Dong Yuhui gets on the Spring Festival Gala. Can New Oriental still rely on education for its future?

Hello everyone, I am Dolphin Analyst!

The education and training industry is an industry that will always be in demand. The scarcity of high-quality social resources makes it impossible for public education to achieve absolute fairness. The 60-year experience of South Korea's education reform also proves that, while public education is implementing policies to reduce the burden, it is also the golden period for the development of education and training industry (mainly including non-compulsory education and quality education). Policy disturbances may bring short-term impacts, but it is difficult to change long-term trends.

From another perspective, before the birth rate of the population has an obvious drag on the industry, as a consumer product with the same investment properties, the education and training industry still has the opportunity to benefit from the dividend of the decline in the proportion of Chinese residents' housing expenditure in the long run.

After the "double reduction" policy was introduced in 2021, the overall education and training industry hibernated for a year, and the handling of the K9 education and training business by leading institutions is also coming to an end. With the promulgation of end-of-year policies to standardize and encourage non-disciplinary education, Dolphin Analyst believes that education and training institutions that actively transform themselves are expected to be the first to emerge from the impact of "double reduction".

Although the "double reduction" policy has had a considerable impact on New Oriental Education & Technology Group Inc., it has enough financial reserves to make a fresh start. In addition to the hot topic of "East Select" in 2022, Dolphin Analyst also pays close attention to its actions to actively transform itself, such as in STEM education and smart learning equipment. Its brand influence and years of industry experience are expected to help new businesses become future growth engines. In addition, the operating data for the first quarter of the 2023 fiscal year showed that New Oriental's high school subject training, overseas study and other teaching-assistance business have successively turned the corner and are expected to continue to rebound after the easing of the epidemic.

Therefore, Dolphin Analyst has started to cover New Oriental and the general education industry. Before elaborating on New Oriental, this article first delves into the bottom of the education industry. Interested users can continue to follow.

I. The competition in the pyramid layer will never stop

Internal friction is everywhere, stemming from human nature. As long as the long-standing education concept and the most widely applicable talent screening mechanism, namely the college entrance examination, exist, the internal friction genes are basically difficult to eliminate, which also means that the demand for education and training (supplementing deficiencies and improving excellence) theoretically has no upper limit.

Since 1980, under the overall trend of expanding enrollment, the enrollment rate of college entrance examination has been increasing, but the number of enrollments in the first layer of the pyramid has not expanded at the same speed. In the past 20 years, the enrollment number of 985 colleges and universities in the country has remained fluctuated between 180,000 and 200,000, which has led to a continuous decline in the admission rate of 985 colleges and universities in the years with the fastest growth in the number of candidates for the college entrance examination.

This means that the competition among the top group in the 40-year trend of expanding college entrance examination has not eased, but has become more crowded.

Although the workplace society does not solely focus on academic qualifications, statistically speaking, the college entrance examination is almost the biggest fork in the road for everyone before they become adults. From campus to society, the difference in average salary between different educational qualifications is hard to ignore, which also leads to parents' eagerness to invest heavily in their children's education before they make their fate decisions through the college entrance examination. "The saying goes, 'Don't make children suffer, and don't make education suffer even if you're poor,' which expresses the 'rigid' demand behind education investment in the most straightforward way.

In recent years, the total expenditure on education and cultural entertainment in Chinese household expenditures has maintained a CAGR of about 10%. According to the 2017 China Education Finance Household Survey, Chinese households spend a total of 1.9 trillion yuan on education each year, accounting for 5-6% of total household expenditures. In addition, the government is also increasing its investment in education, with education funding as a proportion of GDP trending upward since 2000.

Driven by the increasing number of parents' rigid demands, the education industry with a public nature began to accelerate its marketization. In the golden decade before 2021, the market growth rate of extracurricular tutoring (subject and non-subject) was considerable. With the boom of online subject education, the education industry has become a hot commodity in the eyes of investors in the primary market.

However, as a socially significant public service, education also needs government policy indicators and regulations. In addition to general issues such as threshold setting and market concentration, "reducing the burden" has always been the main guidance for government regulation of the education industry. From the first "burden reduction order" in 1955 to the "double reduction" that caused a sensation in 2021, apart from limiting the burden of in-school education, K9 (kindergarten to junior high school) extracurricular tutoring has become the focus of rectification.

