Hsu’s “The Next New Oriental Education”

By Travis Johnson, Stock Gumshoe, September 16, 2010

Investors who got in early on some of Robert Hsu’s other picks in the Chinese for-profit education sector could easily have done quite well (though whether that’s a result of Hsu’s prescience or fortunate timing in the China boom can be debated as much as you like), so I thought we should take a look and see who the next company is that he’s touting as having “even more opportunity.”

This teaser comes in by way of a push for Hsu’s Asia Edge newsletter, which he’s offering up “on sale” for about a thousand bucks — this is the more expensive letter that he typically uses to recommend stocks that are either pan-Asian stocks or that are smaller or more speculative (or have a primary listing overseas, as with the 25-cent Hong Kong-listed rare earth metals stock that his subscribers were “begging him for” back in February (and I’ve seen that same promo again lately, so perhaps they’re “still begging”? The stock is up about 20% since then).

But this time, it’s a stock that’s far easier for US investors to buy — it’s a recent IPO of a Chinese education firm, this is how he teases it:

“This company is China’s leading national provider of educational and career enhancement services — and I’m expecting it to simply explode. It was just listed on the NYSE through an initial public offer (so please don’t worry about all the talk lately about reverse mergers and Chinese stocks — this company wisely sidestepped any potential problems there).

“Not to mention that the company actually originally planned to go public back in 2008 — right as the bottom fell out of the global economy and just about every market around the globe got slammed by the worst recession since the Great Depression.

“But interestingly, while the company postponed its IPO in 2008, it didn’t stop making financing deals. Quite the contrary, the company hooked up with several large venture capital funds and raised nearly $100 million.”

So … sounds a bit promising, though as always its worth noting that even the IPOs that eventually succeed often have a very weak first six months or a year, sometimes because the enthusiasm just leads to the stock being too pricey and sometimes because early investors are selling off shares en masse once they’re allowed to do so. Of course, there have been so few IPOs in recent years that it’s tough to make generalizations like that these days … but still, caution rarely hurts.

What else do we learn about this stock? Well, that’s the bulk of the clues, and probably quite enough to feed into the Thinkolator … but we do get a tiny bit more:

“… while the story surrounding this company is certainly compelling, the even better news can be found in the numbers. Revenues, net income and operating income have all tripled in the past two years, and this significant growth looks set to continue.”

So who is our newly public Chinese education friend? This must be: Ambow (AMBO)

AMBO is indeed a recent IPO, they went public in early August at the low end of their hoped-for $10-12 price range, closing that day at $9.25 and heading quickly down for the next few days of spirited trading — since then, the volume has been extremely low and the price tailed off for a while and then recovered, so it’s back in that IPO range again.

And it looks like Hsu must have recommended this one to his subscribers a few days ago, because volume picked up a bit and the price scraped up against that $10 mark again just recently. They only sold 10.7 million shares in this offering (about a third from insiders, the rest for corporate capital raising), though the company already has a lot of outside shareholders from earlier venture funding, including Cisco (details of the IPO are available here from a WSJ blog).

Growth has been impressive for AMBO over the past couple years, though revenue growth of 100% plus is no surprise in the Chinese education sector, so that’s certainly a match — they make money from private schools (K-12) and from tutoring for the high school and college entrance exams, and from professional training (IT certification, etc.). From just a quick look at their financials they have been showing some very nice margins (60% gross margins, 22% net profit margin), so that puts them in league with the much larger New Oriental Education (EDU), which does compete with them in some areas (EDU is apparently also moving into the lucrative test tutoring business) but is largely focused on English language classes.

It’s newly public, so the info is a bit sparse sometimes — but they do publish some numbers on their website (and the website in general is nice and clean and clearly aimed at US investors, it even features some Chinese students jumping for joy to cheer you up). Those unaudited numbers will help to give you an idea of what their earnings would have been as a public company, since the official numbers reflect that all the income was attributable to preferred shareholders (those venture investors), and those preferred shares have now become common shares.

The numbers on their site indicated that in 2009 the company had net income of 138 million RMB (the Chinese currency). After the IPO they will have about 142 million shares outstanding, but each share sold in the US represents two “ordinary” shares, so we’ll pretend that’s 71 million shares, giving us a market cap of about $710 million. 138 million in RMB equals roughly $20.5 million, so that means the stock is trading for about 34X 2009 earnings, so investors are obviously aware of the huge growth and are willing to pay for it, to at least some degree — the growth is continuing so far, with net income reported at 88 million RMB in the second quarter this year. I don’t know what normal seasonality might be for them, but there clearly is some — they earned less than four million RMB in the first quarter … still, that’s a big second quarter, don’t know if they timed the IPO to impress with that quarter or if the results in future quarters will be as impressive.

So … a fast-growing company, built in large part, it appears, by acquisitions and partnerships in test prep and professional training, particularly IT training … this is a high margin business, too, and clearly one where the level of competition is only growing, but those companies that can establish brand names may have some sustainable advantage. I have no idea whether or not Ambow is in that camp, but they are among the larger players.

The crop of Chinese for-profit education companies continues to grow, with smaller companies including ChinaCast (CAST), ChinaEdu (CEDU) and China Distance Education (DL) also all boasting pretty nice looking profit margins, though all of these companies have a different business mix with varying focus on language learning, K-12, tutoring, training, or higher education. In terms of recent growth, CAST, EDU and AMBO are the winners, all putting together roughly 45% earnings growth year over year in their last quarter — and among those, CAST is the only one with what might stand out as a “reasonable” PE ratio down at 16, which likely means there’s some concern about their future growth (EDU’s PE is now over 50, AMBO’s as we just noted, was about 35 for 2009 and is probably in the high 20s now for the trailing 12 months).

I don’t know anything about the competitive landscape for the various compani