Dong Yuhui left and brought down New Oriental, who is the real scapegoat in the end?

Finally, Dong Yuhui is going to "leave" New Oriental EDU & Tech, but more accurately, he is cutting ties with EAST BUY. The announcement made by East Buy after hours is undoubtedly a huge bombshell, with the key figure attracting a lot of attention. The event not only sparked discussions across the internet but also caused quite a stir in the capital market.

So, what impact does this incident have? Especially for the indirect protagonist New Oriental, the stock fell by 5% last night. This can be considered a sharp drop, even though it doesn't have a significant impact on New Oriental's performance and its valuation is not high. The fluctuation in the stock price during trading hours clearly indicates the dilemma and game between different funds.

New Oriental is a company that Dolphin Jun has been closely following:

1) The financial report for the last quarter of the 2024 fiscal year of New Oriental is about to be released next week. With this incident happening at this juncture, how much will it affect the valuation?

2) Last time when Dong Yuhui had an incident with Sun Dongxu, New Oriental dropped by 15 points in just one day. Can we compare the impact this time with the previous one?

3) In such a crisis event that affects valuation, is it a good opportunity to buy low?

Dolphin will briefly discuss it.

I. Regardless of how much grievance is behind it, this is not righteous

In simple terms, this event revolves around three key points: 1) Dong Yuhui resigning from East Buy; 2) East Buy selling 100% equity of its subsidiary to Yuhui Tongxing for RMB 76.59 million; 3) This money was paid by Yu Minhong.

1. What might be the pressure behind the sale?

Although we do not know the real reasons behind it, Yu Minhong's self-disclosure reveals grievances, conflicts, and helplessness. Dolphin Jun believes that it may stem from shareholder pressure from New Oriental (frequent incidents affecting market value stability in live broadcasts) and organizational issues within East Buy (the recognition of Dong Yuhui by the group's seniors, dissatisfaction with the handling of the Dong-Sun incident, etc.).

Source: Lao Yu's Idle Talk "An Open Letter to the Shareholders of East Buy"

2. The Biggest Issue: Selling Cheap + Related Interests = Core Capital "Great Shift"?

(1) Is it Worthless Without Dong Yuhui's Accompanying Article?

As the pillar of the company, Dong Yuhui's departure is undoubtedly a fatal blow to East Buy. Since he is the pillar, selling for less than 80 million RMB, even if it is an account without Dong Yuhui worth 20 million, it is visibly a cheap sale in the eyes of Dolphin.

a. First, let's calculate the overall valuation of the company with Dong Yuhui's accompanying account, which is = Dong Yuhui + Dong Yuhui's accompanying account + all other assets (part of the brands endorsed by New Oriental, the quality and brand value of products sold such as teaching materials/study tours/cultural tourism, other software and hardware equipment, and technological capabilities, etc.).

Regardless of market expectations, East Buy, with a market value of 1.4 billion USD before yesterday's announcement, has almost the same number of fans as East Buy's live broadcast room after Dong Yuhui's accompanying account was established for half a year.

Moreover, Dong Yuhui's accompanying account on Douyin's live broadcast directly contributed nearly half of East Buy's GMV, so even if the valuation is only 50%, it would still be 700 million USD, 5 billion RMB.

b. Let's carefully calculate another account. According to the announcement, from the establishment of Dong Yuhui's accompanying account on December 22, 2023, to June 30, it achieved a pre-tax profit of 188.55 million RMB and a net profit of 141.41 million RMB, which is equivalent to a net profit of nearly 300 million RMB in 2024 on a simple annualized basis.

In addition, Dong Yuhui's accompanying account had approximately 3.5 billion RMB in revenue in the first half of this year. Based on a commission rate of 15% (Dolphin estimated East Buy's level in the second half of 2023), the income would be 525 million RMB, implying a net profit margin of over 25%. This profit level belongs to the top tier of MCN institutions. Assuming a valuation based on a market P/E ratio of 20x, the overall value of Dong Yuhui's accompanying account would be close to 6 billion RMB.

