profit bef Except. 57 109 115 138 143

Growth
Revenue Gth (%) 23.5 18.7 26.7 27.4 27.1
Opg Profit Gth (%) 4.6 82.1 99.7 26.6 25.1
Net Profit Gth (%) 4.6 82.1 99.7 26.6 25.1

Margins
Gross Margins (%) 41.2 49.6 47.1 49.5 47.0
Opg Profit Margins (%) 19.1 30.9 30.1 30.7 29.6
Net Profit Margins (%) 19.1 30.9 30.1 30.7 29.6
Source: Company, DBS Vickers

Balance Sheet (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F

Net Fixed Assets 1,398 1,506 1,980 2,320 2,651

Invts in Associates & JVs 0 0 0 0 0
Other LT Assets 263 436 521 501 481
Cash & ST Invts 1,122 1,238 1,495 1,827 2,157
Inventory 1 9 10 14 16
Debtors 32 37 32 32 32
Other Current Assets 0 0 0 0 0
Total Assets 2,816 3,226 4,038 4,694 5,338

ST Debt 0 0 0 0 0
Creditors 982 1,184 1,439 1,929 2,337
Other Current Liab 0 0 0 0 0
LT Debt 0 0 335 250 150
Other LT Liabilities 22 21 34 40 80
Shareholder’s Equity 1,812 2,021 2,229 2,474 2,770
Minority Interests 0 0 0 0 0
Total Cap. & Liab. 2,816 3,226 4,038 4,694 5,338

Non-Cash Wkg. Capital (949) (1,137) (1,397) (1,884) (2,289)

Net Cash/(Debt) 1,122 1,238 1,160 1,577 2,007
Debtors Turn (avg days) 15.9 15.3 12.5 8.6 7.2
Creditors Turn (avg days) N/A N/A N/A N/A N/A
Inventory Turn (avg days) 0.8 5.2 7.5 6.7 7.1
Asset Turnover (x) 0.3 0.3 0.3 0.3 0.3
Current Ratio (x) 1.2 1.1 1.1 1.0 0.9
Quick Ratio (x) 1.2 1.1 1.1 1.0 0.9
Net Debt/Equity (X) CASH CASH CASH CASH CASH
Net Debt/Equity ex MI (X) CASH CASH CASH CASH CASH
Capex to Debt (%) N/A N/A 119.4 160.0 400.0
Z-Score (X) NA NA NA NA NA
Source: Company, DBS Vickers

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Company Guide
China Maple Leaf Educational Systems

Cash Flow Statement (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F

Pre-Tax Profit 217 326 394 474 585

Dep. & Amort. 46 46 48 78 87
Tax Paid (1) (2) (11) (23) (6)
Assoc. & JV Inc/(loss) 0 0 0 0 0
(Pft)/ Loss on disposal of FAs (4) (30) 0 0 0
Chg in Wkg.Cap. 205 165 261 487 405
Other Operating CF (18) 27 11 15 12
Net Operating CF 444 533 703 1,031 1,083
Capital Exp.(net) (212) (147) (519) (400) (400)
Other Invts.(net) 169 186 (3) (3) (3)
Invts in Assoc. & JV 0 0 0 0 0
Div from Assoc & JV 0 0 0 0 0
Other Investing CF (196) (6) (331) 0 0
Net Investing CF (240) 33 (853) (403) (403)
Div Paid (27) (125) (163) (201) (242)
Chg in Gross Debt (224) 0 335 (85) (100)
Capital Issues 761 0 0 0 0
Other Financing CF (77) (240) 234 (10) (8)
Net Financing CF 434 (366) 406 (296) (350)
Currency Adjustments 4 15 0 0 0
Chg in Cash 642 216 257 333 330
Opg CFPS (RMB) 152.65 34.84 223.61 447.35 811.98
Free CFPS (RMB) 247.28 10.44 227.46 473.67 361.93

Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

Page 60
China / Hong Kong Company Guide
China Yuhua Education Corp
Version 1 | Bloomberg: 6169 HK Equity | Reuters: 6169.HK
Refer to important disclosures at the end of this report

DBS Group Research . Equity 12 Jul 2017

BUY (Initiate Coverage) Expansion pace to take off

Last Traded Price ( 11 Jul 2017):HK$2.61 (HSI : 25,878) • High margins due to relatively low costs of teachers and high
Price Target 12-mth: HK$3.23 (24% upside) profitability of its university
• Revenue growth and capacity to accelerate in the next 3-5
Analyst
years based on its future usage of RMB 1.4bn IPO proceeds
Manyi LU
manyilu@dbs.com • Long-term growth rate expected to catch up due to its future
Dennis Lam +852 2971 1922 expansion which will help the bridge the current valuation
dennis_lam@dbs.com discount
• Initiating coverage with BUY with TP HK$ 3.23
Price Relative
HK$ Relative Index Revenue growth to pick up. China Yuhua Education Corp (Yuhua) is
3.2

3.0
209 the largest private education provider covering kindergartens to
2.8
189
university in terms of student numbers in Henan province. The
169
2.6
149
company’s revenue growth has been relatively conservative, with
2.4

2.2 129 revenue growth y-o-y slowing down from 16.4% in FY15 to 8% in
2.0 109 1H17. That being said, we are confident in a pickup of this rate as the
1.8
Feb-17 May-17
89
outsourcing of non-teaching services coming to an end and new
China Yuhua Education Corp (LHS) Relative HSI (RHS)
capacity being added. We expect revenue growth to pick up to its FY15
level (16%) by FY20.
Forecasts and Valuation
FY Aug (RMB m) 2016A 2017F 2018F 2019F Where we differ: We have a more bullish view on the company’s EPS
Turnover 781 853 963 1,099
EBITDA 406 393 535 616 growth, supported by its long-term expansion strategic plans to enlarge
Pre-tax Profit 312 264 482 568 its university capacity, and to embark on more acquisitions to expand
Net Profit 312 264 458 517 out of Henan Province in 3 years. Previously, Yuhua’s expansion plans
Net Pft (Pre Ex) (core
312 264 458 517 are not as ambitious as its peers as it was constrained by teacher
profit)
Net Profit Gth (Pre-ex) capacity. The company has stepped up training in recent years and we
241.8 (15.3) 73.4 12.9
(%) believe that the company’s expansion could accelerate in the future,
EPS (RMB) N/A 0.10 0.16 0.18 leading to faster top-line growth. The utilisation rate of the schools is
EPS (HK$) N/A 0.12 0.18 0.20
EPS Gth (%) N/A N/A 51.2 12.9 far from full, implying the key near term focus for growth would be to
Diluted EPS (HK$) N/A 0.12 0.18 0.20 increase enrollment, rather than to expand physical infrastructure.
DPS (HK$) N/A 0.05 0.09 0.10
BV Per Share (HK$) N/A 0.95 1.13 1.33 Critical share price driver: Yuhua has the highest gross margin among
PE (X) N/A 22.0 14.5 12.9 peers at 52% in FY16 due to its relatively low costs of teachers and
P/Cash Flow (X) 0.0 17.7 10.5 10.3 high profitability of its university, which is likely to remain or slightly
P/Free CF (X) N/A 27.1 12.9 21.7
EV/EBITDA (X) 0.0 11.1 8.7 6.7 improve in 2017-2020. The high margin, together with other lower
Net Div Yield (%) N/A 2.0 3.4 3.9 expenses, has driven bottom-line earnings growth. After the accounting
P/Book Value (X) N/A 2.8 2.3 2.0 adjustments for options and listing expense, net profit growth in FY15
Net Debt/Equity (X) 0.0 CASH CASH CASH
and FY16 were 18% 31% despite moderating revenue growth.
ROAE (%) 41.3 15.9 17.3 16.5
Earnings Rev (%): New New New Valuation:
Consensus EPS (RMB) 0.10 0.14 0.16 Our TP of HK$ 3.23 is based on DCF model with WACC of 12.6% and
Other Broker Recs: B: 3 S: 0 H: 1 terminal growth rate of 3%, and this implies 17.5x FY18 PE while the
Source of all data on this page: Company, DBSV, Thomson Reuters, stock is currently trading at 14.5x FY18 PE.
HKEX
Key Risks to Our View:
Future expansion does not materialise as expected
At A Glance
Issued Capital (m shrs) 3,000
Mkt. Cap (HK$m/US$m) 7,835 / 1,003
Major Shareholders
Baikal Lake Investment Holdings Limited (%) 75.0
Bank of Communications (Nominee) (%) 6.3
Free Float (%) 18.7
3m Avg. Daily Val. (US$m) 1.9
ICB Industry : Consumer Services / General Retailers

ASIAN INSIGHTS VICKERS SECURITIES

ed-JS/ sa- CW
Company Guide
China Yuhua Education Corp

CRITICAL FACTORS TO WATCH

Total Capacity
Critical Factors 80,800
80000
74300
Careful capacity expansion in key segments. Unlike its peers, 71200 73100
69,257
62550
Yuhua does not have very aggressive plans to open new
57,714
schools or make acquisitions. Its strategy is to focus on the
46,171
university, the most profitable segments, and high school, the
34,629
most demanded segments, to get the best efforts out of the
23,086
limited capacity addition. The company plans to have 2,000
more university students and 2,000 new high school capacity 11,543

each year in the next three years. This contributes to the overall 0
2015A 2016A 2017F 2018F 2019F
earnings growth of the company because 1) its university  
generates the highest gross margin at 63.3% among all Number of student
segments in FY16 due to the high student-to-teacher ratio; and 62,451.5
2) In FY16, 5,294 of Yuhua’s students were in high school 56,896.3
52,271.5
stage while as 7,865 in middle schools. Driven by high demand 50,960 48,220.0
43,579.0
and 80-90% retention rate, a larger high school capacity could
38,220
keep more of its middle school graduates within the Yuhua
school system and thus lead to higher revenue growth. 25,480

12,740
Student numbers keep increasing with the establishment of
Yuhua brand. Previously known as the “The Affiliated High 0
2015A 2016A 2017F 2018F 2019F
School of Peking University, Henan Branch”, its high schools  
ended co-operation contracts with Peking University in 2014 Average cost per stuent (RMB)
and are now operating under the brand name of Yuhua as the
17,951 17,598.6
company wants to build up its own brand. Though the end of 16,010.1 16,203.5 16,311.3
16,930.5

the relationship with Peking University may have led to some 14,360
unfavourable impact from parents who judge the school by its
10,770
name, this is unlikely to be a future concern as Yuhua schools
have been building up their exam track record since 2014 and 7,180

already established a province-wise reputation .

3,590

ASP could further improve. The components of its ASP are just 0

tuition and boarding fees without any ancillary services. Besides 2015A 2016A 2017F 2018F 2019F
 
the mainstream curriculum targeting Gaokao, Yuhua is also
Gross Margin (%)
known for its arts and international education, which usually
54 55
command higher fees than the common curriculum. With the 55.2 52 53

increase in capacity at its high schools and university, we 44.1

46

expect ASP to grow 0.7% and 4% y-o-y in FY17/18 as they

33.1
plan to raise its university tuition from FY18.
22.1

Gross margins remain high as a main driver of the earnings

11.0
growth. Yuhua’s teacher’s average salary has remained stable
with average salary rises of c.5% every three years. The 0.0

company is able to attract good teachers by 1) the loyalty and 2015A 2016A 2017F 2018F 2019F
 
recognition from Yuhua’s own training system; 2) share
Finance cost (RMB m)
options with vesting period in 15-20 years; 3) clear career path
and good promotion prospects provided; and 4) highest salary 35

level in the province. Controlling staff costs would enable 30

29.9
26.1
Yuhua to maintain or grow GP margins without hurting the 25

quality of teachers. In FY17/18, we are optimistic that gross 20

margins would remain high at 53% and 54%. 15
15.4

10

5 3.6
0
0
2015A 2016A 2017F 2018F 2019F

Source: Company, DBS Vickers

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 Company Guide
China Yuhua Education Corp

