China Education Sector: Classes Poised To Resume

A growing middle class, increased urbanization and strong government support had propelled the Chinese educational industry into one of the investment community’s favorite bets in recent years.

However, the sector has come under a heavy beating in August, with Hong Kong-listed Chinese educational stocks suffering an average 30% (as at August 28[i]) tumble in share prices thanks to a proposed set of regulatory tightening measures. Is the industry’s long term future under threat or are concerns simply overblown?

The trigger

The recent sell-off was triggered by the Ministry of Justice’s “Regulations on the Implementation of the Law for Promoting Private Education (Draft Amendments)” on 10 August 2018. One of the key highlights of the document is that non-profit schools must now seek regulatory approvals before signing agreements with for-profit education firms, while private businesses operating under a “Group” structure will not be allowed to control non-profit schools through M&As, franchises or contractual arrangements.

The suggested changes fuelled many uncertainties although the primary concern was the growth of the education sector could be stymied. In China, government schools benefit from a number of favorable policies such as land properties and lower tax rates. Consequently, private educational groups view them as the ideal candidates for collaboration in order to push forward their own expansion ambitions. Moreover, many Chinese education companies listed in Hong Kong, for example, have a VIE (Variable interest Entity) structure and rely on M&As to expand. The rules could potentially dent their expansion plans, casting a wide shadow over the sector’s outlook.

Still, the rules have yet to be finalized, which means the potential impact of the regulations is still very much up in the air. The introduction of a multi-year transitional period also buffers the sector from any material impact over the short term, providing companies ample time to adapt and transform. Ongoing acquisitions are therefore unlikely to be impacted during this period and may even accelerate, as some owners might be prompted to sell before the proposed regulations come into full effect.