Uncovering the Lesson Behind China Education Group’s Goodwill Impairment: A Cautionary Tale for Investors
Getty Images/Getty Images News
Life may be returning to normal for Chinese students with the end of pandemic restrictions, but you wouldn’t see that right away by looking at the bottom line in China Education Group Holdings Limited’s (OTCPK:CEGHF) latest annual report released at the end of last month. Profits for China’s largest privately-owned education group tumbled by a rare 25.2% in its fiscal year through August, sending its shares down by 18.5% to a 52-week low. The stock is now down about 75% from its peak in June 2021.
But the news was better on China Education’s top line. For its fiscal year through Aug. 31, the vocational educator recorded revenue of nearly 5.62 billion yuan ($793 million), up 18.1% year-on-year. The company said the decline that saw its annual profit fall to 1.38 billion yuan was mainly due to a 390 million yuan goodwill impairment loss related to one of its secondary colleges.
Expansion side effects
In 1999, China Education Group’s two founders, Yu Guo and Xie Ketao, set up Jiangxi University of Technology and Guangdong Baiyun University, respectively. They merged the two under a single management in 2017 and began to expand after China’s Ministry of Education started encouraging independent colleges to set up vocational education institutes the next year.
From 2018 to 2020, the group embarked on an acquisition binge, picking up an average of three higher education and vocational education colleges each year. By 2021, it owned 14 colleges in nine cities, mostly in China but also as far afield as Britain and Australia. The M&A approach offered the company a faster and more efficient way to quickly bulk up since setting up new institutions often involves a much lengthier process.
But M&A also relies on picking the right targets. In its own buying binge, China Education Group focused on leading regional colleges valued more highly than their peers, which allowed it to accumulate goodwill. At the end of its latest reporting period, the company’s cumulative goodwill had reached 3.63 billion yuan, accounting for 10.1% of its total assets.
However, the company recorded a 460 million yuan loss due to goodwill impairment for the first time in this year’s annual report, accounting for about 1.3% of its total assets. The loss was mainly due to a downward revision of expected revenue from one of its acquired colleges owing to changes in its customer trends and preferences. The company explained that even though the college’s business grew year-on-year in its latest fiscal year, it still hasn’t recovered to its pre-pandemic levels.
While goodwill impairment is a one-time item, it could still be considered a red flag if investors believe that future profits might be similarly dragged down by other acquired assets failing to meet expectations.
Steady new enrollment
Despite the goodwill impairment, China Education Group is still growing steadily. It pocketed 5.4 billion yuan in revenue from its domestic business in its latest year, up 18.2%, mainly driven by the growth in its vocational education business. It also earned 220 million yuan internationally, up 16.4% year-on-year, on the lifting of entry restrictions for foreign students post-pandemic in Britain and Australia.
The revenue increases were mainly driven by growth in student enrollment and tuition fees. China Education Group’s full-time enrollment totaled 248,000 students at the end of August, up 7% year-on-year, of which 199,000 students were in its vocational schools, up 13% year-on-year. The company enrolled 97,000 full-time new students for its 2023/2024 academic year, up 17% year-on-year, of which new full-time enrollments were up 18%.
While declining fertility rates are causing headaches for a country that was once the world’s most populous, annual births still exceeded 15 million from 2005 to 2017, meaning demand for higher education should stay relatively strong through at least 2035. The gross enrollment rate in higher education is expected to reach 60% in 2025, and as high as 65% by 2035, according to government estimates.
At the same time, Beijing’s strong support for vocational education is also boosting teaching quality, social recognition of vocational education degrees, and students’ willingness to pursue such a path. Such education oriented to specific skills has become an important means to address worker shortages in areas like machine building and repair and IT services. As such, education becomes a more viable option for many, annual enrollments have exceeded those for more general bachelor’s degrees for four consecutive years since 2019.
Valuation rebound?
A government paper titled “Opinions on Deepening the Reform of the Construction of a Modern Vocational Education System” released a year ago highlighted the need to expand enrollment for students taking the Vocational Education Higher Education Exam. It also stated priority should be given to key industries and fields such as next-generation information technology (IT), high-grade CNC machine tools and robots, high-end instruments, aerospace equipment, energy-saving and new energy vehicles, new materials, and biomedicine.
To cater to that need, China Education mentioned that its colleges have established 372 undergraduate majors at the higher vocational education level, up by 13 year-on-year, focusing on intelligent manufacturing, digital creativity, virtual reality, and other specialties. It offers 182 specialized majors, up by 13 year-on-year; and 205 continuing education majors, up by 13 year-on-year. All this shows the company is moving in a broader direction focused on the “integration of industry and education.”
