Company Focus: The podcast discusses New Oriental Education (EDU), a Chinese education service company, highlighting its history of strong capital compounding and recent challenges due to regulatory changes in China.
Regulatory Impact: New Oriental's stock experienced a significant drop due to China's "double reduction" policy, which aimed to reduce students' homework and after-school tutoring, causing a 95% stock collapse in 2021.
Business Resilience: Despite regulatory challenges, New Oriental has shown resilience, rebounding 350% from its lows, and is considered undervalued by the guest, who cites the company's strong brand awareness and ethical leadership.
Financial Strength: The company boasts a fortress balance sheet with $5 billion in cash and a strategic investment in East Buy, a publicly traded company, which together represent a significant portion of its market cap.
Capital Allocation: New Oriental has committed to returning 50% of net income to shareholders, and there is ongoing dialogue with major shareholders to potentially increase this payout, reflecting a shift towards more shareholder-friendly capital allocation.
AI and Market Dynamics: The discussion highlights the potential impact of AI on the education sector, with New Oriental leveraging AI to enhance its offerings, though concerns about increased competition and market fragmentation remain.
Strategic Diversification: The company's foray into live-streaming e-commerce, initially to provide employment for displaced teachers, has become a profitable venture, illustrating its adaptability and strategic diversification.
Transcript
You're about to listen to yet another value podcast. Today's episode we have Shu from Guinea Value. Shu has a really we're we're talking about New Oriental Education. The ticker there is edu. See the full disclaimer at the end of the episode for all the risks and everything associated with international stocks. But she has a really interesting perspective on this business because I won't spoil it here. He but he's just got a lot of insights that your average person reading a bunch of SEC filings wouldn't have because again I won't spoil that here but I think it's a really fascinating idea. We have a very interesting conversation about all sorts of stuff and it's not just about EDU. We talk about all sorts of stuff on risks of business capital allocation all that he brings a lot of really interesting anecdotes that look I think you're going to enjoy. I think this is unique podcast. We're going to get there in one second but first a word from our sponsors. Today's podcast is sponsored by Alphacense. Look, Alphas and Satikas are two of my longest time uh subscriptions. They're two of the podcast longest time sponsorships. I I love them both and I I'm so glad they merged. The product is awesome. I've done so much work with them. I consider it probably not probably definitely the most valuable subscription I've got between AlphaSense versioning AI tools. They're getting better every month and particularly the expert library on both their uh on both them. Look, I I'll give you a little secret. I I'm always pushing myself to be a better investor. And one of the ways I'm trying to do that is I've pushed myself to once a week I do an expert call on a company or a sector that I'm researching come rain or shine. And it's just a really interesting way to be tapping into new ideas, people who are actually operating, get out of the spreadsheets, get out of the SEC filings and actually talk to somebody about what's going on in industry. I I do that myself out of pocket. AlphaSense doesn't pay. Tigas doesn't pay. That's just me. But I I I mentioned that because look, I I I think it's really continued to help improve me as an investor. You'll notice it in the podcast when I talk to people. I do expert calls on the companies we're going to discuss and I just show it like I I get real value out of it. And if you're a fundamental investor interested in learning more, diving deeper, I think you will, too. So, Tegan Southense, I I love the product. They've been a longtime sponsor and I'm happy to keep having them on the podcast. All right. Hello and welcome to the yet another value podcast. I'm your host, Andrew Walker. with me today. I'm happy to have on from Guinea Value. Shujam Shu, how's it going? >> I'm doing great. Thank you for having me, Andrew. >> I I I'm really excited about this. Uh I was telling you before, I think your background on this company is it's not a company I would normally follow, but with your background, I think it's super unique. So, before we get there, quick disclaimer. Nothing on this podcast is investing advice. Always true. Maybe particularly true today because we're going to be talking about an international stock. So, that carries all sorts of extra risks and all of that sort of stuff. But shoot, the company we are talking about today is New Oriental. They do trade domestically. The ticker is Edu, but obviously New Oriental. People might be able to guess this is Chinese edtech. Uh just love to toss it over to you. What is New Oriental and why are they so interesting? >> Yeah, so New Oriental is an education service company based in China. Uh they were founded by Michael Yu back in 1993 and they went public um on the New York Stock Exchange in 2006. So if you bought them at IPO and they you hold them until um July the 20 of 2021, you would have compounded your capital over that 15 years at about 28% per year. So uh it's a very successful compound but then if you look at the chart the stock collapsed 95% because of a policy that come out from China. So that's the ultimate stress test of this company and from the low it has come up about uh 350% and I believe it is very undervalued. So, so it's it's quite a saga and um uh other than the episode in 2021 which we can uh get a lot more in depth with uh uh there is another incident in two back in 2012. This is actually a pretty famous Chinese ADR in the US because muddy waters shorted the stock like they they came up with a short report. the stock like on that day lost 35% of its market cap and a pre-split uh the reverse split um I think it went from $20 to like high single digit uh however the investigation found nothing wrong because Michael had is one of the most ethical entrepreneur not just in China but from all the companies that I cover on global bas basis he's probably one of the most ethical so nothing was found guilty so the stock recovered and he bought back shares. He per personally added uh bought a lot of shares at the bottom as well. He issued more options to his employee to to uh incentivize them. So uh that was another small episode. So So this is a story battleground stock that has compounded very successfully. I believe it will continue to do so. I've got a lot of questions and I had forgotten about the the muddy water short, but I I do want to dive into a lot of questions, but I think what's particular here is you've got some background and some interesting insights to the space. Do you just want to come on? I I mean, you know, if I was having a cancer researcher on the on the podcast to talk about cancer research and we didn't to talk about a cancer stock and we didn't mention that they knew what they were talking about, I I'd be remiss. So, I'd love to just talk about because I think your background here just led so much credence and interest to the argument. Do you want to talk about that? Yeah, of course. Of course. So, uh I personally funded a business. So, so New Oriental started off as uh helping students in China to uh come to the United States. Uh so, it's overseas test prep like GRE, GMAT, TOEFL, IELTS and uh uh overseas consulting businesses. So, I I did my undergrad at Cornell University and I did my PhD at MIT. So in my first year at MIT, you know, as as the acronym PhD implies, poor, hungry, and driven. So I and I I I was, you know, I my my current wife, we she just become my girlfriend. I want to make some extra bucks. So me and my partner, we started a a consulting u overseas consulting business that does exactly the same as the Oriental. So I I know this space very well. grew the business very successfully from 2012 to all the way to 2019. >> Can you just say exactly what your business was doing because you said overseas consulting but I don't think you said what you guys were doing. >> Yeah. So um because the cultural and the language differences the Chinese students have a lot of difficulties to craft the essays and to prepare for exams. They don't know uh how to apply you know the online common app system and and all and so on. So we help them with uh with streamlining their entire application process providing them with guidance uh that that that's you know in the US it's like you know we we all the most US students probably applied uh for colleges on their own but in China it's very difficult it's it's a very high barrier of entry type of uh task that that needs help so so we we grew that business to about 3% of the study abroad for US graduate school of the market here and we compete directly with new Oriental and I respect Michael and all the consultants there tremendously that we we you know the chief operating officer one of the chief COOs uh we we hired was coming from he actually came from New Orientto and he's of top caliber a very strong execution skills and very excellent services. But we uh at the end of last year, we we sold the business because of, you know, after Trump got elected, I I directly called my partner who's the CEO of the company, and I said, "We should get rid of this thing because it's not going to work." And uh we we were able to sell the business at a severe discount to to what what it would be worth because, you know, the co times was very difficult. We even take on a revolver uh to to keep the business afloat. It helped me tremendously to manage working capital and marketing team and so on and u it was extremely tough and then Trump got elected. I was like this is endless play again. I just want to out of it um completely. So um uh we sold the business and um this year we are seeing IDP which is Australia business at administer more than 50% of the global exam like the stock utly greater if you like a flywire from where where it went public it's done like more than 70% and uh uh if you and and if we still have the business this year we're going to lose millions of dollars of of month and um however what is impressive about new oriental the market is not happy that they are guiding overseas consulting and services uh with a minus uh with like minus4 to 5% growth for this year despite all the visa craziness and all the Trump possibility and everything and yet uh u other players me and a lot of the colleagues and um peers that I know in that industry are getting decimated in absolutely brutal fashion. So, so declining 45% I think it's extremely impressive. That's why I'm very bullish on the start. They will come back stronger than anyone else just like they used to. >> I I think that's such a unique insight, right? Again, it it Chinese tech you don't understand it and then you hear you hear down 5% you're like, "Oh, that's bad." But it's one of those classic things. Yeah. But the market's down 30 and you're down five. You're taking huge amounts of shares and if the market ever stabilizes, normalizes or heaven forbid grow, you know, imagine what that has. So I just think that's such a unique insight. Let me let me just start with a question I like to ask every guest. Market's competitive place, right? This stock is it's actually pretty well covered. I was surprised, you know, JP Morgan's got some research. I I think I saw Goldman analyst. There were several other really big banks analysts on the call. So just ask you market's competitive place. The stock's well covered. What are you seeing that the market's missing that makes this an alpha opportunity? >> Yeah. Yeah. So I have talked with many uh people on the buy side and the sell side not just in the US but in China as well. Um their understanding of this industry is probably not as granular as someone who has fate in this industry for uh about 12 years uh uh like myself. And in addition uh they they don't seem to have a lot of the sources of information um such as you know how how difficult it is for the smaller players because the smaller