Balance Sheet:
Healthy financials. Yuhua’s balance sheet has been quite Leverage & Asset Turnover (x)
healthy. The net gearing was 48% and 1% in FY15/16. In 0.90
0.4
0.4
1H17, there were only RMB 40m and RMB60m in current 0.80
0.4
and non-current debt. Without strong funding needs for 0.70
0.3
0.60
capex and acquisitions at the moment, we expect the debts 0.50
0.3
0.3
to be fully paid, with no new borrowings taken up in the 0.40 0.3
next 3 years. 0.30 0.3
0.20 0.2
0.10 0.2
Capex will be lower from FY17 to FY19 if no major 0.00 0.2
acquisitions take place. The new high school expansion plan 2015A 2016A 2017F 2018F 2019F
Gross Debt to Equity (LHS) Asset Turnover (RHS)
is to build new dorms to add capacity of 2000 to 3 high
Capital Expenditure
schools. The capacity will be fully delivered in the next three RMBm
years with one high school completed each year. The 200.0
180.0
university capacity will also be enlarged. As some of new 160.0
construction plans in the next 3 years are at its current 140.0
120.0
campus, we believe the capex level will be lower than 100.0
FY15/16 levels. The capex is expected to be RMB 80.0
60.0
103m/RMB115m for FY17/18, representing 12% of the 40.0
projected revenue. 20.0
0.0
2015A 2016A 2017F 2018F 2019F

Share Price Drivers: Capital Expenditure (-)

Potential M&A opportunities. Though there are no potential ROE

acquisitions disclosed at the moment, Yuhua has plans for 40.0%

future M&As at both university and K12 schools. It is likely 35.0%

that the company expand its footprint outside of Henan 30.0%

province through M&A. 25.0%

20.0%

15.0%

10.0%
Key Risks:
1. Future expansion and developments do not materialise 5.0%

0.0%
as we expected. 2015A 2016A 2017F 2018F 2019F

Our estimation of its future expansion and spending is Forward PE Band

based on its plans of how IPO proceeds should be used. (x)
Risks exist that listing is just for issuing large amounts of 19.6

options to employees but utilising the proceeds properly 18.6

+2sd: 18.4x
for future expansion. 17.6
+1sd: 17.3x
16.6
Avg: 16.3x
2. Weaker-than-expected growth in student numbers and 15.6
‐1sd: 15.3x
tuition fee levels. 14.6
‐2sd: 14.3x
13.6

12.6
Feb-17 May-17
Company Background:
Based in Henan Province and founded in 2001, Yuhua is PB Band
now the largest private education provider covering x
3.0
kindergartens to university in terms of student numbers as at
2.8
end-FY16. It now has 1 university and 24 K12 schools under
2.6 +1SD: 2.6x
Yuhua brand in 9 cities in Henan province.
2.4 Avg: 2.4x

2.2 -1SD: 2.2x

2.0
Feb-17

Jul-17
Apr-17

May-17

Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

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Company Guide
China Yuhua Education Corp

Key Assumptions
FY Aug 2015A 2016A 2017F 2018F 2019F
Total Capacity 62,550.0 71,200.0 73,100.0 74,300.0 80,000.0
Number of student 43,579.0 48,220.0 52,271.5 56,896.3 62,451.5
Average cost per stuent
16,010.1 16,203.5 16,311.3 16,930.5 17,598.6
(RMB)
Gross Margin (%) 45.6 52.0 52.9 53.7 54.6
Finance cost (RMB m) 26.1 29.9 15.4 3.6 0.0
Source: Company, DBS Vickers

Income Statement (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F
Revenue 698 781 853 963 1,099
Cost of Goods Sold (379) (375) (402) (446) (499)
Gross Profit 318 406 451 518 600
Other Opng (Exp)/Inc (59) (75) (136) (63) (66)
Operating Profit 260 332 314 455 534
Other Non Opg (Exp)/Inc (144) 6 (47) 10 11
Associates & JV Inc 0 0 0 0 0
Net Interest (Exp)/Inc (24) (26) (3) 17 23
Dividend Income 0 0 0 0 0
Exceptional Gain/(Loss) 0 0 0 0 0
Pre-tax Profit 91 312 264 482 568
Tax 0 0 0 (24) (51)
Minority Interest 0 0 0 0 0
Preference Dividend 0 0 0 0 0
Net Profit 91 312 264 458 517
Net Profit before Except. 91 312 264 458 517
EBITDA 326 406 393 535 616
Growth
Revenue Gth (%) 16.4 12.0 9.1 13.0 14.1
EBITDA Gth (%) 19.2 24.4 (3.1) 36.2 15.2
Opg Profit Gth (%) 19.9 27.7 (5.2) 44.8 17.4
Net Profit Gth (%) (56.1) 241.8 (15.3) 73.4 12.9
Margins & Ratio
Gross Margins (%) 45.6 52.0 52.9 53.7 54.6
Opg Profit Margin (%) 37.2 42.4 36.9 47.2 48.6
Net Profit Margin (%) 13.1 39.9 31.0 47.5 47.0
ROAE (%) 16.5 41.3 15.9 17.3 16.5
ROA (%) 4.8 15.6 9.9 12.9 12.7
ROCE (%) 29.8 27.4 16.5 15.9 15.4
Div Payout Ratio (%) 0.0 0.0 50.0 50.0 50.0
Net Interest Cover (x) 10.7 12.7 101.4 NM NM
Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

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 Company Guide
China Yuhua Education Corp

Interim Income Statement (RMB m)

FY Aug 1H2016 2H2016 1H2017 2H2017

Revenue 390 391 421 431

Cost of Goods Sold (192) (183) (211) (191)
Gross Profit 198 208 210 240
Other Oper. (Exp)/Inc (36) (39) (92) (44)
Operating Profit 162 169 118 196
Other Non Opg (Exp)/Inc N/A N/A N/A N/A
Associates & JV Inc N/A N/A N/A N/A
Net Interest (Exp)/Inc 0 0 0 0
Exceptional Gain/(Loss) 0 0 0 0
Pre-tax Profit 162 169 118 196
Tax N/A N/A N/A N/A
Minority Interest N/A N/A N/A N/A
Net Profit 162 169 118 196
Net profit bef Except. 162 169 118 196

Growth
Revenue Gth (%) N/A N/A 8.0 10.2
Opg Profit Gth (%) N/A N/A (27.1) 15.9
Net Profit Gth (%) N/A N/A (27.1) 15.9

Margins
Gross Margins (%) 50.8 53.2 49.9 55.7
Opg Profit Margins (%) 41.5 43.3 28.0 45.5
Net Profit Margins (%) 41.5 43.3 28.0 45.5
Source: Company, DBS Vickers

Balance Sheet (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F

Net Fixed Assets 1,409 1,465 1,494 1,533 1,576

Invts in Associates & JVs 0 0 0 0 0
Other LT Assets 256 247 247 246 245
Cash & ST Invts 215 305 1,551 1,997 2,542
Inventory 0 0 0 0 0
Debtors 76 11 13 14 16
Other Current Assets 0 0 0 0 0
Total Assets 1,956 2,028 3,304 3,790 4,380

ST Debt 362 120 0 0 0

Creditors 210 157 128 144 110
Other Current Liab 592 609 639 742 854
LT Debt 140 195 95 0 0
Other LT Liabilities 55 38 31 34 30
Shareholder’s Equity 598 910 2,411 2,869 3,386
Minority Interests 0 0 0 0 0
Total Cap. & Liab. 1,956 2,028 3,304 3,790 4,380

Non-Cash Wkg. Capital (725) (755) (755) (873) (948)

Net Cash/(Debt) (287) (10) 1,456 1,997 2,542
Debtors Turn (avg days) 22.5 20.5 5.2 5.2 5.1
Creditors Turn (avg days) N/A N/A N/A N/A N/A
Inventory Turn (avg days) N/A N/A N/A N/A N/A
Asset Turnover (x) 0.4 0.4 0.3 0.3 0.3
Current Ratio (x) 0.3 0.4 2.0 2.3 2.7
Quick Ratio (x) 0.3 0.4 2.0 2.3 2.7
Net Debt/Equity (X) 0.5 0.0 CASH CASH CASH
Net Debt/Equity ex MI (X) 0.5 0.0 CASH CASH CASH
Capex to Debt (%) 32.5 32.5 120.5 N/A N/A
Z-Score (X) NA NA NA NA NA
Source: Company, DBS Vickers

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Company Guide
China Yuhua Education Corp

Cash Flow Statement (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F

Pre-Tax Profit 91 312 264 482 568

Dep. & Amort. 66 74 79 80 82
Tax Paid 0 0 0 (4) (41)
Assoc. & JV Inc/(loss) 0 0 0 0 0
(Pft)/ Loss on disposal of FAs 0 2 0 0 0
Chg in Wkg.Cap. 14 35 (5) 95 61
Other Operating CF (3) (2) (9) (18) (23)
Net Operating CF 168 420 328 635 647
Capital Exp.(net) (189) (163) (103) (115) (121)
Other Invts.(net) (60) 61 0 0 0
Invts in Assoc. & JV 0 0 0 0 0
Div from Assoc & JV 0 0 0 0 0
Other Investing CF (55) 60 9 18 23
Net Investing CF (304) (42) (93) (97) (98)
Div Paid 0 0 0 0 0
Chg in Gross Debt 30 (227) (227) (91) (4)
Capital Issues 0 0 1,238 0 0
Other Financing CF 0 (1) 0 0 0
Net Financing CF 30 (227) 1,010 (91) (4)
Currency Adjustments 0 0 0 0 0
Chg in Cash (105) 151 1,246 446 545
Opg CFPS (RMB) N/A N/A 0.10 0.17 0.22
Free CFPS (RMB) N/A N/A 0.08 0.18 0.10

Source: Company, DBS Vickers

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Page 66
China / Hong Kong Company Guide
Wisdom Education Int'l Holdings
Version 1 | Bloomberg: 6068 HK Equity | Reuters: 6068.HK
Refer to important disclosures at the end of this report

DBS Group Research . Equity 12 Jul 2017

BUY (Initiate Coverage) More powerful growth engines

Last Traded Price ( 11 Jul 2017):HK$2.71 (HSI : 25,878) ahead
Price Target 12-mth: HK$3.17 (17% upside) • Ancillary services, capacity expansion and M&A being the
Analyst new revenue growth engine
Manyi LU • Higher gearing than peers but financials have improved and
manyilu@dbs.com
related transactions cleared
Dennis Lam +852 2971 1922
dennis_lam@dbs.com • Initiating Coverage with BUY with HK$3.17 TP

Price Relative Fast capacity expansion under heavy asset model. Wisdom Education
HK$ Relative Index Int’l Holdings (Wisdom) is the largest private education group
3.1
206
operating premium primary and secondary schools in South China.
2.9
2.7 186 Earnings will be boosted by its fast pace of capacity expansion.
2.5 166
Organic growth aside, the company has also announced the recent
2.3 146
2.1
126
acquisition of a school in Jieyang, Guangdong, which would be
consolidated to the financial statements in FY18F.
1.9
1.7 106

1.5 86
Jan-17 Apr-17
Where we differ: We have a more bullish view for EPS and revenue
Wisdom Education Int'l Holdings (LHS) Relative HSI (RHS) growth, especially in FY19/20 as we are expecting higher tuition hike
Forecasts and Valuation and student number growth. Our optimistic view is based on the high
FY Aug (RMB m) 2016A 2017F 2018F 2019F visibility of the development of its new schools and acquired schools
Turnover 701 993 1,223 1,569 because of the company’s established reputation and previous
EBITDA 273 384 457 618
Pre-tax Profit 195 286 359 510 successful experience in managing acquired schools.
Net Profit 154 229 302 434
Net Pft (Pre Ex) (core
Critical share price driver: Significant increase in ancillary services will
154 229 302 434 accelerate revenue growth. 1H17 revenue increased 40.6% y-o-y to
profit)
Net Profit Gth (Pre-ex) RMB 498m mostly driven by ancillary services. During this period,
(15.3) 48.4 31.7 43.7
(%) ancillary service revenue had more than doubled in 1H17 to RMB
EPS (RMB) 0.10 0.13 0.15 0.21
EPS (HK$) 0.12 0.15 0.17 0.24 162m, and made up 32.6% of total revenue compared to the 21.5%
EPS Gth (%) N/A 22.5 17.5 43.7 in FY16. These included new services such as school uniform sales,
Diluted EPS (HK$) 0.12 0.15 0.17 0.24 buses and study tours commenced operations. We expect ancillary
DPS (HK$) 0.00 0.05 0.06 0.07
BV Per Share (HK$) 0.60 0.94 1.05 1.22 revenue to further increase in the future, leading to better overall
PE (X) 22.9 18.7 15.9 11.1 gross margins.
P/Cash Flow (X) 10.5 7.1 7.7 6.0
P/Free CF (X) nm 24.3 24.9 nm
Valuation:
EV/EBITDA (X) 14.8 9.9 9.3 6.5 Our valuation of HK$3.17 is based on DCF model with WACC of
Net Div Yield (%) 0.0 1.7 2.2 2.7 11.9% and perpetuity growth at 3%, which implies 18.4x FY18F PE.
P/Book Value (X) 4.5 2.9 2.6 2.2 The stock is currently trading at 15.9x FY18F PE.
Net Debt/Equity (X) 0.6 CASH CASH CASH
ROAE (%) 20.5 18.3 17.1 21.5 Key Risks to Our View:
Earnings Rev (%): New New New Delay to deliver new schools; weaker-than-expected increase in
Consensus EPS (RMB) 0.12 0.16 0.19 student number and tuition
Other Broker Recs: B: 9 S: 0 H: 0
At A Glance
Source of all data on this page: Company, DBSV, Thomson Reuters, Issued Capital (m shrs) 2,039
HKEX Mkt. Cap (HK$m/US$m) 5,530 / 708
Major Shareholders
Liu Xuebin (%) 45.7
Li Suwen (%) 28.0
Free Float (%) 26.4
3m Avg. Daily Val. (US$m) 1.6
ICB Industry : Consumer Services / General Retailers