However, the transaction price of 80 million RMB means that Dong Yuhui's valuation accounts for 99%, indicating that without Dong Yuhui, Dong Yuhui's accompanying account is basically worthless. The controversy lies in whether this high level of profitability is really 99% dependent on Dong Yuhui alone, with only 1% coming from others.

On the other hand, how did the company arrive at a valuation of 80 million RMB?

The company stated that the cost method valuation was used, which is based on the net assets of Yuhui Tongxing as of June 30, 2024 (book assets - book liabilities). This method is generally applicable to low-quality assets without growth prospects, or when the net asset value is greater than the market comparable valuation.

As for not choosing market method, income method, the so-called independent appraiser also provided reasons:

The announcement implies that when pricing this transaction, since the buyer is Dong Yuhui himself and Dong Yuhui has already left, the price should exclude Dong Yuhui's value. Without Dong Yuhui, the future operations and profit capabilities of Yuhui Tongxing (even if remaining within East Buy) have high uncertainties, making it difficult to value independently.

Combining the "depressed" valuation means that without Dong Yuhui, Yuhui Tongxing is just a soulless shell, completely worthless, and factors such as Yuhui Tongxing's fans, sales, etc., were brought by Dong Yuhui, not significantly related to the influence of New Oriental, Yu Minhong, or the team's infrastructure, and cannot be valued based on current performance.

Although there is some rationale in the above considerations - acknowledging Dong Yuhui's absolute importance to Yuhui Tongxing, the measurement of this importance is debatable.

Furthermore, considering that without Dong Yuhui, the impact on East Buy's live broadcast room is significant, but the GMV has not been directly cut off, instead achieving a win-win situation with Yuhui Tongxing - driving a 50-100% overall GMV growth for East Buy .

Similarly, if we assume that Yuhui Tongxing also faces the scenario of Dong Yuhui leaving but remaining within East Buy, even if it is just a shell, there is still a fan base of over 20 million, making it unreasonable to value it as worthless.

It is intriguing for the Dolphin to consider that when the board of directors approves this transaction plan, if the major shareholder New Oriental has no objections, then would the small and medium shareholders of East Buy be unable to influence this decision due to their lack of voting power? Not to mention the numerous retail investors who have no say at all.

In simple terms, behind the completion of this transaction, the small and medium shareholders of East Buy who have no say can only watch the stock price plummet.

(3) Who benefits from Mr. Yu personally paying for it?

The announcement regarding the transaction process is quite vague, causing ambiguity about how Dong Yuhui paid 80 million. Subsequently, Yu Minhong responded to the questions, clearly stating that he would pay for this money, and Yuhui Tongxing was "gifted" to Dong Yuhui by him personally.

For a moment, Dong Yuhui's fans praised Mr. Yu's generosity, and Mr. Yu seemed to be on the verge of restoring his image as a "heartless capitalist".

However, the capital market has sensed something amiss In the words of Dong Yuhui, there is the grace of a benefactor known to Yu Minhong, and he also expressed the hope and willingness to continue to seek cooperation opportunities with Dong Yuhui in the future.

If we consider traveling with Hui as Dong Yuhui's entrepreneurial company, then Yu Minhong is equivalent to the entrepreneurial project's "personal angel investor." The intuitive feeling given to the outside world is that other shareholders within the company do not view traveling with Hui favorably or do not agree to operate within the company, but Yu Minhong has a positive outlook, so he decides to invest himself. So, as an investor, will the seasoned venture capitalist Yu Minhong not hold any shares?

We all know that the actual equity control of a company may not necessarily be exactly the same as the shareholder structure established during registration with the industry and commerce bureau, and shareholding proxies are also very common. Does traveling with Hui also have this situation? This point does not need to be truthfully disclosed for non-public companies.

However, regardless of how Dong Yuhui and East Buy are separated, the relationship with Chairman Yu Minhong has never been completely severed. To a certain extent, it can even be said that the two are bound by interests. (The new office established independently by Hui after leaving is completed by the professional team of New Oriental Assets, and Yu Minhong has promised to provide government resources and business opportunities to Hui.)