players they're not public so that information is not as well covered. In addition this is a stock that went down 95% because of a policy terrorisk back in 2021. So, so what happened back then was you know I was being uh so I went just went back from US to back to China. So I was isolated in a hotel room for 14 yes 14 days two weeks uh uh in Shenzhen and on July the 24th or 26th I forgot there was a document that came out of called 42nd document and that document basically says we want to have a double reduction to lessen the burden for these students and what double reduction means is first we are going to reduce the amount of homework that students have to do and secondly we are going to reduce the afterchool um a tutoring there is so that that thing you know I remember vividly it was like at 400 pm back in Shenzhen so it's like 4 4 a.m. in the US and then you know in the pre-market session edu and the towel tu they went down 70% 90% respectively and like that collapse is just like so epic and I I think once you have something like that it's sort of like the banking industry like for for many years after the great recession the great financial crisis people still have this stigma associated with that industry they don't want to touch it they are afraid that this might happen again. But my variant perception is that precisely because it happened in 2021 and precisely because the Chinese consumer economy is not doing well and precisely because of a lot of the policy that come out of that 42nd document, it makes edu more resilient. And I'll give you a couple examples. for example. So, so in nowadays, so in order to operate a school or learning center in China, you have to have something called a school running license. And those license are rarely issued if not at all in the in China nowadays. That's the first one. And secondly, just like the tobacco industry, it is like if you advertise in a noticeable fashion, you immediately get killed. So people can't advertise much at all compared to before 2021. So before 21, you go to a bus stop and it will be like ads all over the place like education, send your kids here, send your kids there and like the government is like no, the kids are like they they are being butchered here. So, so stop all that. A and so now there are no advertisement. So, brand awareness is extremely important. And Tao and EDU have the highest brand awareness in China. No more licenses. So supply is significantly constrained and um therefore so it's sort of like a tobacco that another thing is that this industry is very very sticky and I say that because it has been around for more than a thousand years since the tongue dynasty uh the Chinese system like bureaucratic system is con constituted by you know taking exams climb one ladder at a time uh to become the top officials you have to take exams it's always exam and uh preparation uh oriented and you know during the renaissance times I remember like vultire and a lot of like renaissance great thinker from the west specifically said this kind of meritocracy is exactly what we need in the west and so so this taking the exam and excel type of uh uh system rather than holistic review like we have in the US will always be here and it's very resilient and as a um I remember there's an anthropologist clifold gears who said culture is a web of significance that we ourselves have spun once we spawn that culture of a web of significance it's very difficult to get out of it's extremely sticky and we are seeing that so after the crackdown what the government noticed is that the parents are just as competitive as ever in sending their kids to all sorts of tutoring schools and because you no longer have the scale that is provisioned by a tal and edu the price for that is actually higher for the middle class income like families in China it's more burdened not less and it's just as competitive so the government is sort of like one eye open another eye closed and like you you guys can come back and do this again so so the profitability of edu has eclipsed what it was before the crackdown, but the stock is nowhere even close to where that was. That that's because people are scared. >> True. I I've got to be honest, I think this is the first time someone's used uh Renaissance history and Renaissance uh theory to to pitch stock, but I love that pitch. It's really great. And I think people are you've obviously got deep insight to the sector. But let me just slightly push back here, right? We have we've started this podcast off by let's put Muddy Waters aside, right? We started this podcast off by talking about two tail risks that has hit the sector. The big big one where I do remember waking up and seeing these stocks down 70%. Was was Bill Wong from March Ghost in this stock? I think he might have been. I can't remember for sure, but >> do you know >> I don't think he's in this one. He's in Tens Music. >> Okay, I know he's in I thought he was in this one too, but we've talked about regardless we've talked about two different tail risks hitting this company, right? The first and the big one 2021 government crackdown on advertising everything. and the second smaller just one piece of the overall business but the overseas consulting business that you talked about and I do hear you but I worry I I've got this concept of risk writing right and what it is is kind of you buy a company and it goes up 15% per year for eight years and you're like this is a great business it's a compounder whatever and then in the ninth year you know there's that old the turkey thinks the farmer his friend for a thousand days and then he gets to head up risk writing is kind of like that you get 15% per year you think it's a great compounder and then in the ninth year the axe comes down and that axe could be you know Google answers your market or the government changes the regulations all that sort of stuff. In this case, in 2021, it was the government changes their the regulations. In 2024 or 25, it was Trump trades it. And I just have to wonder like, hey, this might generate alpha if you just looked at your screen and held it for two or three years. But are you actually generating alpha or are you kind of doing that risk writing and you know in 27 the government comes and says, "Hey, actually we're changing the rules again. We don't like this." Does that make sense? >> Yes, absolutely. So, so um I I guess we can view the volatility as uh as risk but to me you know before the double reduction uh uh act that come out the stock was trading at like 30 40 times earnings. To me that's risk because it the valuation is so high and after it got butchered the val the market only gives valuation to the overseas business and the K2 K2 is completely wiped out like it's not in their valuation and all the cash on the balance sheet is not so so at that time although the perceived the risk is greatest but actually the risk is dimminimous and Now when we look at a business you know my view like many value masters that the greatest risk is the so-called permanent capital loss can maybe we invest in this thing and we get killed it goes into restructuring or bankruptcy court and then we lose all the capital. So I I think that analyzing the balance sheet is important for this business. you know as as Buffett said in the last annual meetings he said I spend a lot more time analyzing balance sheet than income statement which is different from Wall Street so so the balance sheet of the business this this is really a fortress balance sheet so so the when I reach out to you I think the business was trading at 7.1 or 7.2 billion uh net today I think $7.8 billion at $48 or change of per share market price out of that 7.8 eight or whatever market cap $5 billion is cash. Now one thing with this business that it has one of the most beautiful business models which is negative working capital business model. So when I was doing broadsy which is my own company you know we used to so we we when a kid comes like a freshman student come to us she pays that $10,000 uh uh for service upfront and we provide that service over a three four year time period and after we provide the service we pay the consultants especially the foreign consultants and such. So, so the money comes up front and the cost goes out later. So, you have this negative working capital with a huge amount of the quote unquote float that we can use to you know invest in you know back then I was investing the stock market using that capital and if you just do 10% then your free cash flow margin changes from 30% to 40% per year. So, so it's a very cash generated type of business, negative working capital model and uh uh so they have five billion. Of course, uh if you want to be conservative, the deferred revenue, the the things that you have not provided service for, you exclude that that's two billion. >> So, it has a net cash of $3 billion. >> And after the double reduction, you know, a lot of the teachers have to go home or whatever. So Michael being a very ethical entrepreneur wants to think of something to accommodate these remaining teachers as much as possible. So they started a separate business called New Oriental that called East by Select. So it's a live stream e-commerce business that primarily sells agricultural products uh for various smaller cities and locals and through that live streaming platform it and also a tourist new business called a tourism business. It helps the local governments tremendously uh because now the farmers can sell their pro agricultural products. Now they can attract more tourists to their cities and bring fiscal revenue and through those two ways uh two prongs it further enhance its relationship friendly relationship with the local government uh to yeah and uh just to add one more thing is that they hold 57% of East Dubai which is a publicly traded company on on the Hong Kong stock exchange and based on yesterday's close. Uh that 57% stake is about $3 billion. >> I don't know. I didn't even see that when I was looking at it. That's crazy. >> So if you look at this east by uh uh which is three billion and you have a net cash net excluding all the deferred revenue of three billion add together six billion. So you have this $6 billion and the market cap is 7.8 and it was even lower when I reached out to you. So it's like $1.8 billion dollar of net market cap excluding those two divisions and the next year they are going to generate a free cash flow of more than $500 million more like $550 million. So >> no no I I mean look it's all sound incredible. Let me try and push back on a few things. The first thing I did not know about their agricultural live stream business. Uh let me ask you I mean this is a business that it's new oriental education and you say hey this is great for them they take these people who would have been out of work because of largely the Trump policies and everything and give them a job but I hear hey a company expanding into agricultural live stream from education like I don't get it and now I do know like Chinese companies kind of like Japanese companies all they have their pies and every tentacle and everything but when you say it it sounds oh cool they're doing this and then you think about it, you're like, wait, what? Why? So, I just love to like, wait, what? I'd love to ask that. >> Yeah. So, if you recall back in 2021, uh uh so the the the policy killed like the K to2 temporarily at least for a year or two. U Michael doesn't want to fire all those teachers and want to find something for these teacher to do. So, it was really unintentional. He was not thinking of building like this you know in terms of market cap this big a business but he was just trying to solve the problem for the teachers such that they still get a job they still get a salary uh so they don't have to go back to the rural area where they come from for many of them so however there is a one guy who who has already left the company called he and you know Tik Tok was taking off in 2021 2022 remember meta was killed like all this all the fear like Tik Tok was doing everything right over those two-year period and Tik Tok was growing so fast and this live stream just went phenomenal and and there were so many people buying and uh it's it just becomes an incredibly uh profitable business for this company that grows very quickly. So, so