China Education Group’s goodwill impairment offers lesson in how to spook investors

China’s largest privately-owned vocational educator posted double-digit revenue growth in its latest fiscal year, but also a rare profit decline 

Key Takeaways:

• China Education Group’s profit fell in its latest fiscal year, despite growing revenue, due to a 390 million yuan goodwill impairment by one of its vocational colleges
• The leading vocational educator’s student enrollments are expected to keep growing steadily, boosted by favorable national policies

By Li Shih Ta

Life may be returning to normal for Chinese students with the end of pandemic restrictions, but you wouldn’t see that right away by looking at the bottom line in China Education Group Holdings Ltd.’s (0839.HK) latest annual report released at the end of last month. Profits for China’s largest privately-owned education group tumbled by a rare 25.2% in its fiscal year through August, sending its shares down by 18.5% to a 52-week low. The stock is now down about 75% from its peak in June 2021.

But the news was better on China Education’s top line. For its fiscal year through Aug. 31, the vocational educator recorded revenue of nearly 5.62 billion yuan ($793 million), up 18.1% year-on-year. The company said the decline that saw its annual profit fall to 1.38 billion yuan was mainly due to a 390 million yuan goodwill impairment loss related to one of its secondary colleges. 

Expansion side effects 

In 1999, China Education Group’s two founders, Yu Guo and Xie Ketao, set up Jiangxi University of Technology and Guangdong Baiyun University, respectively. They merged the two under a single management in 2017, and began to expand after China’s Ministry of Education started encouraging independent colleges to set up vocational education institutes the next year.

From 2018 to 2020, the group embarked on an acquisition binge, picking up an average of three higher education and vocational education colleges each year. By 2021, it owned 14 colleges in nine cities, mostly in China but also as far afield as Britain and Australia. The M&A approach offered the company a faster and more efficient way to quickly bulk up, since setting up new institutions often involves a much lengthier process.

But M&A also relies on picking the right targets. In its own buying binge, China Education Group focused on leading regional colleges valued more highly than their peers, which allowed it to accumulate goodwill. At the end of its latest reporting period, the company’s cumulative goodwill had reached 3.63 billion yuan, accounting for 10.1% of its total assets.

But the company recorded a 460 million yuan loss due to goodwill impairment for the first time in this year’s annual report, accounting for about 1.3% of its total assets. The loss was mainly due to a downward revision of expected revenue from one of its acquired colleges owing to changes in its customer trends and preferences. The company explained that even though the college’s business grew year-on-year in its latest fiscal year, it still hasn’t recovered to its pre-pandemic levels.

While goodwill impairment is a one-time item, it could still be considered a red flag if investors believe that future profits might be similarly dragged down by other acquired assets failing to meet expectations.

Steady new enrollment 

Despite the goodwill impairment, China Education Group is still growing steadily. It pocketed 5.4 billion yuan in revenue from its domestic business in its latest year, up 18.2%, mainly driven by the growth in its vocational education business. It also earned 220 million yuan internationally, up 16.4% year-on-year, on the lifting of entry restrictions for foreign students post-pandemic in Britain and Australia.

The revenue increases were mainly driven by growth in student enrollment and tuition fees. China Education Group’s full-time enrollment totaled 248,000 students at the end of August, up 7% year-on-year, of which 199,000 students were in its vocational schools, up 13% year-on-year. The company enrolled 97,000 full-time new students for its 2023/2024 academic year, up 17% year-on-year, of which new full-time enrollments were up 18%.

While declining fertility rates are causing headaches for a country that was once the world’s most populous, annual births still exceeded 15 million from 2005 to 2017, meaning demand for higher education should stay relatively strong through at least 2035. The gross enrollment rate in higher education is expected to reach 60% in 2025, and as high as 65% by 2035, according to government estimates.

At the same time, Beijing’s strong support for vocational education is also boosting teaching quality, social recognition of vocational education degrees, and students’ willingness to pursue such a path. Such education oriented to specific skills has become an important means to address worker shortages in areas like machine building and repair and IT services. As such education becomes a more viable option for many, annual enrollments have exceeded those for more general bachelor’s degrees for four consecutive years since 2019.

Valuation rebound?

A government paper titled “Opinions on Deepening the Reform of the Construction of a Modern Vocational Education System” released a year ago highlighted the need to expand enrollment for students taking the Vocational Education Higher Education Exam. It also stated priority should be given to key industries and fields such as next-generation information technology (IT), high-grade CNC machine tools and robots, high-end instruments, aerospace equipment, energy-saving and new energy vehicles, new materials, and biomedicine.

To cater to that need, China Education mentioned that its colleges have established 372 undergraduate majors at the higher vocational education level, up by 13 year-on-year, focusing on intelligent manufacturing, digital creativity, virtual reality and other specialties. It offers 182 specialized majors, up by 13 year-on-year; and 205 continuing education majors, up by 13 year-on-year. All this shows the company is moving in a broader direction focused on the “integration of industry and education.”

China’s vocational education market grew from 604.5 billion yuan in 2018 to 871.9 billion yuan in 2022, representing annual growth of nearly 10%, and is expected to reach 1.27 trillion yuan in 2027, according to Frost & Sullivan. 

Despite that potential, the sharply negative reaction to China Education’s latest goodwill impairment shows the market may still be wary of this policy-sensitive industry. Even after the selloff, China Education Group’s price-to-earnings (P/E) ratio of 8.2 times is still higher than those for its main rivals Hope Education (1765.HK) at 7.2 times, and China New Higher Education Group (2001.HK) at 4.3 times.

At the end of the day, China Education Group has emerged as the leading private provider of high education in China, with its strong focus on government-favored vocational training. Its steady expansion through M&A and strong policy support should ultimately work to its advantage as it tries to win back the hearts and dollars of investors.

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