From establishment and financing to normal business operations, "double reduction" has made detailed requirements, and the limitation of "non-profit organizations" has almost completely blocked the commercialization path of K9 subject tutoring institutions. Capital led the way, and small and medium-sized education and training institutions closed down or were shut down. New Oriental, the leader in education and training institutions, also closed its K9 subject training courses before the end of 2021, but the head of the dragon had more leftovers at home, which could support business transformation to avoid the fate of complete disappearance.

Although policy strikes are almost devastating in the short term, South Korea's 60-year educational reform experience tells us that policy disturbances cannot eliminate demand, which will only continue to exist in other forms.

II. 60 Years of Education Reform in South Korea: From a Complete Ban on Private Education to Thoroughly Lying Flat

To summarize, through a review of South Korea's 60-year painful educational reform history, the Dolphin Analyst found that some experience is worth helping us predict the future trend of China's education market after reform. (1) The emergence of private tutoring stems from the combined effect of the "nature of turning inwards" and "relative scarcity of high-quality education resources" with the rigid demand of residents. Prior to achieving a 100% admission rate, the participation rate of private tutoring tended to increase, with participation rates in Korea reaching almost 80%.

However, the long-term existence of the scarcity of high-quality resources due to nearly unchanged admission rates for key universities and the government's policy of reducing the burden of pre-university education, means that the demand for individual extracurricular tutoring will not disappear and will also drive up the prices of private training.

(2) Policy changes by private education institutions will hardly affect the demand for student tutoring. Against the backdrop of declining birth rates and increasing public education spending, the proportion of South Korean family education spending to total consumption spending is increasing, albeit against the trend.

(3) "College entrance examination reform" and "higher education popularisation" will affect the participation rate of private tutoring in the short and medium term, but over time, the participation rate will continue to increase naturally. In the long term, only "declining birth rates" can suppress the overall private education market.

(4) However, the competition for key universities (high-quality resources) remains fierce, and is a catalyst for the growth of private tutoring expenditure, making expensive private tutoring increasingly becoming the preserve of the middle and upper income groups.

(5) In private education, STEM training in arts, science, and other areas began to accelerate after the 2008 college entrance exam reforms, with student participation rates continuing to increase, and single-person expenditure growing faster than subject-specific training.

(6) After the college entrance exam reform, in addition to STEM education, markets for learning devices and third-party teaching materials that are suitable for students to use at home also began to thrive.

Overall, the demand for tutoring is difficult to suppress with policy, so there may be some short-term cooling effects but the long-term trend is still upward, and the market scale can only be under pressure to grow due to the sharp decline in the birth rate.

In terms of subdivided industries, after subject-specific training is banned, there will also be significant opportunities for STEM quality education, learning devices, third-party teaching materials, and others that will accelerate growth.

(1) The scarcity of high-quality resources exists, and policies cannot suppress the demand for tutoring.

South Korea's push for education reform to reduce the burden on students can be traced back to the 1980s, when the national participation rate in extracurricular training was less than 10%, which can be said to be a "forward-looking layout" by the government. However, the results were still dismal—the forward-looking policy of reducing the burden did not bring more education accessibility, as the competition for top universities was still fierce, and the demand for tutoring and training increased. As in China, the penetration rate of extracurricular tutoring increased in tandem with the college entrance rate.

Looking back at the past 40 years of education reform, the government's education policies in South Korea have been indecisive in balancing the increasing demand for private tutoring among the public and the goal of reducing the burden and making education more accessible. Faced with the private education industry outside of the school system, the policy direction has gone through four phases: encouragement, tightening, transition, and plateau. However, during this period, residents' education expenses have not been affected at the same pace, and overall have maintained a growth trend.

Especially during the period from 2000 to 2010, when the number of students per year continued to decrease, the proportion of education expenditure for individual families continued to rise.

After 2010, the proportion of total family education expenditure began to decline, partly due to the 2008 college entrance exam reform and increased public education investment by the government (private tutoring participation rate declined). However, Dolphin Analyst believes that the slower growth rate and declining proportion in total size are due to the continuous negative population growth of the population born in the early 2000s.

Although the college entrance exam was reformed in 2008, the average education expenditure per student (total education expenditure/number of K12 students that year) continued to increase until the end of 2016. In 2017, due to the introduction of the "Free Semester system" and the accelerated growth of childless families, average family education expenditure plummeted, but it resumed growth in 2018.