it it's it's sort of something that was done unintentionally just to try to solve the K to2 type of uh issue with the teachers but it actually u however uh it is not a focus for them and remember there's another thing is uh you can't do a lot of advertising so they Michael and the all the executives they leverage this platform uh to do brand advertisement for themselves Because you can advertise like agriculture products like your platform that's fine but it associate with with new oriental and they can talk about books talk about life and so on to to to u make people be more aware of their brand so it actually has some synergy with their education business which you can advertise let's go to the balance sheet so you are right right this is a fortress balance sheet they've got all this cash they've got the investment I I hadn't even picked up. I just saw short-term investments. I assumed that was short-term. I didn't think that was, you know, 55% of a publicly traded Hong Kong stock exchange. But they've got four and a half, five billion, whatever, of cash and investments on a 7 and a half, 8 billion mark cap company. That sounds great. And to their credit, they have bought back shares in the past. They came out with their new three-year plan and they said, "Hey, 50% of net income going forward. We're going to return it to shareholders in some way, shape, or form." So they it's not like they don't do capital returns. But you know if I was being critical and I I have been critical of things in the past. If I like financial engineering, I like debt. I like share buybacks. I have friends who do not. But when I look at this and say, "Hey, you got an 8 billion market cap company with five billion of cash on the balance sheet." And yes, there are negative uh there's negative working capital and everything. But if I just looked at it, I'd say, "Hey, your your biggest issue here is actually that yes, the stock might look cheap on kind of an EV to Ebida basis, but the cash drag is really big here." And that's to say nothing of, you know, I I'm sure most investors remember 2012 to 2014, all all the Chinese, you mentioned muddy waters with this short report, but just the overall Chinese market where you'd find these companies. It was like, hey, there are two billion market cap with 1.4 billion of cash on the balance sheet. Why is that? Well, because all they do is raise money and like their whole operations are fraud. I'm not accusing this of that that by any extent, but like I do think that overhang plays when you think, oh, 8 billion market cap, five billion of cash, big cash dragon, this remind this rings a bell of a lot of these stocks that blew up 10 years ago. So, I threw out a lot of thoughts there. I'd love to just kind of get your your thoughts on my thoughts. >> Yeah. Yeah, definitely. Definitely. That's a very valid critique. And I'd like to offer a personal experience. >> Please. Yeah. Yeah. So me and my partners uh in 2019 we we were that was the most profitable year for our previous um education consulting business. We made so much money and for for us like at a small scale and and I I >> anytime anyone says we made so much money I'm very happy for them. Whether it's 20 bucks or $20 million I'm very happy. So, so I I I even had the pleasure and privilege to go to um the central tower in Beijing to be interviewed by one of the very famed host for the 70th birthday of the communist party as a representative the education small uh small company education space. So we made a lot of money all the dividend we so we we we don't like the cash draft. So at the end of every year because we have been expanding and it's negative working capital business model. So we were like why do we need so much cash? Because you know every March the the season comes and the student the cash just turn out. So, so we paid all the dividend out uh uh in January, February of 2020 and then COVID hits like I I I got left out uh from my perspective because like I when I was a PhD at MIT, I I covered the commodity structural market. So I understand oil gas market very well. So so I I put all that capital into the oil gas space in March when oil price went to negative. But the for the business it's not that lucky because the it's already all divied out and our chief operating officer after co hits he left the company. He's like this this industry is down for and this entire sales team like two of the top sales left the company because it you know one of them went to become a government official and the other you know went to music consulting because they think like study abroad is that's the end of it and in Shanghai we have office in Shanghai Hanjo two of the major cities in China were shut down for more than two months like students parents cannot come to visit that that's the first incident And we at at that time we realized the dividend is already paid out. We can't get it back. We have to take on a revolver to the credit of the uh the government. They they they make the interest rate really low. We took the credit out of the revol revolver from construction bank and that saved our ass. And you know in 2021 the business bust back and we start to pay out the dividend again. But that that's a near-death experience. I had to cut a lot of the people on the marketing team for that. And the second one is with edu. So in 2021 July when that double reduction policy come up. So in China a teacher or you know a employee of a certain company if you have stayed with this company for let's say seven years. If I let's say I work for you and you for seven years and you you said you know sure I'm gonna fire you. If you want me to go you have to pay the so-called M plus one salary. So you have to pay my salary that's worth seven months because I have worked for you for seven years plus one which is eight months of salary. So there are a lot of like old employees in your oriental who have worked their tail off for Michael that he has to fire and he has to pay all these folks. You can't say like force majour because these people and and I have h had this unfortunate experience. Some of them would go to the arbitary court and the court in China will always favor the consumers and the employees always like the employer is very unfortunate in China. So you have to pay out. So uh Michael had to pay out something like I think one or two billion dollars because like all these employees are leaving with that and plus one. So as someone who have gone through that kind of near-death experience, he probably has this conservative in his mind. Uh uh so you you have a valid consu critique here. So actually me and another you know I'm not sure if I should disclose but the 13 of us we there are 13 institutional master including myself. I'm the small fish. There are some really big big folks out there. We own more than 10% of this company and uh we we we all admire Michael tremendously and we wrote a very polite letter um to their um uh executive team and we we said we understand you want to preserve $3 billion of cash on your balance sheet. We we did the most stringent stress test of 2021. We think you can survive with that three billion. So perhaps can you consider pay out a bit more than 50% of your net income back to us shareholders? Of course you know I I've already talked with one of their executive on this matter and she said uh once we hike it to 50% we are not going to lower it ever like it will be there forever. That's the first thing and second thing is uh uh they they will uh they usually are conservative. So when they got to like 5% it will usually come out to be seven 8%. So so they they want to be conservative and last year they paid back paid a special dividend and they they bought back like $7 million their shares and they paid a $100 million of special dividend on top of a market cap that's $78 billion. So that's quite healthy capital return. They are uh and I think we are making progress and they are likely to hike the dividend payout ratio but it will take a little bit of time and we we hope it to be win-win. In China we don't engage in that kind of icon type of you know you just go in and like you want to fight everyone. We we try to resolve it peacefully with a double wing type of situation. So, so to echo your concern, yes, we we try to get a payout ratio a little bit higher, but the balance sheet, we we also we understand Michael, we we see it from his perspective. We can understand as someone who has gone through that kind of experience in 2020. I think preserving some cash will be good. >> First, thank you for that story. It's really unique to hear somebody who who can say, "Hey, look, I went through this and this is I think I see it makes total sense to me." You know, my my only worry is like like let's say 2021 was a once in aundred year storm for the industry or something, right? That as we said, this industry b dates back to Renaissance times plus. I I worry that any company that says, "Hey, we've built this company up to weather uh once in a 100redyear storm." It sounds really good. Uh and you know, there is the Buffet any number times zero is zero. But you often find that companies that do this like they're just so over reserved that it's ridiculous. And it at some point it does become a drag on their a drag on the business, right? Like that cash drag is a huge drag because if you're paying 60% of your market cap in cash, then the business really needs to perform for you even to get like kind of stock market like returns, right? I kind of worry that if they're so wedded to this, like as we said, they're returning 50% of ca of net income for the next three years to shareholders and as you said, they tend to be conservative, they'll probably beat that even if they pay back 60%. like that cash balance has just grown bigger and it's just like man I don't know you know there might be structuring or you know could they run this with $2 billion and then every year you know throw another 250 million onto the balance sheet until they hit three billion and then draw it back down or something like it just it feels very conservative to weather for hey what if we have to lay off like half our sales force because of regulatory changes and pay them all huge change of control huge termination fees it just uh feel it feels pretty pretty slow. Um, >> yeah, I go ahead. >> Understood. Yeah. So, so it probably has something to do with the personality of the founder. So, so Michael is really sort of legendary guy. So, so in China there's this so-called national entrance examination for colleges like you have to take this exam like it's a sort of like SAT but a lot more important than SAT. So, he took this exam the first time and he he's not the brightest of its types. let's say that and he he he himself admits that so he didn't do very well so he waited another year took it again and still didn't do that well and he took it again in the third year finally worked and he got into picking university which were one of the top two and but however it's the one of the worst and easiest departments which is the the the language department which is not popular like physics you know that those types of things >> yeah physics all the girls all the glory all the hype I have, >> right? So, so, so yeah. So, so he is someone who is very down to the earth and you know he he actually did not want to take this company public. It's because he had two other partners that really want to get rich like they they they ended up ultimately leaving the company and formed a venture arm which Michael also hold here with it's a very famous called Jungu fun which is a very famous venture capital fund in China that specifically try to help so new oriental sends student out when students go back to China uh Chungu the venture capital fund uh will help them uh uh uh to to launch businesses. So it's kind of like a Y Combinator spin-off over there. Yeah. >> Yes. So it's a sort of a close group, right? That's awesome. And so Michael is from the rural area. He does not want to take the company public. He doesn't care about money. >> But uh and he he's born in 1962 if I remember correctly. So he's 63 years old. We are trying to change his mind and he has already changed his mind quite a bit by you know with all the buyback and dividend but things take time and uh uh we are trying to a gently and friendly