Turbulent New Oriental: Without Dong Yuhui, will education collapse too?

$New Oriental EDU & Tech(EDU.US) New Oriental Education & Technology Group Inc. released its first-quarter financial results for the fiscal year 2025 before the U.S. stock market on October 23, Beijing time, covering the operating conditions from June to August 2025, including the peak summer season.

During these two quarters, due to the turbulence in the live streaming business, New Oriental's days were not smooth. As the changes in the live streaming business were significant and Dolphin Jun was not optimistic in the short term, this performance review mainly focuses on the education business:

1. Education: Growth Slowing Down?

Dolphin Jun has been emphasizing the core value of quality education and downplaying live streaming since covering New Oriental. The core education revenue in Q1 was 1.27 billion, in line with the guidance from the previous quarter. However, the management's guidance for education revenue growth in Q2 is in the range of 25% to 28%, while the previous market consensus was a growth expectation of over 30% for 2025.

Therefore, the Q2 guidance is clearly disappointing. Where did the problem lie?

(1) Decline in Study Abroad Demand:

Let's first talk about the study abroad business, which was an issue that the management took precautions against in September. The company explained that due to the impact of macroeconomic consumption power, the demand for high-priced 1-on-1 study abroad tutoring has weakened, and some of the lost demand has been converted into cheaper group classes. Therefore, the growth expectation for the study abroad business was adjusted from 20%-25% to 15%-20%.

Dolphin Jun believes that the slowdown in study abroad demand was actually somewhat expected. On the one hand, the prosperity of study abroad is closely related to epidemic lockdowns, so as the duration of reopening becomes longer, a slowdown in demand is a major trend.

(2) Slowdown in High School Growth Expectations:

For the high school subject tutoring business, New Oriental's expectation for Q2 is a 20% growth, also lower than the previous guidance of 25%. Dolphin Jun believes that besides moving out of the epidemic dividend, there are also factors such as New Oriental not having a dominant advantage in subject tutoring.

(3) Unexpected Weakness in Quality Education and Training?

In the pre-market "First take," Dolphin Jun was very concerned about the slowing growth rate of enrollment in quality education and training to 10%. In the subsequent conference call, the management provided some explanation: classes started earlier this year than last summer, so some enrollment numbers were counted in the previous quarter. The management's revenue growth guidance for new businesses in Q2 (quality education and training, learning machines, study camps) is still at 45%, with the combined revenue growth rate of quality education and learning machines at 50%.

If we calculate the enrollment numbers for Q4 and Q1 together on a year-on-year basis as per the management's statement, the overall growth rate is still 27%. However, Dolphin Jun believes that even if the growth rate is restored to 27%, the trend of slowdown is inevitable. Moreover, a 27% increase in enrollment numbers and a revenue guidance of over 50% imply that the company's expectations for an increase in average order value are still not low The growth in average customer spending is driven not only by the increase in user payment demand but also by the company itself raising prices to stimulate it.

2. Operational efficiency improvement, profit margin slightly exceeds expectations

In the previous quarter, leading companies such as New Oriental and TAL Education Group successively announced plans to accelerate expansion, indicating that the investment period in quality education is far from over. In Q1, New Oriental opened 64 new learning centers, with the expansion rate slightly slowing down compared to the previous quarter, but still exceeding market expectations.

However, with the improvement in overall gross profit margin due to increased class occupancy rates and changes in some 1V1 to group classes, operating expenses have also expanded in sync during the investment period, especially marketing expenses, which increased by 41% year-on-year. However, the growth rate of management expenses was lower than expected, resulting in a profit beat.

3. Increase in share repurchase amount

New Oriental has a considerable amount of cash on hand, and its business model of prepaid tuition fees means that its cash flow is basically not a major concern. However, in the first quarter, the spin-off from Koolearn Technology Co., Ltd. had a significant impact on free cash flow.

As of the end of August, the company's cash and short-term investments totaled $4.9 billion, excluding $1.7 billion in deferred revenue mainly from prepaid tuition fees, leaving a net cash of $3.2 billion available for discretionary use.

In the previous quarter, the management repurchased 2.5 million ADR shares, using $161.8 million, with an average repurchase price of $65 per share. The board further approved an extension of the repurchase plan until May 2025, increasing the repurchase amount from $400 million to $700 million.