But the situation is different when it comes to the competition for quality education resources. The demand for private tutoring has not weakened, but instead has intensified. According to data, the scale of private tutoring expenses for students has strongly absorbed the negative impact of the decline in the number of children born in 2017, maintaining a continuous growth trend and an increasingly high proportion of total family education expenses.

If the impact of being "averaged" is eliminated and only the paying group participating in private tutoring is considered, the expenditure on individual tutoring even exceeds the total education expenditure of the national average family. Private extracurricular tutoring is becoming more and more an exclusive service of the middle and high-income classes. **

The fundamental reason why the cost of single-child tutoring is becoming more and more exaggerated lies in the relative scarcity of high-quality resources. Many top universities in Korea are located in Seoul, but the number of students admitted to all universities in Seoul has remained stable over the years. Therefore, the admission rate has not increased accordingly, which leads to fierce competition in the pyramid layer, and the subjective demand for "tutoring" and "improving" persists.

Especially during the period from 2007 to 2016, the proportion of enrollment in first-class Seoul universities with the most high-quality universities is declining. Although the Korean government started the college entrance examination reform in 2008, cancelled the score system and replaced it with the level system, and increased the weight of students' comprehensive scores and life record evaluation, "expanding the autonomy of higher education in admission and allowing colleges to independently test selection" measures have stimulated a new round of "tutoring fever" in top universities.

It was not until the new education reform was launched in 2016-implementing the "free semester system" for junior high school, canceling all exams or inspections during the free semester, expanding the introduction of vocational experience, promoting policies such as employment before study, and driving down the enrollment rate of ordinary universities that the admission rate of universities in Seoul slightly increased.

2. The alternative market for subject tutoring

Above, we mentioned that the participation rate of private education for 1980s students continued to increase despite South Korea's strictest ban on private education. This is mainly an observation from the perspective of the overall private education industry. However, if we look at the situation in the segmented market, South Korea's policies regarding college entrance examination reform are not entirely ineffective.

For example, after the college entrance examination reform in 2008, coupled with the fact that the admission rate for higher education itself is close to 100%, the participation rate of private education throughout the country has declined significantly before 2016. However, at the same time, the participation rate of non-disciplinary training such as language learning and STEM has risen rapidly, and the growth rate has accelerated in recent years, even driving up the participation rate of the entire private education industry.

Looking at individual students, although the price of subject training has risen sharply, the proportion of money spent on non-disciplinary training per person has increased from 19% in 2007 to 26% before the epidemic in 2019, and it has quickly returned to 23% after the lockdown in 2021. In the five years before the epidemic, the CAGR of the average investment in non-disciplinary training per student exceeded 10%.

Therefore, despite the precipitous decline in the birth rate in Korea after 2012, the non-disciplinary education market still maintained a growth trend, with a CAGR of about 7% from 2016 to 2019 before the pandemic. In contrast, the vocational training and counseling sub-sectors in private education have shown no signs of significant growth.

Three, there is still room for growth in education and training demand, and New Oriental's self-redemption

1. The proportion of housing expenditure has decreased, and education is expected to benefit.

Although the constantly rising spending on education by domestic families has always been a social problem that has been criticized, in fact, Chinese families' overinvestment in education is far less than that of Korea if compared to the situation in Korea.

In terms of detailed spending of Chinese and Korean families, the proportion of residents' spending on food and housing in China is not particularly high when compared with that of Korea. Instead, expenses on life services, education and entertainment of Chinese residents are relatively low. In terms of education and entertainment, the proportion of Korean education expenses is almost equal to the total education and entertainment expenses of China. After the proportional decline in education spending in Korea since 2017, the gap in the proportion of education and entertainment spending between the two countries has significantly narrowed.

For food and housing expenditures where the difference between Chinese and Korean families is relatively large:

In addition to the high proportion of food expenditures caused by the lower per capita income of Chinese and the higher Engel coefficient, the proportion of housing expenditures of ordinary Chinese people was originally similar to that of Korea, but suddenly increased to over 20% since 2013. It was not until the landing contraction policies such as the three red line in 2020 that the proportion of housing expenditure slightly declined.