Since the money used to buy traveling with Hui is paid by Yu Minhong, it is hard not to think more: is there a suspicion of intentionally conducting a low-priced transaction (excessively reducing the value of traveling with Hui after excluding Dong Yuhui)?

Perhaps in the eyes of Dong Yuhui's fans, without Dong Yuhui, traveling with Hui is worthless. But from the results, this operation is detrimental and offers no benefits to small and medium shareholders, as the most core assets of the listed company are directly stripped away.

Of course, it is also possible that this low price was completely proposed by Dong Yuhui as a negotiating tactic when resigning, facing the strong pillar, other shareholders of East Buy had almost no choice.

But since Yu Minhong is the actual investor and related party behind the scenes, what role does he play in such a cheap sale?

Of course, all of this is the unfounded speculation of the dolphin, but what cannot be changed is that in this game process, no one considered the interests of small and medium shareholders. In this situation, shareholders have truly suffered huge losses, and the corporate governance reputation of New Oriental and East Buy has also been harmed by this completely irrational operation.

Of course, hindsight is 20/20. To avoid the risk of seemingly innocent related parties but only causing huge losses to small shareholders, one must stay away from investing in companies with similar celebrity brokerage business models from the beginning, especially those with unprecedented influence that can easily influence the company's management direction.

II. Crisis Strikes Again, Is it a "Golden Pit" or a "Mud Pit"?

Next, the Dolphin will talk about New Oriental, which we are particularly concerned about.

New Oriental holds 57% of the equity in East Buy (increased some in Q1 this year, from 56% to 57%), serving as the controlling party. Since discontinuing the online K9 education business and selling the remaining adult online education to the New Oriental parent company, East Buy no longer includes education-related businesses and is now a pure live e-commerce company Therefore, when the market evaluates New Oriental, most institutions adopt the sum-of-the-parts valuation method, with education as one part and live broadcasting as another part (multiplied by a 57% equity ratio). A small portion chooses to directly evaluate the overall performance of the group.

Although when Dolphin Jun first covered New Oriental in 2023, it emphasized the logic of being optimistic about quality education, its development speed still exceeded Dolphin Jun's expectations. However, the biggest difference from the market's perception is that we have never recognized the value of the live broadcasting business.

It is well known that last year was a year of complete transformation for New Oriental's education business. When the market saw the strong demand for quality education gradually supporting the potential of the original K9 business, and the explosive release of the study abroad demand suppressed by the epidemic for three years, the market's bias against education stocks slowly faded away from New Oriental.

Therefore, as the valuation took off from the safety line and continued to rise, Dolphin Jun's view on New Oriental also adjusted to waiting to bet on a crisis moment. In the short term, potential crisis moments include concerns about a stricter attitude towards education policies and unexpected incidents in live broadcasting.

(1) Live Broadcasting, We Have Never Been Optimistic

Friends familiar with Dolphin Jun know that despite the market's bias against education post double reductions, we have always expressed "bias" towards live broadcasting. Therefore, when the GMV performance of East Buy was good in the first half of 2023, leading to a significant increase in New Oriental's valuation, Dolphin Jun became more cautious instead.

The judgment of not being optimistic about live broadcasting too early is not only due to considerations of increasingly fierce industry competition but also because we are more vigilant about the long-term stability and predictability of performance affected by the personal behavior risks of anchors, especially "Dong Yuhui-style" East Buy.

Whether from the comparison of fans on the Douyin platform, or from the most intuitive comparison between Dong Yuhui's live and non-live GMV periods, as well as the comparison between the GMV of East Buy's live room selling a full range of products and the live room of Yuhui Tongxing mainly selling books, appliances, and cultural and tourism specialties, it can be seen that Dong Yuhui's star effect has never weakened. Instead, in a year and a half, it has doubled, indicating that his absolute influence on East Buy has only increased, not decreased.

