Last year Muddy Waters – the US-based short-seller – targeted New Oriental Education, accusing it of improper accounting practices. China’s largest private sector education and training company saw its shares plummet from $22 to $9.50 in just one week (see WiC160). In November, Muddy Waters backed off and New Oriental jumped to its highest price since July.
While it would appear that New Oriental’s management had the last laugh, the company is not in a celebratory mood. That’s because in early February New Oriental posted a $26.9 million loss for its second-quarter (which ended in November), compared to a $3.2 million loss in the same period of the previous fiscal year. That’s surprising because revenue grew 30% year-on-year to $165.9 million in the same quarter.
The New York-listed company admitted that it was overly aggressive with store openings over the last quarter. In the past 12 months, the company added 238 new teaching centres and over 10,000 employees, compared with only 80 new centres in the same period a year ago. The accelerated network expansion has significantly increased New Oriental’s cost base, says Economic Information Daily.
In light of the latest results, the company’s CFO promises to tighten its spending. “The company will close 15 to 25 unprofitable teaching centres and will lay off 1,000 to 1,500 employees in the next four months,” says Louis Hsieh, the CFO of New Oriental.
“Yu Minhong [the company founder and chief executive] and I were so distracted by the SEC investigation and Muddy Waters’ accusation that we lost track of the expansion plan,” he offers as an explanation for the slip-up.
As an educator, perhaps Hsieh should know that blaming only detracts from the real problem. Analysts say New Oriental’s biggest challenge now is that its most lucrative schools, mainly in Beijing and Shanghai, continue to underperform, with revenues increasing by only 20% and net income falling over 50% year-on-year. The company said as competition is intensifying among players offering its core product: overseas test preparation classes (such as SAT and GMAT).
The number of Chinese students taking the SAT has gone up substantially in the last year – in fact, an estimated 95% of the candidates taking the SAT tests in Hong Kong were from the mainland, where SAT test centres are still non-existent, says the South China Morning Post – smaller rivals have cropped up in the last few years, undercutting New Oriental on price. In fact, many of these start-ups were Yu’s former employees, says Forbes China.
On the plus side, the potential of China’s overseas test preparation market is huge. From October 2007 to June 2008, up to 7,000 mainland students came to Hong Kong to take the exams. From October 2008 to June 2009, the figure had nearly doubled to more than 15,000. The Hong Kong Examinations and Assessment Authority, which operates the exam in the city, estimates that the figure surpassed 40,000 last year.
Tour operators in China have been quick to cash in on the growing phenomenon, providing chartered buses shuttling candidates directly to test centres, hotel rooms and offering entire packages for students and parents. It’s spawned a whole new industry dubbed “exam tourism,” says Time Weekly.
Still, Beijing Morning Post questions whether New Oriental’s golden era may be over. The problem is that labour and rental costs will continue to climb, and this in turn puts pressure on profit growth. The company is still figuring out how to deal with margin pressure from intensifying competition.
New Oriental, however, retorts these challenges are only growing pains. “A company only grows to become mature after it’s made mistakes. And New Oriental is no exception. What’s important is to be able to continue to learn from our mistakes and remember the lessons. That’s how you become more powerful,” says Chen Xiangdong, the company’s executive president.
© ChinTell Ltd. All rights reserved.
Exclusively sponsored by HSBC.
The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.