In May of this year, the implementation of the “Civil Promotion Law” caused the domestic private compulsory education industry to be overcast.

And as listed private compulsory education companies have recently revealed their fiscal year results one after another, the impact brought about by the Civil Promotion Law is gradually becoming apparent. After Hong Kong-owned K12 education company Maple Leaf Education (01317.HK) recently took the lead in announcing its annual report after cutting out the K9 business, stock prices fell in response, with a cumulative collapse of more than 40% over four trading days.

As the first private K12 education company to announce major internal adjustments due to the Public Promotion Law to the market, Maple Leaf Education faced huge losses, huge debts, and enrollment difficulties, which also made the market take a higher degree of caution against other related listed companies that have not disclosed their annual financial reports. Because the “Public Promotion Law” came into effect on September 1, but local governments have yet to introduce corresponding regulations and rules, if relevant enterprises do not divest non-compliant K9 business early, they may face the risk of being seriously punished for violating regulations.

Following Maple Leaf Education, Guangzheng Education (06068.HK) (previously known as “Rui Jian Education”), another private K12 education company with roots in the Greater Bay Area, also revealed a bleak annual financial report on December 19.

However, unlike Maple Leaf Education,Guangzheng Education directly divested all of its K12 business, leaving only the supporting service business within the listed companyThey are no less likely to change course than companies such as New Oriental (09901.HK) and Good Future (TAL) in the field of education and training.

Farewell to K12

Prior to the divestiture of the K12 business, Guangzheng Education was one of the largest private education groups operating high-end primary and secondary schools in South China.

In the 2020/21 school year, Guangzheng Education had a total of nearly 70,000 students and operated 15 boarding schools on 13 campuses. Out of these 13 campuses, up to 11 schools run the 1st to 12th grade Chinese courses (that is, K12 courses); 3 of these schools run international courses at the same time, while the remaining 2 schools run the 1st to 6th grade Chinese courses.

Last year, Guangzheng Education announced an ambitious three-year plan to reach 15,000 students within three years (including the acquisition, management of schools, and new high-asset schools). This means that the compound growth rate of the company's total students over 3 years will be as high as 28%. However, the implementation of the Civil Promotion Law has thrown cold water on Guangzheng Education's ambitions.

The Public Promotion Law states that no social organization or individual shall control private schools implementing compulsory education or non-profit preschool education through mergers, acquisitions, agreement control, etc.; private schools implementing compulsory education shall not trade with stakeholders.

This means that mergers, acquisitions, and agreement control of private education at the compulsory education stage are prohibited, and private education schools cannot trade with stakeholders, so divesting the compulsory education school business by a listed company is one of the best options.

Private compulsory education school enterprises, including Guangzheng Education, all operate schools by means of agreement control. Therefore, Guangzheng Education mentioned in its annual fiscal report that there are major doubts about the legal enforceability of the contractual arrangement, and that the company should terminate the execution of the contractual arrangement to ensure full compliance with the implementing regulations after its entry into force.

To this end, Guangzheng Education divested the affected entities from the financial statements of listed companies. However, since all of Guangzheng Education's high school education services are provided by the same school entity along with compulsory education, Guangzheng Education can only directly include all of its schools as “affected entities.”

In other words, the company divested all of its schools from listed companies, including the high school business.The only listed companies left are providing non-classroom services to students, such as providing outdoor activities, arranging school buses, social activities, and campus cafeterias, but these businesses don't make any money.

According to the annual fiscal report, Guangzheng Education's revenue from affected entities reached 2,044 million yuan, while the remaining business revenue was 220 million yuan, accounting for only 9.7%.

As a result of the divestment of the affected business, Guangzheng Education's business lost 2,056 million yuan, while the remaining business also recorded losses of 222 million yuan. Affected by this, Guangzheng Education achieved revenue of 2,264 billion yuan in FY2021, an increase of 2.63 billion yuan over the previous year; a loss of 2.12 billion yuan, while achieving net profit of 512 million yuan in the same period last year.

How should we follow the path ahead?

Since all of its schools are involved in compulsory education business, it can be said that Guangzheng Education has only one “skin bag” left after losing weight this time. Listed companies have left only a small and uncompetitive service platform, which can be described as a result of a small scale and uncompetitive service platform.