ASIAN INSIGHTS VICKERS SECURITIES

ed-JS/ sa- CW
Company Guide
Wisdom Education Int'l Holdings

CRITICAL FACTORS TO WATCH

Capacity
Critical Factors
55215
Total capacity to increase through “2+2+2” strategy. In recent 50306
years, Wisdom has been proactive in seeking opportunities in 47,800

other parts of China in addition to its home province 39,834

33151
Guangdong. Its recent locations are spread wide across China, 31,867 30556
25723
in Panjin, Weifang, Guang’an and Yunfu. Out of its current 23,900
portfolio of six schools, only two in Dongguan are mature 15,933
schools. Others were established after 2013 and still have large 7,967
potential to expand utilisation. The company expects to expand 0
in a “2+2+2”mode in the future, which means that in each 2015A 2016A 2017F 2018F 2019F
 
year, there will be 2 new schools, 2 schools under construction
and 2 in preparation stage. We expect capacity to grow Number of students
significantly in FY18/19 at 52% and 10% each year based on 49,892 48,914.1

its current pipeline including M&A. The expansion is amongst 41,130.0

39,914
the most aggressive in the sector.
31,788.0
29,935 27,644.0
Potential M&A opportunities after IPO. With more flexible 22,837.0
financing sources after the IPO, Wisdom is now looking for 19,957

more M&A opportunities. It has already set up a group of

9,978
experts to research potential opportunities. Acquisition of a
school in Guangdong with 3,200 students, is expected to be 0
2015A 2016A 2017F 2018F 2019F
completed in September. Wisdom targets to have 4,500  
students in the school in FY18. With its previous success in
Average cost per student (RMB)
acquiring Dongguang Guangzheng, the company is now
32,078.3
looking at schools with a certain scale and potential for 32,720 31,250.2
29,742.2
improvements. Unlike some of its peers, Wisdom does not have 26,176 24,903.2 25,348.8
plans to acquire universities at the moment as the
management wants to focus on segments where private 19,632

schools could get good resources. 13,088

Utilisation rate kept high with outstanding academic 6,544

performance. Utilisation rate has been improving in the past
years from 84% in 2013 to 96% in 2016. The utilisation rates 0

of its two mature schools were higher at 98-99% in 2016. We

2015A 2016A 2017F 2018F 2019F
 
expect utilisation to slightly drop to 96%/82% in FY17/18 due Gross Margin (%)
to fast capacity expansion. Overall, the number of students will 49
49.6 47 47 48
continue to increase. We expect total number of students to 46

reach 40,000 by FY18 from current 31,788 , including 4,500 39.7

students from schools acquired.

29.8

ASP level to increase due to increase in both tuition and non-

19.9
tuition fee income. In the school year 2016/17, tuition and
boarding fees in Guangdong increased by 10-20%. ASP was 9.9

RMB 25,349 per year per student, 7.2% higher than 2015’s 0.0
RMB 24,903. In FY17, we are expecting ASP to be RMB 31,250 2015A 2016A 2017F 2018F 2019F
with the acceleration in 2017 because of the significant
 
increase in ancillary services. The decrease of tuition level and Finance cost (RMB m)
GP margin in FY18 is due to the relative low tuition level of the 120
newly acquired school (e.g targets RMB 10,000, or 1/3 of 107
100
Wisdom school in FY18) and commence of new ancillary
services while we expect it is going to gradually pick up in the 80
70

coming years. 60

Finance cost lower as a result of deleveraging. Finance costs are 40

30
21
expected to keep dropping from RMB 107m in FY15 to RMB 20 16

70m in FY16 due to ongoing deleveraging process. 0

2015A 2016A 2017F 2018F 2019F
 
Source: Company, DBS Vickers

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 Company Guide
Wisdom Education Int'l Holdings

Balance Sheet:
Balance sheet improved with lower leverage and higher asset Leverage & Asset Turnover (x)
turnover. The net gearing dropped to negative (net cash 1.80
0.5

position) in 1H17 from 60% in FY16. We expect this to further 1.60 0.5

keep net cash in FY18/19 as the increase in new debt slows. 1.40
0.4
Asset turnover increased to 0.26 in FY16 from 0.2 in FY15. 1.20
1.00 0.4
0.80
Capital expenditure sharply higher as a result of acquisitions 0.60 0.3

and Wisdom’s heavy asset model. The capex for FY16 was 0.40
0.3
0.20
RMB 178m, indicating RMB 41,000 for each new capacity 0.00 0.2
added. Wisdom prefers to keep buildings and land on their 2015A 2016A 2017F 2018F 2019F
Gross Debt to Equity (LHS) Asset Turnover (RHS)
balance sheet as it believe it will benefit them in the long term
Capital Expenditure
without any split of profit with other parties. In the past, RMBm
Wisdom had built some school buildings through a related 500.0
450.0
party, Cinese Real Estate owned by its Chairman Mr. Liu. The 400.0
related transaction was cleared from the balance sheet after 350.0
300.0
the IPO and no further plans of such related transactions are 250.0
expected for now. 1H17 saw large y-o-y increase in capex, 200.0
150.0
from RMB 53m to 203m driven by acquisitions. We forecast 100.0
the trend will carry into the future and capex in FY17/18 will be 50.0
0.0
around RMB 400m and 500m based on Wisdom’s expansion 2015A 2016A 2017F 2018F 2019F

strategy. Capital Expenditure (-)

ROE
Share Price Drivers: 30.0%

Potential M&A opportunities. It is likely that more acquisitions 25.0%

will happen in the future with a pipeline of a number of 20.0%

projects. Wisdom’s operating cash flows are stable as it charges
tuition fees every half year, which could well cover the cost of 15.0%

acquisitions. The company pays more attention to targets in its 10.0%

home provinces in Guangdong, and also Shandong and 5.0%

Sichuan in the project selecting process.
0.0%
2015A 2016A 2017F 2018F 2019F

Key Risks: Forward PE Band

1. Delay to deliver school capacity as planned (x)
20.6
The new school in Yunfu, which was expected to open in
+2sd: 18.9x
Sep 2017, has delayed its opening to Sep 2018 as the 18.6

local government and the company would like to use 16.6 +1sd: 16.6x
another site to develop the school. Switching to a larger 14.6
Avg: 14.2x
and better site could benefit the company in the long term,
12.6
but defers revenue generation in the short term. ‐1sd: 11.9x
10.6
‐2sd: 9.6x
2. Weaker-than-expected growth in student numbers and 8.6
Jan-17 Apr-17
tuition fee levels.
PB Band
(x)
Company Background
3.8
With its first school established in 2003, Wisdom Education is
+2sd: 3.55x
the largest private education group operating premium 3.3
primary and secondary schools in South China as measured by +1sd: 3.18x

student enrolment in school year 2015/16. As at September 2.8 Avg: 2.8x

2016, it operates 6 schools located in 4 cities and focuses on ‐1sd: 2.43x
providing high quality PRC curriculum programs. 2.3

‐2sd: 2.05x
1.8
Jan-17 Apr-17

Source: Company, DBS Vickers

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Company Guide
Wisdom Education Int'l Holdings

Key Assumptions
FY Aug 2015A 2016A 2017F 2018F 2019F
Capacity 25,722.7 30,556.2 33,151.4 50,306.4 55,214.9
Number of students 22,837.0 27,644.0 31,788.0 41,130.0 48,914.1
Average cost per student
24,903.2 25,348.8 31,250.2 29,742.2 32,078.3
(RMB)
Gross Margin (%) 49.1 47.1 46.9 45.6 48.1
Finance cost (RMB m) 106.8 69.6 29.8 20.7 15.9
Source: Company, DBS Vickers

Segmental Breakdown (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F
Revenues (RMB m)
Tuition and boarding fee 442 550 666 778 946
Ancillary services 126 151 328 445 623
Total 569 701 993 1,223 1,569

Source: Company, DBS Vickers

Income Statement (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F
Revenue 569 701 993 1,223 1,569
Cost of Goods Sold (289) (370) (528) (665) (814)
Gross Profit 280 330 466 558 755
Other Opng (Exp)/Inc (84) (107) (149) (183) (235)
Operating Profit 196 223 317 375 519
Other Non Opg (Exp)/Inc 6 (23) (7) 3 3
Associates & JV Inc 0 0 0 0 0
Net Interest (Exp)/Inc 11 (6) (23) (18) (12)
Dividend Income 0 0 0 0 0
Exceptional Gain/(Loss) 0 0 0 0 0
Pre-tax Profit 212 195 286 359 510
Tax (30) (40) (57) (57) (77)
Minority Interest 0 0 0 0 0
Preference Dividend 0 0 0 0 0
Net Profit 182 154 229 302 434
Net Profit before Except. 182 154 229 302 434
EBITDA 237 273 384 457 618
Growth
Revenue Gth (%) 26.1 23.2 41.8 23.1 28.3
EBITDA Gth (%) 46.2 15.0 40.8 19.1 35.1
Opg Profit Gth (%) 47.6 13.9 41.8 18.4 38.6
Net Profit Gth (%) 100.5 (15.3) 48.4 31.7 43.7
Margins & Ratio
Gross Margins (%) 49.1 47.1 46.9 45.6 48.1
Opg Profit Margin (%) 34.4 31.8 31.9 30.6 33.1
Net Profit Margin (%) 32.1 22.0 23.1 24.7 27.6
ROAE (%) 30.7 20.5 18.3 17.1 21.5
ROA (%) 6.5 5.7 8.5 9.8 12.6
ROCE (%) 9.0 10.4 14.4 14.8 19.3
Div Payout Ratio (%) 0.0 0.0 35.8 35.0 30.0
Net Interest Cover (x) NM 40.3 13.9 20.6 44.1
Source: Company, DBS Vickers

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 Company Guide
Wisdom Education Int'l Holdings

Interim Income Statement (RMB m)

FY Aug 1H2016 2H2016 1H2017

Revenue 354 346 498

Cost of Goods Sold (188) (182) (267)
Gross Profit 166 164 231
Other Oper. (Exp)/Inc (50) (49) (73)
Operating Profit 116 115 158
Other Non Opg (Exp)/Inc N/A N/A N/A
Associates & JV Inc N/A N/A N/A
Net Interest (Exp)/Inc 0 0 0
Exceptional Gain/(Loss) 0 0 0
Pre-tax Profit 116 115 158
Tax N/A N/A N/A
Minority Interest N/A N/A N/A
Net Profit 116 115 158
Net profit bef Except. 116 115 158

Growth
Revenue Gth (%) N/A N/A 40.6
Opg Profit Gth (%) N/A N/A 36.6
Net Profit Gth (%) N/A N/A 36.6

Margins
Gross Margins (%) 46.9 47.4 46.3
Opg Profit Margins (%) 32.7 33.2 31.7
Net Profit Margins (%) 32.7 33.2 31.7
Source: Company, DBS Vickers

Balance Sheet (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F

Net Fixed Assets 1,007 1,344 1,646 1,967 2,283

Invts in Associates & JVs 0 0 0 0 0
Other LT Assets 426 419 363 277 292
Cash & ST Invts 12 104 879 879 1,019
Inventory 2 5 6 6 8
Debtors 1,512 581 45 55 71
Other Current Assets 5 6 6 6 6
Total Assets 2,965 2,458 2,944 3,190 3,679

ST Debt 538 142 0 0 0

Creditors 662 587 308 318 384
Other Current Liab 346 423 574 694 892
LT Debt 738 465 385 305 225
Other LT Liabilities 6 9 9 9 9
Shareholder’s Equity 675 831 1,668 1,864 2,167
Minority Interests 0 0 0 0 0
Total Cap. & Liab. 2,965 2,458 2,944 3,190 3,679

Non-Cash Wkg. Capital 511 (419) (825) (944) (1,192)

