New Oriental: privatisation bid on tap?

New Oriental's new share buyback program could presage a privatisation offer if its stock doesn't make significant gains over the next two to three months

PUBLISHED : Thursday, 25 April, 2013, 12:46pm
UPDATED : Thursday, 25 April, 2013, 12:46pm

I have to extend my sympathies to education services provider New Oriental (NYSE: EDU), which seems unable to earn any respect from US investors these days. The company has just reported earnings that look quite respectable to me, after being exonerated last year by the US securities regulator over potentially problematic accounting. And yet despite all that good news, investors have greeted this latest earnings report largely with indifference, leading me to speculate that New Oriental could soon join a growing list of US-traded Chinese firms to privatise.

In this particular case, investors seem to have lost interest not only in New Oriental, but also in the Chinese educational services sector, which is being confronted by slowing growth, quality issues and intensifying competition. I'm not an expert on the sector, but one of my friends in the industry says one of the biggest issues is scalability. While tech companies, especially Internet firms, can often easily boost their scale with little extra costs, the same isn't true for education firms. That's because education is a product that requires large fixed costs like classrooms and teachers, which increase proportionally with growing student enrollments.

So all of that said, let's take a quick look at New Oriental's latest earnings report that shows its profit and revenue both grew by 25-28 per cent in its latest reporting quarter. At the same time, the company also said its student enrollment dipped by 3 per cent during that time, and its number of schools in operation fell by about 1.5 per cent.

While some might say those declines look worrisome, others could argue they reflect New Oriental's growing focus on quality over quantity. The fact that both its revenue and profits rose by healthy amounts despite the enrollment decline seems to prove that approach is working, with New Oriental reporting that its income from operations rose by 36 per cent - even faster than its net profit growth. On top of all this relatively upbeat news, New Oriental also announced a program to buy back up to US$50 million worth of its stock.

Despite all that relatively upbeat news, investors greeted New Oriental's latest results and share buyback program announcement largely with indifference. The company's shares initially jumped after the report came out, but later gave back all their gains and actually ended down 1 per cent in Wednesday trade in New York.

This latest investor indifference reflects a broader theme that has seen shares of New Oriental and rival TAL Education Services (NYSE: XRS) languish over the last year. New Oriental shares briefly tanked last summer, losing more than half their value after it disclosed it was being investigated by the US Securities Exchange Commission for potential accounting irregularities. It was later exonerated of any wrongdoing, but its shares currently trade at more than 30 per cent below their year-ago levels. TAL shares have struggled as well, now trading 20 per cent below their year-ago levels as investors lose interest in the sector.

All of this leads me to my next point, which is that New Oriental may quite possibly be weighing a complete privatisation of the company due to this lack of investor interest. The company's market capitalisation is still a bit high at nearly US$3 billion, and it would no doubt have to offer at least a 10 per cent premium to win shareholder approval of a privatisation bid. But the company is also relatively cash rich, with around US$800 million in cash and short-term investments. What's more, private equity firms have shown a recent strong interest in helping to finance such privatisations, believing many US-listed Chinese companies are undervalued at their current prices.

We've already seen a number of similar privatisation bids by similar firms for similar reasons, with IT services Camelot Information Systems (NYSE: CIS) making the latest such bid. I suspect we'll see New Oriental watch how its stock performs over the next two or three months, waiting to see if investors react more positively over that period. If they don't, which seems very possible, I wouldn't be surprised to see the company launch a privatisation bid in the second half of the year.

Bottom line: New Oriental's new share buyback program could presage a privatisation offer if its stock doesn't make significant gains over the next 2-3 months.

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