Incidents: The company's revenue in 2022 was 7.87 billion yuan, up 11.8% year on year; net profit of the mother was 8.3 billion yuan, down 21.5% year on year; gross margin fell 9.4% to 54.9% year on year. The company's annual revenue from the game business fell 5.8% year on year to 3.43 billion yuan, mainly due to a decrease in the number of gamers due to the macro environment; revenue from the education business increased 34.2% year on year to 4.34 billion yuan, mainly benefiting from changes in customer order cycles. The company then disclosed a number of matters such as the split and listing of its education business, the redemption of convertible bonds and special dividends, and announced that it would increase investment in AI and use AI to empower its education business in the future.
Report summary
The overseas education business was split and restructured to achieve listing on the New York Stock Exchange. NetDragon and Best (NetDragon's non-wholly owned subsidiary) reached a merger agreement with GEHI and its subsidiary companies. It is proposed to carry out 3 transactions: 1) establish ElmTree as a wholly-owned subsidiary of Best and transfer the full amount of Best's overseas education business to ElmTree; 2) Best redeems all of its shares (except 1 common share held by NetDragon's wholly-owned subsidiary ND (BVI)) in exchange for ElmTree's newly issued common stock; 3) ElmTree merged with GEHI. GEHI will then pay the consolidation fee for the newly issued common shares and own 100% of ElmTree's shares. ElmTree's equity value is approximately $7.5 billion, and the new entity is valued at approximately $800 million after the merger. The new company will change its name to MYND.AI after the transaction is completed to indicate the company's vision of using AI to empower its education business. The transaction is expected to close in the third quarter of 2023.
Some convertible bonds are redeemed, and GEHI shares are distributed to shareholders in the form of physical dividends. The company will inject $1.2 billion into Best through ND (BVI) in exchange for about 476 million Best common shares, and Best will then use the funds to redeem $125 million of its existing $150 million convertible debt. Upon completion of the transaction, GEHI and Best will sign a new convertible bond investment agreement with convertible bond investors (ACP investors). In addition, the company plans to distribute a special dividend to existing shareholders in the form of physical dividends, issuing no more than 2% of GEHI common shares held indirectly by the company, which is approximately 1.49% of GEHI shares after the transaction is completed. After the transaction is completed, ND (BVI), a wholly-owned subsidiary of NetDragon, will hold approximately 61.3% of GEHI's shares (after the physical dividend was paid, but the new ACP bonds were fully converted and all employee equity rewards were granted as planned) or 72.9% of the shares (after the physical dividend was paid, but the new ACP bonds were not converted and employee equity rewards were not granted as planned). After the transaction is completed, 50% of GEHI shares held by ND (BVI) will have a December ban period, and the remaining 50% shares will be banned for 24 months; we expect the company to sell some GEHI shares after the ban expires to seek shares from overseas public or strategic investors.
With the promotion of AI+ education, overseas markets are expected to expand. In the future, Best will develop overseas education business through four wholly-owned subsidiaries of Promethean/Edmodo/ElnerityThailand/Sky Knight. The net profit of this business reached 170 million yuan in 2022. GEHI, on the other hand, mainly engages in early childhood education and trusteeship services in China and Singapore. Before the merger is completed, GEHI will sell all of its Chinese businesses and keep only the profitable Singaporean business. The net profit of GEHI's Singapore business in 2022 was approximately US$4.75 million. We believe that after the split and listing, the valuation of the company's overseas education business can be fully released, and an independent development platform can be obtained to bring in overseas investors. The company plans to fully promote AI education tablet product development this year. It is expected that after the product launch, it will bring additional volume to the overseas education business. However, due to the innate nature of AI products collecting customer data, the company's split and listing of overseas education businesses may reduce concerns about data security among overseas customers and regulators. Currently, the company Pumi Educational Tablet maintains the number one sales position in the world (excluding China), and has the highest market share in the US, the UK, Italy and Australia.
Investment advice: The transaction was carried out through a stock exchange and had no impact on the company's cash on hand, but redeeming 125 million US dollars of convertible bonds would consume the company's cash reserves. Currently, the company has a total of 3.70 billion yuan (about 540 million US dollars) in cash and equivalents. The redemption of convertible bonds will not put much pressure on the company. In the future, expenses related to transactions and employee equity incentives will have a certain negative impact on NetDragon's net profit, and we anticipate that the company's R&D expenses will increase to support AI product development.
In summary, according to the 2024E 10x price-earnings ratio, we gave the company a target price of HK$20.0 to maintain the “buy” rating.
Risk warning: industry policy risks; game business development falls short of expectations; education orders fall short of expectations.