Net Cash/(Debt) (1,263) (504) 493 573 794
Debtors Turn (avg days) 594.2 545.2 115.0 14.9 14.6
Creditors Turn (avg days) N/A N/A N/A N/A N/A
Inventory Turn (avg days) 2.6 3.7 4.2 3.8 3.6
Asset Turnover (x) 0.2 0.3 0.4 0.4 0.5
Current Ratio (x) 1.0 0.6 1.1 0.9 0.9
Quick Ratio (x) 1.0 0.6 1.0 0.9 0.9
Net Debt/Equity (X) 1.9 0.6 CASH CASH CASH
Net Debt/Equity ex MI (X) 1.9 0.6 CASH CASH CASH
Capex to Debt (%) 15.7 64.0 109.9 142.3 385.9
Z-Score (X) NA NA NA NA NA
Source: Company, DBS Vickers

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Company Guide
Wisdom Education Int'l Holdings

Cash Flow Statement (RMB m)

FY Aug 2015A 2016A 2017F 2018F 2019F

Pre-Tax Profit 212 195 286 359 510

Dep. & Amort. 41 49 67 82 98
Tax Paid (6) (42) (58) (57) (57)
Assoc. & JV Inc/(loss) 0 0 0 0 0
(Pft)/ Loss on disposal of FAs 0 3 0 0 0
Chg in Wkg.Cap. 78 98 196 119 229
Other Operating CF (6) 34 108 124 17
Net Operating CF 319 338 600 627 797
Capital Exp.(net) (211) (200) (389) (423) (435)
Other Invts.(net) 0 0 0 0 0
Invts in Assoc. & JV 0 0 0 0 0
Div from Assoc & JV 0 0 0 0 0
Other Investing CF (98) 451 558 3 4
Net Investing CF (309) 251 169 (421) (430)
Div Paid 0 0 (82) (106) (130)
Chg in Gross Debt 99 (396) (562) (80) (80)
Capital Issues 0 0 690 0 0
Other Financing CF (110) (101) (40) (21) (16)
Net Financing CF (11) (497) 6 (206) (226)
Currency Adjustments 0 0 0 0 0
Chg in Cash (1) 91 775 0 141
Opg CFPS (RMB) N/A 0.15 0.20 0.21 0.39
Free CFPS (RMB) N/A (0.03) 0.10 0.09 (0.04)

Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

Page 72
China / Hong Kong Company Guide
Virscend Education Co Ltd
Version 1 | Bloomberg: 1565 HK Equity | Reuters: 1565.HK
Refer to important disclosures at the end of this report

DBS Group Research . Equity 12 Jul 2017

HOLD (Initiate Coverage) Strong outlook priced in

Last Traded Price ( 11 Jul 2017):HK$4.88 (HSI : 25,878) y Strong brand name and reputation to support its fast
Price Target 12-mth: HK$4.97 (2% upside) expansion
y Current valuation of 40x FY17F PE reflects its strong growth
Analyst
outlook
Manyi LU
manyilu@dbs.com y Initiating Coverage with HOLD and HK$ 4.97 TP
Dennis Lam +852 2971 1922 Strong growth momentum already fully reflected in price. Virscend
dennis_lam@dbs.com
Education Co is the largest provider of K-12 (kindergarten to twelfth
Price Relative grade) private education in Southwest China, and also operates a
HK$ Relative Index university. We are positive on the earnings growth outlook of Virscend,
6.2
5.7 209
supported by an enlarged market, accelerated expansion plan, and
5.2 189 lower finance costs from 2017. However, we think the current
4.7
4.2
169
valuation has already fully reflected its strong growth outlook.
149
3.7
3.2
129
Where we differ: We are more bullish in our revenue and EPS growth
109
estimates for FY17-19. With confidence in the brand value of
2.7
2.2 89
Jan-16 Jun-16 Nov-16 Apr-17
Virscend’s high schools, its new capacity will drive earnings. Its good
Virscend Education Co Ltd (LHS) Relative HSI (RHS)
reputation in Sichuan province will help the company to achieve more
Forecasts and Valuation than 90% utilisation rate for its new schools in the initial 3 years.
FY Dec (RMB m) 2016A 2017F 2018F 2019F
Turnover 827 1,148 1,534 1,980 Critical share price driver: Leveraging on its strong brand name,
EBITDA 387 528 737 991 Virscend is expanding into previously unexplored segments. With full
Pre-tax Profit 322 413 622 891 coverage from kindergarten to university, the company has made a
Net Profit 302 376 566 757
Net Pft (Pre Ex) (core strategic investment into one of China’s largest early education
302 376 566 757
profit) institution franchises to further extend its exposure to the fast-
Net Profit Gth (Pre-ex) developing early education industry targeting 0-5-year-old children.
141.4 24.4 50.5 33.8
(%)
EPS (RMB) 0.10 0.12 0.18 0.25 Well known for its foreign language schools, the company is also
EPS (HK$) 0.11 0.14 0.21 0.28 seeking opportunities to co-operate with renowned overseas
EPS Gth (%) 78.3 22.7 50.5 33.8 universities to set new international schools in Shenzhen and Hong
Diluted EPS (HK$) 0.11 0.14 0.21 0.28
Kong. This is still in the early stages, and is potentially a longer term
DPS (HK$) 0.08 0.07 0.08 0.11
BV Per Share (HK$) 0.95 1.02 1.14 1.31 catalyst.
PE (X) 42.8 34.9 23.2 17.3
Valuation:
P/Cash Flow (X) 28.2 15.6 12.1 10.9
P/Free CF (X) nm 43.1 28.0 23.2 Given its strong brand name, we believe that Virscend has the best
EV/EBITDA (X) 34.5 24.9 17.4 12.7 growth potential in the long term and deserves a higher valuation than
Net Div Yield (%) 1.6 1.4 1.7 2.3 its peers. However, we think the current valuation of 35.5x FY17 PE
P/Book Value (X) 5.1 4.8 4.3 3.7
Net Debt/Equity (X) 0.2 0.0 CASH CASH already reflects the company’s strong long-term growth outlook. Our
ROAE (%) 19.3 14.2 19.5 22.9 TP of HK$ 4.97 is based on a DCF model, which assumes WACC of
Earnings Rev (%): New New New 12.6%, and 3%terminal growth. This implies a 35.4x FY17F PE.
Consensus EPS (RMB) 0.11 0.16 0.22 Key Risks to Our View:
Other Broker Recs: B: 1 S: 0 H: 2
Failure to deliver new schools; weaker-than-expected increase in
Source of all data on this page: Company, DBSV, Thomson Reuters, student numbers and tuition fees.
HKEX
At A Glance
Issued Capital (m shrs) 3,089
Mkt. Cap (HK$m/US$m) 15,083 / 1,931
Major Shareholders
Wang Xiaoying (%) 44.0
China First Capital Group Limited (%) 10.0
Happy Venus Limited (%) 5.8
Free Float (%) 40.2
3m Avg. Daily Val. (US$m) 1.7
ICB Industry : Consumer Services / General

ASIAN INSIGHTS VICKERS SECURITIES

ed-JS/ sa- CW
Company Guide
Virscend Education Co Ltd

CRITICAL FACTORS TO WATCH

Total Capacity
Critical Factors 47,003
46538
Capacity expansion pace to accelerate with more funding 39638
40,289
sources and enlarged target market. There are two factors to
32626
support the aggressive capacity growth of the company: 1) 33,574 31397 31501

Cooperation with third parties, such as property developers, 26,859

local enterprises and governments to provide land and 20,144
buildings after its listing for asset light expansion; 2)
13,430
broadening its target student base. Previously, Virscend took in
only the best students while it is now also targeting the rest of 6,715

the student population. In FY17, it will enter new markets by 0

2014A 2015A 2016A 2017F 2018F
expanding outside of Chengdu to two other cities in Sichuan  
province. Among all new schools this year, only Wenjiang
campus is built and owned by Virscend itself. Number of students
49,247 48,281.2

Utilisation rate is high thanks to high reputation. The brand 41,353.4

value of the company is supported by the outstanding 39,397
34,477.0
performance of its high schools, especially Chengdu Foreign 31,838.0 32,706.0
29,548
Languages School. The admission rate into Tier 1 universities in
China reached 70%/77%/87% from 2014 to 2016, beating 19,699
most of its competitors including both public and private
schools in Sichuan. The high quality of the school underpins a 9,849
high utilisation rate. The overall utilisation rate of all schools
under Virscend is over 105%. Upcoming capacity expansion 0
2014A 2015A 2016A 2017F 2018F
will address the over-capacity issue to some extent, but this is  
still not sufficient. The admission rate remains low for current
Average cost per student (RMB)
schools and enrollment at new schools is progressing well. We
expect utilisation will drop a little bit due to capacity expansion, 32,407 31,771.2

but the overall level will still be high at around 104% for 27,766.9

FY17/18. 25,925
21,637.9
23,993.0

19,662.3
19,444
Tuition level to further increase, especially for high schools. All
Virscend’s revenue comes from tuition and boarding fees. 12,963
Specialising in English teaching, its primary and middle schools
charge higher tuition fees than its local peers. Its pricing power 6,481

in high school is even stronger as it has differentiated itself well

0
with high quality. In FY16, overall ASP was near RMB24,000. In
the years to come, we expect there will be more room for
2014A 2015A 2016A 2017F 2018F
 
tuition fees to rise because of the imbalance between demands Gross Margin (%)
and supply.
50
50.1 47 47
42
GP margin not negatively affected much by new schools. In 40.1
41

general, new schools usually have lower gross margins because

of the lower utilisation rate and higher costs at the initial stages. 30.1

The gross margins of Virscend’s new schools are likely to be 20.0

40-45% (vs 47.3% for existing schools) as : 1) new schools

10.0
should easily meet their enrolment targets; and 2) additional
costs for more teachers is not as high as expected as new 0.0

schools are located in the same city as existing schools, with 2014A 2015A 2016A 2017F 2018F
 
the convenience to share teaching information and teacher
training courses. The overall gross margin is expected to drop Finance cost (RMB m)
slightly to 47% in FY17 but should pick up as new schools 120
110
mature. Previously, the gross margins for existing schools was 100
103

able to improve from 42% in FY15 to 47.3% in FY16.

80

Finance costs to drop after repayment of debt. The repayment 60 54

of a large amount of debt in 2016 shows the company’s 40 37

deleveraging trend. As a result, finance costs are expected to 20

21

head lower at RMB 37m/21m for FY17/18. 0

2014A 2015A 2016A 2017F 2018F

Source: Company, DBS Vickers

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 Company Guide
Virscend Education Co Ltd

Balance Sheet:
Deleverage in progress. The company repaid debts of RMB Leverage & Asset Turnover (x)
341m in 2016, with gross gearing decreasing sharply from 0.4
0.4
227% in FY15 to 39% in FY16. We believe the company will 2.00
0.4
continue to move towards a lighter-geared balance sheet as 0.3
1.50
a result of 1) increasingly adopting more light-asset models 0.3
0.3
for its schools, and 2) strong operation cash inflows. Gross 1.00 0.3
gearing is expected to further drop to 22% and 10% in 0.3

FY17/18 without too much of new debts taken. 0.50 0.2

0.2
0.00 0.2
Capex will drop in the years to come. Despite the aggressive 2014A 2015A 2016A 2017F 2018F
Gross Debt to Equity (LHS) Asset Turnover (RHS)
capacity expansion, we expect capex levels to drop in the
Capital Expenditure
coming years through the increasing adoption of more light- RMBm
asset models. In FY16, capex was RMB 860 million or 60% 1,000.0
900.0
of revenue, mainly for building the Wenjiang campus and 800.0
improving current teaching facilities. In FY17/18, we expect 700.0
600.0
capex level to drop to below 40% of total revenue at RMB 500.0
690m and RMB536m. 400.0
300.0
200.0
Share Price Drivers: 100.0
0.0
Potential M&A opportunities. More mergers and acquisitions 2014A 2015A 2016A 2017F 2018F

are expected take place in the education industry. With its Capital Expenditure (-)

strong financials and ambition to expand, Virscend is likely to ROE

undertake M&As in the future. 20.0%

Supportive regulations. The details of new education 15.0%

regulations are published at the provincial level. As a western

province with fewer good quality education resources, 10.0%

Sichuan may have more positive regulations on private

schools than other regions. 5.0%

0.0%
2014A 2015A 2016A 2017F 2018F

Key Risks: Forward PE Band

1. Failure to deliver new campuses as planned (x)
The new schools are still under construction. The school 42.7

licenses can only be approved at the end of 37.7

+2sd: 39.8x

construction. The formal admission process would begin +1sd: 35x

only afterwards. The timeline is tight for new schools to 32.7
Avg: 30.3x
open this September. 27.7
‐1sd: 25.5x

