2 November 2018China Higher Education Sector 2Focus chartsFigure 2: Current gross higher education enrolmentrate and national target in 2020 Figure 3: Penetration rate of private schools inChina’s higher educationSource: Ministry of Education, local government press releasesSource: Ministry of Education, Frost & SullivanFigure 4: Hope Education’s student enrolmentsFigure 5: Hope Education’s adjusted net profitSource: Company data, Credit Suisse estimatesSource: Company data, Credit Suisse estimatesFigure 6: Peers comps tableNote: Close price as of 31-Oct-2018. Source: Company data, Thomson Reuters for companies marked with *, Credit Suisse estimates for the rest.50%46% 42%42%37% 35%34%33% 0% 10% 20% 30% 40% 50% 60% 20.8%21.1% 21.5%21.7%21.9% 22.8%23.3% 23.6%23.9% 24.3% 15% 16% 17% 18% 19% 20% 21% 22% 23% 24% 25% 2012201320142015201620172018E2019E2020E2021E 33,654 40,04751,67275,66485,964 95,1640% 10% 20% 30% 40% 50%-20,00040,00060,00080,000100,000 2014/152015/162016/172017/182018/192019/20 No. of student enrollmentsYoY 88179 165358573743-20% 0% 20% 40% 60% 80% 100% 120% 140%-100200300400500600700800 201520162017201820192020 Adjusted net profit (Rmb mn)YoY Market cap17-19 EPS CompanyTicker(USD mn) CAGR2017201820192019201720182019201720182019China education peers HK listed higher education Hope Education1765.HK1,003 86%45.420.913.10.211.52.01.738%9%14% China Education Group*0839.HK2,417 25%29.624.718.80.72.32.72.411%11%13% China New Higher Education*2001.HK67229%18.814.511.20.42.62.22.018%16%19% Minsheng Education*1569.HK70726%17.313.110.90.41.51.41.311%11%12% China Xinhua Education*2779.HK425N/A11.610.4N/A1.21.2N/A13%12% Average27.8x17.0x12.9x0.4x4.5x1.9x1.7x19%12%14% US listed China K12 educationNew OrientalEDU.N9,285 20%28.226.019.61.04.73.93.216%14%16% TAL TAL.N14,474 38%74.156.838.81.011.79.27.518%15%17% RISE EducationREDU.OQ68734%N/AN/A19.20.614.39.16.1-13%41%36% RYB EducationRYB.N53357%N/AN/A22.10.45.65.44.713%0%17% Average51.2x41.4x24.9x0.7x9.1x6.9x5.4x8%18%21% HK listed K12 school operators Wisdom Education6068.HK91528%21.617.413.30.53.23.12.616%18%21% Maple Leaf1317.HK1,284 20%18.015.212.50.63.02.32.118%17%17% Yuhua Education*6169.HK1,312 28%20.215.012.40.43.12.62.418%18%20% Average19.9x15.9x12.7x0.5x3.1x2.7x2.3x17%18%19% Global education peersGlobal higher education Grand Canyan*LOPE.OQ6,014 13%31.325.624.31.822%21%18% Strayer*STRA.OQ2,731 38%40.529.421.30.6 Adtalem*ATGE.N3,006 7%19.218.016.72.3 Navitas Ltd*NVT.AX1,290 3%23.023.021.88.111.865.346.7 Average28.5x24.0x21.0x3.2x PEGROEPEPB2 November 2018China Higher Education Sector 3Modelling the landscape under regulationPrivate higher education: Rising penetration andsubstantial consolidation opportunityWe expect the government to support the expansion of leading private higher educationproviders, to fulfil its target of a higher enrolment rate. According to Frost & Sullivan, thepenetration rate of private schools in China’s higher education rose from 20.8% in 2012 to22.8% in 2017, and is expected to reach 24.3% in 2021. The market is highly fragmented,as the top five players only accounted for 5.8% of market share in terms of studentenrolment as of 2017. Higher education is also the sub-segment with the highest entrybarrier among all segments in China’s education sector. Acquisition has been the keystrategy of leading players to accelerate consolidation in the market.We expect regulation to allow further M&A in highereducationShare prices of the higher education sector fell by 40% mainly due to regulation risk fromthe draft policy released on 10 Aug. However, we believe that leading higher educationproviders can continue to expand, with both M&A and robust organic growth. We expectlisted higher education providers to choose the for-profit category for all schools. We alsoexpect the government to allow M&A before completing conversion to for-profit schools inthe transition period of classified administration reform. We view higher education schoolshaving more flexibility