September 19, 2017

Education Invest for a bright future

HINA C

■ We assume coverage on the China education sector with an Overweight rating. K-12 after-school tutoring is our preferred segment and New Oriental Education (EDU) is our top pick. Our order of preference is: 1) K-12 after-school tutoring providers, EDU and TAL Education (TAL), 2) K-12 private school players, China Yuhua and China Maple Leaf, and 3) vocational training provider, Tarena. ■ We forecast the K-12 after-school tutoring market to post a 4-year revenue CAGR of 12.7% yoy to Rmb1.29tr by 2020F. This market is still quite fragmented as the market shares of the no.1 and no.2 players, TAL and EDU, were only 0.8% and 0.7% in 2016, respectively. We expect leading players to benefit from the recent ‘Gaokao’ reform and further consolidate the market. ■ We view the amendment to the Law for Promoting Private Education that came into AVIGATING AVIGATING effect on 1 Sep 2017 as beneficial to private education providers, including Yuhua and China Maple Leaf. ■ We use DCF as our key valuation methodology given education players’ relatively

N stable and predictable cash flows.

Analyst(s) Lei YANG, CFA T (86) 21 5047 1771 x108 E [email protected] ONG Khang Chuen T (852) 2539 1326 E [email protected]

IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE Powered by END OF THIS REPORT. IF THIS REPORT IS DISTRIBUTED IN THE UNITED STATES IT IS DISTRIBUTED BY CIMB the EFA SECURITIES (USA), INC. AND IS CONSIDERED THIRD-PARTY AFFILIATED RESEARCH. Platform

Navigating China│Services - Education│September 19, 2017

TABLE OF CONTENTS Investment summary ...... 5 Informal education ...... 11 Formal education ...... 32 Favourable government policy trends ...... 39 PRC education industry overview ...... 44 Valuation and top picks ...... 48 Company Briefs… ...... 53

2

Navigating China│Education│September 19, 2017

Sector Note

China Education Invest for a bright future Overweight (no change) ■ We assume coverage on China education with an Overweight. K-12 after-school

Highlighted companies tutoring is our preferred segment; New Oriental Education (EDU) is our top pick. ■ We view the K-12 after-school tutoring providers as the key beneficiaries of ‘Gaokao’ China Yuhua Education Corp ADD, TP HK$4.50, HK$3.80 close reform and see top players enjoying policy tailwinds and gaining market share rapidly. ■ Among the private education providers, China Yuhua is our top pick. Share price drivers include: 1) expansion of ■ We expect further cooperation between tertiary education providers and vocational new schools in the pipeline, 2) earnings improvement driven by higher utilisation rates education providers to bode well for industry players like Tarena, in the long term. and operational leverage, and 3) further Assume coverage with Overweight; EDU is top pick earnings upside from M&A activities. Riding the tailwinds of favourable policy and consumption upgrade trends in China, we New Oriental Education see education as a defensive sector with strong growth potential. We assume coverage ADD, TP US$114.3, US$87.2 close on the China education sector with an Overweight rating and choose EDU as our top Share price drivers include: 1) acceleration in pick. Our order of preference is: 1) K-12 after-school tutoring providers, EDU and TAL learning centre growth, 2) continued utilisation Education (TAL), 2) K-12 private school players, China Yuhua and China Maple Leaf, improvement, and 3) dual-teacher model as a followed by 3) vocational training provider, Tarena International (Tarena). mid-term growth driver. TAL Education Group K-12 after-school tutoring the key beneficiary of Gaokao reform ADD, TP US$40.30, US$33.01 close We forecast K-12 after-school tutoring 4-year revenue CAGR of 12.7% yoy to Rmb1.29tr Share price drivers include: 1) continued rapid by 2020F. This market is still quite fragmented as the market shares of the no.1 and no.2 learning centre expansion, 2) fast growth of players, TAL and EDU, were only 0.8% and 0.7%, respectively, in 2016. With the dual-teacher model and online education, and standardisation of the National Higher Education Entrance Examination (Gaokao), we 3) enhanced course offerings driving near-term expect TAL and EDU to record strong 3-year offline K-12 enrolment CAGR of 40.0% and growth. 30.7%, respectively, lifting their market shares to 1.7% and 1.2% in 2020F. Top players embracing “ed-tech” for further market consolidation Summary valuation metrics Education technology (ed-tech) will continue to serve as an important supplement for P/E (x) Dec-17F Dec-18F Dec-19F offline education providers to increase education quality and facilitate penetration into China Yuhua Education Corp 20.91 15.68 lower-tier cities, enabling market share gain, in our view. We expect EDU, TAL and New Oriental Education 42.06 31.68 23.96 TAL Education Group 88.13 52.19 33.92 Tarena to successfully expand into lower-tier cities, capitalising on their dual-teaching models (live broadcast teaching) and online platforms. We forecast EDU’s and TAL’s P/BV (x) Dec-17F Dec-18F Dec-19F online revenue to record CAGR of 30.7% and 72.8%, respectively, in FY17-20F. China Yuhua Education Corp 2.93 2.71 New Oriental Education 7.57 6.24 5.02 Favourable government policies a boost to private education TAL Education Group 19.23 13.39 9.19 We view the amendment to the Law for Promoting Private Education that came into effect on 1 Sep 2017 as beneficial for private education providers like Yuhua and China Maple Dividend Yield Dec-17F Dec-18F Dec-19F Leaf. Both are waiting for detailed rules from local government before deciding whether to China Yuhua Education Corp 2.94% 3.16% change their high schools to profit-making entities, which will give them greater flexibility New Oriental Education 0.52% 0.52% 0.52% in tuition fees. We forecast Yuhua to deliver 3-year core net profit CAGR of 19.4% in TAL Education Group 0.08% 0.00% 0.00% FY16-19F, driven by new school openings, higher utilisation rates and tuition fees.