4. Overview of financial indicators

Dolphin's Viewpoint

In this financial report, for Dolphin, besides the Q2 education revenue growth rate guidance miss, the biggest question is why the enrollment growth rate for New Oriental's quality education training has rapidly slowed down?

As for the idea that the demand for quality education training is waning, Dolphin still finds it hard to believe. After all, whether from personal experience or the vigorous expansion actions of industry leaders, it is evident that the industry's growth prospects are still very promising, far from reaching saturation.

But why has New Oriental's enrollment growth rate dropped to only 10%? In subsequent conference calls, the management provided some explanation: classes started earlier this summer compared to last year, so some enrollments were counted in the previous quarter, and they still have confidence in the 50% growth rate of new businesses in Q2.

If we calculate the enrollment figures for Q4 and Q1 together according to the management's explanation, the overall growth rate is still 27%. However, if we continue to compare the growth rates of previous quarters, there is still no good explanation for the overall slowdown.

(1) There is likely to be intensified competition due to increased funding.

This has been a lingering concern in the market, especially since regulatory authorities began gradually issuing licenses for quality education training from 2023. However, theoretically, the monthly issuance rate of around 1% is still not enough to cover the surging demand in the industry

However, the prevalence of non-standard "small workshops" may have blurred the actual industry supply situation. But from another perspective, the leading companies have maintained or increased their full capacity, at least indicating that the disturbance of small workshops may not be as great as imagined.

(2) Therefore, Dolphin believes that it is very likely to be a climbing period for school expansion, where production capacity cannot keep up.

Although New Oriental's end-of-quarter learning centers increased by 37% to 1,089 compared to the previous year, there is a climbing period of six months to a year from the establishment of a new center to its full operation, during which teaching equipment and teacher resources need to be synchronized.

In the past two years, although the number of New Oriental's learning centers has not increased significantly, the transformation of the K9 business can directly reuse the original basic teaching equipment and teachers, so the climbing speed of the learning centers will be faster than now, which is reflected in the situation where the growth rate of enrollment far exceeds the growth rate of learning centers.

Furthermore, combined with the relatively stable gross profit margin, it can also to some extent indicate that the prosperity of quality education and training has not undergone significant directional changes.

Therefore, based on the analysis in (2), Dolphin believes that New Oriental still has long-term tracking value. However, the slowdown in study abroad and high school business, as well as the elongation of quality education and training expansion, will inevitably have a certain impact on short-term performance growth.

(Note: New Oriental's financial report only discloses some business performance, most of the operating conditions & guidance are disclosed in performance public conference calls and institution-specific meetings, so the content of the later conference calls is relatively important)

Detailed Comments Below

1. Education: Growth Slowing Down?

Total revenue in the first quarter was 1.435 billion, with a year-on-year growth of 30.5% in USD terms, slightly lower than expected. Excluding the core education revenue from live broadcasting, it was 1.278 billion, falling within the upper range of the company's guidance.

The situation of segmented businesses will be announced half during the conference call and half during institution-specific meetings. Dolphin currently provides estimated values for segmentation, and specific data will be clarified in the comments section later:

From a trend perspective, K12 education overall maintains high growth, mainly reflected in the strong demand for K9 quality education and learning devices during the summer, closely following the company's guidance, but the growth rate of high school subject tutoring is 20%, lower than the previous guidance of 25%-27% On the other hand, the demand for adult English education, mainly targeting college students, continues to maintain a high growth rate of 30%, in line with expectations. However, due to the fading pandemic dividend and declining consumer spending, the growth rates of study abroad preparation and consulting businesses have declined to 19% and 21%, respectively, lower than the management's previous guidance of 20%-25%.

1) New businesses (quality education, learning machines) still maintain a high growth rate of 49.8%+ (USD denominated).

Among them, the combined revenue growth of non-disciplinary businesses and learning machines is 55% (USD denominated). Breaking it down, the growth is mainly driven by the number of enrolled students, with 875,000 enrollments in the last quarter Q4, a 39% year-on-year increase. Calculated backwards, tuition fees have increased by 6-7% year-on-year.

In other details of the new businesses, learning machines have seen a significant rebound in growth this quarter, with a 78% year-on-year increase in subscribed users and a 72% increase compared to the previous quarter. The educational projects continue to be in a high growth range.