in pricing after becoming for-profit schools.Modelling the new landscape: Higher tax rate, capexfor land and M&A potentialBase case impact: We expect the effective tax rate of listed higher education companieswill rise from 0-2% to 15% in 2023, after completing changes to become for-profit schools,which is the preferential tax rate for industries promoted by the government as indicatedby rule no. 53 of Draft Rules. We expect Hope Education to pay no more than Rmb300 mnin total for land of 3,500 mu. Capex for land has an amortisation period of 50 years. Weestimate 12%/19% incremental earnings growth from further M&A in 2019/2020. Bearcase: we assume (1) further M&A is not allowed; (2) no preferential tax rate, all income issubject to 25% corporate tax rate from 2023; (3) organic growth to continue with capacityexpansion and tuition fee increase. Our grey-sky scenario target price is HK$1.10 for HopeEducation. Initiate on Hope Education with OUTPERFORMWe initiate on Hope Education with an OUTPERFORM rating. We like the company for itsmarket leadership, considerable M&A potential and robust organic growth. Our DCF- based TP is HK$1.72. We prefer Hope Education to its peers given its large scale (thesecond largest private higher education group in China according to Frost & Sullivan),higher earnings growth and rich experience in post-M&A operation. Catalysts include: (1)favourable clarification on some key regulation rules at the central government level; (2)successful M&A of high quality targets at fair valuation. Our pecking order for segments inthe China education space is: K12 tutoringhigher educationK12 schools. We preferEDU and TAL to school operators because regulation has less impact on the profitability oftutoring services providers than that of school operators. We prefer higher educationnames to K12 school operators on lower risks from regulation, since higher educationschools can choose to become for-profit schools and conduct M&A. Credit Suisse HOLTalso concurs with our OUTPERFORM rating on Hope Education. Key risks include: (1)regulation risks; (2) slower-than-expected progress in M&A; (3) intensified competition. The market is highlyfragmented, as the topfive players onlyaccounted for 5.8% ofmarket share in termsof student enrolment asof 2017We expect thegovernment to allowM&A in the transitionperiod of reform We expect the effectivetax rate of listed highereducation companieswill rise from 0-2% to15% in 2023Our DCF-based TP isHK$1.72 for HopeEducation 2 November 2018China Higher Education Sector 4Table of contentsFocus charts 2Modelling the new landscape: Higher tax rate, capex for land and M&A potential .. 3Private higher education: rising penetration and substantial consolidationopportunity 5China higher education overview ...... 5We expect the government to support the expansion of leading private highereducation providers ... 6Highly fragmented market, and high barrier for new schools, leads to consolidationtrend .. 7We expect regulation to allow further M&A in higher education 8Overview of recent regulation in the private higher education industry ........ 8We expect listed companies to choose for-profit schools and continue M&Atransactions ... 9We expect more acquisition targets and accelerated consolidation under the newregulation .... 11Modelling the new landscape: Higher tax rate, capex for land and M&A potential12Base case of regulation impact ....... 12Assessing incremental growth potential from further M&A . 13Bear case of no further M&A and no preferential tax rate .. 13Initiate on Hope Education with OUTPERFORM 14Hope Education in HOLT .... 16Investment risks 18Regulation risk ........ 18Weak recognition for private higher education ....... 18Deterioration of economic conditions .......... 18Hope Education Group (1765.HK / 1765 HK) 19Leading higher education group with successful expansion experience 21Solid track record in M&A, post-acquisition operation and establishing new schools........ 2