瑞信-中国K12教育行业监管过度

DISCLOSUREAPPENDIXATTHEBACKOFTHISREPORTCONTAINSIMPORTANTDISCLOSURES,ANALYSTCERTIFICATIONS,LEGALENTITYDISCLOSUREANDTHESTATUSOFNON-USANALYSTS.USDisclosure:CreditSuissedoesandseekstodobusinesswithcompaniescoveredinitsresearchreports.Asaresult,investorsshouldbeawarethattheFirmmayhaveaconflictofinterestthatcouldaffecttheobjectivityofthisreport.Investorsshouldconsiderthisreportasonlyasinglefactorinmakingtheirinvestmentdecision.24August2018AsiaPacific/ChinaEquityResearchEducationServicesChinaK12EducationSectorINITIATIONResearchAnalystsAlexXie85221017462alex.xie@credit-suisse.comThomasChong85221016164thomas.chong@credit-suisse.comRegulationconcernsoverplayedFigure1:PrivateK12schools’studentenrolmentisexpectedtorisewithahigherpenetrationratetomeetstrongdemand24.425.727.529.631.834.57.68.18.58.99.39.75.35.86.16.56.857.22.83.13.33.53.73.90102030405060201620172018E2019E2020E2021EKindergartenElementaryschoolMiddleschoolHighschoolmnSource:Frost&Sullivan,CreditSuisseestimates■Regulationconcernsoverdone:organicgrowthtocontinuewithnewregulation.TheseconddraftoftheImplementationRulesfortheLawforPromotingPrivateEducationreleasedon10Augusthassignificantlyaffectedinvestors’confidenceintheprivateK12educationsectorandledtoa40%correctioninsharepricesofthesector.However,webelievetheultimategoalofregulationistoprovidebettereducationservicesformorefamiliesratherthancuttingqualityeducationsupply.Weexpectleadingprivateschooloperatorstokeepexpandingwithstrongorganicgrowth,butexpectthegovernmenttobanM&AinK9(grade1-9)schools.■PrivateK12schools:Healthyseculargrowthtomeethugedemand.PenetrationrateofprivateK12schoolsinChinabyenrolmentincreasedsignificantlyfrom15.2%in2012to19.9%in2017.Weexpectprivateeducationpenetrationtorisefurther,sincethereisagreatgapbetweentheenormousdemandforqualityK12educationandashortageofsupplyduetoimbalancesinpubliceducationresourcesacrossdifferentregions.■InitiateonWisdomEducationandMapleLeafwithOUTPERFORM.Welikethesetwofortheirmarketleadership,deeppartnershipswithlocalgovernmentandsolidgrowthstrategyexecution.ForChina'sK12educationsector,ourpeckingorderis:EDU>TAL>Wisdom>MapleLeaf>RISE>RYB.WepreferEDUandTALbecausetighteningregulationshavelessimpactonK12tutoringthanK12privateschools.Keyrisks:(1)regulationrisks;and(2)lower-than-expectedstudentenrolment.24August2018ChinaK12EducationSector2FocuschartsFigure2:PenetrationrateofprivateschoolsbyenrolmentatdifferentstagesFigure3:No.ofChinesestudentscommencingoverseasstudyatdifferentprogramlevels7.6%8.1%8.4%8.6%8.9%9.1%12.3%13.0%13.5%14.0%14.4%14.8%11.8%12.9%13.2%13.5%13.8%14.1%6%7%8%9%10%11%12%13%14%15%16%201620172018E2019E2020E2021EElementaryschoolMiddleschoolHighschool193208218230243256166188204220236252185212232250266282-100200300400500600700800201620172018E2019E2020E2021EGraduateUndergraduateOtherskSource:Frost&Sullivan,CreditSuisseestimatesSource:MinistryofEducation,Frost&Sullivan,CreditSuisseestimatesFigure4:Wisdom’scapacityatexistingschoolsFigure5:MapleLeaf’scapacityandenrolment-10,00020,00030,00040,00050,00060,00070,000FY14FY15FY16FY17FY18EFY19EFY20EDonguanGuangmingDongguanGuangzhengHuizhouPanjinWeifangJieyang13,51316,07819,33426,08833,25138,44145,07122,49026,09030,04038,66051,29054,29062,690-10,00020,00030,00040,00050,00060,00070,000FY14FY15FY16FY17FY18EFY19EFY20ETotalenrolmentTotalcapacitySource:Companydata,CreditSuisseestimatesSource:Companydata,CreditSuisseestimatesFigure6:PeercomparisontableCloseMktcapCompanyTickerCcyprice(USDmn)201720182019201720182019201720182019ChinaeducationpeersUSlistedChinaK12educationNewOrientalEDU.NUSD75.9312,00636.627.818.96.35.14.017%18%21%TALTAL.NUSD30.0415,00476.858.832.312.19.57.318%14%21%RISEEducationREDU.OQUSD10.46632N/AN/A17.413.08.35.5-13%41%36%RYBEducationRYB.NUSD19.22561N/AN/A24.15.95.85.013%0%16%BrightScholar*BEDU.NUSD12.751,62246.232.524.35.53.63.319%14%14%Average53.2x39.7x23.4x8.5x6.5x5.0x11%17%22%HKlistedK12educationWisdomEducation6068.HKHKD4.271,11125.920.915.93.93.73.10.218%21%MapleLeaf1317.HKHKD4.191,59021.918.515.33.62.92.50.217%17%Tianli*1773.HKHKD2.0754720.415.61.51.4N/A16%18%Yuhua*6169.HKHKD3.721,54724.017.814.63.63.02.818%18%20%Average24.0x19.1x15.1x3.6x2.3x2.1x18%17%19%A-sharelistedK12educationXinNanyang*600661.SSCNY23.6098452.342.533.010%9%11%KaiwenEducation*002659.SZCNY11.05801N/AN/A44.72.52.52.31%0%5%Average52.3x42.5x38.9x2.5x2.5x2.3x5%5%8%GlobaleducationpeersUSK12educationBrightHorizons*BFAM.NUSD116.486,75743.336.932.19.27.85.323%17%22%K12Inc*LRN.NUSD17.4268930.827.227.21.24%4%4%Average37.0x32.1x29.7x9.2x4.5x5.3x13%11%13%ROEPEPBNote:Closepriceasof23August2018.Source:Reuters,CreditSuisseestimates.24August2018ChinaK12EducationSector3RegulationconcernsoverplayedPrivateK12schools:StrongdemandtodriveseculargrowthThepenetrationrateofprivateK12schoolsinChinabyenrolmentincreasedsignificantlyfrom15.2%in2012to19.9%in2017andisexpectedtofurtherriseto22.3%in2021,basedonFrost&Sullivanestimates.WeexpectthestudentenrolmentofChina’sprivatefundamentaleducationtoincreasefrom42.7mnin2017to55.3mnin2021.Inaddition,privateeducationpenetration,inourview,willrisefurther,sincethereisagreatgapbetweentheenormousdemandforqualityK12educationandashortageofsupplyduetoimbalancesinpubliceducationresourcesacrossdifferentregions.InternationalK12schools:HighlyscalablemodelinalargemarketwithlowpenetrationThestrongmomentumofChinesestudentsgoingoverseasisdrivingthedemandforinternationalK12educationinChina.Thenumberofstudentsgoingoverseasrosefrom400kin2012to608kin2017,representinga9%CAGR.Penetrationofhigh-qualityinternationalK12schoolsisstilllow.Weviewinternationalschoolsasahighlyscalablemodelinnationwideexpansion,withstandardisedteachingandtests,andwithlessrelianceonsourcingtopstudents.Weexpectfurtherpenetrationofinternationalschools.WeexpectregulationtobanM&AinK9andalloworganicgrowthoflistedschooloperatorsThoughvariousitemsinthecurrentdraftofrulesareambiguous,webelievefutureregulationclarification,particularlylocalimplementationrules,willsupportthehealthygrowthoflistedprivateschooloperators.Moreover,weviewtheultimategoalofstrengtheningregulationistoprovidebettereducationservicesformorefamiliesratherthancuttingthesupplyofqualityprivateeducation.WeexpectthegovernmenttobanM&AofK9(primary/middleschools)byschoolgroupstomanageinstabilityrisks.Weexpectleadinglistedprivateschooloperatorstokeepexpandingonstrongorganicgrowth.Base-caseimpact:Ourforecastexcludes3kstudentenrolmentfromoneM&Aineachyear,leadingto4-5%/6-7%revenuedecreasesforWisdom/MapleLeafinFY19-20.Andweforecasta15%taxratefromFY23,aswebelievefutureregulationwillnolongerallowlistedcompaniestoenjoythetaxexemptionaftertheclassifiedadministrationreform.Bearcase:Ifthegovernmentdoesnotallowlistedcompaniestomakeaprofitfromtheirconnectedtransactionwithnon-profitschoolspostthereformtransitionperiod,theOPMoftheK9segmentwoulddecreasefrom30-40%to0%.Thetaxrateisexpectedtobe25%.InitiateonWisdomEducationandMapleLeafwithOUTPERFORMWeinitiateonWisdomEducationandMapleLeafwithOUTPERFORMratings.Welikethetwofortheirmarketleadership,deeppartnershipswithlocalgovernmentandsolidexecutionofanorganicgrowthstrategy.ForthewholeChinaK12educationsector,ourpeckingorderis:EDU>TAL>Wisdom>MapleLeaf>RISE>RYB.WepreferEDUandTALbecausetighteningregulationhaslessimpactontheK12after-schooltutoringmarketthanK12privateschools.WepreferWisdomtoMapleLeafaswebelieveWisdom’sfocusonGuangdong,thelargestprovincialmarketforprivateeducationwithfavorablepolicies,canhelpreduceregulationriskssignificantly.KeyrisksfortheprivateK12schoolssectorinclude:(1)regulationrisks;and(2)slower-than-expectedstudentenrolmentgrowth.WeexpectthestudentenrolmentofChina’sprivatefundamentaleducationtoincreaseto55.3mnin2021WeviewinternationalschoolsasahighlyscalablemodelinnationwideexpansionWeexpectleadinglistedprivateschooloperatorstokeepexpandingwithstrongorganicgrowthOurpeckingorderforChinaK12educationis:EDU>TAL>Wisdom>MapleLeaf>RISE>RYB24August2018ChinaK12EducationSector4PrivateK12schools:StrongdemandtodriveseculargrowthChinaK12andprivateK12educationoverviewK12(kindergartento12thgrade)educationisthelargestsegmentinChina’seducationindustrywith215mnstudentenrolmentsin2017.InChina,elementaryschool(grade1-6)andmiddleschooleducation(grade6-9)arecompulsorywhilepre-schooleducation(age3-6)andhighschools(grade9-12)arenot.Inthe13thFive-yearPlanfornationaleducationdevelopment,thegovernmenthassettargetstoraisetherossenrolmentrateofkindergartensfrom75%in2015to85%in2020,andtoincreasethemiddle-schoolretentionrate(middleschoolgraduatesasa%ofthegrade1studentcohort)from93%to95%.AmongthefourstagesofK12education,elementaryschoolrepresents47%ofenrolmentin2017,followedbykindergarten(21%),middleschool(21%)andhighschool(11%).Pre-schoolenrolmenthasthehighestgrowthrate(4.2%)duetolowpenetration.Thegrowthrateofenrolmentinmiddleschoolshasstartedtoreboundfromnegativein2016mainlyonfavourabledemographicchanges.Figure7:K12educationenrolmentinChinainfourstagesFigure8:GrowthrateofenrolmentinfourstagesofChinaK12education38.940.542.644.146.093.694.596.999.1100.944.443.843.143.344.424.424.023.723.723.705010015020025020132014201520162017KindergartenElementaryschoolMiddleschoolHighschoolmn-8%-6%-4%-2%0%2%4%6%8%20132014201520162017KindergartenElementaryschoolMiddleschoolHighschoolSource:MinistryofEducationSource:MinistryofEducationAccordingtoFrostandSullivan,thetotalrevenueofChina’sfundamentaleducationmarket(formalK12schoolswithofficialcurriculum)isexpectedtoincreasebyaCAGRof8.7%fromRmb2,434bnin2016toRmb3,688bnin2021.China’sfundamentaleducationismainlyprovidedbypublicschoolswithgovernmentsupport.ThepenetrationrateofprivateK12schoolenrolmentincreasedsignificantlyfrom15.2%in2012to19.9%in2017andisexpectedtofurtherincreaseto22.3%in2021,basedonFrost&Sullivanestimates.WeexpectthestudentenrolmentofChina’sprivatefundamentaleducationtoincreasefrom42.7mnin2017to55.3mnin2021,representingaCAGRof6.5%asaresultoffurtherpenetrationtomeettheenormousdemandforqualityK12education.ThetotalrevenueofChina'sprivatefundamentaleducationmarketisexpectedtoincreasefromRmb279mnin2017toRmb467mnin2021,registeringaCAGRof13.7%.ThepenetrationrateofprivateK12schoolsinChinabyenrolmentincreasedsignificantlyfrom15.2%in2012to19.9%in201724August2018ChinaK12EducationSector5Figure9:PrivateK12schools’studentenrolmentisexpectedtorisewithahigherpenetrationrateFigure10:Penetrationrateofprivateschoolsbyenrolmentatdifferentstages24.425.727.529.631.834.57.68.18.58.99.39.75.35.86.16.56.857.22.83.13.33.53.73.90102030405060201620172018E2019E2020E2021EKindergartenElementaryschoolMiddleschoolHighschoolmn7.6%8.1%8.4%8.6%8.9%9.1%12.3%13.0%13.5%14.0%14.4%14.8%11.8%12.9%13.2%13.5%13.8%14.1%6%7%8%9%10%11%12%13%14%15%16%201620172018E2019E2020E2021EElementaryschoolMiddleschoolHighschoolSource:Frost&Sullivan,CreditSuisseestimatesSource:Frost&Sullivan,CreditSuisseestimatesMultiplefactorstosupportdemandforqualityprivateK12educationWeexpectmultiplefactorstoboostthedemandforqualityprivateK12educationandprovideseculargrowthopportunitiesfortheprivateK12educationsector.■RelaxationofOne-ChildPolicy.TheK12schoolpopulationhasbeenadverselyaffectedbythelowbirthrate.Thetwo-childpolicyfrom2016helpedincreasethenumberofnewbornbabiestosustainlong-termdemandforK12education.In2017,over50%ofnewbornbabiesinGuangdongwerethesecondchildintheirfamily,accordingtotheGuangdonggovernment.■Animbalanceofpubliceducationresourcesindifferentregions.AsFigure11shows,thereishugegapbetweendifferentregions’fiscalspendingoneducationperstudent.Manylocalgovernmentsdonothaveenoughresourcestooperateenoughschoolswithhighqualityeducationservices.■Risingincomeandhigherpurchasingpower.AnnualdisposableincomeforurbanfamiliespercapitahasincreasedsignificantlyfromRmb24,565in2012toRmb33,616in2017.Thusparentsaremorecapableofpayingforpremiumprivateeducation.Figure11:Fiscalbudgetformiddleschooleducationperstudentenrolmentbyprovincesin201613.413.745.505101520253035404550Rmb,thousandSource:MinistryofEducation24August2018ChinaK12EducationSector6K12schoolsvs.K12tutoring:HigherentrybarriersandmoretimeneededtobuildbrandandexpandWeviewK12schoolsasasectorwithhigherentrybarriersbutaslowerexpansionpacethantheK12tutoringsector.FormostK12schoolsundertheasset-heavymodel,theyhavetoacquirelargeparcelsoflandandconstructtheirownbuildings.FormostK12tutoringplayers,theyonlyneedtoleaseteachingspacefromtenants.Inaddition,K12schoolsneedtoobtainlicencesandstrongsupportfromthegovernmentincurriculumdesign,teachingstaffhiring,enrolmentquotasandmanyotheroperationalaspects.ThesuccessofK12schoolsreliesonstrongrecognitionanddirectresourcesupportfromthegovernment.Thiscreateshighentrybarriersfornewentrants,particularlyforcross-areaexpansion.Therefore,theexpansionoftheK12tutoringlearningcentrenetworkismuchfasterthanforK12schools.Figure12:ComparisonbetweenK12schoolsandK12tutoringK12schoolsK12tutoringFixedassetAsset-heavy,mainlyself-ownedAsset-light,mainlyleaseCapexHigh,canbeover30%ofrevenueLow,5-7%ofrevenueCapacityexpansionSlowFastToplinegrowth20-30%Over40%EnrolmentcompetitionNotveryintenseFierceSalesandmarketingexpenseLow,1-3%ofrevenueHigh,12-15%ofrevenueTechnologyinvestmentLowHighRelianceongovernmentsupportVeryhighinoveralloperationLowindailyoperationRegulationVerycomprehensiveandstrictBecomingmorestringentTimetobuildbrandLong,morethan3yearsRelativelyshortGPM46-52%49-58%OPM33-35%13%-20%Source