However, so far, the expenditure ratio of nearly 25% is still not low. If it can continue to steadily decline in the long term, perhaps the additional expenditure budget will mainly flow to the consumption areas which are currently lower than Korea's, such as **daily necessities and services, education and entertainment, **and transportation and communication.，Dolphin Analyst believes that the education sector, as a consumption expenditure with less investment attributes except for finance and real estate, has a high probability of being the first to obtain excess budget.

In other words, there is still room for improvement in the overall budget for education spending by residents. If we combine the 60-year history of South Korea's education reform with the potential for further demand from residents, the market size of private education and training may experience short-term cooling due to a lack of supply caused by policy changes, but this does not mean that it will be under long-term pressure.

Due to the pursuit of high-quality resources, private education demand will continue to exist despite increased investment in public education. Before the substantial decline in market growth caused by the decrease in birth rate, the overall demand for education and training among the Chinese people remains greater than the supply, especially after the implementation of the "double reduction" policy. This means that as long as the supply is restored, the overall market size will continue to grow.

In addition, the Korean experience also tells us that with the improvement of the rate of higher education and reforms in the assessment of subjects in the college entrance examination, the participation rate in subject-specific training will experience natural stagnation and decline, but education demand will not decline significantly, but rather migrate to other subdivisions.

1. The pursuit of fair and universal education reform drives the prosperity of the education and training market

The cultivation of China's education and training market originated from the early 1990s when the state-owned enterprise system was broken and the market economy was launched. With a development trajectory similar to that of South Korea, the more reduction policies are implemented in public education, the more demand there is for private education and training. New Oriental took advantage of the industry's favorable winds to establish a new pillar of business outside its starting point in overseas study.

(1) In the early 2000s, the high school and college admission rates were both hovering around 50%, and the college admission rate even declined year by year from 2005 to 2008. Like South Korea, a high elimination rate represents the scarcity of high-quality resources. However, relevant regulations on reducing schoolwork in China were introduced early on. In the case of low admission rates, the reduction of in-school education in China naturally gave rise to the rise of extra-curricular tutoring.

Furthermore, with a relatively relaxed policy environment, the government encourages social forces to fill in educational infrastructure gaps, driving the flourishing development of private education and training institutions during this period. Before the implementation of the "double reduction" policy, several education and training industry leaders that started with K12 subject-specific training (such as TAL Education, Elite, Xueba, and Zhoe Education) were established around 2000.

New Oriental, which started with overseas study, also focused on K12 education and training business starting in 2005. In 2008, New Oriental's K12 education and training revenue reached 44 million U.S. dollars, accounting for 21.8% of its overall revenue. The five-year compound annual growth rate (CAGR) from 2008 to 2013 was 55%, with the main representative of subject-specific training being "Youthology" (a brand under New Oriental), whose revenue grew at a CAGR of more than 60%, representing a golden period for subject-specific tutoring. (2) With the launch of the government's support policies for private high schools and colleges in 2013, the high school enrollment rate quickly jumped to over 90%, and the college entrance examination admission rate also exceeded 75%, with a slight cooling of the off-campus education and training market.

New Oriental’s K12 subject training (Youth Employability International School) revenue growth rate also quickly decreased from 66.5% in 2012 to 38.3%, and then continued to decline at a low rate from 2014 to 2015.

(3) However, with the release of the "Opinions" canceling national encouragement points (extra points for special skills and competitions) in 2015 and implementing parallel voluntary reporting and admissions in 31 provinces in 2018, and having universities adjust their own admissions tests to the National Higher Education Entrance Examination, the pressure to become enrolled in higher education increased again, thereby accelerating the growth of K12 subject training.

New Oriental’s Youth Employability International School's revenue growth rate also increased to more than 30% in 2016, and continued to increase annually until the policy on regulating the establishment conditions and educational qualifications of off-campus training institutions was introduced in 2018.

(4) After 2018, there was a gradual period of tightening for off-campus education and training. It was not until the introduction of the "double reduction" policy in 2021 that for-profit institutions providing K9 subject training completely withdrew from the market.

Before 2022, New Oriental had also closed its K9 subject training courses, and its overall education services and exam preparation revenue for the 2022 fiscal year (June 2021 - June 2022) decreased by nearly 30% compared to the previous year. The number of schools and learning centers also decreased by half from its peak of 1,669 to the current 706. Dolphin Analyst expects that after removing K9, Youth Employability International School's subject training revenue will also decrease by nearly 35% compared to the previous year, and its absolute value will return to the level of the 2019 fiscal year.

