A leading ratings agency has said that the impact of a new law affecting for-profit schooling providers in China is “uncertain at this stage”, as regulations could prove difficult to implement without disrupting schools’ operations.
Fitch Ratings, which grades the credit of public and private companies worldwide, said that new rules intended to strengthen the supervision of compulsory schooling – Grades 1-9 – in China will affect “the majority of Chinese K12 school operators”.
Last week, following the publication of the new law by China’s government, EducationInvestor Global reported on the risk of British independent schools’ Chinese branch campuses being impacted when enacted in September. The restrictions, if implemented based on the strictest interpretation, will affect compulsory education providers’ ability to access cash generated by G1-9 schools, according to Fitch Ratings.
The rules are designed to prohibit related-party transactions and restrict any person or institution from controlling Grades 1-9 schools and non-profit kindergartens through acquisitions or contractual agreements.
However, Fitch Ratings added that restrictions around related-party transactions “will probably be hard to implement in practice and may encounter difficulties at local government levels”, at which for-profit education in China is ultimately regulated.
“Private schools’ daily operations involve related parties, which means prohibiting these transactions would disrupt their normal operations,” Fitch Ratings continued. “It is also unclear whether existing schools that offer compulsory education will be affected, and it may take time for local governments to enact the regulations in their regions, which could lead to grace periods.”
Publicly listed and private operators of for-profit schools in China use structures of varying complexity to extract cash from operations.
Listed organisations, such as Bright Scholar (New York) and Wisdom Education (Hong Kong), use variable interest entities (VIEs), which are essentially networks of offshore holding companies through which management fees are channelled. Similarly, Western school groups with Chinese campuses – the majority of which encompass compulsory grades – share revenues by charging brand-licensing or management fees to domestic partners, which own the mainland schools.
Appetite among private investors for stakes in compulsory schools is “likely to cool in the short term, leading to slower growth for compulsory education providers”, according to Fitch Ratings. M&A in China’s compulsory education sector has been banned since August 2018, when draft amendments to rules announced the previous year were published.
“We also expect K-12 education companies to continue expanding into other businesses beyond this segment and seek growth opportunities overseas amid the heightened regulatory risk in compulsory education,” said Fitch Ratings. “Wisdom, for example, has expanded into higher education with one vocational college under construction and another in the pipeline.”
Fitch Ratings has downgraded its outlook on Bright Scholar, which owns six private schools in the UK, and Wisdom Education to ‘negative’ from ‘stable’.
Bright Scholar Education is down 30% year-to-date, and Wisdom Education International Holdings is down 37% over the same period.
Date published: 24 May 2021