Tal was hitting new lows, while New Oriental has been a bit of a high flyer. I was impressed by Robert Karr’s commitment to New Oriental. The stock makes up 26.57% of his total assets managed. Karr’s not messing around with this position. When he goes, he goes big. If you’re not familiar with Karr and his focused investment approach, click through the link above to read a brief profile on him.
Like Tal, fellow Tiger Cub Steve Mandel also owns New Oriental. Mandel owns 7.35% of the company. George Soros also owns a small part of the company, but it seems as if Soros owns a small chunk of every Chinese company I’ve come across.
New Oriental is a Chinese education play focusing on English and other foreign language programs, test prep, and the development and editing of education materials such as books and software. They also operate schools in Yangzhou and tutoring facilities. They’re the largest education provider in China.
With a rising middle class in China and a strong focus on education, education providers like New Oriental would seem to be a good place to be in the coming years. Competition will be an issue. It’s unclear how big of a moat you can have in this industry, but at least for New Oriental you have a number one position in the country, along with the operation of schools. The schools would seem to be a monopoly, but it’s difficult to determine the barriers to entry in regards to the education material, test prep, and tutoring. Being number one helps, though.
It is easy to say that their revenue growth has been impressive. Their English training segment revenue jumped 40% to $194 million annualized. Their test prep segment is $136.5 million annualized, and up 75% for the quarter. And those are their biggest segments. For their smaller and newer segments in non-English tutoring they say they’re exceeding their expectations. For all segments, revenue rose 56% YoY and net income rose by almost 66%. In response to these results from January 18, Oppenheimer increased their price target to $125. Conversely, Morningstar’s target is $70.
Here’s the rub: What would you pay for this growth? Tal has also had impressive growth but valuations are very high. First, I would back out the cash and investments. They have negligable debt, so we don’t have to worry there. They’ve got about $13 of cash on their balance sheet and are trading at $98 right now. If you back that out to get to $85 and take an EPS figure of $2.19, you’ve still got a hefty 39 PE. Now, they are growing fast enough to justify that kind of PE, but it still makes me feel uncomfortable. Any misstep will hurt the multiple. They are focusing on investing in the future which, although great for the long term, will put pressure on profits in the near term. That could lead to a pullback, and I’m not comfortable enough to pull the trigger at these levels.
I respect Robert Karr and Steve Mandel’s commitment to New Oriental, and I would rarely want to take the other side of their trade. However, at these valuation levels, with increasing competition and less of a moat than I’d like, I’m going to have to let this pitch sale by. It may still be a strike, but it’s definitely not a 3-1 fastball down the middle.
Disclosure: No Positions