(3) With K9 completely shut down, what is the logic of focusing on New Oriental now?

After a year of purgatory, with the popularity of Eastern Selection, New Oriental resumed its financial report disclosure by the end of April last year. As the timeline for the 2022 fiscal year coincided with the implementation of the double reduction education reform, the year's operational data was naturally unattractive. However, starting from the first quarter of the 2023 fiscal year (May to August 2022), the education services and exam preparation business recovered to 50% of the revenue in Q1 of the 2021 fiscal year, which was a slight improvement compared to last quarter's 45% recovery rate.

(4) Coupled with the data on New Oriental's school closures, the gradually slowing rate of closures suggests that the marginal impact of the 'double reduction' policy is also continuing to weaken. Plus, with the increase in natural returning students due to the lifting of the epidemic, we expect that both the K12 old business and overseas study business (preparation + counseling) will have a significant rebound. Therefore, the short-term fluctuations caused by the policy are expected to quickly stabilize. But for the stabilizing trend of the old business and the expectation of recovery, Dolphin Analyst tends to think that most of it has been priced in the current stock price, and it still needs to see the performance of operations in the future. The core logic of continuing to focus on New Oriental lies in its new businesses, such as STEM education, intelligent learning devices, and Dongfang Selection's live e-commerce, which have already increased the stock price five times from the bottom.

Based on the experience of South Korea, it is expected that non-subject training (such as art, language, science, etc.) will mainly take over the budget reduction of Chinese parents in K9 subject training, and the learning hardware and software devices that can partially replace the subject courses of education and training institutions will also benefit. At the same time, it is expected that the proportion of education expenditure with investment attributes will increase under the expectation of a decrease in the proportion of household living expenses in the future.

According to iResearch data, the scale of non-subject training market was 529 billion yuan in 2019. Due to the impact of the epidemic blockade, it declined sharply in 2020, but it has recovered significantly to 505 billion yuan in 2021.

Considering the continuous decline in the birth population in recent years, and the target group of non-subject training is mostly preschool children and primary school students, it is expected that there may be some dragging, but despite the considerable pressure, Da Mo still predicts that the non-subject training market in the next five years can achieve a compound annual growth rate of 5%.

This is a new business with relatively high certainty for New Oriental, and the key is how big it can be and the gradual realization of expectations. Although the growth rate of the non-subject market in the future may be lower than the subject training track that New Oriental has focused on since 2008, what Dolphin Analyst is concerned about is that New Oriental can rely on its brand influence in the entire education and training market to achieve a larger growth logic from its own market share.

And the recent policy direction is also to regulate and encourage non-subject education industry. On December 29, 2022, the Ministry of Education and 12 other departments issued the "Opinions on Standardizing Non-Subject Extracurricular Training for Primary and Secondary School Students", proposing that by the end of June 2023, the policy and system of non-subject training for each region will be basically established, and by 2024, the financial burden of families will be effectively reduced, and non-subject training will become a beneficial supplement to school education.

There are no strict restrictions for non-subject education institutions on the policy, such as those for subject counseling institutions. As long as they do not involve red lines in terms of institutional profitability, advertising and financing measures, an appropriate implementation space will be given. The standardized requirements for non-subject education institutions will also accelerate industry concentration. Dolphin Analyst believes that after experiencing multiple rounds of supervision in the education and training industry, New Oriental has more experience than most miscellaneous non-subject education institutions in terms of ensuring teaching venues safety and grasping the qualifications for teaching staff, which has significantly reduced the difficulty of New Oriental's entry into the market and further increased its market share. Overall, the Dolphin Analyst has chosen to keep a close eye on New Oriental due to the combination of the recovery in its core business and the expected increase in market share from new businesses. However, due to the impact of the "double reduction" policy, the suppression of the education industry's sentiment valuation by funding has not yet been eliminated. Under the expectation of moderate policy easing, it is also a catalyst for valuation improvement in the future.

In the next article, the Dolphin Analyst will focus on the performance forecast of New Oriental, conducting research on the growth space of the industries where the new and old businesses are located and the market competitive landscape, among other things, and provide our valuation assessment of New Oriental.

Risk Disclosure and Statement for this article: Dolphin Disclaimer and General Disclosure