2. Quality not maintained as a result of fast expansion and 22.7

‐2sd: 20.7x
this may negatively impact future revenue. 17.7
Jan-16 Jun-16 Nov-16 Apr-17

PB Band
(x)
Company Background: 9.0
Virscend is the largest provider of K-12 private education in
8.0 +2sd: 7.92x
Southwest China. It operates all stages from kindergarten to
university. As at the end of 2016, there were 34,477 7.0
+1sd: 6.87x

students in total in all its schools and university. 6.0

Avg: 5.81x
5.0
‐1sd: 4.76x
4.0
‐2sd: 3.71x
3.0
Jan-16 Jun-16 Nov-16 Apr-17

Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

Page 75
Company Guide
Virscend Education Co Ltd

Key Assumptions
FY Dec 2015A 2016A 2017F 2018F 2019F
Total Capacity 31,501.0 32,626.0 39,638.0 46,538.0 53,238.0
Number of students 32,706.0 34,477.0 41,353.4 48,281.2 55,064.6
Average cost per student
21,637.9 23,993.0 27,766.9 31,771.2 35,949.1
(RMB)
Gross Margin (%) 41.9 47.3 47.0 49.6 52.9
Finance cost (RMB m) 102.5 54.3 37.0 20.9 7.0
Source: Company, DBS Vickers

Segmental Breakdown (RMB m)

FY Dec 2015A 2016A 2017F 2018F 2019F
Revenues (RMB m)
Tuition 669 788 1,091 1,457 1,881
Boarding fee 39 40 57 77 99
Total 708 827 1,148 1,534 1,980
Source: Company, DBS Vickers

Income Statement (RMB m)

FY Dec 2015A 2016A 2017F 2018F 2019F
Revenue 708 827 1,148 1,534 1,980
Cost of Goods Sold (411) (436) (608) (773) (931)
Gross Profit 296 391 540 761 1,048
Other Opng (Exp)/Inc (74) (72) (95) (127) (164)
Operating Profit 223 319 445 633 884
Other Non Opg (Exp)/Inc 4 54 0 0 0
Associates & JV Inc 0 0 2 6 11
Net Interest (Exp)/Inc (102) (51) (34) (18) (4)
Dividend Income 0 0 0 0 0
Exceptional Gain/(Loss) 0 0 0 0 0
Pre-tax Profit 125 322 413 622 891
Tax 0 (20) (37) (56) (134)
Minority Interest 0 0 0 0 0
Preference Dividend 0 0 0 0 0
Net Profit 125 302 376 566 757
Net Profit before Except. 125 302 376 566 757
EBITDA 279 387 528 737 991
Growth
Revenue Gth (%) 13.0 16.9 38.8 33.6 29.0
EBITDA Gth (%) 7.4 38.8 36.4 39.6 34.5
Opg Profit Gth (%) 1.4 43.5 39.2 42.5 39.5
Net Profit Gth (%) 9.5 141.4 24.4 50.5 33.8
Margins & Ratio
Gross Margins (%) 41.9 47.3 47.0 49.6 52.9
Opg Profit Margin (%) 31.4 38.6 38.7 41.3 44.6
Net Profit Margin (%) 17.7 36.5 32.7 36.9 38.2
ROAE (%) 21.2 19.3 14.2 19.5 22.9
ROA (%) 4.8 8.9 8.9 12.7 15.6
ROCE (%) 10.9 10.9 11.8 17.1 21.7
Div Payout Ratio (%) 175.8 71.6 50.0 40.0 40.0
Net Interest Cover (x) 2.2 6.3 13.0 35.1 210.5
Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

Page 76
 Company Guide
Virscend Education Co Ltd

Interim Income Statement (RMB m)

FY Dec 1H2015 2H2015 1H2016 2H2016

Revenue 365 343 439 389

Cost of Goods Sold (182) (229) (211) (225)
Gross Profit 183 113 228 163
Other Oper. (Exp)/Inc (20) (49) (8) (7)
Operating Profit 163 65 220 157
Other Non Opg (Exp)/Inc N/A N/A N/A N/A
Associates & JV Inc N/A N/A N/A N/A
Net Interest (Exp)/Inc N/A N/A N/A N/A
Exceptional Gain/(Loss) 0 0 0 0
Pre-tax Profit N/A N/A N/A N/A
Tax N/A N/A N/A N/A
Minority Interest N/A N/A N/A N/A
Net Profit 110 15 163 122
Net profit bef Except. 110 15 163 122

Growth
Revenue Gth (%) N/A N/A 20.2 13.4
Opg Profit Gth (%) N/A N/A 34.5 143.0
Net Profit Gth (%) N/A N/A 47.5 728.3

Margins
Gross Margins (%) 50.1 33.1 52.0 42.0
Opg Profit Margins (%) 44.7 18.8 50.1 40.3
Net Profit Margins (%) 30.3 4.3 37.1 31.4
Source: Company, DBS Vickers

Balance Sheet (RMB m)

FY Dec 2015A 2016A 2017F 2018F 2019F

Net Fixed Assets 2,064 2,518 3,125 3,558 4,067

Invts in Associates & JVs 0 0 2 9 20
Other LT Assets 260 589 510 367 354
Cash & ST Invts 249 564 563 569 549
Inventory 0 0 0 0 0
Debtors 40 55 75 100 129
Other Current Assets 0 474 0 0 0
Total Assets 2,613 4,201 4,276 4,602 5,118

ST Debt 589 899 500 300 0

Creditors 248 154 207 276 297
Other Current Liab 436 500 730 940 1,278
LT Debt 746 95 95 0 0
Other LT Liabilities 6 7 9 12 16
Shareholder’s Equity 588 2,547 2,734 3,073 3,528
Minority Interests 0 0 1 1 1
Total Cap. & Liab. 2,613 4,201 4,276 4,602 5,118

Non-Cash Wkg. Capital (643) (124) (862) (1,116) (1,446)

Net Cash/(Debt) (1,086) (430) (32) 269 549
Debtors Turn (avg days) 45.5 21.1 20.7 20.7 21.1
Creditors Turn (avg days) N/A N/A N/A N/A N/A
Inventory Turn (avg days) N/A N/A N/A N/A N/A
Asset Turnover (x) 0.3 0.2 0.3 0.3 0.4
Current Ratio (x) 0.2 0.7 0.4 0.4 0.4
Quick Ratio (x) 0.2 0.4 0.4 0.4 0.4
Net Debt/Equity (X) 1.8 0.2 0.0 CASH CASH
Net Debt/Equity ex MI (X) 1.8 0.2 0.0 CASH CASH
Capex to Debt (%) 64.2 69.4 90.1 205.3 N/A
Z-Score (X) NA NA NA NA NA
Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

Page 77
Company Guide
Virscend Education Co Ltd

Cash Flow Statement (RMB m)

FY Dec 2015A 2016A 2017F 2018F 2019F

Pre-Tax Profit 125 322 413 622 891

Dep. & Amort. 56 68 83 103 107
Tax Paid 0 (1) (27) (36) (114)
Assoc. & JV Inc/(loss) 0 0 (2) (6) (11)
(Pft)/ Loss on disposal of FAs 0 0 0 0 0
Chg in Wkg.Cap. 287 6 322 367 313
Other Operating CF 108 63 51 34 20
Net Operating CF 577 459 840 1,084 1,205
Capital Exp.(net) (27) (858) (690) (536) (616)
Other Invts.(net) 0 0 0 0 0
Invts in Assoc. & JV 0 0 0 0 0
Div from Assoc & JV 0 0 0 0 0
Other Investing CF (192) (497) 473 0 0
Net Investing CF (219) (1,354) (217) (536) (616)
Div Paid (101) (53) (188) (226) (303)
Chg in Gross Debt (17) (342) (399) (295) (300)
Capital Issues 0 1,697 0 0 0
Other Financing CF (101) (94) (37) (21) (7)
Net Financing CF (219) 1,209 (624) (542) (610)
Currency Adjustments 0 2 0 0 0
Chg in Cash 139 316 (1) 6 (20)
Opg CFPS (RMB) 0.11 0.03 0.17 0.26 0.39
Free CFPS (RMB) (0.12) (0.08) 0.10 0.15 0.18

Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIES

Page 78
 Industry Focus
China Education Sector

Appendix I: Critical factors study A. Critical factors for the industry

Critical factors refer to the factors which impact the returns
or cash flows materially within the investment horizon and
could be predicted.
As education is a new and niche sector in Hong Kong and
China, we studied the U.S market for a longer tracking
period and believe that similar factors would also impact the
Hong Kong-listed education companies.
Even in the US, education is a rather new sector in the stock
market. The S&P 1500 Education Index did not start until
April 2005. It set the value on 29 April 2005 as 100. The
sector was counter-cyclical and outperformed the S&P 500
during the crisis period of 2008-2009. However, it lagged
the market thereafter. The current index has lost near half of
its value to around 54 while the S&P 500 has more than
doubled during the same period.

The stocks we studied are Career Education (CECO.US),

Adtalem Global Education (ATGE.US) and Strayer Education S&P 1500 Education relative to S&P 500
(STRA.US). They are the only three education stocks that can
be traced back to as early as 1999. Similar as those Hong Apr 29, 2005 =1.0
Kong-listed companies, they have on-ground campus 2.5
providing degree education.
2.0

Three US-listed companies studied 1.5

Price based on J uly 11,2017

1.0
Mkt
Cap P/ E P/ B P/ S
Co mp an y D esc rip t io n US$ m (x) (x) (x) 0.5
Career Priv ate, for-profit post- 640.6 14.3 2.0 1.0
Ed u c at io n secondary edu in US and 0.0
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017
Co rp o rat io n Canada. Offer bachelor's
degree, associate degree and
non-degree programs Sector Index vs. benchmark
A d t alem Higher education sy stems 2214.4 13.4 1.3 1.2
G lo b al throught North A merica. Source: Bloomberg Finance L.P., DBS Vickers
Ed u c at io n Offers v arious degrees
including associate, bachelor
and master's degree program To get a longer period, we generated a customised sector
St ray er Offers working adults 1023.2 30.8 5.2 2.2 index using the average stock price of the three companies
Ed u c at io n undergraduate and graduate
we studied (CECO, ATGE, STRA). The three stocks show
degree programs
great weight and impact in the S&P 1500 education index.
* Price based on 11July 2017 Our customised sector index matches well with the S&P
sector index and we believe that the customised sector index
Source: Bloomberg Finance L.P., DBS Vickers
could well represent the sector.

Public spending on education and student numbers are the

key drivers for the sector and single companies respectively.
By studying both the sector and companies, ROE has high
correlation with share price in the long term. Several factors
contribute to ROE and thus affect share price. Among them,
public education spending and student numbers show the
most importance in affecting returns and prices. As a result,
we believe that these are the two most important factors we
should study and predict in order to understand the
education industry and companies in China.

Page 79
Industry Focus
China Education Sector

S&P and customised education index vs benchmark The industry's share price performance is in line with the
average ROE of the sector. The sector ROE shows a
Jan 1, 2005 = 1.0 Jan 1, 2005 = 1.0 downward trend from 2003 to 2006 and an upward trend
9.4 2.5 from 2007 to 2012. The low level of ROE after 2013 was
8.4 also well reflected in the index performance. In our view,
7.4 2.0 there are several factors affecting the returns and thus the
6.4 share price.
1.5
5.4
4.4 Customised sector index and average ROE
1.0
3.4
2.4 Jan 1, 1999 = 1.0 (%)
0.5
1.4 9 70
0.4 0.0 8 60
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

7
50
Customer sector index vs. benchmark 6
Sector Index vs. benchmark 40
5
Source: Bloomberg, DBS Vickers 4 30
3
20
By such method, we generated our own customised 2
10
education sector index relative to the S&P 500 Index back to 1
1 January 1999. The relative index on the starting date was 1. 0 0
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Greater than 1 means beating the market while less than 1
means underperforming.

Two peaks were shown on the chart where the sector Source: Bloomberg, DBS Vickers
significantly outperformed the market: 2001-2004 and
2008-2009. In fact, the sector kept beating the market Factor 1: Public education spending
during 2001 to 2012. After 2013, however, the sector
remained stable despite that the overall market was The first factor we looked into is the public education
recovering. Our main task here is to find out what are the spending, which is calculated as the public spending on
key factors leading to these outperformance and education as of total GDP in US. The government spending
underperformance. goes to both public and private schools. More government
grants mean more development opportunities and less
Customised education index vs benchmark expenditure from the school’s own accounts.