nudge and hopefully you know he will get and his mind is actually changing it's changing more and more like cap capitalist oriented in capital return especially since the uh the I mean it's still going to be grow at the the EPA S is going to keep growing at mid mid double digit. So it's not a no growth like slow growing company. It's a very cheap mid teens EPS growth company and the capital return should ultimately uh uh uh increase over time. I I believe I I have faith in Michael. >> Let me let me ask one last question here. Right at Tech, you mentioned the the core business is tutoring students basically, right? training them for these tests and everything. It anyone who's been following the stock market knows AI is here. It's coming and edtech has been the area where I would say just in the public markets you've seen the most disruption. Right? I would point to CHE which was cheat sheets for college students and that business has been crushed. But I I I think it's really impacted and there's a lot of reasons it's really impacted in my opinion education first. First because there's great data online about education, but second because education users tend to be youngsters who tend to be early adopters of educa. Like I I just think it's a it's education is the forefront of AI in my my opinion. I might be slightly overstating there, but I I don't think I'm saying anything too crazy. It strikes me you have an education company that you know they're advertising, but it is expensive. They're offering a bespoke product. Yes, if you can improve the test scores, people will pay anything to, you know, improve their children's test scores. But strikes me that this is a place where AI is is very vulnerable to AI. So, I just want to ask all of that to you. Is is AI a riskier? Or you could come to me and say, "Hey, AI, where you used to need one tutor for every five students, with AI, one tutor for every 20 students. So you get a little bit more, you get better results, so you get more pricing power, you need less tutors, boom, profit margins through the roof, and you've got proprietary data, but because you've got 30 years worth of test scores and training. So I could actually see either route. I'd love to just ask you AI risk or opportunity here." >> Yeah. Yeah. I I I believe you know the fascinating part is really so so in in China the primary school is like uh oneth grade to the sixth grade and then junior high is like uh 7th to 9th and the senior high is 10th to 12th it's it's slightly different here so if for junior high because of that K to9 you know double reduction is primarily focusing on K to9 so you can't teach the kids subject oriented like uh uh courses anymore. So for junior high, how do you prepare for the so-called junk? Like this is the entrance exam to get into the best senior high schools. It's so it's it's a very uh invol rooted if you will. And for junior high since you can't teach the subjects, you have to rely on artificial intelligence. You can't have the teachers anymore. So what they do is that they sell devices So in these devices there would be like uh words and phrases already written. There will be teacher with recorded videos that the students will buy this device take home and uh watch this and there will be teacher in the back end. If you have any question you can ask the teachers and in addition they have so much they have like decades of data of the student behavior. They know what type of student it is and they will provide you based on your learning curve u the corresponding types of questions that help you to climb up the learning curve the best. Like they will first prompt you with easy questions then slightly more sophisticated then cross-disciplinary the most difficult problems in the in the exam. And because they are doing this they no longer need to have learning centers. They don't have to pay the landlord. They don't need schools. They don't have to lease those. They don't have to have classrooms nor teachers. And they they can't the scalability of the business makes the operating margin of that segment actually higher than three. >> Can I pull Can I pull on that for a second? Because what you just described is pansia for a business, right? It's awesome. You get rid of it. But my only counter to that would be, hey, that sounds great, but all of this is AI on the internet. like you're eliminating a lot of the fixed costs. And once you eliminate those fixed costs, don't you expose yourself to you and me tomorrow could go release Andrew Shu's like incredible tutorial, right, with AI, all this knowledge and stuff like don't you expose don't you really lower the barriers to entry? So yes, you've removed the cost, but now the barriers to entry are gone and a thousand products can flood the market. And maybe these guys are the best, but maybe you and I could launch a product that's 95% as good and gets up to 98% as it generates more data and we launch it at, you know, 20% of the cost, 30. I I don't know. I'm just speculating. But it does seem to me like there's the risk that it always sounds great when you take all the margin out, but you take all the margin out and all of a sudden, hey, you know, unlimited demand newspapers, right? Hey, we're going to lose all the we don't need to print everything anymore. We lose all this. And then, oh yeah, but now it's unlimited distribution and there thousand places and all the newspapers are bankrupt. Like that is a loose analogy, but I could see how that holds here. So just want to ask you that question. >> Yeah. Yeah. So Andrew, if we were to start a business like that, we we need to like first need to have a really like star level teacher who is willing to do it for us. >> You went to MIT. I'm relying on you, man. I'm from the south. I can barely read. >> Oh, come on. So, so I I guess you know the best teachers they want the most amount of like commission, right? So, they probably want to go to a bigger platform that can give them that like scale like scale. That's the first one. And secondly, we need to collect a lot of questions. And thirdly, we need to have a lot of the data to really know when to give the student the best type of question, the prompt to help them learn the best. And lastly, we need to have the uh uh the the resources that we put into developing not just the hardware, but the software and the marketing and sales expenses. >> So, it's >> No, that's a great answer. Can I ask you the question in one more way just because as you say this strikes me and I do remember China has like much more superstar teachers than the United States. I say this you know from a literal thousand mile rad 3,000 milei radius but I do remember hearing a lot about the superstar you know I do wonder so new edu does have advantages of this they have the data they have the built-in infrastructure but you know in the United States you've seen a Mr. Beast, Instagram influencers, all this sort of stuff really supplant the legacy networks because distribution became free. Mr. Beast is launching uh you chocolates, right? He's trying to disrupt Hershey's. 10 years ago, I I would have told you no one could launch chocolates and disrupt Hershey's. Will he be successful? Yes. No. I don't know. But you are seeing people build the brands into themselves and capture all the economics. I would point to Joe Rogan. I'd point to Mr. Beast. We could point to any number of examples here. And I I do wonder if I said, "Hey, with all this AI tooling, maybe the celebrity, right, the the celebrity teachers that you're mentioning, maybe they partner with new edu, but they get much higher revenue shares because the celebrity is what drives the signups. The celebrity is what or maybe they say, "Hey, I don't even need new edu as we've seen so many I mean, you know, Joe Rogan 20 years ago would be on SiriusXM." Howard Stern, I think that's obviously a different generation, but his contract with SiriusXM's running up. I wouldn't be surprised if he's launching a podcast. Now, Stephen Cobear, he's getting fired from CBS. I bet you he will make more running a podcast than he was at CBS. So, I just wonder if these superstar teachers that you mentioned, drive, actually, maybe they take more or maybe they just launch their own network. So, that will probably be my last question, but I'd love to ask that because I find this fascinating. >> It's a great question. Actually this had what you described the star teacher leaving the the company to set up their own has happened throughout the existence of the business and the reason for that is if you are a teacher there I mean after all you are getting sort of a fixed salary maybe some incentives maybe some shears but if you form your own studio then you know you can capture all the profit. Yeah. So, so it's almost u has always been the case that the best teachers at edu art they would leave and form their own studios. >> Yep. >> But this market is firstly it's a very fragmented market even in the most concentrated parts like picking where mo and edu both are located there they have a combined market share of only about 15%. So there are a lot of studios uh uh out there uh uh competing with them. So, so competition is probably uh something familiar to them. And uh uh secondly, you have a constant replenishment of new talent that need to go to edu and tell once they have the system that cultivate these teachers, then they just uh every year you know the fresh out grads they will go there and work a couple years maybe they leave. But the system is still the strongest at EDU and of course what you mentioned you know for for the for the hardware and the scalability question you know can we have something like that I think the answer is probably yes for especially for junior high I'm not sure whether it will be the case for the senior high because that the learning quality is just not as good uh uh if you are not like face to face with a teacher especially for senior high where you have a lot of the difficult questions like math, physics, biology, then you want to have someone to see exactly how you think I walk you through that logic, train of logic. So I think and you can see that in retention their senior high school retention rate is something like 80%. But for junior high despite the high operating margin, the retention rate is only 60 70%. So so I I I believe senior high is less of a threat. junior high. Yes, they can be threatened. Uh uh and it will probably be something that if you and I'm already a shareholder and if you end up being a shareholder, it's probably something that we need to keep a close eye on. However, it's so fragmented. I I I feel like there are so many like mom and pop that will be weeded out uh in this long slope with a lot of snow. >> This was great. Well, should I I don't know if you heard my phone was just blowing up. So, I'm sure something terrible or awesome is going on in the portfolio. So, I'm probably gonna have to call this. But you, this is great. She writes.comblog is what I call. But you know what we're going to have to do? You've got to write more. I don't think there's been a post up there since late 2024 that people are after this podcast that people are going to demand more writing, man. You got to we got to get some uh written word up there. >> Yeah. Yeah. I So, I have a substack. I update that and at the end of every year I I will replenish the all the letters uh up there. So so so that substack uh u it's also I think it's just called guinea value. Um I have a substack that I that I replenish almost by monthly basis. >> Perfect. Perfect. >> Yeah. Well, hey this has been a ton of fun. I really this was a really fascinating idea. So, I really appreciate you hopping on and uh I really appreciate you hopping on walking through all of this sort of stuff. And look, we're going to have to have you back on at some point to talk about some maybe it's you do a lot more than just Chinese, so maybe it's something else, but I'd love to have you back on and we'll go from there. >> Sounds good. Thank you so much for having me, Andrew. I have always been a fan. It's so nice talking to you in person finally. >> I really appreciate that. A quick disclaimer, nothing on this podcast should be considered investment advice. Guests or the hosts may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial adviser. Thanks.
