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Chinese Government Issues a Directive

By Scott Chan on March 16, 2018

TAL Education (NYSE: TAL) has removed two rigorous courses from its syllabus due to new government regulation. China’s education ministry has banned off-campus training institutes (which includes after-school tutoring classes) from holding primary and secondary school-level exams or competitions. This is probably the ministry’s strictest mandate ever on the after-school tutoring sector.

The two classes removed are the International Mathematical Olympiad and the XRS Cup. As you may guess from the names, both are highly competitive courses. TAL does not break down its revenues into individual course level so it’s unknown how much the removal of the two courses will cause TAL.

The education ministry now also explicitly forbids advanced syllabus teaching. This means that the likes of TAL cannot teach high-school material to middle-school students or teach middle-school material to primary-school students. Tutoring companies will need to submit their curriculum and syllabus to the government for review.

On a more positive side of the new regulations, the education ministry also intends to tighten licensing rules for tutorial service providers. This would benefit legitimate tutoring companies like TAL because licensing rules in some parts of China have traditionally been pretty lax, which has allowed many local small tutoring companies to get licenses even if they did not have the greatest qualifications.

If the Chinese government follows through with stricter enforcement of licensing regulation, that will likely remove some competition for TAL, a positive. We note that TAL and its largest rival New Oriental Education together only own about 4% market share, so there is still plenty of untapped grounds here.

We currently have TAL rated as a “hold” with the suggested buy-up-to price at $35. When we first recommended the stock, we noted that unless the Chinese government reformed its educational system in a detrimental manner to TAL, the demand for private tutoring should continue to strongly grow. Now the government has taken concrete action to try to reduce the pressure placed on young students. We don’t think what’s announced so far will significantly impact TAL’s growth potential because parents will continue to seek ways to give their kids an edge, but if this is the first step of more restrictions on tutoring companies to come, then we’d be concerned.

The stock trades at about 68-times projected forward twelve-month earnings, so it’s richly valued based on rising growth expectations. We think the company can deliver, but if the Chinese government handicaps the tutoring sector then all bets are off.

We have moved the stock to our watch list and may decide to sell it even though our reference fund Tiger Global has added to its position in the latest reported quarter. We have more research and analytic work to do before we make a decision.

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