This kind of operational risk often occurs in disputes between celebrities and brokerage companies. Live MCN agencies also operate in the mode of brokerage companies, and there are several vivid cases of failure in the industry—Zhang Dayi and Ruhens, Viya and Qianxun, Li Jiaqi and Meione.

Although Dong Yuhui did not have any serious personal behavior risks (except for the small essay incident), the conflicts and contradictions between him and the former CEO of East Buy, Sun Dongxu, in 2023 have actually exposed the usual pitfalls of brokerage companies.

Therefore, in Dolphin Jun's neutral and pessimistic expectations for New Oriental, the value of the live broadcasting business has never been considered, only giving some value to the live broadcasting business in optimistic valuations.

(2) Short-Term No Worries about Education Growth Prospects In other words, for New Oriental, we only focus on changes in the education business.

In the last quarter 3Q24FY, New Oriental's performance was still excellent.

a. Total revenue maintained a high growth of 68% (in RMB);

b. The most outstanding is undoubtedly quality education with a +75% yoy growth;

c. Followed by adult English with +53%;

d. Overseas study consulting and exam preparation comprehensive growth is around 40%;

e. Even high school subject tutoring also saw a growth of 23%;

Due to the base effect, all businesses are showing an accelerating trend on a quarter-on-quarter basis. Although the study tour business has a growth rate of over 200% due to its early stage, the absolute value is too low to make any significant contribution to performance and valuation.

In addition, Dolphin believes that the relatively positive reason for the last quarter's performance is that New Oriental further accelerated the establishment of learning centers. Although this may affect the progress of profit margin improvement in the short term, in our view, it indicates that the supply-demand imbalance will continue for some time (New Oriental's management has been cautious and rational in the pace of expansion after the "double reduction").

As for the upcoming financial report for 4Q24FY, corresponding to the months of March to May in the calendar year, the market may be more concerned about the guidance this performance release will provide for the next quarter, which is the summer performance. Recent surveys indicate that the demand for summer in the entire education industry remains high. Faced with strong demand, there is an overall price increase of 5-10% in the industry. Therefore, under this expectation, the growth rate during the summer vacation period will certainly not be low.

Here, Dolphin has reviewed some research notes and forward-looking reports from major banks (often issued after the company's preview), and market expectations are generally high:

The total revenue expectation for 4Q24 is +30% (USD), +35% (RMB) or more, mainly driven by new businesses such as quality education. However, for 1Q25FY corresponding to the summer period, based on the current strong demand, the market has slightly raised its growth expectations.

However, due to reasons such as live broadcasting business and accelerated expansion, the operating profit margin is expected to decline by 2-3 percentage points year-on-year, resulting in an annual operating profit margin close to 9%.

Based on a 20% tax rate on after-tax operating profit, the market value plummeted to $11.6 billion yesterday due to Dong Yuhui's departure, corresponding to an EV/Non-GAAP net profit multiple of 32 times for the 2024 fiscal year.

Regarding the revenue guidance for 2025, the major banks expect +30% (USD), which is generally higher than the company's guidance of 25% to 30%. With an OPM guidance of at least 1 percentage point increase, it is expected to achieve an after-tax operating profit of less than $470 million The current valuation coefficient for next year's performance is EV/Non-GAAP Net Profit = 25x.

In addition, New Oriental has a considerable amount of cash, some of which is the amount of prepaid tuition fees. Since this amount is restricted for use according to policy, we further deduct the amount corresponding to deferred revenue from the cash, which is the cash and short-term investments that New Oriental can freely dispose of, totaling $3.2 billion as of 4Q24FY.

Source: Notice from the Ministry of Education and five other departments on strengthening the supervision of prepayments by extracurricular training institutions.

Therefore, excluding this self-used net cash, the current market value of New Oriental corresponds to 2024/2025 performance at 23x/18x EV/Non-GAAP Net Profit. Although higher than its Chinese peers, compared to New Oriental's strong performance in the past two years (operating profit compound annual growth rate of approximately 35%+ from 24FY to 26FY), it is clearly undervalued.