Guinea Value's Jingshu Zhang on $EDU
Summary
Transcript
You're about to listen to yet another value podcast. Today's episode we have Shu from Guinea Value. Shu has a really we're we're talking about New Oriental Education. The ticker there is edu. See the full disclaimer at the end of the episode for all the risks and everything associated with international stocks. But she has a really interesting perspective on this business because I won't spoil it here. He but he's just got a lot of insights that your average person reading a bunch of SEC filings wouldn't have because again I won't spoil that here but I think it's a really fascinating idea. We have a very interesting conversation about all sorts of stuff and it's not just about EDU. We talk about all sorts of stuff on risks of business capital allocation all that he brings a lot of really interesting anecdotes that look I think you're going to enjoy. I think this is unique podcast. We're going to get there in one second but first a word from our sponsors. Today's podcast is sponsored by Alphacense. Look, Alphas and Satikas are two of my longest time uh subscriptions. They're two of the podcast longest time sponsorships. I I love them both and I I'm so glad they merged. The product is awesome. I've done so much work with them. I consider it probably not probably definitely the most valuable subscription I've got between AlphaSense versioning AI tools. They're getting better every month and particularly the expert library on both their uh on both them. Look, I I'll give you a little secret. I I'm always pushing myself to be a better investor. And one of the ways I'm trying to do that is I've pushed myself to once a week I do an expert call on a company or a sector that I'm researching come rain or shine. And it's just a really interesting way to be tapping into new ideas, people who are actually operating, get out of the spreadsheets, get out of the SEC filings and actually talk to somebody about what's going on in industry. I I do that myself out of pocket. AlphaSense doesn't pay. Tigas doesn't pay. That's just me. But I I I mentioned that because look, I I I think it's really continued to help improve me as an investor. You'll notice it in the podcast when I talk to people. I do expert calls on the companies we're going to discuss and I just show it like I I get real value out of it. And if you're a fundamental investor interested in learning more, diving deeper, I think you will, too. So, Tegan Southense, I I love the product. They've been a longtime sponsor and I'm happy to keep having them on the podcast. All right. Hello and welcome to the yet another value podcast. I'm your host, Andrew Walker. with me today. I'm happy to have on from Guinea Value. Shujam Shu, how's it going? >> I'm doing great. Thank you for having me, Andrew. >> I I I'm really excited about this. Uh I was telling you before, I think your background on this company is it's not a company I would normally follow, but with your background, I think it's super unique. So, before we get there, quick disclaimer. Nothing on this podcast is investing advice. Always true. Maybe particularly true today because we're going to be talking about an international stock. So, that carries all sorts of extra risks and all of that sort of stuff. But shoot, the company we are talking about today is New Oriental. They do trade domestically. The ticker is Edu, but obviously New Oriental. People might be able to guess this is Chinese edtech. Uh just love to toss it over to you. What is New Oriental and why are they so interesting? >> Yeah, so New Oriental is an education service company based in China. Uh they were founded by Michael Yu back in 1993 and they went public um on the New York Stock Exchange in 2006. So if you bought them at IPO and they you hold them until um July the 20 of 2021, you would have compounded your capital over that 15 years at about 28% per year. So uh it's a very successful compound but then if you look at the chart the stock collapsed 95% because of a policy that come out from China. So that's the ultimate stress test of this company and from the low it has come up about uh 350% and I believe it is very undervalued. So, so it's it's quite a saga and um uh other than the episode in 2021 which we can uh get a lot more in depth with uh uh there is another incident in two back in 2012. This is actually a pretty famous Chinese ADR in the US because muddy waters shorted the stock like they they came up with a short report. the stock like on that day lost 35% of its market cap and a pre-split uh the reverse split um I think it went from $20 to like high single digit uh however the investigation found nothing wrong because Michael had is one of the most ethical entrepreneur not just in China but from all the companies that I cover on global bas basis he's probably one of the most ethical so nothing was found guilty so the stock recovered and he bought back shares. He per personally added uh bought a lot of shares at the bottom as well. He issued more options to his employee to to uh incentivize them. So uh that was another small episode. So So this is a story battleground stock that has compounded very successfully. I believe it will continue to do so. I've got a lot of questions and I had forgotten about the the muddy water short, but I I do want to dive into a lot of questions, but I think what's particular here is you've got some background and some interesting insights to the space. Do you just want to come on? I I mean, you know, if I was having a cancer researcher on the on the podcast to talk about cancer research and we didn't to talk about a cancer stock and we didn't mention that they knew what they were talking about, I I'd be remiss. So, I'd love to just talk about because I think your background here just led so much credence and interest to the argument. Do you want to talk about that? Yeah, of course. Of course. So, uh I personally funded a business. So, so New Oriental started off as uh helping students in China to uh come to the United States. Uh so, it's overseas test prep like GRE, GMAT, TOEFL, IELTS and uh uh overseas consulting businesses. So, I I did my undergrad at Cornell University and I did my PhD at MIT. So in my first year at MIT, you know, as as the acronym PhD implies, poor, hungry, and driven. So I and I I I was, you know, I my my current wife, we she just become my girlfriend. I want to make some extra bucks. So me and my partner, we started a a consulting u overseas consulting business that does exactly the same as the Oriental. So I I know this space very well. grew the business very successfully from 2012 to all the way to 2019. >> Can you just say exactly what your business was doing because you said overseas consulting but I don't think you said what you guys were doing. >> Yeah. So um because the cultural and the language differences the Chinese students have a lot of difficulties to craft the essays and to prepare for exams. They don't know uh how to apply you know the online common app system and and all and so on. So we help them with uh with streamlining their entire application process providing them with guidance uh that that that's you know in the US it's like you know we we all the most US students probably applied uh for colleges on their own but in China it's very difficult it's it's a very high barrier of entry type of uh task that that needs help so so we we grew that business to about 3% of the study abroad for US graduate school of the market here and we compete directly with new Oriental and I respect Michael and all the consultants there tremendously that we we you know the chief operating officer one of the chief COOs uh we we hired was coming from he actually came from New Orientto and he's of top caliber a very strong execution skills and very excellent services. But we uh at the end of last year, we we sold the business because of, you know, after Trump got elected, I I directly called my partner who's the CEO of the company, and I said, "We should get rid of this thing because it's not going to work." And uh we we were able to sell the business at a severe discount to to what what it would be worth because, you know, the co times was very difficult. We even take on a revolver uh to to keep the business afloat. It helped me tremendously to manage working capital and marketing team and so on and u it was extremely tough and then Trump got elected. I was like this is endless play again. I just want to out of it um completely. So um uh we sold the business and um this year we are seeing IDP which is Australia business at administer more than 50% of the global exam like the stock utly greater if you like a flywire from where where it went public it's done like more than 70% and uh uh if you and and if we still have the business this year we're going to lose millions of dollars of of month and um however what is impressive about new oriental the market is not happy that they are guiding overseas consulting and services uh with a minus uh with like minus4 to 5% growth for this year despite all the visa craziness and all the Trump possibility and everything and yet uh u other players me and a lot of the colleagues and um peers that I know in that industry are getting decimated in absolutely brutal fashion. So, so declining 45% I think it's extremely impressive. That's why I'm very bullish on the start. They will come back stronger than anyone else just like they used to. >> I I think that's such a unique insight, right? Again, it it Chinese tech you don't understand it and then you hear you hear down 5% you're like, "Oh, that's bad." But it's one of those classic things. Yeah. But the market's down 30 and you're down five. You're taking huge amounts of shares and if the market ever stabilizes, normalizes or heaven forbid grow, you know, imagine what that has. So I just think that's such a unique insight. Let me let me just start with a question I like to ask every guest. Market's competitive place, right? This stock is it's actually pretty well covered. I was surprised, you know, JP Morgan's got some research. I I think I saw Goldman analyst. There were several other really big banks analysts on the call. So just ask you market's competitive place. The stock's well covered. What are you seeing that the market's missing that makes this an alpha opportunity? >> Yeah. Yeah. So I have talked with many uh people on the buy side and the sell side not just in the US but in China as well. Um their understanding of this industry is probably not as granular as someone who has fate in this industry for uh about 12 years uh uh like myself. And in addition uh they they don't seem to have a lot of the sources of information um such as you know how how difficult it is for the smaller players because the smaller players they're not public so that information is not as well covered. In addition this is a stock that went down 95% because of a policy terrorisk back in 2021. So, so what happened back then was you know I was being uh so I went just went back from US to back to China. So I was isolated in a hotel room for 14 yes 14 days two weeks uh uh in Shenzhen and on July the 24th or 26th I forgot there was a document that came out of called 42nd document and that document basically says we want to have a double reduction to lessen the burden for these students and what double reduction means is first we are going to reduce the amount of homework that students have to do and secondly we are going to reduce the afterchool um a tutoring there is so that that thing you know I remember vividly it was like at 400 pm back in Shenzhen so it's like 4 4 a.m. in the US and then you know in the pre-market session edu and the towel tu they went down 70% 90% respectively and like that collapse is just like so epic and I I think once you have something like that it's sort of like the banking industry like for for many years after the great recession the great financial crisis people