Summary:
- Growing urban middle class, increasing trend of after-school education, and improving overall economics of Chinese people will lead the local education sector to further growth.
- One Smart Education is an attractive buy at current level with a target price of $21.
- In recent quarters, profits margins have shrunk because of increasing marketing, selling, and administrative expense as One Smart is currently focusing on expansion. We believe margins will improve over time which will result in positive upside in net income.
Introduction:
With 430 learning centers across 43 cities in China, One Smart International Education Group Ltd is an innovative and leading educational company which provides K-12 after-school education. One Smart Education caters kindergarten and primary, middle, and high schools (K12) segments of education industry and offers them tutoring services. By revenue of 2016 and 2017, One Smart Education is the largest K-12 after-school education service provider in China.
One Smart Education’s vision is to become the best and most trusted “Third Class” outside home and school by utilizing motivation, capability and perseverance of each and every student and bring the best learning power out of him. With customer focus, execution, innovation, and teamwork as their core values, One Smart Education aims to thrive further in the competitive environment of China and take the full benefit of opportunities provided by growing industry of education.
One Smart Education (One) raised $179 million by issuing 16.3 million shares on New York Stock Exchange on 27th March, 2018.
Management:
One Smart Education was founded by Xi Zhang in 2008 in Shanghai, China. Xi Zhang did his master in business administration from Harvard Business School and had an experience of working with big multi nationals like Johnson & Johnson and Wrigley. Zhang was also recognized as a “Top 10 Most Innovative Entrepreneurs in China in 2012” by Global Times.
Honggang (Greg) Zuo is the Chief Financial Officer of One Smart Education. He completed his MBA from MIT Sloan School of Management in 2004. He has a vast experience of working in both, China and USA. Previously, he was engaged with Asian Special Situations Group of Goldman Sachs, MasterCard, General Electric, and PricewaterhouseCoopers.
XiaoqiangMeng serves at the senior vice president of One Smart Education and looks after the sales division. He has an experience of working in sales department of PepsicoLimited, Philip Morris, and Colgate Palmolive.
On the research and development side, Muyuan Ma uses his technical expertise to keep bringing latest updates to software of One Smart Education. He has a master degree from Warwick Business School.
One Smart Education currently employs 9023 employees. All of the top executives and employees of One Smart Education are well educated, experienced, and professionals in their respective fields.
Market Dynamics:
Business Outlook:
China’s economy is improving; poverty is on the decline and the overall living standard is rising. People are spending more money than ever on their kids’ education. China’s education market is poised to touch a mark of RMB3.36 trillion by 2020, increasing from a market of RMB2.68 trillion in 2018. (Source: Deloitte) The main triggers for this vibrant growth in the education sector are changing dynamics of Chinese demographics, increase in the governmental spending on education, and availability of capital to education sector through IPOs and VCs.
China is witnessing massive growth in its middle class population. With a middle class population larger than the total population of USA, it is estimated that there will 120 million applications for pre-school admissions by 2022, taking the pre-school school education market to RMB800 billion by2020. Moreover, these stats are also supported by the fact that the people born is 80s and 90s are becoming parents and they are more cautious regarding their kids’ pre and after-school education, including tutoring, as compared to their earlier generations. (Source: Deloitte)
The Chinese government has shown keen intention towards improving the educational standards in the country and making it more inclusive. In the budget of 2018, the government allocated RMB171.122 billion towards to educational sector, up by RMB10.501 billion, increasing by a growth rate of 6.5% as compared to last year. Preschool and high schooleducation received the most attention among all the other segments of education, getting a funding from government of RMB803million (increased by 35.6% from 2017’s actual spending) and RMB2.064 billion (increased by 21.5% from 2017’s actual spending). (Source: Ministry of Finance, China)
The capital markets and financial strategists also see a huge potential in Chinese educational sector. Eight educational companies proceeded towards IPOs in 2018 and deals worth of USD2.57 billion took place in the education sector in just the first six months of 2018, surpassing the number of total deals happened in 2017. (Source: Deloitte)
Industry-related risks:
This industry has no barriers to entry and this has started to trouble older players. With new players entering the market like Gogokid who are backed by big tech firms like ByteDance, the problems for One Smart Education will increase and this might result in shrinkage of profit margins and market share.