Of course, this is just a financial treatment made by Guangzheng Education to avoid policy risks. It's just that the divested K12 business has been excluded. It cannot generate benefits for shareholders, nor can it generate cash flow for listed companies.

Compared to Maple Leaf Education, which also cut out non-compliant businesses, Guangzheng Education has both positive points and worrying issues.

The good news is that Guangzheng Education does not face the same pressure to pay debts as Maple Leaf Education. Due to the crazy expansion of Maple Leaf Education in recent years, debt problems also became apparent after divesting K9 and the kindergarten business. Short-term debt repayment pressure also caused its independent auditors not to comment on the company's comprehensive financial statements.

However, the overall debt structure of Guangzheng Education is healthy, and there is even capital to be used as an investment product, so there is no pressure to repay debts in the short term.

One worrying aspect is that the foundation of Guangzheng Education after slimming down is too weak and its assets are very limited, so it may face quite a few obstacles in the future when it comes to financing to support transformation. Maple Leaf Education has a stronger foundation than Guangzheng Education. After cutting out K9 and the kindergarten business, some high school business was left behind. Overseas international schools not affected by the Civil Promotion Law can also continue to provide the company with cash flow.

After releasing the policy risks posed by the Public Promotion Law, Guangzheng Education, which began almost from scratch, also drew up a blueprint for future development. The blueprint was divided into two lines.

Article 1. A larger education service platform with a wider range of business. This mainly provides value-added services to schools and students, which can be said to be similar to the current model of the property management industry. Guangzheng Education mentioned that the future will shift its strategic focus to building a comprehensive education supply chain platform, including school catering management, education supply chain management, school property management, teacher training and recruitment.

However, unlike the property management industry, there has been an overall negative increase in the number and scale of primary and secondary schools in China in recent years, indicating that the primary and secondary education market can bring very limited incremental space to enterprises providing value-added services.

Therefore, if the comprehensive education supply chain platform of Guangzheng Education is to grow in the future, it needs to be integrated into the supply chain of existing schools. However, there are obvious limitations. Domestic schools often have stable partners for services in catering, property management, etc. This poses quite a challenge to developing markets in this area for Guangzheng Education, which has a small business scale.

Article 2. Explore opportunities in independent high schools and the vocational education market. Since their original business involved high schools with relevant teaching resources and teaching experience, both Guangzheng Education and Maple Leaf Education are applying for independent high schools that are not affected by the Civil Promotion Law.

Vocational education is a golden circuit for enjoying policy and market dividends. Of course, the competitive environment is also becoming increasingly intense. Leading K12 education and training companies, including New Oriental and Good Future, also have plans and actions to lay out vocational education. Guangzheng Education mentioned that it will operate according to an asset-light model in the future. However, high schools and vocational education are asset-heavy industries. If they want to advance into these two fields, how can an asset-light model support the establishment and operation of schools?

Summary:

Currently, Guangzheng Education is at the crossroads of development. The K12 business, which has always been the backbone, has been cleared, leaving almost an empty shell for the company: net assets of only 580 million yuan.

Transformation has also become a way out for private K12 education enterprises. Among them, Maple Leaf Education will expand the catering and business attire business. Guangzheng Education also has its own “small goals,” but it has a long way to go; it can be said that it is once again on the starting line of entrepreneurship.

After the financial report was released, Guangzheng Education also couldn't escape the vortex of a sharp decline in stock prices. On the first day of the resumption of trading (December 20), Guangzheng Education opened sharply lower by more than 47%. Although the stock price rebounded in early trading, it maintained a volatile downward trend in midday trading, eventually closing down 42.86%. The market value of nearly HK$1.4 billion instantly went up in smoke.

Recently dragged down by Maple Leaf Education and Guangzheng Education Institute, the Hong Kong stock education sector continued to be sluggish. On December 20, the Tonghuashun Education Service Index plummeted 3.98%, with a cumulative decline of more than 12% over the past month.

Currently, there are private K12 education companies that have not published their annual financial report data in the Hong Kong stock market, including Cheng Fai Education (01565.HK), Tianli Education (01773.HK), and Bojun Education (01758.HK), which are still in the suspension stage and will disclose their annual financial reports in the near future. According to the current market environment, the divestment of the K9 business by these three companies would also be a probable event. It may not be possible to escape huge losses, and investors should take it with caution.