still have this stigma associated with that industry they don't want to touch it they are afraid that this might happen again. But my variant perception is that precisely because it happened in 2021 and precisely because the Chinese consumer economy is not doing well and precisely because of a lot of the policy that come out of that 42nd document, it makes edu more resilient. And I'll give you a couple examples. for example. So, so in nowadays, so in order to operate a school or learning center in China, you have to have something called a school running license. And those license are rarely issued if not at all in the in China nowadays. That's the first one. And secondly, just like the tobacco industry, it is like if you advertise in a noticeable fashion, you immediately get killed. So people can't advertise much at all compared to before 2021. So before 21, you go to a bus stop and it will be like ads all over the place like education, send your kids here, send your kids there and like the government is like no, the kids are like they they are being butchered here. So, so stop all that. A and so now there are no advertisement. So, brand awareness is extremely important. And Tao and EDU have the highest brand awareness in China. No more licenses. So supply is significantly constrained and um therefore so it's sort of like a tobacco that another thing is that this industry is very very sticky and I say that because it has been around for more than a thousand years since the tongue dynasty uh the Chinese system like bureaucratic system is con constituted by you know taking exams climb one ladder at a time uh to become the top officials you have to take exams it's always exam and uh preparation uh oriented and you know during the renaissance times I remember like vultire and a lot of like renaissance great thinker from the west specifically said this kind of meritocracy is exactly what we need in the west and so so this taking the exam and excel type of uh uh system rather than holistic review like we have in the US will always be here and it's very resilient and as a um I remember there's an anthropologist clifold gears who said culture is a web of significance that we ourselves have spun once we spawn that culture of a web of significance it's very difficult to get out of it's extremely sticky and we are seeing that so after the crackdown what the government noticed is that the parents are just as competitive as ever in sending their kids to all sorts of tutoring schools and because you no longer have the scale that is provisioned by a tal and edu the price for that is actually higher for the middle class income like families in China it's more burdened not less and it's just as competitive so the government is sort of like one eye open another eye closed and like you you guys can come back and do this again so so the profitability of edu has eclipsed what it was before the crackdown, but the stock is nowhere even close to where that was. That that's because people are scared. >> True. I I've got to be honest, I think this is the first time someone's used uh Renaissance history and Renaissance uh theory to to pitch stock, but I love that pitch. It's really great. And I think people are you've obviously got deep insight to the sector. But let me just slightly push back here, right? We have we've started this podcast off by let's put Muddy Waters aside, right? We started this podcast off by talking about two tail risks that has hit the sector. The big big one where I do remember waking up and seeing these stocks down 70%. Was was Bill Wong from March Ghost in this stock? I think he might have been. I can't remember for sure, but >> do you know >> I don't think he's in this one. He's in Tens Music. >> Okay, I know he's in I thought he was in this one too, but we've talked about regardless we've talked about two different tail risks hitting this company, right? The first and the big one 2021 government crackdown on advertising everything. and the second smaller just one piece of the overall business but the overseas consulting business that you talked about and I do hear you but I worry I I've got this concept of risk writing right and what it is is kind of you buy a company and it goes up 15% per year for eight years and you're like this is a great business it's a compounder whatever and then in the ninth year you know there's that old the turkey thinks the farmer his friend for a thousand days and then he gets to head up risk writing is kind of like that you get 15% per year you think it's a great compounder and then in the ninth year the axe comes down and that axe could be you know Google answers your market or the government changes the regulations all that sort of stuff. In this case, in 2021, it was the government changes their the regulations. In 2024 or 25, it was Trump trades it. And I just have to wonder like, hey, this might generate alpha if you just looked at your screen and held it for two or three years. But are you actually generating alpha or are you kind of doing that risk writing and you know in 27 the government comes and says, "Hey, actually we're changing the rules again. We don't like this." Does that make sense? >> Yes, absolutely. So, so um I I guess we can view the volatility as uh as risk but to me you know before the double reduction uh uh act that come out the stock was trading at like 30 40 times earnings. To me that's risk because it the valuation is so high and after it got butchered the val the market only gives valuation to the overseas business and the K2 K2 is completely wiped out like it's not in their valuation and all the cash on the balance sheet is not so so at that time although the perceived the risk is greatest but actually the risk is dimminimous and Now when we look at a business you know my view like many value masters that the greatest risk is the so-called permanent capital loss can maybe we invest in this thing and we get killed it goes into restructuring or bankruptcy court and then we lose all the capital. So I I think that analyzing the balance sheet is important for this business. you know as as Buffett said in the last annual meetings he said I spend a lot more time analyzing balance sheet than income statement which is different from Wall Street so so the balance sheet of the business this this is really a fortress balance sheet so so the when I reach out to you I think the business was trading at 7.1 or 7.2 billion uh net today I think $7.8 billion at $48 or change of per share market price out of that 7.8 eight or whatever market cap $5 billion is cash. Now one thing with this business that it has one of the most beautiful business models which is negative working capital business model. So when I was doing broadsy which is my own company you know we used to so we we when a kid comes like a freshman student come to us she pays that $10,000 uh uh for service upfront and we provide that service over a three four year time period and after we provide the service we pay the consultants especially the foreign consultants and such. So, so the money comes up front and the cost goes out later. So, you have this negative working capital with a huge amount of the quote unquote float that we can use to you know invest in you know back then I was investing the stock market using that capital and if you just do 10% then your free cash flow margin changes from 30% to 40% per year. So, so it's a very cash generated type of business, negative working capital model and uh uh so they have five billion. Of course, uh if you want to be conservative, the deferred revenue, the the things that you have not provided service for, you exclude that that's two billion. >> So, it has a net cash of $3 billion. >> And after the double reduction, you know, a lot of the teachers have to go home or whatever. So Michael being a very ethical entrepreneur wants to think of something to accommodate these remaining teachers as much as possible. So they started a separate business called New Oriental that called East by Select. So it's a live stream e-commerce business that primarily sells agricultural products uh for various smaller cities and locals and through that live streaming platform it and also a tourist new business called a tourism business. It helps the local governments tremendously uh because now the farmers can sell their pro agricultural products. Now they can attract more tourists to their cities and bring fiscal revenue and through those two ways uh two prongs it further enhance its relationship friendly relationship with the local government uh to yeah and uh just to add one more thing is that they hold 57% of East Dubai which is a publicly traded company on on the Hong Kong stock exchange and based on yesterday's close. Uh that 57% stake is about $3 billion. >> I don't know. I didn't even see that when I was looking at it. That's crazy. >> So if you look at this east by uh uh which is three billion and you have a net cash net excluding all the deferred revenue of three billion add together six billion. So you have this $6 billion and the market cap is 7.8 and it was even lower when I reached out to you. So it's like $1.8 billion dollar of net market cap excluding those two divisions and the next year they are going to generate a free cash flow of more than $500 million more like $550 million. So >> no no I I mean look it's all sound incredible. Let me try and push back on a few things. The first thing I did not know about their agricultural live stream business. Uh let me ask you I mean this is a business that it's new oriental education and you say hey this is great for them they take these people who would have been out of work because of largely the Trump policies and everything and give them a job but I hear hey a company expanding into agricultural live stream from education like I don't get it and now I do know like Chinese companies kind of like Japanese companies all they have their pies and every tentacle and everything but when you say it it sounds oh cool they're doing this and then you think about it, you're like, wait, what? Why? So, I just love to like, wait, what? I'd love to ask that. >> Yeah. So, if you recall back in 2021, uh uh so the the the policy killed like the K to2 temporarily at least for a year or two. U Michael doesn't want to fire all those teachers and want to find something for these teacher to do. So, it was really unintentional. He was not thinking of building like this you know in terms of market cap this big a business but he was just trying to solve the problem for the teachers such that they still get a job they still get a salary uh so they don't have to go back to the rural area where they come from for many of them so however there is a one guy who who has already left the company called he and you know Tik Tok was taking off in 2021 2022 remember meta was killed like all this all the fear like Tik Tok was doing everything right over those two-year period and Tik Tok was growing so fast and this live stream just went phenomenal and and there were so many people buying and uh it's it just becomes an incredibly uh profitable business for this company that grows very quickly. So, so it it's it's sort of something that was done unintentionally just to try to solve the K to2 type of uh issue with the teachers but it actually u however uh it is not a focus for them and remember there's another thing is uh you can't do a lot of advertising so they Michael and the all the executives they leverage this platform uh to do brand advertisement for themselves Because you can advertise like agriculture products like your platform that's fine but it associate with with new oriental and they can talk about books talk about life and so on to to to u make people be more aware of their brand so it actually has some synergy with their education business which you can advertise let's go to the balance sheet so you are right right this is a fortress balance sheet they've