TAL Education finds gold – and risk – in U.S. acquisition

The educator’s $95 million purchase of digital reading platform Epic in a bankruptcy sale last year appears to be the source of a $405 million investment gain in its latest financial report

Key Takeaways:

• TAL Education reported a massive profit increase in its fiscal quarter through May, mostly due to a one-time investment gain
• The gain looks tied to the company’s fire sale purchase last year of digital U.S. children’s reading platform Epic, which has raised concerns from some U.S. politicians

By Doug Young

Nice investment!

Investors gave education services provider TAL Education Group (TAL.US) a major round of applause after the release of its latest financial report on Thursday, bidding up the stock 13.3% to a three-month high after the announcement. The report itself was relatively ho-hum, showing strong but slowing growth for the company’s core education services as its rebound from a brutal crackdown five years ago loses momentum.

Instead, what appears to have excited investors was a huge jump in the company’s profit, which was nearly triple what analysts were expecting. The source behind that upside surprise was a massive $405 million gain related to the value of unspecified investments. TAL isn’t the most transparent company, and it kept that tradition by failing to disclose the source of the big one-time gain.

But a likely candidate appears to be its controversial purchase of Epic, a U.S.-based digital reading platform for kids that TAL acquired about a year ago for a bargain price of $95 million. TAL acquired Epic in a bankruptcy liquidation of assets held by Indian firm Byju, which purchased the U.S. company in 2021 for $500 million. That was just one of several Byju purchases that were sold off at the time, including a coding platform that Byju paid $200 million for in 2021, but fetched just $2.2 million in the bankruptcy sale.

Byju looks like a classic case of a company that went on an acquisition binge in a bid to quickly build itself up as the leader in an emerging niche, in this case edtech, only to overpay for assets and ultimately collapse after taking on too much debt.

Founded in California in 2013, Epic is near the top of its class among companies providing e-books for kids, with a catalog of more than 40,000 titles from more than 250 publishers, according to its website. The company doesn’t release financials, but one website estimates its revenue ranges between $50 million and $100 million annually.

Given what Byju paid for Epic, and the circumstances behind its fire sale to TAL, we suspect that most or even all of TAL’s $405 million gain is related to this purchase. But the purchase wasn’t without controversy, as some U.S. politicians voiced concerns about Chinese ownership for a company whose products reach so many young American children.

We’ll return to that part of the story shortly, along with another major risk that TAL faces from its positioning as a leading private education services provider in China. But first a little history to put all of this in context.

TAL and longtime rival New Oriental (EDU.US; 9901.HK) were two of China’s earliest private education providers, with histories dating back more than 20 years as the country’s economy was starting to take off. As leaders in their field, both found huge business by offering after-school tutoring for K-12 students, whose parents were looking to give them an extra edge over their classmates.

Killer crackdown

But the old adage says that “All good things must end,” and they ended quite abruptly for TAL, New Oriental, and a large field of newer rivals in 2021, when Beijing banned the offering of private tutoring services for K-12 students in core curriculum areas.

TAL was representative of the group, watching its revenue and stock price both tumble in the year after the crackdown, as many smaller players went out of business completely. Even after a gradual comeback over the last four years, TAL’s latest annual revenue of $3.05 billion is just two-thirds of the $4.5 billion it recorded in its fiscal year through February 2021 just before the crackdown. Similarly, its latest stock price of about $12.50 is about one-seventh of where it traded at its height in 2021.

Fast forward the present, where the few surviving companies have taken different routes to survive in the current landscape. New Oriental has moved to services targeted at young adults, such as study abroad consulting and preparation for tests like China’s civil service exam. Others have moved to providing services for schools rather than students, while still others have moved to educational products rather than tutoring services.

Within that group, TAL has stayed closest to its roots by continuing to focus mostly on K-12 students, but with more general courses outside the core school curriculum, such as critical thinking, writing and conducting scientific experiments. Despite launching its own learning device segment, centered on tablet-style computers, the company still considers its Peiyou face-to-face learning services, offered in 600 education centers throughout China, as its core product.

The company’s revenue rose 25% to 5.19 billion yuan ($767 million) in the three months to May 31, its fiscal first quarter. While 25% is nothing to be ashamed of, the growth rate has been coming down steadily from nearly 40% in the first quarter of its previous fiscal year, and TAL cautioned it is likely to keep declining.

The company doesn’t break out specific revenue for its three key areas – classroom learning, online learning and educational devices – though it says each of those continues to grow. In a slightly worrisome sign, it flagged potential challenges facing its device business, which looks related to stiff competition and soaring memory prices that are straining all makers of computing products. But again, the classroom-based services appear to be the company’s most important revenue source, and that part of the business is doing well.

TAL has also been doing a good job of controlling costs, with its total operating costs and expenses up just 10.8% in the latest quarter – less than half its revenue growth rate. That boosted its gross margin by nearly 3 percentage points to 57.8% in the latest quarter from 54.9% a year earlier. And on its bottom line, the company’s profit rose to $408 million from $31.3 million year-on-year, though much of that was due to the one-time $405 million gain. Here, we should quickly note that TAL quotes most of its figures in U.S. dollars. But it does most of its business in Chinese yuan, and gives out select yuan figures on its earnings calls.

The bottom line for TAL is that its Epic purchase could quickly shape up as a double-edged sword. On the positive side, it purchased Epic for a bargain price, and that business appears to be doing well and is outside the sensitive China market. But with U.S.-China tensions running high, it’s quite possible TAL may ultimately have to sell the asset. Meantime, its core China business is slowing down, and its own continued focus on the sensitive K-12 student group could also leave the company more exposed than some of its peers to future crackdowns.

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