Sweeping reforms in China’s edtech sector keep its stocks depressed

Many of the edtech companies share prices were down by more than 80% since the measures were announced

By IFAST RESEARCH TEAM / Pic BLOOMBERG

THIS year Chinese regulators announced sweeping reforms to the nation’s private education sector, the most damaging of which is to require all existing school subject-based tutoring institutions to register as non-profit entities.

Other measures include preventing such institutions from pursuing IPOs or taking in foreign capital, and putting a complete stop to vacation tutoring, as well as school curriculum teaching for children below six years old.

The regulations come as Beijing seeks to rein in the sprawling sector, which is estimated to be worth US$100 billion (RM413.73 billion), after private equity and venture capital funds kept pouring money in over the years.

The Chinese government described the sector as “severely hijacked by capital” and views it as a social problem.

Aside from putting a stop to the flow of hot money into this industry, the new rules are also intended to ease homework and after-school study hours for young children, reduce the financial burden on parents and to maintain social equality by levelling the playing field.

Taken together, we expect these measures to have a significant negative impact on edtech companies, such as New Oriental Technology Group and TAL Education Group, and their ability to maintain the same level of profitability as before.

Barring any further significant policy changes, we do not expect to see any meaningful recovery in the share prices of edtech companies and advice investors to stay away from them considering the significant regulatory risks that are currently weighing on the sector.

Needless to say, the impact on share prices of edtech companies has been severe, with many of them down by more than 80% since the measures were announced.

The pessimism has even spilled over to the broader tech sector, dragging the Hang Seng Tech Index down.

We think this is a knee-jerk reaction from investors and is largely sentiment-driven, as the edtech regulations have minimal direct impact on the Hang Seng Tech Index.

Even though certain big tech firms, such as the likes of Tencent Holdings Ltd and Alibaba Group, have investments in the edtech sector, they are relatively small compared to the scale of their core businesses and thus, should not be severely impacted by the recent developments.

In the near-term, investors should brace for further volatility as China may continue to implement reforms on its tech sector.

The heightened regulatory risk should continue to weigh on investor sentiment and will likely keep share prices at depressed levels for the time being.

The lack of positive news during this period also means that there may not be a catalyst for the time being.

However, we would like to reiterate our conviction in China’s tech sector. Despite the recent developments that have taken place, we remain positive on its long-term prospects.

The government has made it clear that the main purpose of the increased regulation is to safeguard consumers, and to promote healthy competition and the sustainable growth of China’s tech sector in the long run.

They are not meant to stifle the growth of tech companies.

Anti-monopoly laws could be a way for China’s government to preserve the country’s innovative spirit by protecting young companies, giving them a chance to develop.

This is very similar to what the government did in the past for today’s big tech companies, during which it shielded them from the threat of foreign competition, contributing to their rapid expansion.

As China seeks to achieve technology self-sufficiency — an urgent agenda in light of rising tensions with the US — opportunities still remain in the tech sector.

The recent sell-off has left valuations more attractive than before, and could serve as an attractive entry opportunity for those who are able to stomach the volatility.