Another risk associated with this industry is very high customer acquisition cost. The firms in this industry typically spend a lot of money in trial classes, commission to sales employees and referral bonuses to teachers and parents. Sometimes the costs spent on acquiring customers exceed the profits which results in shrinking profit margins.
Corporate Strategy:
Going forward One Smart Education will eye following key strategies in order to retain its number one spot in China’s after-school education market and thrive further to grow its revenues.
For the next phase of growth, management of One Smart Education has made following strategies:
Reach national coverage and then scale:
One smart education wants to increase their coverage, open more class rooms and cater more students. From having 117 study centers in 2015 to 430 study centers in 2019, One Smart Education has executed this strategy fairly well. However, in order to boast its coverage to national level, it might have to face shrinkage in its margins. One Smart Education believes that once it has attained national coverage, it will scale and improve its margins.
Particular focus on “Premium tutoring services”
Although being number one in after-school education in China, One Smart Education only have 2.4% share of the Premium tutoring services market. The segment “Premium tutoring services” includes 1-1 class sessions or classes of very small groups; hence, increased instructor’s attention and better learning environment result in personalized and highly effective outcomes, leading to outstanding study results.
This particular segment of after-school education in China is poised to grow at a CAGR of 16% from the period of 2017 to 2022, faster than the overall tutoring market (9%). The key strategy of One Smart Education is to focus more on this segment and capture a bigger chunk of total market size. The aim of One Smart Education is to grow its share from 2.4% to 25% in the total market of Premium tutoring series, worth RMB433 billion.
Particular focus on key regions:
One Smart Education has strategized to focus on key regions and scale up the operations in the top 20 cities in order to increase revenue and improve profit margins.
Strengthening operational Excellency:
Work on core competencies in order to excel further towards being the market leader, drive continued product and services innovation through new technologies and revamp the incentive system to increase productivity.
Financial Analysis:
One Smart Education generates the largest revenue as compared to its peers.
According to our analysis, the stock of One Smart Education is an attractive buy at the current level of $7.26, with an estimated target price of $21. The main reason behind this projected upside is the increase in the net revenue because of the increasing of study centers and consumed class units. As per our forecast, the revenue will increase by 11.58%, 10.91%, and 10.50% in up-coming three quarters.
In recent quarters, the profit margins has shrunk slightly because of the increasing marketing, and advertising expense; we expect that profit margins will further deteriorate as One Smart will focus on expending and launching new study centers nationwide.
The decreasing profit margin is because One Smart Education is currently focusing on growth instead sustainability and retention. In order to increase the number of enrollments and to cater growing number of students, One Smart Education is spending much of its sales revenue on marketing and commissions.
We believe that profit margins will improve with time which will result in healthy growth in net income in future.
Lower SG&A Expenses:
SG&A expense of One Smart has declined in last two quarters and is lower than other of its peers.
Liquidity Management:
So far, One Smart Education has not been able to maintain a current ratio of above 1 which may not be a sign of risk as much of current liability consists of “Prepayments from customers”. However, the average current ratio of One Smart Education, since its IPO, is below than the industry average Current Ratio. (MRQ)
On the risk side, One Smart Education is highly leveraged and its net income has struggled in recent quarters due to high interest payments. We expect the interest expense to increase further in coming quarters as One Smart is focusing on expanding its operations right now; hence, further distress on net income is anticipated.
Price to book ratio of One Smart Education is in line with the industry trend with the exception of Puxin, which is slightly over valued as per the P/B ratio.
Valuation Methodology:
For the purpose of valuating One Smart Education, the analyst has used the “Discounted Cash Flow” methodology. After discounting the estimated “Earning before Income and Taxes” of next 3 quarters by an appropriate discount rate, the analyst has arrived at the target price of $21.
Conclusion:
One Smart Education caters kindergarten and primary, middle, and high schools (K12) segments of education industry and offers them tutoring services. One Smart Education is currently trading at $7.26, below its IPO price of $11, as recently net income has declined because of increasing expenses on advertisement and administration. But with key dominating factors like rapidly growing Chinese middle class population with increasing focus on children after school education, hike in government’s spending on education, and increasing influx of capital in education sector of China, we believe the stock of One Smart Education has the potential of reaching the a price of $21 in coming quarters.
Moreover, One Smart Education has funding from strong financial players like GoldmanSachs and Black Rock which shows further credibility and strength of this stock.
Sources:
https://markets.ft.com/data/equities/tearsheet/profile?s=ONE:NYQ
