I assign a Neutral rating to Chinese online education company Koolearn Technology Holding Limited (OTCPK:KLTHF) [1797:HK].
The K-12 education business is the key growth driver for Koolearn Technology, and all eyes are its location-based live interactive after-school tutoring courses referred to as DFUB. Looking ahead, DFUB has significant room to grow via further expansion into lower-tier cities in Mainland China and price increases.
On the flip side, Koolearn Technology’s K-12 education business remains loss-making, and the company’s recent share placement could possibly suggest that its share price has peaked. Koolearn Technology trades at a premium to most of its online peers, with consensus forward FY 2021 (YE May 31) and FY 2022 Enterprise Value-to-Revenue multiples at 15.9 times and 9.9 times, respectively. As such, I see a Neutral rating for Koolearn Technology as fair.
Readers have the option of trading in Koolearn Technology shares listed either on the Over-The-Counter Bulletin Board/OTCBB as ADRs with the ticker KLTHF or on the Hong Kong Stock Exchange with the ticker 1797:HK. For those shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.
For those shares listed in Hong Kong, there are limited risks associated with buying or selling the shares in terms of trade execution given that the Hong Kong Stock Exchange is one of the major stock exchanges that is internationally recognized, and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $30 million, and market capitalization is above $4.4 billion, which is comparable to the majority of stocks traded on the US stock exchanges.
Institutional investors who own Koolearn Technology shares listed in Hong Kong include The Vanguard Group, Wells Capital Management, Matthews International Capital Management, and Norges Bank Investment Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers or Fidelity, or international brokers with Asian coverage, like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.
Started in 2005 and listed on the Hong Kong Stock Exchange in March 2019, Koolearn Technology is a leading provider of online extracurricular or after-school education services in China. The company is the “largest comprehensive online after-school tutoring and test preparation service provider in China” and it is also the market leader in the Chinese college test preparation market with an 8.2% market share based on 2017 financial numbers, according to its media release.
Koolearn Technology’s parent and major shareholder is New Oriental Education & Technology Group Inc (EDU) with a 53.2% equity stake, while Chinese internet giant Tencent (OTCPK:TCEHY) (OTCPK:TCTZF) [700:HK] is Koolearn Technology’s second-largest shareholder with a 9.6% equity interest via its subsidiary Image Frame Investment (HK) Limited.
Koolearn Technology derived approximately 59%, 27%, 3%, and 1% of its FY 2020 revenue from the company’s college education, K-12 education, pre-school education, and institutional customers business segments, respectively. Excluding losses from its K-12 education business, the college education, pre-school education, and institutional customers business segments contributed 81%, 2% and 17% of Koolearn Technology’s gross profit for FY 2020.
Koolearn Technology’s Four Business Segments
Source: Koolearn Technology’s FY 2020 Annual Report
I will be focusing primarily on Koolearn Technology’s K-12 education business for the purpose of this article, as this is the fastest growing business segment for the company and the narrowing of losses for the K-12 education business is the key re-rating catalyst for the stock.
K-12 Education Business Is Key Growth Driver With All Eyes On DFUB
Koolearn Technology used to be solely focused on the college test preparation market in China where it is the market leader, prior to entering the Chinese K-12 education market in 2015 with the offering of online K-12 education services in the large classes format branded as Koolearn. In 2017, Koolearn Technology also started to provide K-12 education services in the small classes format through its subsidiary Dongfang Youbo or otherwise known as DFUB. According to the company’s FY 2020 annual report, Koolearn Technology’s K-12 education services include “after-school tutoring courses that cover the majority of standard school subjects from primary to high school in China” and “preparation courses designed for standardized high school and national college entrance exams.”
Although Koolearn Technology’s K-12 education business suffered from a gross loss of -RMB44.9 million in FY 2020, the K-12 education business’ revenue grew by +85.4% from RMB159.2 million in FY 2019 to RMB295.1 million in FY 2020, and student enrolment in the K-12 education segment expanded by +224.5% YoY to approximately 1.86 million over the same period. In contrast, revenue for Koolearn Technology’s core college education business increased marginally by +1.6% YoY to RMB641.7 million in the most recent fiscal year. Furthermore, Koolearn Technology’s total student enrolment across all its business segments increased by a relatively lower +30.8% YoY to 2.85 million in FY 2020.
Within the K-12 education business segment, DFUB, which Koolearn Technology refers to as “location-based live interactive after-school tutoring courses”, has significant growth potential, and accounted for approximately 35% of Koolearn Technology’s total K-12 student enrolment in FY 2020. There are a number of reasons why DFUB is differentiated from other online K-12 education services and seen as the key growth area for the K-12 business segment and Koolearn Technology as a whole.
Firstly, DFUB caps its class size at a maximum of 25 students (classes can be as small as 10 students), unlike the company’s Koolearn K-12 large classes. In addition to a smaller class size, DFUB also focuses on facilitating greater interaction between tutors and students through various communication tools such as “web cameras, microphones, headphones and e-writing pads” according to Koolearn Technology’s IPO prospectus.