got all this cash they've got the investment I I hadn't even picked up. I just saw short-term investments. I assumed that was short-term. I didn't think that was, you know, 55% of a publicly traded Hong Kong stock exchange. But they've got four and a half, five billion, whatever, of cash and investments on a 7 and a half, 8 billion mark cap company. That sounds great. And to their credit, they have bought back shares in the past. They came out with their new three-year plan and they said, "Hey, 50% of net income going forward. We're going to return it to shareholders in some way, shape, or form." So they it's not like they don't do capital returns. But you know if I was being critical and I I have been critical of things in the past. If I like financial engineering, I like debt. I like share buybacks. I have friends who do not. But when I look at this and say, "Hey, you got an 8 billion market cap company with five billion of cash on the balance sheet." And yes, there are negative uh there's negative working capital and everything. But if I just looked at it, I'd say, "Hey, your your biggest issue here is actually that yes, the stock might look cheap on kind of an EV to Ebida basis, but the cash drag is really big here." And that's to say nothing of, you know, I I'm sure most investors remember 2012 to 2014, all all the Chinese, you mentioned muddy waters with this short report, but just the overall Chinese market where you'd find these companies. It was like, hey, there are two billion market cap with 1.4 billion of cash on the balance sheet. Why is that? Well, because all they do is raise money and like their whole operations are fraud. I'm not accusing this of that that by any extent, but like I do think that overhang plays when you think, oh, 8 billion market cap, five billion of cash, big cash dragon, this remind this rings a bell of a lot of these stocks that blew up 10 years ago. So, I threw out a lot of thoughts there. I'd love to just kind of get your your thoughts on my thoughts. >> Yeah. Yeah, definitely. Definitely. That's a very valid critique. And I'd like to offer a personal experience. >> Please. Yeah. Yeah. So me and my partners uh in 2019 we we were that was the most profitable year for our previous um education consulting business. We made so much money and for for us like at a small scale and and I I >> anytime anyone says we made so much money I'm very happy for them. Whether it's 20 bucks or $20 million I'm very happy. So, so I I I even had the pleasure and privilege to go to um the central tower in Beijing to be interviewed by one of the very famed host for the 70th birthday of the communist party as a representative the education small uh small company education space. So we made a lot of money all the dividend we so we we we don't like the cash draft. So at the end of every year because we have been expanding and it's negative working capital business model. So we were like why do we need so much cash? Because you know every March the the season comes and the student the cash just turn out. So, so we paid all the dividend out uh uh in January, February of 2020 and then COVID hits like I I I got left out uh from my perspective because like I when I was a PhD at MIT, I I covered the commodity structural market. So I understand oil gas market very well. So so I I put all that capital into the oil gas space in March when oil price went to negative. But the for the business it's not that lucky because the it's already all divied out and our chief operating officer after co hits he left the company. He's like this this industry is down for and this entire sales team like two of the top sales left the company because it you know one of them went to become a government official and the other you know went to music consulting because they think like study abroad is that's the end of it and in Shanghai we have office in Shanghai Hanjo two of the major cities in China were shut down for more than two months like students parents cannot come to visit that that's the first incident And we at at that time we realized the dividend is already paid out. We can't get it back. We have to take on a revolver to the credit of the uh the government. They they they make the interest rate really low. We took the credit out of the revol revolver from construction bank and that saved our ass. And you know in 2021 the business bust back and we start to pay out the dividend again. But that that's a near-death experience. I had to cut a lot of the people on the marketing team for that. And the second one is with edu. So in 2021 July when that double reduction policy come up. So in China a teacher or you know a employee of a certain company if you have stayed with this company for let's say seven years. If I let's say I work for you and you for seven years and you you said you know sure I'm gonna fire you. If you want me to go you have to pay the so-called M plus one salary. So you have to pay my salary that's worth seven months because I have worked for you for seven years plus one which is eight months of salary. So there are a lot of like old employees in your oriental who have worked their tail off for Michael that he has to fire and he has to pay all these folks. You can't say like force majour because these people and and I have h had this unfortunate experience. Some of them would go to the arbitary court and the court in China will always favor the consumers and the employees always like the employer is very unfortunate in China. So you have to pay out. So uh Michael had to pay out something like I think one or two billion dollars because like all these employees are leaving with that and plus one. So as someone who have gone through that kind of near-death experience, he probably has this conservative in his mind. Uh uh so you you have a valid consu critique here. So actually me and another you know I'm not sure if I should disclose but the 13 of us we there are 13 institutional master including myself. I'm the small fish. There are some really big big folks out there. We own more than 10% of this company and uh we we we all admire Michael tremendously and we wrote a very polite letter um to their um uh executive team and we we said we understand you want to preserve $3 billion of cash on your balance sheet. We we did the most stringent stress test of 2021. We think you can survive with that three billion. So perhaps can you consider pay out a bit more than 50% of your net income back to us shareholders? Of course you know I I've already talked with one of their executive on this matter and she said uh once we hike it to 50% we are not going to lower it ever like it will be there forever. That's the first thing and second thing is uh uh they they will uh they usually are conservative. So when they got to like 5% it will usually come out to be seven 8%. So so they they want to be conservative and last year they paid back paid a special dividend and they they bought back like $7 million their shares and they paid a $100 million of special dividend on top of a market cap that's $78 billion. So that's quite healthy capital return. They are uh and I think we are making progress and they are likely to hike the dividend payout ratio but it will take a little bit of time and we we hope it to be win-win. In China we don't engage in that kind of icon type of you know you just go in and like you want to fight everyone. We we try to resolve it peacefully with a double wing type of situation. So, so to echo your concern, yes, we we try to get a payout ratio a little bit higher, but the balance sheet, we we also we understand Michael, we we see it from his perspective. We can understand as someone who has gone through that kind of experience in 2020. I think preserving some cash will be good. >> First, thank you for that story. It's really unique to hear somebody who who can say, "Hey, look, I went through this and this is I think I see it makes total sense to me." You know, my my only worry is like like let's say 2021 was a once in aundred year storm for the industry or something, right? That as we said, this industry b dates back to Renaissance times plus. I I worry that any company that says, "Hey, we've built this company up to weather uh once in a 100redyear storm." It sounds really good. Uh and you know, there is the Buffet any number times zero is zero. But you often find that companies that do this like they're just so over reserved that it's ridiculous. And it at some point it does become a drag on their a drag on the business, right? Like that cash drag is a huge drag because if you're paying 60% of your market cap in cash, then the business really needs to perform for you even to get like kind of stock market like returns, right? I kind of worry that if they're so wedded to this, like as we said, they're returning 50% of ca of net income for the next three years to shareholders and as you said, they tend to be conservative, they'll probably beat that even if they pay back 60%. like that cash balance has just grown bigger and it's just like man I don't know you know there might be structuring or you know could they run this with $2 billion and then every year you know throw another 250 million onto the balance sheet until they hit three billion and then draw it back down or something like it just it feels very conservative to weather for hey what if we have to lay off like half our sales force because of regulatory changes and pay them all huge change of control huge termination fees it just uh feel it feels pretty pretty slow. Um, >> yeah, I go ahead. >> Understood. Yeah. So, so it probably has something to do with the personality of the founder. So, so Michael is really sort of legendary guy. So, so in China there's this so-called national entrance examination for colleges like you have to take this exam like it's a sort of like SAT but a lot more important than SAT. So, he took this exam the first time and he he's not the brightest of its types. let's say that and he he he himself admits that so he didn't do very well so he waited another year took it again and still didn't do that well and he took it again in the third year finally worked and he got into picking university which were one of the top two and but however it's the one of the worst and easiest departments which is the the the language department which is not popular like physics you know that those types of things >> yeah physics all the girls all the glory all the hype I have, >> right? So, so, so yeah. So, so he is someone who is very down to the earth and you know he he actually did not want to take this company public. It's because he had two other partners that really want to get rich like they they they ended up ultimately leaving the company and formed a venture arm which Michael also hold here with it's a very famous called Jungu fun which is a very famous venture capital fund in China that specifically try to help so new oriental sends student out when students go back to China uh Chungu the venture capital fund uh will help them uh uh uh to to launch businesses. So it's kind of like a Y Combinator spin-off over there. Yeah. >> Yes. So it's a sort of a close group, right? That's awesome. And so Michael is from the rural area. He does not want to take the company public. He doesn't care about money. >> But uh and he he's born in 1962 if I remember correctly. So he's 63 years old. We are trying to change his mind and he has already changed his mind quite a bit by you know with all the buyback and dividend but things take time and uh uh we are trying to a gently and friendly nudge and hopefully you know he will get and his mind is actually changing it's changing more and more like cap capitalist oriented in capital return especially since the uh the I mean it's still going to be grow at the the EPA S is going to keep growing at mid mid double digit. So it's not a no growth like slow growing company. It's a very cheap mid teens EPS growth company and the