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$EDU is trading at NEGATIVE $600m. Yes we all know Chinese stocks are risky, $EDU has a $600m cushion and already the shittiest-tier sentiment

The de-gens couldn’t stop screeching about China risk last time so here it is again: this is plain and simple a market inefficiency and nothing else. Yes Adam, everyone knows investing in China is risky, that’s obviously priced in and we don’t need your “expert” opinion.

# Summary

Very simple negative EV trade, these don’t come up often and are hard to find, but [historically have been consistently lucrative](https://blogs.cfainstitute.org/investor/2013/07/10/returns-on-negative-enterprise-value-stocks-money-for-nothing/), especially in a name as liquid as $EDU traded on the NASDAQ:

* Price: ~$2.00 USD (8/5/21 morning)
* Shares out: 1.7b
* Cash + Equiv: $6b (1.6 cash, 1.1 term deposits, 3.3 ST investments)
* Gross Debt: $2b (0.5 current lease + 1.2 LT lease + 0.3 LT debt)
* Negligible minority interest and prefs

# EDU has $4b of net cash but trades at $3.4b (-$600m EV)

**Positions:**

* 10,000 shares EDU
* 80 EDU call options (WSB doesn’t let you say which exact contract but ~4,000 total delta)
* 5,000 shares HKG:9901 (same company but HK listing)

# Thesis

Obviously mispriced asset. Say what you will about China stonks, Chinese education stonks, VIEs, yadda yadda NONE of that is as relevant as CASH.

>**You’re paying $3.4b for a $4b net cash shell on the balance sheet. Regardless of what the company actually does, you’ve got a cushion.**

That doesn’t make sense because it doesn’t. In my 5+ years I’ve only personally stumbled upon 2 cases like this: $EVE.LN and $LK (yup, that LK). Literally any “not shitstorm” news would make this pop WAY more than just the $4b of net cash on the balance sheet, which is available to you at $3.4b for no reason other than people are selling into shit-tier China sentiment they read on Twitter without ever taking an Accounting 101 class (inb4 watch this unfold live in the comments).

Here’s the scoop on EDU, and historical examples of how much LK and EVE popped in the next year after they went into negative EV land.

# Why this situation exists

Fundamentals don’t really matter for this trade (it’s just a market inefficiency), but as background: New Oriental Education (EDU) is a Chinese company that has 7 business lines, the largest of which (66-75% of their $4b revenue) is private tutoring. As you know for-profit private tutoring has recently been banned in China because of several reasons (won’t go into detail but mostly around cost of education, ethics, widening wealth gap, low birth rate).

# Why it’s a lucrative trade

None of the above is really that important. Here’s what important:

1. **87% of EDU ownership is institutional, and most of that is US institutions.**
This is important because common shareholders are less likely to get completely screwed because of poor geo-political optics. Despite what American news tells you, American and Chinese LPs are both balls deep in each other and both care oh so very much about optics so it’s unlikely common equity gets TOTALLY screwed over.
2. **25-33% of EDU’s $4b of revenue is still legal.**
Keep in mind tutoring is only 66-75% of EDU’s $4b run rate revenue that’s been outlawed, the other 25% (language, admissions consulting, bookstores, school tours etc.) is still perfectly legal.
3. **EDU has a TON of residual “assets” to pivot with.**
69k employees, 10.6m student enrollments, 118 schools, 1,625 learning centers, 11 bookstores. They could start a god damn car wash tomorrow with assets like that, but whatever this $4b cash shell becomes, it’s not worth -$600m, or even remotely close to $0 for that matter.

So it’s clear that EDU is not worth $0, much less negative $600m. What can happen from here on? [Here’s the only study from the CFA Institute (albeit from 2013) I could find on negative EV trading performance](https://blogs.cfainstitute.org/investor/2013/07/10/returns-on-negative-enterprise-value-stocks-money-for-nothing/):

>**The average 1-year return of 2,613 negative EV opportunities over 40 years was 50.4%.**

Looking good so far. But let’s look to 2 recent examples I’ve traded through first hand for guidance:

# $LK (up 15x from negative EV)

Now trading OTC as $LKNCY. This is the best comparable out there imo: Luckin Coffee, a Chinese fraud that got exposed, got sold to negative EV at a low of $0.95 in May 2020, traded up to high of $15.65 (up 17x) and today on 8/3/2021 trades at $14 (up 15x in 15 months).

# $EVE.LN (up 6x from negative EV)

Eve Sleep. British mattress shitco trading on a shitty exchange (AIM). Traded to lows of 1.15 GBP in May 2020 due to COVID and grazed negative EV land–promptly re-rated to 6 GBP (up 5x) by September 2020 and peaked at 7 GBP (up 6x) in February 2021. Still trading at 3.30 GBP today.

# Conclusion

It’s a cash shell worth $4b trading at $3.4b. Don’t overthink the whole “CHYNA” deal everyone knows it’s risky so it’s fully priced in.

DYODD.

**Positions:**

* 10,000 shares EDU
* 80 EDU call options (WSB doesn’t let you say which exact contract but ~4,000 total delta)
* 5,000 shares HKG:9901 (same company but HK listing)

What do you think?

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19 Comments

  1. What’s your average price per share? I appreciate the write up! I don’t consider employees to be assets but would be a liability as they need to be paid and would see cash outflow for salary etc.

    What’s your take on the legal issue? It is now illegal to tutor? Will that illegality/ban remain?

  2. I really like this trade, its like if Ben Graham did bath salts.

    ​

    Edit: Did some follow up DD. Where are you getting your numbers? The last 20-F was 9/30/2020.

    ​

    Liquidity was:

    Cash & Equivalents : $915.057 million

    Term Deposits : $284.793 million

    ST Investments : $2.318 billion

    Total Liquidity : $3.518 billion, down pretty significantly from your $6.6 billion number

    ​

    On the debt side, I’m not actually sure why you included operating lease liabilities. You probably know better then I do but from my understanding, those were just added recently to GAAP statements to provide disclosure about the liability but I don’t think those are true external obligations to the Company, at least in full, since, worst case, the Company can release those spaces to cover the rent payments. In fact, the notes say explicitly the operating leases aren’t recourse to the Company. The only obligating line items I see are the due to related party item which is negligible and long-term debt of $117.881 million which is also noted to be non-recourse to the Company. Should still probably count it though since the 20-F said the debt was issued to the Company.

    As of close today, the market cap was $3.67 billion which would put the EV around $270 million assuming the operating leases don’t need to be counted.

    ​

    So where’d you source that $6 billion liquidity figure, the EV might be a lot lower then you suggest if you buy that the non-recourse liabilities don’t need to be included.

    ​

    The 20-F is here:

    [https://www.sec.gov/ix?doc=/Archives/edgar/data/0001372920/000119312520247160/d159290d20f.htm#fin159290_2](https://www.sec.gov/ix?doc=/Archives/edgar/data/0001372920/000119312520247160/d159290d20f.htm#fin159290_2)

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