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Ari Yonker
September 6, 2021
TAL (Tomorrow Advancing Life) Education Group is one of the leading K-12 after-school tutoring providers in China. They provide three flexible class formats for students to learn: small classes, personalized premium services, and online courses. TAL has been an absolute growth engine, with revenues increasing 625% from 2016 to 2021. Even though the company didn’t experience a lot of margin expansion since the company was rapidly expanding their operations and reinvesting everything back into the business, they saw nice profitability and free cash flow generation, which isn’t super common for a high growth technology stock. The market rewarded TAL’s revenue growth; the stock appreciated a little over 600% from 2016 to 2020. All of this sounds great, right? Why would the stock fall over 90% if the company is growing topline at a high clip and has experienced decent profitability in the past? Let’s check it out.
This all starts in the beginning of 2021 when Chinese regulators hinted at a crackdown of the private education sector, this fear caused TAL’s stock price to start down trending. A lot of news came out of China throughout 2021 that spooked investors. The biggest piece of news that spooked investors was Ant Group’s IPO. Ant Group, the company that operates the world’s largest mobile and online payments platform (Alipay), was planning on raising $37 billion dollars which would have been the largest IPO to have ever occurred. What happened? Days before the IPO Jack Ma, founder of Alibaba and Ant Group, bashed the CCP at the Bund Summit in Shanghai. He pretty much said that Chinese regulation would suffocate innovation in China. The CCP didn’t take this lightly and decided to suspend Ant Group’s IPO one day after the conference, stating that they did it due to “changes in the financial technology regulatory environment” and that Ant Group “may not meet the conditions for listing due to these changes.” Everyone knew this was a personal attack on Jack Ma. One week later, the “antitrust authority issued 22 pages of proposed anti-monopoly rules”, which would personally hurt Jack Ma’s massive multibillion-dollar equity stake in Alibaba. Right around the release of the proposal Jack Ma went missing. Literally no one knew if he was alive or not for over a month. All this news really scared investors with exposure to China which can be seen by some of the biggest Chinese companies like JD.com, Baidu, and Tencent going down over 25% over the next 6 months. As you might imagine, smaller capitalization stocks like TAL that have greater and more concentrated regulatory risk got hit way harder. TAL went down over 70% in the same time frame. More bearish news came out throughout 2021 which proceeded to send stocks lower. One example is DiDi’s stock price falling over 30% shortly after its IPO due to a regulatory crackdown on their data collection practices and on ride-hailing companies in general. They forced DiDi to stop signing up new users and its app was also removed from Chinese app stores which reduced projected topline growth by a ton. All this news created a ton of volatility in Chinese equities. Any news that was slightly bearish would send a stock down 10%+ in a day.
July 23 changed everything for Chinese EdTech companies. China released new regulations for the private education sector that shocked the street. The new regulations banned most for-profit tutoring activities, it banned core curriculum tutoring during weekends and vacations, and it banned hiring foreigners outside of China to teach remotely. Analysts were expecting some regulation to the sector but nothing to this scale. Alan Wang, an analyst covering education at Beijing-based asset manager Harvest Fund Management stated that the crackdown is “far beyond expectations.” EdTech companies plunged on the 23rd, with EDU dropping 50% and TAL dropping over 70% in a single day. It is no surprise that TAL dropped 70% on that news since their business model revolves around K-12 tutoring and the CCP is saying they can’t profit from it.
You may be curious as to why China cracked down on the EdTech sector? Well, if you are, let me tell you why. China’s education revolves around the Gaokao, which is an extremely important college entrance exam. It is like the SAT on steroids, parents will spend thousands of dollars a year on private tutoring to keep their kids competitive for the test. This creates a lot of financial stress among parents who aren’t wealthy and is one of the reasons why parents don’t want to have kids in China. The CCP wants more kids. They aren’t happy with China’s declining birth rate, and they figured that reducing this financial stress would be a good way to increase China’s birth rate. The CCP is also very strict on what Chinese students are learning, which is why the banned foreign curricula, they don’t want foreign ideas influencing Chinese students’ college decisions.
To sum things up, a lot of bearish news came out throughout 2021 that hurt Chinese technology stocks. Each piece of news would keep sending technology stocks down even more until the final blow came, which would end their pain. In TAL’s case, it was new regulation that ended their primary source of revenue. I think everything I talked about is a good lesson on investing in foreign equities. Understanding the regulatory environment in a different country is hard and very important, so you better make sure you understand it well if you are going to have exposure to that particular country.
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