capital return should ultimately uh uh uh increase over time. I I believe I I have faith in Michael. >> Let me let me ask one last question here. Right at Tech, you mentioned the the core business is tutoring students basically, right? training them for these tests and everything. It anyone who's been following the stock market knows AI is here. It's coming and edtech has been the area where I would say just in the public markets you've seen the most disruption. Right? I would point to CHE which was cheat sheets for college students and that business has been crushed. But I I I think it's really impacted and there's a lot of reasons it's really impacted in my opinion education first. First because there's great data online about education, but second because education users tend to be youngsters who tend to be early adopters of educa. Like I I just think it's a it's education is the forefront of AI in my my opinion. I might be slightly overstating there, but I I don't think I'm saying anything too crazy. It strikes me you have an education company that you know they're advertising, but it is expensive. They're offering a bespoke product. Yes, if you can improve the test scores, people will pay anything to, you know, improve their children's test scores. But strikes me that this is a place where AI is is very vulnerable to AI. So, I just want to ask all of that to you. Is is AI a riskier? Or you could come to me and say, "Hey, AI, where you used to need one tutor for every five students, with AI, one tutor for every 20 students. So you get a little bit more, you get better results, so you get more pricing power, you need less tutors, boom, profit margins through the roof, and you've got proprietary data, but because you've got 30 years worth of test scores and training. So I could actually see either route. I'd love to just ask you AI risk or opportunity here." >> Yeah. Yeah. I I I believe you know the fascinating part is really so so in in China the primary school is like uh oneth grade to the sixth grade and then junior high is like uh 7th to 9th and the senior high is 10th to 12th it's it's slightly different here so if for junior high because of that K to9 you know double reduction is primarily focusing on K to9 so you can't teach the kids subject oriented like uh uh courses anymore. So for junior high, how do you prepare for the so-called junk? Like this is the entrance exam to get into the best senior high schools. It's so it's it's a very uh invol rooted if you will. And for junior high since you can't teach the subjects, you have to rely on artificial intelligence. You can't have the teachers anymore. So what they do is that they sell devices So in these devices there would be like uh words and phrases already written. There will be teacher with recorded videos that the students will buy this device take home and uh watch this and there will be teacher in the back end. If you have any question you can ask the teachers and in addition they have so much they have like decades of data of the student behavior. They know what type of student it is and they will provide you based on your learning curve u the corresponding types of questions that help you to climb up the learning curve the best. Like they will first prompt you with easy questions then slightly more sophisticated then cross-disciplinary the most difficult problems in the in the exam. And because they are doing this they no longer need to have learning centers. They don't have to pay the landlord. They don't need schools. They don't have to lease those. They don't have to have classrooms nor teachers. And they they can't the scalability of the business makes the operating margin of that segment actually higher than three. >> Can I pull Can I pull on that for a second? Because what you just described is pansia for a business, right? It's awesome. You get rid of it. But my only counter to that would be, hey, that sounds great, but all of this is AI on the internet. like you're eliminating a lot of the fixed costs. And once you eliminate those fixed costs, don't you expose yourself to you and me tomorrow could go release Andrew Shu's like incredible tutorial, right, with AI, all this knowledge and stuff like don't you expose don't you really lower the barriers to entry? So yes, you've removed the cost, but now the barriers to entry are gone and a thousand products can flood the market. And maybe these guys are the best, but maybe you and I could launch a product that's 95% as good and gets up to 98% as it generates more data and we launch it at, you know, 20% of the cost, 30. I I don't know. I'm just speculating. But it does seem to me like there's the risk that it always sounds great when you take all the margin out, but you take all the margin out and all of a sudden, hey, you know, unlimited demand newspapers, right? Hey, we're going to lose all the we don't need to print everything anymore. We lose all this. And then, oh yeah, but now it's unlimited distribution and there thousand places and all the newspapers are bankrupt. Like that is a loose analogy, but I could see how that holds here. So just want to ask you that question. >> Yeah. Yeah. So Andrew, if we were to start a business like that, we we need to like first need to have a really like star level teacher who is willing to do it for us. >> You went to MIT. I'm relying on you, man. I'm from the south. I can barely read. >> Oh, come on. So, so I I guess you know the best teachers they want the most amount of like commission, right? So, they probably want to go to a bigger platform that can give them that like scale like scale. That's the first one. And secondly, we need to collect a lot of questions. And thirdly, we need to have a lot of the data to really know when to give the student the best type of question, the prompt to help them learn the best. And lastly, we need to have the uh uh the the resources that we put into developing not just the hardware, but the software and the marketing and sales expenses. >> So, it's >> No, that's a great answer. Can I ask you the question in one more way just because as you say this strikes me and I do remember China has like much more superstar teachers than the United States. I say this you know from a literal thousand mile rad 3,000 milei radius but I do remember hearing a lot about the superstar you know I do wonder so new edu does have advantages of this they have the data they have the built-in infrastructure but you know in the United States you've seen a Mr. Beast, Instagram influencers, all this sort of stuff really supplant the legacy networks because distribution became free. Mr. Beast is launching uh you chocolates, right? He's trying to disrupt Hershey's. 10 years ago, I I would have told you no one could launch chocolates and disrupt Hershey's. Will he be successful? Yes. No. I don't know. But you are seeing people build the brands into themselves and capture all the economics. I would point to Joe Rogan. I'd point to Mr. Beast. We could point to any number of examples here. And I I do wonder if I said, "Hey, with all this AI tooling, maybe the celebrity, right, the the celebrity teachers that you're mentioning, maybe they partner with new edu, but they get much higher revenue shares because the celebrity is what drives the signups. The celebrity is what or maybe they say, "Hey, I don't even need new edu as we've seen so many I mean, you know, Joe Rogan 20 years ago would be on SiriusXM." Howard Stern, I think that's obviously a different generation, but his contract with SiriusXM's running up. I wouldn't be surprised if he's launching a podcast. Now, Stephen Cobear, he's getting fired from CBS. I bet you he will make more running a podcast than he was at CBS. So, I just wonder if these superstar teachers that you mentioned, drive, actually, maybe they take more or maybe they just launch their own network. So, that will probably be my last question, but I'd love to ask that because I find this fascinating. >> It's a great question. Actually this had what you described the star teacher leaving the the company to set up their own has happened throughout the existence of the business and the reason for that is if you are a teacher there I mean after all you are getting sort of a fixed salary maybe some incentives maybe some shears but if you form your own studio then you know you can capture all the profit. Yeah. So, so it's almost u has always been the case that the best teachers at edu art they would leave and form their own studios. >> Yep. >> But this market is firstly it's a very fragmented market even in the most concentrated parts like picking where mo and edu both are located there they have a combined market share of only about 15%. So there are a lot of studios uh uh out there uh uh competing with them. So, so competition is probably uh something familiar to them. And uh uh secondly, you have a constant replenishment of new talent that need to go to edu and tell once they have the system that cultivate these teachers, then they just uh every year you know the fresh out grads they will go there and work a couple years maybe they leave. But the system is still the strongest at EDU and of course what you mentioned you know for for the for the hardware and the scalability question you know can we have something like that I think the answer is probably yes for especially for junior high I'm not sure whether it will be the case for the senior high because that the learning quality is just not as good uh uh if you are not like face to face with a teacher especially for senior high where you have a lot of the difficult questions like math, physics, biology, then you want to have someone to see exactly how you think I walk you through that logic, train of logic. So I think and you can see that in retention their senior high school retention rate is something like 80%. But for junior high despite the high operating margin, the retention rate is only 60 70%. So so I I I believe senior high is less of a threat. junior high. Yes, they can be threatened. Uh uh and it will probably be something that if you and I'm already a shareholder and if you end up being a shareholder, it's probably something that we need to keep a close eye on. However, it's so fragmented. I I I feel like there are so many like mom and pop that will be weeded out uh in this long slope with a lot of snow. >> This was great. Well, should I I don't know if you heard my phone was just blowing up. So, I'm sure something terrible or awesome is going on in the portfolio. So, I'm probably gonna have to call this. But you, this is great. She writes.comblog is what I call. But you know what we're going to have to do? You've got to write more. I don't think there's been a post up there since late 2024 that people are after this podcast that people are going to demand more writing, man. You got to we got to get some uh written word up there. >> Yeah. Yeah. I So, I have a substack. I update that and at the end of every year I I will replenish the all the letters uh up there. So so so that substack uh u it's also I think it's just called guinea value. Um I have a substack that I that I replenish almost by monthly basis. >> Perfect. Perfect. >> Yeah. Well, hey this has been a ton of fun. I really this was a really fascinating idea. So, I really appreciate you hopping on and uh I really appreciate you hopping on walking through all of this sort of stuff. And look, we're going to have to have you back on at some point to talk about some maybe it's you do a lot more than just Chinese, so maybe it's something else, but I'd love to have you back on and we'll go from there. >> Sounds good. Thank you so much for having me, Andrew. I have always been a fan. It's so nice talking to you in person finally. >> I really appreciate that. A quick disclaimer, nothing on this podcast should be considered investment advice. Guests or the hosts may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial adviser. Thanks.