Dolphin expects to be slightly more conservative than the market, but the valuation under neutral expectations is still significantly higher than the current market value (excluding the discount on the company's management integrity after this event). The specific forecast values are as follows, for reference only:

(3) What is the market worried about during the three-month decline?

So, what has been causing the decline in New Oriental and other K12 education stocks in the past few months since the last earnings report?

Dolphin believes that the main reasons for the continued decline in New Oriental are threefold:

1) Slowdown in expected profit margin improvement: This is due to the acceleration of expansion and the impact of the initial period of new school establishment on short-term profitability. However, it was indeed the most dissatisfactory point for the market after the release of the 3Q24FY financial report conference call.

2) Concerns about policy regulation: On one hand, in May, the Ministry of Education launched a campaign to standardize basic education, listing 12 negative lists. However, this action is not closely related to the overall compulsory education at present, but more focused on subject education. For example, it strictly prohibits assessing schools based on enrollment rates and exam rankings, prohibits inducing the purchase of teaching materials outside the scope, and prohibits competitive selection in compulsory education stages.

On the other hand, the market was concerned about some new regulations during this year's meetings related to the "three-year anniversary of double reduction," or worried that some relevant departments might make slightly negative descriptions of the current education industry. However, this concern gradually diminished as the meeting ended last week, and the speeches by the Ministry of Education leaders did not carry negative evaluations but instead gradually softened

3) Concerns about easing supply-demand imbalances: In addition, there are concerns in the market about further relaxing licenses to alleviate the supply-demand imbalance. The approval of licenses for quality education has indeed accelerated, but it is still difficult to keep up with the current explosive demand in the short to medium term.

Moreover, unlike in the past, without early-stage capital support from primary capital, new entrants face significant challenges in scaling up. Not to mention the gap in brand strength compared to the existing leading companies.

Summary: At least for now, the fundamental logic (educational demand) of New Oriental in the short to medium term seems fine, and some concerns that have previously suppressed the stock price are gradually being digested.

This live broadcast crisis event may trigger some negative speculations about the motives behind New Oriental, as well as criticisms of the irrational behavior of the company's founders disregarding the interests of small and medium shareholders, which may lead to a discount in valuation.

However, looking at the core logic affecting the valuation of New Oriental, during the period of subsequent stock price digestion, depending on individual risk preferences, Dolphin Research believes it is still worth actively paying attention to this "crisis moment" opportunity.

Dolphin Research on "New Oriental" Historical Articles

Financial Reports

April 24, 2024 - "New Oriental: Improved Resource Utilization, Raised Expansion Targets (3Q24FY Conference Call)"

April 24, 2024 - "New Oriental: Live Broadcasting Drags Down Profits, Education Supports Bottom Line Again"

January 25, 2024 - Conference Call - "New Oriental: Education Demand Overwhelming, But We Don't Want to Expand Too Fast, Profit Margin First (2Q24FY Conference Call)"

January 25, 2024 - Financial Report Review - "New Oriental: Enjoying the Fruits of Labor"

October 27, 2023 - Conference Call - "New Oriental: Actively Expanding, Demand Stronger Than Initially Expected (1Q24FY Performance Meeting Summary)"

October 27, 2023 - Financial Report Review - "Education is the True Face of New Oriental" 2023 年 7 月 28 日电话会《 New Oriental: Strong Demand for Education (4Q23FY Conference Call Summary)》

2023 年 7 月 26 日财报点评《 New Oriental: The Reversal Logic of New and Old Businesses is Gradually Being Realized》

2023 年 4 月 20 日电话会《 New Oriental: Repair is not yet complete, growth is still ahead (3Q23FY Conference Call Summary)》

2023 年 4 月 19 日财报点评《 New Oriental: How many more times of exceeding expectations are needed to regain market faith?》

2023 年 1 月 18 日电话会《 New Oriental: While increasing investment, more attention is paid to group profit margin (FY2Q23 Conference Call Summary)》