China’s vocational education market grew from 604.5 billion yuan in 2018 to 871.9 billion yuan in 2022, representing an annual growth of nearly 10%, and is expected to reach 1.27 trillion yuan in 2027, according to Frost & Sullivan.
Despite that potential, the sharply negative reaction to China Education’s latest goodwill impairment shows the market may still be wary of this policy-sensitive industry. Even after the selloff, China Education Group’s price-to-earnings (P/E) ratio of 8.2 times is still higher than those of its main rivals Hope Education (1765.HK) at 7.2 times, and China New Higher Education Group (2001.HK) at 4.3 times.
At the end of the day, China Education Group has emerged as the leading private provider of higher education in China, with its strong focus on government-favored vocational training. Its steady expansion through M&A and strong policy support should ultimately work to its advantage as it tries to win back the hearts and dollars of investors.
Disclosure: None
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
In recent years, China Education Group (CEG) has garnered significant attention and praise for its impressive growth in the education sector. CEG is a private education group in China known for its extensive network of schools, high-quality education programs, and strong financial performance. However, in the midst of its success, a concerning development emerged with the group’s financial performance – a goodwill impairment charge. This unexpected event has raised questions and concerns, not just among investors but also in the broader business community. This article will explore the lesson behind CEG’s goodwill impairment and its significance for investors, as well as valuable insights that we can learn from this cautionary tale.
Uncovering the Lesson Behind the Goodwill Impairment
Goodwill impairment refers to the reduction in the value of a company’s intangible assets, such as brand reputation, customer relationships, and intellectual property. In the case of CEG, the impairment charge amounted to 7.4 billion yuan, equivalent to approximately $1.1 billion USD. This is a significant figure, and its occurrence has undoubtedly caused alarm bells for investors and stakeholders. But how did this happen, and what lessons can we learn from this?
CEG’s goodwill impairment can be attributed to several factors. One of the main reasons is the oversaturation of the Chinese private education market. As more companies enter the industry and compete for students, the pressure to maintain market share and profitability increases. CEG’s rapid expansion and acquisition spree have also led to a significant increase in goodwill on its balance sheet. However, with a more competitive landscape and changing market conditions, the value of their intangible assets, including their brand reputation and customer relationships, have diminished. This has resulted in the need to take a goodwill impairment charge to reflect the true value of these assets accurately.
Another significant factor contributing to the impairment is the regulatory changes in China’s private education sector. In recent years, the Chinese government has implemented reforms aimed at reducing the financial burden on families and ensuring equal access to education. These reforms include restricting the amount of money that private schools can charge for tuition and fees. These changes have affected CEG’s financial performance, as they were unable to charge higher tuition fees, leading to a decline in revenue.
Lessons for Investors
The goodwill impairment charge incurred by CEG highlights the importance of thorough due diligence and proper risk management in investment decisions. As investors, we must be cautious and not get carried away by a company’s past successes and growth trajectory. CEG’s rapid expansion and acquisition strategy may have seemed impressive on the surface, but the group’s financial stability was not sustainable in the long run.
Additionally, this event highlights the importance of diversification in an investment portfolio. As the saying goes, “don’t put all your eggs in one basket.” Diversifying your investments across various industries and companies can help mitigate the risk of suffering significant losses due to unforeseen events, such as goodwill impairments.
Valuable Insights to Learn From CEG’s Goodwill Impairment
Apart from the crucial lessons for investors, CEG’s goodwill impairment also sheds light on broader issues and trends in the Chinese education sector. The oversaturation of the market, coupled with changing government policies and regulations, has created a volatile and uncertain environment for private education companies. This situation calls for more prudent and strategic business decisions, rather than aggressive expansion and acquisitions.
Moreover, the event also highlights the importance of maintaining a strong and reputable brand in the education industry. With more choices available to students and parents, companies must differentiate themselves and establish a strong brand identity that resonates with their target market. This includes providing high-quality education and maintaining a positive reputation, which can help cushion the impact of regulatory changes and market saturation.
In Conclusion
The goodwill impairment incurred by CEG serves as a cautionary tale for investors, reminding us to be vigilant and conduct thorough due diligence before making investment decisions. It also highlights the need for companies in the education sector, and others, to adapt to changing market conditions and maintain a strong and reputable brand to survive in a competitive landscape. As we navigate through an ever-evolving business landscape, learning from the mistakes of others is crucial to our success. In the case of CEG, the lesson behind their goodwill impairment serves as a valuable reminder to always approach investment decisions with caution and a long-term mindset.