Jan 1, 1999 = 1.0 Compared to training institutions, schools are more

9.4 impacted by government spending. As our index is formed
8.4 with degree providing on-ground schools, it has high
7.4 correlation with the government spending. For example, the
6.4 index peaked when the public spending reached its highest
5.4 in 2004 while the low public spending period of 1999-2001
4.4 and 2013-2017 are also where the sector underperformed.
3.4
2.4
1.4
0.4
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

Customer sector index vs. benchmark

Source: Bloomberg, DBS Vickers

Page 80
 Industry Focus
China Education Sector

Customised sector index and public education spending education are basically young adults instead of teenagers);
and 2) enrolment ratio lower than 100% (e.g. unlike K12
Jan 1, 1999 = 1.0 (%) stage, not everyone receives higher education. Admission
10.4 5.8 rate also contributes to the student number apart from
5.6 population).
8.4
5.4
6.4 5.2
4.4 5
4.8 Factor 3: Unemployment rate
2.4
4.6
0.4 4.4 Considering the three companies in the sector are all
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
focused on higher education and adult-training, we reckon
Customised sector index vs. benchmark that there might be some relationship between their
Public Education Spending (RHS) performance and the unemployment rate. Interestingly, the
two data series show the same trend though the sector
Source: Bloomberg, DBS Vickers performance is more volatile and fluctuates in a wider range.

Customised sector index and unemployment rate

Factor 2: Demographic change

Compared to other industries, the education market highly Jan 1, 1999 = 1.0 (%)
10.4 20
depends on the population, especially K12 education which
everyone has to attend. Thus, we calculated the y-o-y 8.4 15
change of young population in the US (e.g. age under 15) as 6.4
our input. Though not as closely related to the index 10
4.4
performance as Factor 1 is, the demographic change also
2.4 5
shows some extent of impact. It experienced a flat period
from 2005 to 2007 and a high-growth period from 2007 to 0.4 0
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2011, which matches the index performance.
Customer sector index vs. benchmark
Customised sector index and demographic change Unemployment rate(RHS)

Source: Bloomberg, DBS Vickers

Jan 1, 1999 = 1.0
9.4 1.5%
8.4 The data we used is the US unemployment rate of those
1.0%
7.4 with less than high school diploma. Explanations about how
6.4 0.5% the factor impacts the performance are 1) when it becomes
5.4 harder for high school graduates to find a job, they have
0.0%
4.4 more incentive to further their studies in colleges; 2) when
3.4 -0.5% people lose their jobs during an economic downturn, they
2.4 have time and willingness to attend either a degree
-1.0%
1.4 programme or job skill training programmes in order to
0.4 -1.5%
improve their competitive strength in the job market.
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

As a result, the unemployment rate shows a large impact on

Customer sector index vs. benchmark
Young population yoy growth(RHS)
Source: Bloomberg, DBS Vickers
As the population change is on the macro level, it works
better on reflecting the long-term trend of the market
growth than the short-term performance. Mismatches
between demographic growth and sector performance are
brought by 1) age group difference (e.g. students for higher
our sector performance and explains why the sector is
counter-cyclical. In 2008 and 2009, the high unemployment
rate drove up the demand for degree education and training.
In contrast, when the economy is recovering and
unemployment rate drops, people are more likely to work
instead of continuing their studies.
The sector index and the GDP growth also clearly show the
counter-cyclical nature of the higher education and adult
training companies.

Page 81
Industry Focus
China Education Sector

B. Critical factors for a single company

Customised sector index and US GDP growth
ROE of each company drives the share price. After studying
Jan 1, 1999 = 1.0 (%) the sector performance, we tried to find out the winner
within the sector. Similarly, we derived their relative
9.4 10
performance against the customised sector index where we
8.4 8
7.4 set the value on 1 January 1999 as 1. As we had expected,
6 ROE and share price shows the same trend, e.g. from 2000
6.4
5.4 4 to 2010, share price and ROE of ATGE changes in the same
4.4 2 direction. Also, the company tends to be the outperformer
3.4 when its ROE level is high, e.g. CECO outperformed the
0
2.4 sector index by 100-150% from 2000 to 2005 when its ROE
1.4 -2
was at the highest level in its history.
0.4 -4
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

CECO relative performance and ROE

Customer sector index vs. benchmark
US GDP yoy (RHS) Jan 1, 1999 = 1.0 (%)

Source: Bloomberg, DBS Vickers 3.0 30

20
2.5
10
In contrast, we believe that the K12 education sector should 2.0 0
be cyclical and negatively related to unemployment as the -10
1.5
K12 market is largely driven by the purchasing power of -20
parents, which will be reduced if they lose their jobs. 1.0 -30
-40
0.5
At the current stage where we are mainly focus on the K12 -50
education providers listed in Hong Kong, this may not give 0.0 -60
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
us many insights. However, it shows us the different
characteristics of higher education and could help us in the
Stock 1 (CECO) vs. sector Index
future when studying the Hong Kong-listed universities. It CECO ROE
indicates that this might not be the best time to buy higher
education stocks as the Chinese economy is still quite good Source: Bloomberg, DBS Vickers
despite slowing down.

Currently, we are optimistic about the Factor 1 and Factor 2 ATGE relative performance and ROE
based on our industry study. Public spending on education in
China is likely to further improve as the current level is (%)
Jan 1, 1999 = 1.0
relatively low compared to other countries. The young
1.2 30
population growth is also expected to accelerate due to the
policy change. As such, we are reinforced that the sector 1.0 25
would outperform the market in the coming cycle. 20
0.8
15
0.6
10
0.4
5
0.2 0
0.0 -5
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

Stock 2 (ATGE) vs. sector index

ATGE ROE

Source: Bloomberg, DBS Vickers

Page 82
 Industry Focus
China Education Sector

STRA relative performance and ROE CECO relative performance and student number growth

(%) Jan 1, 1999 = 1.0 (%)

Jan 1, 1999 = 1.0
2.0 180 3.0 0.7
1.8 160 0.6
1.6 2.5 0.5
140
1.4 120 2.0 0.4
1.2 0.3
100
1.0 1.5 0.2
80
0.8 0.1
0.6 60 1.0 0.0
0.4 40 -0.1
0.5
0.2 20 -0.2
0.0 0 0.0 -0.3

1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

Stock 3 (STRA) vs. sector index Stock 1 (CECO) vs. sector Index
STRA ROE student number growth

Source: Bloomberg, DBS Vickers Source: Bloomberg, DBS Vickers

Factor 1: Student number growth STRA relative performance and student number growth

Student number growth drives the return materially. There

Jan 1, 1999 = 1.0 (%)
are several factors that could impact the bottom-line return
of an education provider such as revenue growth, gross 2.0 30%
1.8 25%
margin and financial costs. Among them, average tuition
1.6 20%
level and student number are the two factors that impact 1.4 15%
the top-line growth. Unlike tuition, which usually only 1.2 10%
changes every several years and only affects newly admitted 1.0 5%
students, student number growth usually have a large 0.8 0%
0.6 -5%
impact on revenue. Our study shows that the student 0.4 -10%
number growth, as a single factor, already has a significant 0.2 -15%
impact on share price performance, which means that it 0.0 -20%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
deserves our attention to spend more time studying the
trend of student number growth in the future.
Stock 3 (STRA) vs. sector index
As ATGE did not clearly report its total number of students in student number growth
its annual reports, we studied only CECO and STRA by
calculating their y-o-y growth in student numbers. When the Source: Bloomberg, DBS Vickers
growth slows down, the price tends to drop accordingly.
When the growth accelerates, the share price usually rises as
Factor 2: Gross margin
well.
Gross margin also has a large impact on share price. Also, it
is relatively easy to study. For schools with on-ground
campus, the main costs of revenue come from teacher’s
salaries, D&A expenses and other expenses like utility costs
which are likely to be linked with student numbers. Though
prices are more volatile than the change in gross margin,
they usually have the same moving trend. If we could detect
some factors that would lead the gross margin to move, the
share price is likely to move in the same direction.

Page 83
Industry Focus
China Education Sector

CECO relative performance and gross margin STRA relative performance and gross margin

Jan 1, 1999 = 1.0 (%) Jan 1, 1999 = 1.0 (%)

3.0 75 2.0 70
1.8
2.5 1.6 65
70
1.4 60
2.0
65 1.2
1.5 1.0 55
60 0.8
1.0 0.6 50

0.5 55 0.4 45
0.2
0.0 50 0.0 40
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Stock 1 (CECO) vs. sector Index Stock 3 (STRA) vs. sector index
gross margin gross margin

Source: Bloomberg, DBS Vickers Source: Bloomberg, DBS Vickers

ATGE relative performance and gross margin C. Critical factors to study and monitor for Hong
Kong-listed companies
Jan 1, 1999 = 1.0 (%)
As what we learnt from the US education sector, public
1.2 60
58 education spending, demographic changes and GDP growth
1.0 56 are the three factors we are going to study for the industry
0.8 54 as a whole. However, we expect the correlation of each
52 factor to the industry performance to be slightly different
0.6 50
from the U.S experience. As we are studying K12 education
48
0.4 46 providers in China, we expect that 1) higher impact from
0.2 44 demographic change as admission rate for K12 should be
42 near 100%; 2) GDP should be positively correlated with the
0.0 40 sector performance as we discussed previously.
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

For critical factors for companies, as discussed, we choose

Stock 2 (ATGE) vs. sector index
gross margin
Source: Bloomberg, DBS Vickers
student number growth and gross margin as two critical
factors to focus on. On the one hand, they are key drivers of
company growth. On the other hand, they are relatively
visible and easy to study. Each of them can be further
broken down to several inputs. Due to the industry nature,
the inputs are quite stable and predictable. Review on a
quarterly or semi-annually base would be enough to
generate quality forecast.

While most of the information can be derived from the

company filings and management discussions, we also plan
to do some ground channel checks to better facilitate our
prediction. The methods may include interviews with parents
and teachers, school visits and public opinion studies from
local education forums and media. Up until now, we have
already talked to a former principal of a Maple Leaf school
and some parents of Yuhua and obtained some valuable
information from them.

Page 84

Critical factors breakdown for companies
Po te nti a l c a ta l ys t for i n c re a s e Da ta s ou rc e
Ca p a c i ty Large cash position; high utilization of Capacity enlarge plan from
current campus
Stud e nt Uti l i z a ti o n Outstanding exam performance; high
nu mb e r teaching quality and reputation; new
capacity added
ASP New ancillary services provided; high School plan for tuition rise from
demand; portion taken by non-
compulsory education or international
Gro ss education rises
Ma rg i n Te a c he rs' Teacher's salary lower than peers; no School plan for salary rise from
s a l a ry other benefits such as empolyment
stock options; improving teacher to
student ratio
Source: Bloomberg, DBS Vickers
Student number growth could be broken down as total
capacity and utilisation. Unlike the seasonality patterns for
training institutions, the student numbers in schools are
relatively stable over the year. The student number of the
next fiscal year could be easily obtained from the
management’s new student admission plans. As the listed
schools are all leading players with very highly demanding
parents, their planned position for September could be
easily filled by April or May. The student growth in the
longer term, however, needs more efforts to be cross
checked.
Schools usually have capacity enlargement plans for several
years into the future. What we need to check is how they
stick to the planned progress. Despite the site visit to check
the construction progress, the online advertisement for
teacher and student recruitment could also be a good
information source. Usually, if a new school is to open in the
coming September, it has to begin student admission
process by May or earlier. New teachers should also be
recruited. If no such information could be found online, we
should be cautious about the on-time delivery of new
capacity.
The utilisation ratio depends on the teaching quality if the
capacity remains unchanged. It is more difficult to be
quantified. In addition to the exam performance, school visit
usually gives a direct impression on the class size and
teaching style. Public opinions and reputations could also
help us to judge.
Two factors to study for gross margin are the ASP level on
the revenue side and teacher’s salary on the cost side. D&A
expense also make up a large portion of the costs of
Industry Focus
China Education Sector
Ch a n ne l c he c k
Construction progress on site; New
management school ads for students and teacher
recruitment
New student enrollment plan from Enrollment discussion from parents'
management forums and media
School exam performance from Overall reputation from public
company website comments; teaching quality from site
visit
Discussion from parents' forums and
management media
Contact with school employees
management
revenue. However, as it is related to the capital expenditure
and ultimately the capacity, we could make our conclusions
based on the capacity study.
Schools usually have plans to raise their tuition every two to
three years by a certain percentage for the new students.
The approval process of local governments for tuition hikes
is quite simple, which means that schools can raise the
tuition as long as they believe it is suitable. At the moment,
the rise in tuition will not affect the student number in the
listed schools due to the high demand, giving companies
higher incentive and more room for tuition hike. In addition
to the tuitions, new ancillary services, such as summer
camps, school bus and uniforms could also increase ASP.
The main data source would still be school’s tuition plan
while other channels may be from the parent’s discussion.
Sometimes, local pricing website or media would also have
such information. For example, Wisdom’s latest tuition plans
and approvals could be easily found on the website of
Dongguan Development and Reform Commission.
Teacher’s salary is affected by the number of teachers and
average salary level. The former could be calculated through
the student number and the teacher-to-student ratio, which
remained relatively stable in the past years. Historical level
would be good enough for making the prediction while we
should also take into account the accelerated capacity
expansion post IPO.
The average salary level is rather hard to check as employees
are usually reluctant to disclose their salary and they will not
have an idea about the average salary on the company level.
Like tuition, schools usually have a fixed pattern of
increasing salary every several years. The historical pattern
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Industry Focus
China Education Sector

would be our main source while some other hints might be

derived from the teacher’s recruitment advertisements or
even head hunters.