:Companydata,CreditSuisseestimatesForK12schools,salesandmarketingexpensesasapercentageofrevenuearemuchlowerthanK12tutoring.TheenrolmentprocessofK12schoolsisadministratedbythegovernmentandcompetitionislimited.Usually,eachstudentwillstayforthreetosixyears.ForK12tutoring,competitioninstudentacquisitionisfierce.ForK12schools,itusuallytakesalongtimetoaccumulateatrackrecordandestablishabrand.Enrolmentofnewschoolisfromjuniorgrades.Parentsfocusedonacademicresultsoffinalyearstudentsinkeyexaminations,suchasGaokao,todecidereputationofaschool.Anditishardforanewschooltoattractenoughgoodstudentsinthefirstbatch.Theschoolcanonlyproveitscapabilitybyimprovingstudents’performancesignificantly.ForK12tutoring,itisrelativelyeasytobuildatrackrecordandbrand.Oncethelearningcenterisabletohireseveralrenownedteachersinthearea,studentsandparentswillfollowthetrustedteachertothelearningcenter.Andthelearningcentercanproveitsqualityafterthefirstyearofoperation.ForK12schools,itusuallytakeslongtimetoaccumulatetrackrecordandestablishabrand24August2018ChinaK12EducationSector7InternationalK12schools:HighlyscalablemodelinalargemarketwithlowpenetrationAlargeaddressablemarketwithmorestudentstostudyoverseasatyoungerageChinahasthelargestgroupofoverseasstudentsintheworld.ThenumberofChinesestudentsoptingtostudyoverseasrosefrom400kin2012to608kin2017,representingaCAGRof9%.In2017,thegrowthrateoftotalnumberofChinesestudentsgoingoverseasreacceleratedto11.7%,drivenbystrongmomentuminundergraduateorlowerlevels.Weestimate31%ofChinesestudentsgoingoverseasareintheundergraduateleveland35%ofChineseoverseasstudentsareinlowerlevels.Figure13:NunberofChinesestudentsoptingtostudyoverseasatdifferentprogramlevels193208218230243256166188204220236252185212232250266282-100200300400500600700800201620172018E2019E2020E2021EGraduateUndergraduateOtherskSource:MinistryofEducation,Frost&Sullivan,CreditSuisseestimatesWeexpectthenumberofundergraduatelevelChinesestudentsgoingoverseastofurtherregisteran8%CAGRfrom188kin2017to252kin2021.Thegrowthtrendismainlydrivenby:■DifficultyingettingoffersfromtopuniversitiesinChina.Theadmissionrateintotop100universitiesinChinaislowerthan5%.■Highereducationindevelopedcountriesismoreadvanced.OnlysixuniversitiesinChinawererankedamongtop100universitiesbyQSWorldUniversityRankings,comparedwith33universitiesintheUSand18universitiesintheUK.■Consumptionupgradewithhigherincomeofmiddleclassfamilies.MiddleclasspopulationinChinaisexpandingandmoreparentsarewillingtopayforqualityoverseaseducationathigherprice.Over90%ofChinesestudentsgoingoverseaschosetogototop10countiesincluding(UnitedStates,UnitedKingdom,Canada,andAustralia).HighqualityinternationalschoolshavegreatroomtopenetrateInternationalprivateK-12educationprovidesinternationalcurriculaaccreditedbyinternationallyrecognisededucationalorganisationssuchastheIBOrganization,CambridgeInternationalExaminations,theU.S.CollegeBoardandtheMinistryofEducationofBritishColumbiatohelpstudentsinChinaprepareforfurtherstudiesabroadandseamlesslyintegratewithwesternculture.InternationalschoolsareWeexpectthenumberofundergraduatelevelChinesestudentsgoingoverseastofurtherregisteran8%CAGRfrom188kin2017to252kin202124August2018ChinaK12EducationSector8typicallycharacterizedbybetterschoolfacilities,smalleraverageclasssizes(25vs.50inotherK12schools),morediversifiedcourseofferingswithlessfocusonexampreparationandmorecertifiedforeignteachers.Asaresult,internationalschoolscanchargehightuitionfees.WeestimateaveragetuitionfeeofinternationalschooltobeRmb97k,whichis13timeshigherthanaveragetuitionfeesofRmb6.5kingeneralprivateK12schoolsStrongmomentumofChinesestudentsgoingoverseasdrivesthedemandforinternationalK12educationinChina.AccordingtoFrost&Sullivan,thenumberofstudentsenrolledininternationalprivateK12schoolsincreasedbyaCAGRof13%from118kin2012to218kin2017andisexpectedtoreach340kby2021.TotalrevenueofinternationalprivateK12educationincreasedfromRmb7bnin2012toRmb20bnin2017,registeringaCAGRof20%,andisexpectedtoreachRmb40bnin2021.Figure14:TotalnumberofstudentsenrolledininternationalprivateK12educationinChinaFigure15:TotalrevenueofinternationalprivateK12educationinChina193218245275307340-50100150200250300350400201620172018E2019E2020E2021Ek172024293440-51015202530354045201620172018E2019E2020E2021ERmbbnSource:Frost&SullivanSource:Frost&SullivanPenetrationofhighqualityinternationalK12schoolsisstilllow.AccordingtoNewOriental’ssurvey,amongtheK12studentswhoareplanningoverseasstudyinChina,58%ofthemarestudyinginPRC-curriculumclassesofpublicschoolswhileonly8%arecurrentlystudyinginprivateinternationalschools.ThenumberofprivateinternationalK12schoolsinChinaincreasedrapidlyfrom257in2015to367in2017,basedonNewSchoolInsightestimates.WeexpectthenumberofprivateinternationalK12educationschoolstofurtherincreasemainlybecause:(1)thedemandforqualityinternationaleducationisstrongwhilepenetrationislow;(2)governmentpoliciesdonotsupportexpansionofinternationalsectionsinpublicschoolsbecausecostlyinternationaleducationdilutededucationresourcesofmorepublicschoolstudentswhoarenotstudyinginternationalcurriculum;(3)leadinginternationalschooloperatorshavegainedexperienceinfastexpansionthroughassetlightmodelswheregovernmentprovideslandandconstructsbuildings.24August2018ChinaK12EducationSector9Figure16:ProspectiveChineseoverseasstudentsingrade1-9byschoolcurriculumtypemixFigure17:ThenumberofschoolswithinternationalprograminChinabyoperatorsPRCcurriculuminpublicschools,58%Internationalcurriculumsectioninpublicschools,11%PRCcurriculuminprivateschools,12%Internationalcurriculumsectioninprivateschools,6%Internationalschool,8%Others,5%227218241257321367113122126050100150200250300350400201520162017PublicschoolsPrivateschoolsForeignnationalsSource:NewOrientalEducationSource:NewSchoolInsightInternationalschoolsvs.otherprivateK12schools:higherentrybarrierandmorereplicableInternationalschoolsaredifferentfromotherprivateK12schoolsinanumberofaspects.■Higherentrybarrier.InternationalschoolsneedtoobtaincertificationfromnotonlytheChinesegovernmentbutalsointernationaleducationorganisations.Teachinginternationally-accreditedcurriculumrequiresmoretalentwithinternationalbackgroundandschooloperatorsneedtolookfortalentglobally.■Amorereplicablemodelinnationalexpansion.PrivateK12schooloperatorsingeneralneedtoadapttocurriculumandexamdifferencesineachprovinceinordertodeliversatisfyingacademicresults.InternationalschoolshavethesamestandardisedcurriculumandstandardisedtestsinallcitiesacrossChina.■Lessrelianceonsourcingtopstudents.PremiumprivateK12schooloperatorsingeneralhavetoselectstudentswithhighthresholdinexamstoensureperformanceinGaokao(NationalCollegeEntranceExaminationinChina