2) In the existing businesses, the growth rates of study abroad and high school businesses are slowing down due to the high base, reflecting a gradual reduction in post-pandemic dividends. However, the impact on the study abroad business may be greater due to its higher average customer price, especially during macro pressure periods. Particularly, the weakening demand for 1v1 services, which accounts for about 20%-30% of the overall overseas study business, roughly equivalent to 6% of the entire education revenue, is dragging down the growth rates of study abroad preparation income in 1Q25 and the 2025 fiscal year by about 0-5 percentage points.

Specifically, the study abroad business (consulting and exam preparation) has a growth rate of 19%-21% in USD terms; and the income growth rate of high school subject tutoring, which is not a New Oriental advantage, is 20% in USD terms, also lower than the previous guidance.

3) The growth rate of adult tutoring is at 30%, higher than the previous guidance. The company's expectations for Q2 are also not low, with the growth rate maintained at 30%-35%.

4) In terms of live streaming revenue, with Huitongxing leaving the table in July, meaning that only August revenue is not included in Q1, looking solely at the third quarter situation included in the table, the revenue is still growing. However, based on the latest third-party data from Douyin, excluding Huitongxing, the impact on GMV is halved compared to the previous period. But the remaining East Buy main account also experienced a 20%-30% decline

Regarding the revenue guidance for 2Q25FY, the company once again only provided a calculation excluding live e-commerce. The estimated core education revenue for the second quarter is expected to be in the range of USD 850 million to USD 870 million, with a year-on-year growth rate of 25% to 28%, which is clearly lower than the market's expectation of over 30% growth for the education business.

During the conference call, the company provided a detailed breakdown of the growth rates for each business. Compared to previous guidance, the main expected differences are in study abroad and high school subject businesses.

(1) Overseas study business growth rate exceeds 20%;

(2) Domestic adult English 30% to 35%;

(3) High school subject tutoring growth rate 20%;

(4) New business growth rate 50%;

However, as analyzed earlier, Dolphin believes that the likelihood of a passive slowdown in the demand for quality education is low. The slowdown in the growth rate of enrollment in Q1 may be more related to insufficient capacity during the expansion phase, which is equivalent to an active slowing down of expansion.

2. Operational efficiency improvement, profit margin finally not missing the mark

In the previous quarter, industry leaders such as New Oriental and TAL Education Group successively announced accelerated expansion, indicating that the investment period in quality education will not end in the short term. In Q1, New Oriental opened 64 new learning centers, with the expansion rate slightly slowing down compared to the previous quarter, but still exceeding market expectations.

Perhaps tired of consistently falling short of profit margin in the first two quarters and being criticized by the market, in Q1, the profit margin slightly exceeded expectations, fulfilling the commitment in the original guidance to improve year-on-year by 2 percentage points.

On one hand, with the improvement in class occupancy rates and changes in some 1v1 to group classes, the overall gross profit margin improved compared to the previous quarter.

On the other hand, although operating expenses have also expanded in sync during the investment period, especially marketing expenses, which increased by 41% year-on-year, the growth rate of administrative expenses was lower than expected, resulting in a profit beat.

Although the company intends to slow down its expansion, short-term production mismatches will still slow down the pace of profit margin improvement. The company aims to increase its operating profit margin by at least 1% by 2025, and from a medium to long-term perspective after the mismatch period, the direction of stable profit margin improvement should not change.

3. Can increasing buybacks support the stock price?

Operating net inflows in the first quarter were $183 million, a 45% year-on-year decrease, mainly due to the divestiture related to the live streaming business. Capital expenditures in the first quarter were $80 million, resulting in free cash flow for 1Q25 decreasing to $103 million.

As of the end of August 2024, the company had a net cash balance of $4.9 billion (cash + deposits + short-term investments), with nearly $3.2 billion in cash available for discretionary use after deducting $1.7 billion in deferred revenue (mostly tuition fees, subject to special regulation and cannot be used freely).

In the last quarter, the management repurchased 2.5 million ADR shares, using $161.8 million, at an average repurchase price of $65 per share. The board further approved an extension of the repurchase plan until May 2025, increasing the repurchase amount from $400 million to $700 million.

Assuming the entire repurchase amount can be used up by May next year, the estimated annualized repurchase yield is 4%, which is not very high. Therefore, New Oriental needs the valuation support of its main business's high sustained growth.