“When you climb to the top of a mountain and want to reach the top of another hill, you are going to have to start all the way from the bottom. That’s because no two mountains are connected,” Yu Minhong told an audience at Tongji University in Shanghai three years ago.
Perhaps it’s time for Yu to put on his mountaineering boots. New Oriental, a company he founded, is in deep trouble. Last week the US-listed firm announced that the Securities and Exchange Commission (SEC) is looking closely at the company’s complex ownership structure as a variable interest entity (or VIE). And then New Oriental became the latest target for the short-sellers, after it was accused of issuing misleading financial data.
Let’s backtrack a little. New Oriental is the largest provider of private education services in China. Millions of young children and adults have enrolled in the company’s classes to learn English, and it also offers preparation courses for TOEFL and SAT, two exams used for college entrance in the US.
Education can be a lucrative sector as Chinese parents will go to great lengths to see their children get ahead. So much so that spending on schooling accounts for 15% of total consumer expenditure, second only to food, according to material in Tom Doctoroff’s recently published What Chinese Want.
Last year, business seemed to be good for New Oriental too, as revenues jumped 41% to $193.3 million. That was a result of a 7.7% rise in enrolment to 527,000 students at 664 schools. In fact, the company was so successful that Yu became something of a cult hero. Some of his books (there are 10) have made the bestseller lists, including The Relentless Pursuit of Success, a motivational tome now translated into English (in case you are looking for something to take to the beach this summer).
So why is the SEC investigating? According to the Chinese media, the probe concerns the company’s VIE structure. This arrangement has allowed an offshore holding company listed in New York to control an education business (a field that isn’t supposed to be foreign-owned in China). Chinese companies like Sina and Baidu have also used VIEs to work around similar restrictions and news of the SEC’s interest triggered share price declines for a number of other VIE-structured firms.
The specific reasons for the investigation aren’t clear. Some observers think that it might have something to do with a recent stock deal between Yu and several other shareholders in the VIE, although Louis Hsieh, CFO of New Oriental, told Caijing Magazine that the transaction was a cleaning-up exercise which would not be detrimental to overseas shareholders nor lead to a change of control or a transfer of assets. But New Oriental’s woes were then compounded just a few days later when short-seller Muddy Waters published a report accusing the company of fraud, alleging that revenues were boosted by the disguising of franchises as wholly-owned outlets.
The two negative reports in the same week (as well as speculation that they might be linked) sent shares of New Oriental down 57%, wiping almost $2 billion from its market value.
Yu then took to his personal weibo page to accuse Muddy Waters of “baseless” accusation. He claims that all of New Oriental’s schools are 100%-owned and directly run by the company, with the exception of some pilot programme or “co-op operations” in smaller cities. Only the “cooperation fees” in these arrangements were included in the company’s financial data, Yu insists.
“Muddy Waters turned something that’s the size of a small pimple into cancer. New Oriental does not have serious problems,” says Yu, adding that the company would not “harm investors’ interests using the VIE structure” and would “respect the SEC investigation”.
Trying to match words with action, Yu then announced that senior management, including himself and CFO Hsieh, plan to purchase New Oriental’s American depositary shares on the open market for an aggregate amount of up to $50 million. They will do so within the next three months, the Securities Daily reported. The stock has since recovered 24% from its low.
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