Secondly, DFUB only allocates students from the same region in China to a single class, and DFUB courses are customized based on the specific region that the students in the class come from. This suggests that DFUB has a long growth runway in lower-tier cities in China specifically. The demand for quality online after-school K-12 courses such as DFUB is even stronger in lower-tier Chinese cities since the quality of education in schools located in lower-tier cities is deemed to be relatively compared to that for first-tier and second-tier cities in China.
Thirdly, DFUB has only penetrated 172 cities in 24 provinces in Mainland China as of May 28, 2020. In the company’s FY 2020 annual report, Koolearn Technology noted that DFUB “has significant first-mover advantage” in third to fifth-tier cities in China, and the company has plans to “expand its (DFUB) footprint even deeper into county-level cities.” Furthermore, there is room for Koolearn Technology to raise its prices for DFUB. At the company’s 1H 2020 results briefing on August 21, 2020 (audio recording and transcript not publicly available). Koolearn Technology disclosed that the average pricing for DFUB courses is currently RMB60 per hour, and certain of its competitors’ K-12 courses in the large-classes format are already charging students at a similar price level.
On the flip side, Koolearn Technology’s K-12 education business (including DFUB) is loss-making due to high student acquisition costs and significant marketing expenses. This is a key characteristic of the online K-12 education market in China, where competition for students is intense and it has been challenging to translate student enrolments and revenue into profits and cash flows.
It is noteworthy that Koolearn Technology disclosed at its 1H 2020 earnings call on August 21, 2020, that the company’s first batch of DFUB operations in cities like Yanqing and Datong have gross profit margins of around 30% after three full years of operation. As Koolearn Technology continues to expand DFUB operations into other lower-tier cities in China, it could take some time for most of its DFUB operations to be mature and profitable.
Furthermore, DFUB’s first-mover advantage might not be sustained for a long period of time, as it is not difficult for competitors to replicate DFUB’s small-class size, location-based live interactive after-school tutoring course formats.
Recent Share Placement In The Spotlight
Koolearn Technology announced on September 8, 2020, that the company is issuing 59.4 million new shares (or 5.95% of its enlarged share capital) at $3.87 or HK$30.00 as part of a share placement.
On the positive side of things, Koolearn Technology raised HK$1,781 million in net proceeds from the recent share placement, and the funds will be largely allocated to sales and marketing activities and the upgrading of the company’s technology infrastructure.
More importantly, Koolearn Technology’s parent and major shareholder New Oriental Education & Technology Group and Tigerstep Developments Limited, an investment holding company wholly-owned and controlled by Mr. Yu Minhong, are the subscribers for the share placement. Mr. Yu Minhong is Koolearn Technology’s chairman and the founder of New Oriental Education & Technology Group. This represents a vote of confidence in Koolearn Technology from the company’s controlling shareholders, as they are increasing their stakes in the company.
On the negative side of things, the subscription price for the share placement represented a 15.5% discount to Koolearn Technology’s average closing price of approximately HK$35.49 for the past ten consecutive trading days prior to the share placement. Also, a share placement could potentially suggest that Koolearn Technology’s share price has peaked, since companies typically tend to issue shares when they perceive their stocks’ valuations to be high. Koolearn Technology’s share price has more than tripled since its IPO in March 2019, and the stock trades at a premium to its peers as highlighted in the next section of this article.
Valuation And Outlook For FY 2021 And FY 2022
Koolearn Technology trades at consensus forward FY 2021 (YE May 31) and FY 2022 Enterprise Value-to-Revenue multiples of 15.9 times and 9.9 times, respectively based on its share price of HK$36.65 as of September 18, 2020. Since its IPO in March 2019, Koolearn Technology has traded between four and 21 times consensus forward next twelve months’ Enterprise Value-to-Revenue.
Notably, Koolearn Technology is valued by the market at a premium to most of its online education peers. With the exception of GSX Techedu (GSX) which trades at 16.9 times consensus forward next twelve months’ Enterprise Value-to-Revenue, Koolearn Technology’s other peers, TAL Education Group (TAL), Youdao (DAO), China Distance Education Holdings (DL) and China Online Education Group (COE), are valued by the market at consensus forward next twelve months’ Enterprise Value-to-Revenue multiples in the 1-9 times range.
Market consensus expects Koolearn Technology’s revenue to grow by +64% and +61% YoY to RMB1,772 million and RMB2,885 million in FY 2021 and FY 2022, respectively. Sell-side analysts also see Koolearn Technology’s headline net loss widening from -RMB785 million in FY 2020 to -RMB845 million in FY 2021, prior to narrowing to RMB586 million in FY 2022.
The key risk factors for Koolearn Technology are a longer-than-expected taken for the company to be profitable, stiffer-than-expected competition from existing players and new entrants, and new regulations that have a negative impact on the Chinese online after-school education sector.
Note that readers who choose to trade in Koolearn Technology shares listed as ADRs on the OTCBB (rather than shares listed in Hong Kong) could potentially suffer from lower liquidity and wider bid/ask spreads.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.