New Oriental Education & Technology Group Inc. (EDU)

Analysts: Weifeng Liang

Sector: Services Current Price: $47.97 EPS: $1.43 Market cap: 7.55B Target Price: $66 Beta: 1.51 Investment Thesis 1: Downward Momentum Resulted from Recent Negative News Is Creating a Better Buy-in Opportunity

New Oriental’s share price has had a downward momentum since Reuters, a media, issued an article in Dec 2016 about New Oriental engaging in college/university application fraud. Recently, a shareholder rights firm announced a class action lawsuit against New Oriental for the investors who purchased the stocks prior to the Reuters article publishing and suffered from the price big fall on the publishing date. However, the Reuters’ article didn’t provide any conclusive evidences, which is not convincing at all. Therefore, I treat the recent price drop as a better buy-in opportunity. Investment Thesis 2: China’s Studying Abroad Trend

According to Chinese Ministry of Education, as of 2015, the numbers of Chinese outbound students reached 524 thousands and the corresponding growth rate kept growing at two digits. With the development of Chinese economy and the improvement of Chinese people’s income level, studying abroad is no longer a luxury; instead, it is becoming popular to ordinary people. Furthermore, Chinese people believe that knowledge can change destiny, so Chinese parents are willing to spend on education for their children to let them have better education conditions. Therefore, I believe the studying abroad trend will keep going on in the coming future. New Oriental is the most prestigious band for the English training and test preparation in China. Getting benefits from the studying abroad trend and its unique competitiveness, I predicted New Oriental’s revenue would maintain satisfying growth momentum.

Investment Thesis 3: The New Blue Ocean: K-12 Tutoring

According to chyxx.com’s report, Chinese K-12 tutoring market scale will go up to CNY0.5 trillions in 2020 and the growth rates will keep growing at two-digits from 2016 to 2020.

As above chart based on Morgan Stanley’s research shown, the percentage of K-12 tutoring is becoming the largest portion among the education industry. In 2020, K-12 tutoring will even account for a half of the industry. All these charts are telling us a strong trend, which is K-12 tutoring is absolutely a blue ocean for education industry in China.

According to chyxx.com’s report, China’s percentage of K-12 families education spending per capita GDP is 15%, which is far below the average level of OECD countries. This is another strong proof that this market has extremely great growth potential.

Based on above chart from chyxx.com’s report, the top 10 companies with the most market share only accounted for 6% in the K-12 industry. Although it was the data in 2013, this structure would not change a lot as of today. Through this information, the industry is in the stage of between Introduction and Growth in terms of the industry cycle theory. Realizing this blue ocean, New Oriental has been actively expanding networks and conducting acquisitions among the industry. Taking advantages of its large numbers of networks, abundant resources, unique band recognition and rich experiences, I believe New Oriental will successfully dominate relatively large potions of the market share, which will become an extremely strong catalyst for future revenue growth. According to the1st and 2nd quarterly reports of fiscal year 2017, the YOY growth of K-12 were 28% and 45% respectively, which proved that New Oriental is executing effective strategies. DCF Analysis In order to predict the future revenue growth rate, I referred to the average growth rate for the past 5 years, which is 18%. Considering above strong catalysts and the uncertainty of the future, I predicted a relatively modest growth rate for the coming 10 years, which is 15%. The constant growth rate is 3.5% because I tend to be positive to the development in a very long run. Besides, the discount rate is 8% because New Oriental almost has no debts and I can just use the cost of equity as the WACC. Finally, I got the target price $66 and the margin of safety is 27.32%. Also, I performed the MOS sensitivity analysis, the results are very positive. Relative Valuation 1. Key Ratio Comparison

As above table shown, New Oriental is undervalued among the industry based on P/E and P/B ratio. Furthermore, in terms of the accounting performance, New Oriental is far ahead of the industry average level. 2. Regression Analysis

I also run regression analysis to calculate intrinsic P/E and P/B based on Log(Revenue), ROA and Beta. Although the results are not very convincing, this is because of insufficient competitors among the industry. So I would rely less on these results.

3. Precedent Analysis

Same as regression analysis, most results are not satisfying, which is caused by insufficient data in the sample. Valuation Spread

As above table shown, most values fall in the lower part of the table. Even though there are 8 values in less than 10%, it doesn’t raise my concerns because most those values resulted from the calculations based on insufficient sample data. Potential Risk 1. New Oriental is facing a class action lawsuit as mentioned in investment thesis 1 and being suspected of engaging in college application fraud. On Dec 2 2016, Reuters, a media, issued an article in Dec 2016 about New Oriental engaging in college/university application fraud, including writing application letters and recommendation letters. Later, a shareholder rights firm announced a class action lawsuit against New Oriental for the investors who purchased the stocks prior to the Reuters article publishing and suffered from the price big fall on the publishing date. Due to these issues, the stock price maybe still impacted in the coming short run. 2. New Oriental may be seriously impacted if colleges and universities rely less on assessment tests. Since admission policies of colleges or graduate Schools are uncertain in the future, New Oriental’s English training and test preparation business may be hurt if colleges and universities rely less on assessment tests in the future. 3. New Oriental may be adversely affected if it can’t retain qualified teachers. For education industry, teachers are the most important assets. Having large numbers of qualified teachers is what New Oriental has been proud of. However, those qualified teachers are the key targets of other competitors’ HR. If New Oriental can’t retain them, the quality of services and the reputation would be damaged.