Potential event-driven factors are likely to be M&A and

regulations in the next 12 months. Almost all companies
announced some new M&A or at least M&A intentions after
listing. M&A is very likely to happen for all the education
companies in the near future. However, whether this would
have positive or negative impacts may depend on their
acquisition target, how the deal fits their development
strategy and their ways of financing.

New education regulation is also an important factor that

may affect school’s decisions and performance in the short
term. At the moment, details have not been disclosed at the
provincial level and there is still great uncertainty. We will
discuss in detail later about how this would affect school’s
decision and what we should pay attention to.

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 Industry Focus
China Education Sector

Appendix II. Case Study: Lessons learned timely reaction of the management team and the in-depth
from New Oriental third-party investigation, the share price recovered gradually
in the following weeks.
Education is a new sector for most Chinese investors.
Muddy Water called a “strong sell” on New Oriental
Not many schools are listed until this year. However,
because of four main reasons. Some of them were partly
some training institutions did find their way to go
true while some were a total misinterpretation of related
public in the overseas market in the past few years.
regulations by Muddy Water. The report turned out to be
Among them, New Oriental, a famous training
not so accurate and New Oriental finally won the battle, but
institution providing after-school tutoring mainly in
it still gives us some hints of the potential red flags in the
foreign languages across China is the vanguard. With
education companies, especially about the grey area existing
more than ten years of listing history, it offers us a case
in tax expenses in education industry.
of the drivers of growth and potential risks of the
education industry. Summary of the short sell report
Share price of New Oriental (EDU. NYSE) Pote nti a l ri s ks
Re la tionship ba s e d on
US$ Muddy Wa te r Ac c us e me nt wi th HK l iste d c urre nt
90 a c c use d... true ? c ompa ni e s re porti ng
80 Undisclosed Partly true Low Low
franchises
70
GP margin too Unlikely to be Medium Low
60 C high true
50 Tax fraud Not true High High
B VIE Partly true High Medium
40 A
30 Source: Company, DBS Vickers
20
10
1) Revenue from undisclosed franchises
0
In its research, Muddy Water accused New Oriental of
Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

having a great amount of undisclosed franchises and

Source: National Bureau of Statistics of PRC, DBS Vickers
In the past ten years, New Oriental enjoyed strong growth in
share price driven by the fast growth of the company as well
as the market. Its share price increased from around USD 8
at the beginning of 2007 to the current level of USD 72,
while the S&P 500 has less than doubled during the same
period. However, the company also suffered from some bad
times when its share price either suffered from a sudden
large drop or kept decreasing in a period of time. What
caused the downside move and how the company came
through it show us some colors of the industry. Besides the
financial fundamentals, we should also be cautious to avoid
the potential targets of short sellers as scandals and suspect
of fraud kills value in a blink.
A. Surviving from Muddy Water
Listed in 2006, New Oriental (EDU.NYSE) suffered from a
significant drop in share price in July 2012 following a short-
selling report from Muddy Water Research. It lost more than
50% of its share value in two days. Fortunately, with the
consolidating their revenue to its own balance sheet.
According to the franchise contract, New Oriental only
charges a one-time franchise fee without further profit split
required from franchisees. However, the company asks its
franchisees to provide financial statements each year.
Muddy Water suspects it may use the information for
financial fraud purposes.
It is true that New Oriental allowed some franchises in its
Pop Kids brand, but the number is rather small. By the time
of the Muddy Water research, there were only 20 franchises
out of 300 Pop Kids schools. The adult training and other
tutoring centres were all 100% owned and directly
operated by New Oriental itself. The company did not
disclose the franchises of its Pop Kids brand in a timely
manner, but the problem was not as serious as what Muddy
Water claimed. According to the Chairman Mr. Yu, in 2010
and 2011, the franchise fee only counted for 0.009% and
0.045% of the total revenue.
The revenue fraud from franchises is more likely to happen
in educational institutions with lower entry barriers, e.g.
after-school training institutions, early education and
kindergartens. They do not require high quality teachers and
large land bank for school buildings and dorms and the
related licenses are easier to get.

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Industry Focus
China Education Sector

its revenues were generated from the low-margin VIP

Potential franchises would not be a problem for the four services (e.g. 1v1 tutoring). Muddy Water doubted that the
listed K12 school education providers. Unlike training whole industry might be lying at the same time. However,
institutions, degree-providing schools have to seek land and the solid fundamentals and outperformance of these stocks
buildings. They are more willing to co-operate with local in 2012-2017 proved the short seller wrong at this point.
governments and property developers instead of seeking
franchisees. Some of them have application forms for GP Margin of peers
Private-Public-Partnership (PPP) on their website for
interested local governments to apply for the partnership FY0 7 FY0 8 FY0 9 FY1 0 FY1 1
EDU 59.5% 61.6% 61.7% 61.9% 60.1%
while none of them have franchise application forms like
GEDU 57.6% 60.2% 58.6% 55.8% NA
Pop Kids.
XUE -35.1% 6.3% 25.7% 32.9% 29.5%
AM B O NA 36.2% 58.5% 62.4% 60.5%
2) GP Margin too high to be true XR S NA 50.8% 51.0% 46.0% 49.2%
Gross margin of New Oriental remained at 60% for years.
Muddy Water pointed out that a 60% GP margin seems too Source: Company, DBS Vickers
high to be true. The suspects mainly come from the
Concerns on unrealistically high GP margins should be less
utilisation rate. They doubt that the efficiency could be so
for schools than for training institutions because 1) unlike
high if there were only few classes in the evening or during
training institutions that may be faced with the low
weekends. The truth is that the after-school tutoring market
efficiency of their rentals paid on weekdays, schools have
in China in those years was very profitable. The class size
stable utilisation five days a week; 2) due to the higher entry
was very large, usually 100-200 students per class and the
barrier of schools, they have fewer competitors and higher
tuition level is several hundreds of RMB per hour.
brand value in their home cities; and 3) no low margin VIP
Meanwhile, the teacher’s salary is usually 20% or less as
business for school operators.
reported by teachers working there. The 60% GP margin for
a single class of large size is possible while the margin at
The four companies reported similar levels of GP margin at
group level might be lower should the utilisation rate be low.
48-52%. The variation depends on their teacher’s salaries
Muddy Water may have some reasons for its suspicions, but
and their expansion pace. Taking New Oriental’s 60%
the stable and high level of margin of the company in the
margin as a hurdle rate for both lower utilisation rate and
past five years indicates that the short seller was wrong.
low fixed asset costs, we believe that the roughly 50%
GP Margin of New Oriental margin for school education providers is reasonable.

3) Tax and asset ownership fraud

62% Muddy Water claimed that New Oriental was not exempted
from enterprise income tax (“EIT”) under current education
61% regulations while the company reported very small other
expenses which should have included 25% income tax. Also,
60% Muddy Water believed that as New Oriental claimed itself as
“not requiring reasonable return”, its assets should be
59% defined as “state property”.

58%
We have to admit that the current regulations for private
schools and training institutions are far from clear. An
executable and detailed guideline over how to pay tax and
57%
the type of asset ownership are not available. Uncertainties
and risks related to the unclear regulations do exist, but
56% Muddy Water also missed some points, especially the subtle
2012 2013 2014 2015 2016
meanings of the regulations.
Source: Company, DBS Vickers
Grey areas exist in the types of private schools. Under
The gross margin of New Oriental is in line with its peers. All current regulations, the situation for private schools looks
companies in the industry except for Xueda Education (XUE) ambiguous. On the one hand, the government wants to
reported quite high gross margin. New Oriental’s 60% keep the “public good” character of schools. On the other
margin does not look too exaggerated if compared with its hand, school investors are allowed to have some reasonable
peers. The relatively low margin of Xueda is because 90% of returns to encourage private capital to enter the education

Page 88

field. The so-called “reasonable return” is an alternative and
concession of “profit” without a clear definition of
“reasonable”. Meanwhile, just like Muddy Water mentioned,
education investors who claimed to be “not requiring
reasonable returns” (“NRRR”) usually set up separate
companies that provide services to schools (e.g. trademarks,
curricula, etc.) and transfer profits out of the schools and
into those corporate entities. The situation is improving with
the new regulation clearly claiming that private schools
could be “for-profit” after 1 September 2017 if they are not
compulsory education stage schools.
“Reasonable return” is more like a self-deceiving saying of
“profit”. The meaning of “reasonable return” under current
framework is unclear and subject to further discussions.
Even law experts have different views and understanding
about the definition. Some argue that education is for
public good and non-profit. The reasonable return is not a
form of profit, but a kind of encouragement and award.
However, a significant vulnerability exists in this argument:
how could the government use someone’s own earnings to
award him? Thus, it makes more sense to reckon the
“reasonable return” as another saying of “profit” when
regulators do not want to admit that private education is in
fact an investment and business.
School assets are “state properties”, but sponsors could still
get returns. A typical NRRR school is established through
asset donations while a typical “for-profit” training
institution is established through investments and
considered as a corporate. Donated assets belong to the
school and public while for-profit investors could still gain
returns from his assets. Does it mean that all assets of NRRR
schools are state properties? The real situation in China is
more complicated than Muddy Water observed. The main
spirits of the regulations states that “the assets belong to
the one who invests”. Even for an NRRR school, sponsors
reserve some rights over the school assets. Again, the
regulations are unclear, but a famous precedent case of
dividing school assets in two founders’ divorce shows the
opinion from Supreme People’s Court that though the
value-added part due to government grants and policies
should be counted as state property, other parts of assets
and their value added could be considered as assets of
founders and be divided.
We expect the chaos and disorderly situation of private
school’s asset ownership to gradually end after the new
regulations come into effect and more details are released.
At least schools no longer have to face an ambiguous
concept of “reasonable return”. The “state property” is a
misunderstanding by Muddy Water in the operational level.
A simple explanation is that assets provided by school
founders will still belong to schools.
Industry Focus
China Education Sector
More tricks played in tax expense. According to the current
unclear regulation, whether a school “requires reasonable
return” (RRR) and whether it is “for-profit” is different.
Though New Oriental declared itself as “NRRR School”, the
current regulation regarding training institutions says that
training institutions could be for-profit and have to pay tax
as other corporates for their profits. Muddy Water’s point is
right that New Oriental could not be exempted from EIT as a
training institution. However, based on the chairman Mr. Yu,
its EIT is exempted not because of education regulations,
but the tax exemption and discount for “Hi-tech”
enterprises. Mr.Yu claimed that New Oriental has been
recognised as a high-tech company by local government
and could thus enjoy the tax discount accordingly.
Contrast to training institutions, both NRRR and RRR schools
are defined as non-profit. Different types of schools have
different tax treatment. In summary, NRRR schools are
treated as public schools and do not have to pay tax on their
tuition income. RRR schools, however, have to pay tax but
could still enjoy some preferential tax treatment according
to their provincial level regulations.
Types of schools under current regulations
Donations,
Type 1 NRRR Same tax and
state property
land policies as
and non-profit and no asset
public schools
returns
Type 2 Require Investment for Some tax
reasonable degree education, discount but
investor has
return and non- ownership, using have to pay tax
profit rights and profits for its profits
Investment for Same tax
Type 3 For-profit
training training treatment as
institutions, common
institutions purely for profit corporates
Source: DBS Vickers
Virscend’s tax is fully waived though it requires reasonable
return while others are more understandable. Besides
Wisdom, other three listed companies all reported zero tax
rates on tuition income in their past financial statements
despite their different return types. The high tax paid by
Wisdom is due to its requirement for returns. Maple Leaf
and Yuhua pay zero tax on tuition as they do not require
reasonable returns. The total tax paid by Maple Leaf was not
exactly zero and was generated from other revenues apart
from tuition income and the entities in its VIE structure.
Unlike its peers, however, Virscend’s tax report looks
unreasonable at first sight. All schools in the group are
established as RRR schools. However, it did not record any
tax in its tracking period. The company claims that it is not
required to pay any PRC income tax according to the
confirmation letters issued by the PRC local tax bureau and
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Industry Focus
China Education Sector

the local offices of State Administration of Taxation,

respectively. No further information is disclosed. Neither did
we find any related details on tax regulations in Sichuan Shareholder structure adjustment in 2012
Province. Though the likely reason is local government’s
special treatment over high-quality education resources, Public Tiger Global
Shareholders Investment
more information is needed if we want to confirm the real
reason of the EIT exemption and to decide whether it is
sustainable.
Listed entity
(incorporated in
Tax on tuition income of listed companies Cayman)
offshore
Ta x ra te of tuition Re quire re a sona ble
onshore
Compa ny inc ome re turn?
Maple Leaf 0 N WFOE
Wisdom 0.25 Y
Virscend 0 Y
Yuhua 0 N Controlled by VIE structure

Operating units:
Source: Company, DBS Vickers New Oriental in Original
China Shareholders:
11 people
Though the new regulation will be in effect this coming After
adjustment:
September, the details of tax treatment are yet to come. We
Schools in Other only Mr. Yu
expect that the companies will maintain their status before China subsidiaries
more details are determined as tax treatment is an
important factor in companies’ decision-making process to
Source: Company, DBS Vickers
claim themselves as a non-profit or for-profit school.

