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The repression of China’s education sector is affecting foreign investors

China’s complete overhaul of its $ 100 billion private education industry will eliminate foreign investors from much of the sector and threaten to cancel billions of dollars of investment from groups such as BlackRock, Baillie Gifford , Tencent, Sequoia and the SoftBank Vision Fund.

The regulations will prohibit companies that teach school curriculum subjects from making profits, raising capital or listing them on the stock exchange worldwide, and will prevent them from accepting foreign investment.

The move could fundamentally damage a sector that has been growing in recent years, resulting in poor ratings for the three largest groups listed in the US, TAL Education, New Oriental Education and Gaotu Techedu.

The changes are part of the Communist Party’s action to raise children and education more cheaply and fight against an imminent population decline that threatens the country’s economic future.

The reduction was also a sign of China’s growing willingness to limit foreign investment in its companies. Chinese regulators have revised the rules for groups seeking U.S. IPOs after ordering a security review of ride-hailing app Didi Chuxing a few days after its $ 4.4bn listing in New York last month.

Chinese authorities have announced measures aimed at education companies over the weekend, sending actions to listed companies expiring on Monday and ending months of regulatory uncertainty.

Shares of New Eastern Education have fallen 60 percent in New York since Friday, when a leaked note suggested Beijing was planning to control the sector, and fell 37 percent Monday in Hong Kong. The market value of TAL Education, listed in New York, fell from $ 59 billion in February to less than $ 4 billion. Gaotu Techedu, formerly known as GSX, has gone from a market capitalization of $ 38 billion in January to $ 900 million.

Goldman Sachs analysts have predicted that China’s tutorial market size will collapse 76 percent, to $ 24 billion.

The sale has spread beyond the education technology sector. Quotes on China’s Meituan delivery platform fell 13.8 percent in its record-breaking performance day when Beijing announced new regulations for the food delivery sector.

JPMorgan said: “It is unclear what level of restructuring companies will have to undergo with a new regime and, in our view, this makes these stocks virtually uninvestable.”

The regulatory move will also have a broader impact on the economy. The profitable tutorial industry employs hundreds of thousands of teachers and staff. Investment in e-learning has intensified during the coronavirus pandemic, and the industry is a significant driver for large internet companies such as Baidu and Tencent.

Education companies such as Yuanfudao, VIPKID backed by Tencent and Gaotu had already started small-scale licensing in recent months. Employees said Monday they expected more to come.

The latest move could also further increase risk for investors in variable-interest, offshore vehicles that allow foreign investors to own internally listed Chinese companies. The new regulations prohibit for-profit education companies from using this structure.

“It’s as bad as it can be,” said the executive director of a large private equity firm in Hong Kong that has exposure to Chinese education technology companies. “It will take three to six months for the sector to adapt, but then we will have to assess whether to write off the investments or write them all down. Every private equity firm will have to take this necessary revaluation.”

The children leave from a school in Shenzhen, China

Chinese authorities are trying to reduce the cost of raising children, which, along with facilitating family planning policies, is intended to reverse the slowdown in population growth.

Foreign investors such as BlackRock, which in November had a 5 percent stake in Hong Kong’s New Oriental listing, have found themselves blocked from investing in Chinese education companies that cover subjects taught in schools. .

They may also maintain stakes if the companies move to other areas of education, however. The rules focused on after-school teaching but did not apply to adult education or vocational and technical training.

BlackRock is also the third-largest listed TAL shareholder in the US, behind Baillie Gifford, the UK-based investor who has made big bets on China’s technology sector. Bailie Gifford owns nearly 9 percent of TAL shares in the U.S. after increasing her stake in March.

Meanwhile, investors including SoftBank’s Vision Fund, Tiger Global and Sequoia China, which have invested large sums in privately owned learning applications such as Zuoyebang and Yuanfudao, may be unable to leverage their investments by taking over public companies.

BlackRock, SoftBank, Tencent, Tiger Global, Baillie Gifford and Sequoia did not immediately respond to comments.

TAL, New Oriental and Gaotu released quick responses over the weekend to the regulations, promising to join the Chinese Communist Party.

New Oriental said it will “fulfill its social duties and serve the development of the nation,” although he added that there would be “material adverse impacts” on his tutoring activity after school.

An education technology leader said: “What should we do? We cannot fight with the communist party.”

Announcing the rules, China’s education minister said: “In recent years, a large amount of capital has been invested in education. . . advertisements are everywhere, bombarding the whole society. . . It has destroyed the normal environment for education. ”

By prohibiting tutoring companies from using the widespread VIE structure, which gives access to international capital to parts outside the confines of the Chinese economy, the rules set an important precedent for investors. VIEs operate in a legal gray area and are not officially recognized by Chinese regulators. Analysts have predicted that VIEs in all sectors will face tighter regulation.

Gaotu, New Oriental, TAL Education and several private start-ups use the VIE structure to manage part of their activities. “Those currently in violation will be cleaned and rectified,” the new rule warned, without elaborating. Chinese authorities have not established a clear timetable or process for foreign investors to exit their stakes.

This has left private equity and venture capital funds a success in their ability to raise capital to invest in Chinese technology companies.

“For global investments in US dollars, the sentiment on the short-term technology sector is significantly negative,” the Hong Kong head of private capital said.

However, “in the long run, sentiments may be reversed in a few days,” the person added, citing a change in attitude in favor of technology groups even after the Ant Group dropped its $ 37 billion IPO. last year.

Additional reports from Hudson Lockett in Hong Kong

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