Didi, a Chinese ride-hailing company, offers cars to guests of the Annual Meeting of the New Champions 2017, which took place in Dalian (Liaoning Province of China) on June 27, 2017. Visual China Group
BEIJING - As foreign investors struggle to recover from Beijing's regulatory crackdown on tutoring schools, the rapid fallout of an industry such as after-school tutoring can provide clues about what went wrong and where there are future opportunities in China. Major investment firms such as SoftBank had been pouring billions into Chinese education companies before China clamped down on tutoring schools. Many of these were either publicly traded in the U.S., or were on the way to becoming listed. This strategy consisted of using cash to fund rapid user growth and future profit. Investors aimed to achieve a winner takes all approach, similar to the one they used with Chinese start-ups like Didi and Luckin Coffee. Didi paid Chinese consumers to use its app to get cheap rides. It beat Uber to the top with about 90% of mainland market share and raised more than $4B in a New York IPO. It soon became apparent that this investment strategy may not be viable. Chinese authorities began investigating data security just days after Didi's IPO. This effectively shut down the business's growth prospects for the short term. This happened months after Beijing had attempted to combat monopolistic practices of internet giants Tencent and Alibaba. Beijing was clear in its next target by the end of July: The education sector.
After-school tutoring is under attack
In harsher-than-expected measures, regulators ordered tutoring companies in kindergarten to 12th grade academic subjects to restructure as non-profits, cut operating hours and remove foreign investment. On this news, shares of industry leaders like Gaotu Techedu, New Oriental Education & Technology Group, and Tal Education plunged. Over the past three months, they have each lost more than 75%. Chinese tutoring startups that investment funds had been betting on for months suddenly lost their way to a public listing.
Yuanfudao, an online tutoring company, announced that it had raised $2.2 billion from Tencent and Hillhouse Capital. Temasek also contributed to the total valuation of $15.5 million. Two months later, Zuoyebang, a competitor, raised $1.6 billion from investors such as SoftBank's Vision Fund 1, Sequoia China and Tiger Global. According to a CNBC translation, he said that they were trying to create another oligopoly similar to Didi. With market pricing power, he added. Because of the sensitive nature of the matter, he requested anonymity. He pointed out that the education market already had many major players and "it turned out no business could really beat each other before the crackdown." It was a profitable prospect to become a market leader in after school tutoring. China's population of over 1.4 billion and the culture where parents value education made this a huge opportunity. New Oriental, an early player in the industry, started out with physical leased spaces and in-person classes. The coronavirus pandemic of 2020 caused the tutoring industry to shift online.
Advertising wars
Chinese tutoring companies after school began spending heavily on advertising last year to attract students. A person familiar with the matter said that Gaotu, an American-listed company, spent more than 50 millions yuan ($7.75million) on ads on Kuaishou's short-video platform Kuaishou in a single week last winter. According to CNBC's translation, the source stated in Mandarin that Kuaishou was a smaller platform in China than Douyin/TikTok. Therefore, the total traffic spend by all K-12 education companies would be higher." Gaotu didn't respond to a request for comment. The company's earnings report for the first three month of the year stated that its selling and marketing expenses were 2.29 billion Yuan, which is three times higher than the previous year. Tal Education revealed that its spending in this category increased by 172% compared to last year, reaching 660.5 million Yuan for the three-months ending February 28. Both companies reported a quarter-end loss, as did OneSmart International Education Group which revealed a 47% increase in its selling and marketing expenses year-on-year to 288.8 millions yuan.
OneSmart was listed in the U.S. as an IPO in 2018, underwritten by Morgan Stanley and Deutsche Bank. The education company later acquired Juren, a tutoring business in China. The new regulations after school struck a devastating blow to the 27-year old company. Just one day before the opening of public schools on September 1, Juren fell just a month after new rules were published. OneSmart could be removed from the New York Stock Exchange as its shares have been below $1 since July. Other U.S.-listed Chinese shares are also in trouble. New Oriental reported no net loss in the quarter that ended February 28, but it disclosed that it spent $156.1million on marketing and selling during this period, 32% more than last year. As investors invested in the industry, increased competition drove up customer acquisition costs and a surge in advertising spending to increase student enrollment.
The landscape has changed significantly. Ming Liao founding partner, Prospect Avenue Capital
China's 'Common Prosperity'
Beijing's latest attempt to limit the sprawling growth of the education sector and its burden on parents is a concern for authorities seeking to increase births in the face a rapidly shrinking population and aging workforce. Ming Liao, founder partner at Beijing-based Prospect Avenue Capital which has $500 million in assets, stated that investors need to understand that the Chinese government is concerned about tackling the problem of the growing population, slowing down economic growth, and tensions with the U.S. He said that the landscape had changed significantly and that investors should now consider national policies more than industry developments.
Authorities have also ordered internet video game companies to limit children's online gaming time to three hours per week. In speeches by President Xi Jinping, he stressed the goal of "common prosperity" or moderate wealth for all. Chinese authorities are working to tackle education as one of three mountains. Other two mountains are real estate, and health care. These areas have been a source of frustration for hundreds of millions of Chinese citizens. Liao stated that corporate profits have been dominated by property developers and companies founded on internet platforms over the past 20 years. He said that investors need to be able to tell the difference between internet-based companies and those who are developing tangible types of technology such as hardware, in light of recent policy priorities.
The U.S. is now under President Joe Biden, and Beijing is increasing its investment in a multi-year plan for building up its domestic technology. This includes semiconductors and quantum computing. In a September 10 report, Bank of America Securities analysts stated that the "China market could still offer attractive investment returns to global investors, but the challenge lies in identifying potential future winners amid China’s rebalancing." The analysts pointed out a shift in market capitalization over the past two decades among the largest Chinese companies from telecommunications to banks to internet stocks. They expect more regulation of the internet and property industry, while advanced manufacturing, technology and green energy related industries will be encouraged. A few potential "future winners" were listed by the bank. Sportswear - Anta
Anta Health care: Wuxi Bio
BYD: Electric vehicles and EV batteries
Ganfeng: Lithium in new materials
Renewable energy: Long Yuan
Flat Glass: Tech hardware
Future of China investing
After-school tutoring firms in China that once drew billions of dollars have now found a way to survive. They're creating courses in non-academic fields like art and adult education. It's an uncertain path with a market that is only a fraction what it used to be, according to those in the industry. SoftBank's Chief Executive Masayoshi son stated in an earnings call that it is still waiting on clarity from the regulatory side before it resumes "active investment" in China. "We have no doubt about the future potential of China. According to a FactSet transcript, Son stated that he believes things will become clearer in one or two years, depending on the new rules and the new orders.