4) Vulnerable VIE structure Immediately following the SEC’s investigation, on 18 July

2012, Muddy Water commented New Oriental’s VIE
Share price more driven by panic of the VIE structure in
structure with a comparison with Baidu. It believes that
“Chinese concept stocks”. Five days before the short sell
Baidu, an internet company listed in the US, had the “best
report, New Oriental was informed that it was under SEC’s
practice” in VIE while New Oriental did not perform so well.
investigation because of an adjustment in its VIE structure.
The key point is that, Baidu’s WFOE has better controls of
The share price crashed by 34% that day, but it is more like
operating company, while New Oriental does not have
a panic selling impacted by the VIE event of Alipay.
similar package in its VIE and its operating entity could easily
The adjustment actually had hardly any links with the VIE walk away from the offshore public company. As a result,
structure. It is related to the onshore operating units only. the shareholders’ rights could not be well protected.
Before, there were 11 shareholders of New Oriental in
China. After the adjustment, only Mr. Yu stayed. The
company did the adjustment because the senior
management was not so stable. Senior managers kept
leaving and changing. As a result, the company finally
decided to make Mr. Yu the only shareholder of the VIE
structure. The action itself meant to be good and did not
have material negative impacts at that moment, but the
share price moved significantly downward.

Possible reasons for the price drop include 1) panic of VIE

structure of Chinese companies following Alipay; 2) worries
about the senior management change and thus the
management of the company; 3) worries about the absolute
power held by Mr. Yu; and 4) New Oriental did not disclose
this change timely.

Page 90

Comparison of VIE terms Baidu and New Oriental
Agre e me n t " Be s t Pra c ti c e " o f Ba i du
Technology WFOE to provide key operating
Consulting services to the operating company
Service including secondment of employees,
Agreement and internet search services and
Business advertising services
Cooperation
Agreement
Operating Operating company to appoint
Agreement directors the WFOE designates
WFOE receives the right to appoint
the operating company's senior
executives
Operating company is prohibited from
making material business decisions
without WFOE's approval
Proxy Operating company shareholders
Agreement agree to allow WFOE (via an
individual the WFOE appoints) to vote
for them on all matters
Irrevocable Speficying the individuals who will
Power of vote on behalf of operating company
Attorney shareholders. The power of attorney
shall terminate if the designated
individuals cease the employment
with WFOE
Equity Pledge Operating company shareholders
pledge at SAIC in favor of WFOE over
their equity in the operating
company.
Equity Option Operating company issued WFOE an
option to purchase its shares when it
bcomes legal for the WFOE to own the
operating company.
Source: Company, DBS Vickers
Industry Focus
China Education Sector
Recent listed education companies all followed the “best
practice”. The VIE structure has cost “Chinese concept
Ne w
stocks” a lot in the past. Learning from the precedents,
Ori e nta l
newly listed companies have more structured and complete
Little
business agreements between WFOE and VIE, ensuring the
substance controlling power of the WFOE and the listed entity. All the
in WFOE four listed schools followed the “best practice”, lowering
down the similar risks brought by New Oriental’s VIE.
Still, WFOE could not control as closely in the operating
Few business in education companies by industry nature. For IT
substantial
companies, WFOEs usually provide key operating services.
controls
from WFOE
For example, the WFOE of Baidu provides internet search
services and internet advertising services to the operating
company. It also owns key software code for Baidu’s search
and advertising business and web domains for Baidu’s
websites. The WFOEs of schools claims to provide advisory
No
services to the operating company, which include business
operation, education software, course materials, research
and development, employee training, network development,
No etc. The list of services is very long, but due to the nature of
running schools, it is hard for WFOE to have substantial
controls over operating companies like holding codes and
domains for an IT company.
Not until
May 2012
Yes
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Industry Focus
China Education Sector

B. Waterloos in 2014 and 2015 New Oriental revenue (USD m) and y-o-y growth

Share price in longer term closely correlates with earnings USD mn

and returns. In line with the disappointing revenue and 600 30%
profit numbers, New Oriental’s share price kept the
500 25%
downward trend in 2014 and 2015. The price dropped from
around US$33 in the beginning of 2014 to around US$20 in 400 20%
October 2015 with more than 1/3 of the value lost during 300 15%
the period. After October 2015, the share price began to
200 10%
bounce back, when the y-o-y profit growth recovered to
14.4% and 146.2% for 1Q16 (ended in August 2015) and 100 5%
2Q16 (ended in November 2015) respectively. 0 0%

4Q13
1Q14
2Q14
3Q14
4Q14
1Q15
2Q15
3Q15
4Q15
1Q16
2Q16
3Q16
4Q16
1Q17
2Q17
New Oriental share price and net profit y-o-y change

Revenue (LHS) yoy growth (RHS)

35 190%
33
31 140% Source: Company, DBS Vickers
29
As a critical factor to move the share price, student number
27 90%
25
has large impact on revenues generated. The historical y-o-y
23 40% growth of student number and revenues shows the similar
21 trend.
19 -10%
17 Student number and revenue y-o-y growth
15 -60%
Jun-14

Jun-15
Oct-13

Feb-14

Oct-14

Feb-15

Oct-15

70%
60%
Price (LHS) Net profit yoy change (RHS) 50%
40%
Source: Bloomberg, DBS Vickers 30%
20%
Top-line growth slowed down as a result of student number
10%
decrease. Revenues show great seasonality for training
institutions, e.g. income peaks in summer times when 0%
schools are on holiday. As a result, only the year-over-year -10%
Aug-07

Aug-08

Aug-09

Aug-10

Aug-11

Aug-12

Aug-13

Aug-14

Aug-15

Aug-16
Feb-08

Feb-09

Feb-10

Feb-11

Feb-12

Feb-13

Feb-14

Feb-15

Feb-16

comparison is meaningful. In FY15, the y-o-y growth rates Feb-17

of revenue for all four quarters decreased and were the
lowest from 2013 to 2017.
Student number yoy growth Revenue yoy growth

Source: Company, DBS Vickers

Margin lowered when traditional training institutions are

faced with new challenges. In 2014 and 2015, online
education became the new hot spot. A crazy story is about
Qtone Education Group (300359.CH), an online education
company whose share price was eight times higher in 2015.
The senior management of New Oriental did not pay
enough attention on online education at that time. In
addition, competitors such as TAL and Xueda are becoming
stronger, especially in the K12 tutoring segment. As a result,
the net margin of the company decreased and the y-o-y
change of net profit was negative for all the four quarters in
2015.

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China Education Sector

New Oriental net profit (USD m) and y-o-y growth Reuter accused New Oriental of academic fraud

USD mn The company, New Oriental Education & Technology Group Inc, has
160 200% regularly provided items from the tests to clients shortly after the
exams are administered. Because material from past SATs is typically
140 reused on later exams, the items New Oriental is distributing could
150%
120 provide test-takers with an unfair advantage.
100 100%
New Oriental has put some of the exam items on its Chinese website.
80 50% On Dec. 6, for instance, the Beijing-based company posted a reading
passage that had been used on a version of the SAT administered in
60 the United States three days earlier. New Oriental also has been
0%
40 posting information about recent questions on the TOEFL, the English-
-50% language exam widely used by colleges to assess foreign applicants.
20
TOEFL questions are also sometimes recycled.
0 -100%
New Oriental also gave students access to a March version of the SAT
4Q13
1Q14
2Q14
3Q14
4Q14
1Q15
2Q15
3Q15
4Q15
1Q16
2Q16
3Q16
4Q16
1Q17
2Q17

Net Profit yoy growth (RHS)
Source: Company, DBS Vickers
Unlikely for similar situations to happen to schools. With
relatively low entry barriers, the after-school training
institutions are faced with intense competition. Schools, on
the other hand, have to go through a long and tedious
process to gain lands and relative approvals. The established
schools with high reputation are thus protected by the
industry nature.
Also, schools are not impacted by the online education. The
online education is booming in recent years with more and
more capital rushing into the industry. Training institutions
like New Oriental have to find their way out as they are
directly competing with each other. For example, New
Oriental is also proactively engaging in online education by
launching apps and teaching via broadcasting. Its online
education subsidiary was also listed on the NEEQ concept
stock market in March 2017. In contrast, school education
could never be replaced by computers, at least in the visible
future. So companies operating schools have lower risk of
revenue growth slowing down as a result of accelerated
development of online education platforms.
C. Cheating in overseas university applications
Another shock happened to New Oriental by the end of
2016. By 2 December 2016, the price had dropped for five
trading days, from US$50 to US$42. On that single day, the
stock tumbled 14.3% of its value as a Reuters report
claimed that its learning centres were helping students to
cheat on standardised tests and falsifying their college
applications. As the overseas consulting contributes to 8%
of the company’s total revenue and 5% of profit, a 14%
slump indicates a wipe out of the entire overseas consulting
business.
that was administered in the United States, two students from Beijing
told Reuters. One of the students showed Reuters 36 pages from that
test.
In addition, the news agency viewed a copy of a full version of the
SAT given in Asia last month. Most pages of the document were
emblazoned with the words “Beijing New Oriental School,” a major
tutoring operation run by New Oriental. A person who identified
himself as a test-prep teacher at the school posted 15 pages of that
exam on Chinese social media.
Source: Reuters, DBS Vickers
Once again, the scandal did not result in any material harm
to New Oriental. Three reasons supported the price recovery:
1) Timely response by the company saying no fraudulent
activity is tolerated and it had sent two non-compliant staff
to the police in early 2016; 2) The price drop is largely driven
by the report saying that an organisation called AIRC would
cancel its certification of New Oriental if the fraud is true.
However, it turned out that the AIRC itself is not a licensed
issuer but rather an NGO which will not have any impact on
the company’s business; 3) The main business of the
company, which are overseas test prep (30% of revenue)
and K12 tutoring (55% of revenue) are not materially
affected as exams are more objective with no tricks to play.
The high quality of New Oriental’s test prep courses
continued to attract students and generate revenues for the
company.
There is almost nothing to worry about for school or
training institution targets on Gaokao. The admission of
Chinese universities is completely based on scores and the
Gaokao questions are never standardised, which means
there is no other way to get into the university other than
answering the questions right.
International schools are left with more room for playing
tricks in the university admission. However, it is unlikely that
schools such as Maple Leaf would help each student make
or fake their application as schools usually have large scale
and are focused on many other teaching tasks. The cheating,
if any, is still more likely to happen in overseas university
consulting business, which is usually a part of international
courses or services offered by after-school training
institutions.

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Industry Focus
China Education Sector

DBSVHK recommendations are based an Absolute Total Return* Rating system, defined as follows:
STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame)
BUY (>15% total return over the next 12 months for small caps, >10% for large caps)
HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps)
FULLY VALUED (negative total return i.e. > -10% over the next 12 months)
SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends

Completed Date: 12 Jul 2017 12:10:18 (HKT)

Dissemination Date: 12 Jul 2017 19:54:32 (HKT)

Sources for all charts and tables are DBS Vickers unless otherwise specified.

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1
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2
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1
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China Education Sector

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