Goldman Sachs downgrades Chinese education stocks on prediction market will 'shrink significantly'

Published Mon, Jul 26 20211:12 AM EDT

Evelyn Cheng @in/evelyn-cheng-53b23624 @chengevelyn

Goldman Sachs downgraded three U.S.-listed Chinese education stocks Monday on expectations new regulation will slash the after-school tutoring market by tens of billions of dollars. Over the weekend, Chinese regulators officially released new policy forcing after-school tutoring institutions to become non-profits, banning foreign investment and prohibiting the organization of subject tutoring during public holidays, weekends as well as winter and summer vacation. Goldman Sachs analyst Christine Cho and her team estimate the new rules will shrink the after-school tutoring market — which was $106 billion last year — by more than three-fourths in the next year, leaving it at only $24 billion in size. Given industry uncertainty and risk to earnings, the analysts made the following downgrades: TAL Education from buy to neutral. New Oriental Education and Technology from buy to neutral. Gaotu Techedu from neutral to sell. The analysts maintained their sell rating on Hong Kong-listed Koolearn . The analysts said they suspended their rating, price target and estimates for U.S.-listed 17 Education & Technology Group since there is not enough information for the company, which is 100% exposed to the kindergarten to 12th grade business. On Friday, shares of Chinese education companies plunged in the U.S. and Hong Kong when copies of the harsh policy began to circulate. Notably, the rules specified that foreign capital cannot hold shares of the after-school tutoring companies, including through the variable interest entity structure that many Chinese companies use to list in the U.S. As a result, "profits obtained from operating K-12 [after-school tutoring] institutions may no longer be attributable to shareholders under the current contractual arrangement," the Goldman report said. While the new policy said violations must be addressed, it was not immediately clear what the enforcement process was. Potential upside The Goldman analysts expect the size of the after-school tutoring market to remain near $24 billion or less for the next four years, but they said growth of other segments like foreign language courses for adults could help the businesses, particularly Gaotu. "Management expects gross billings for the adult business to resume growth in 3Q21, together with more products introduced such as teaching certificate training and finance related courses," the report said. "We could turn incrementally more positive if we witness any signs of revenue acceleration or successful subject/category expansion." The report also pointed out that new information for investors could come when New Oriental and TAL Education release earnings. The financial results and conference calls with management are set for early August, on the 3rd and 5th, respectively. — CNBC's Michael Bloom contributed to this report.

Xinhua bookstore staff sort out the new semester textbooks. Handan city, Hebei Province, China, 24 August 2020.

Costfoto | Barcroft Media | Getty Images

Goldman Sachs downgraded three U.S.-listed Chinese education stocks Monday on expectations new regulation will slash the after-school tutoring market by tens of billions of dollars.