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New Oriental Education (EDU): Great Growth, But You’ve Got to Pay For It

February 01, 2011 | About:
I stumbled upon New Oriental Education (EDU) while doing research for a recent article I wrote on one of their competitors: Tal Education (XRS). You can read that article at Tal Education XRS Hits New Lows: Robert Karr Buys More.

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

About the author:

Steven Kiel
Steven Kiel is the president and chief investment officer for Arquitos Capital Management, a Virginia-based investment management firm. He is a graduate of George Mason School of Law and a captain in the Army Reserves. He manages two spoke funds, The Freedom Fund, a value-oriented portfolio, and The Hayek Fund, a portfolio dedicated to free market principles. He can be contacted at steven.kiel@arquitos.com or through the firm's website at www.arquitos.com.

Visit Steven Kiel's Website


Rating: 3.4/5 (8 votes)

Comments

batbeer2
Batbeer2 premium member - 3 years ago
EDU says:

“We face competition for our “Elite English” program primarily from Wall Street Institute and EF English First, both of which offer English training courses for adults in many cities in China. Wall Street Institute began providing high-end English training courses to adults in major cities several years before we entered this market and enjoys a first-mover advantage.”

Last year, Carlyle group sold Wall Street Institute to U.K.-based publisher Pearson PLC for $ 240m.

http://peureport.blogspot.com/2010/07/carlyle-sells-rest-of-wall-street.html

mr. Market offers us EDU for $ 3.9B !
slkiel
Slkiel - 3 years ago
Nice catch.

Yeah, very expensive. I'm not sure how Karr can have 26% of his portfolio in this name. Seems like a ton of risk.

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