Insert Vocational education providers to cooperate with universities Many provincial governments have, in recent years, encouraged the private sector to partner with universities to provide practical training to raise job landing rates. We expect Tarena to cooperate more with universities to offer special classes beginning in the first year of university, bringing in recurring cash flows and lowering customer acquisition costs. Its IT-related K-12 courses are also a medium-term earnings growth driver, in our view. We project 3-year non-GAAP net profit CAGR of 23.2% for FY16-19F for Tarena. Valuation justified by strong earnings growth We use DCF as our key valuation methodology given education players’ fairly stable and predictable cash flows. We believe K-12 after-school tutoring players should command a higher PEG relative to other education sub-segments due to their more robust long-term earnings growth profiles, driven by strong brand names and their ability to provide high quality education vs. peers by leveraging technology. The 1.25x CY18F target PEG we attribute to our top pick, EDU, is 0.6 s.d. above its 5-year average historical forward PEG.

Analyst(s) Figure 1: Target price and implied valuation comparison Implied CY18F PEG Implied Implied 2-year 2-year (against 2 Target price CY17F CY18F revenue core EPS year core (LC$) Upside P/E P/E CAGR CAGR EPS CAGR) Lei YANG, CFA New Oriental Education 114.30 31.1% 51.8 39.4 24.5% 31.5% 1.25 T (86) 21 5047 1771 x108 TAL Education 40.30 22.1% 100.8 68.9 40.7% 55.1% 1.25 E [email protected] China Yuhua 4.50 18.4% 19.9 16.5 9.8% 16.3% 1.01 ONG Khang Chuen Maple Leaf Education 9.60 16.6% 30.0 22.7 24.6% 24.0% 0.95 T (852) 2539 1326 Tarena 16.70 15.3% 20.3 14.4 15.7% 21.1% 0.68 E [email protected] SOURCES: CIMB, COMPANY REPORTS

IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE END OF THIS REPORT. IF THIS REPORT IS DISTRIBUTED IN Powered by EFA THE UNITED STATES IT IS DISTRIBUTED BY CIMB SECURITIES (USA), INC. AND IS CONSIDERED THIRD-PARTY AFFILIATED RESEARCH. EFACustomEntityStatement Platform

Navigating China│Education│September 19, 2017

KEY CHARTS

K-12 after-school tutoring market size 1,400 Title: According to the Chinese Society of Education, the K-12 1,290 Source: after-school tutoring market generated Rmb800bn 1,200 1,143 revenue in 2016, with more than 137m students enrolled. 1,022 Please fill in the values above to have them entered in your report 1,000 Assuming that each student who takes up after-school 900 800 tutoring is enrolled in 1.7 classes, this implies national 800 707 penetration rate of 38.4% in 2016. We forecast the K-12

(Rmb bn) 600 after-school tutoring market size to post a 5-year CAGR of 12.8% from Rmb707bn in 2015 to Rmb1,291bn in 400

2020F. 200

0 2015 2016 2017F 2018F 2019F 2020F

Penetration rate of private schools in

60.0% 55.3% Title: 54.0% 54.1% 54.6% 54.8% 55.0% 52.5% fundamental education by number of 51.1% Source: 49.5% 50.3% student enrolments in China, 2011-2020F 50.0% Please fill in the values above to have them entered in your report The penetration rate of private schools in fundamental 40.0% education stood at 18.3% in 2015. With the increasing preference for private schools over public schools, Frost 30.0% 20.7% 21.3% 19.5% 20.1% 18.3% 18.9% 16.5% 17.4% & Sullivan forecasts the penetration rate to rise to 21.3% 20.0% 15.2% 14.1% 12.9% 13.3% 13.8% 11.7% 12.2% 12.6% 10.4% 11.1% by 2020F. 8.7% 9.5% 12.8% 10.0% 10.8% 11.2% 11.7% 12.1% 12.5% 9.5% 9.5% 9.5% 9.9% 8.6% 8.9% 7.1% 7.4% 7.6% 7.9% 8.2% 5.7% 6.2% 6.7% 0.0% 2011 2012 2013 2014 2015 2016F 2017F 2018F 2019F 2020F

Primary School High School Middle School Overall Preschool

Proposed Gaokao reforms The Gaokao used to place great emphasis on scores, which were used to separate students into the Science or Arts streams. In 2014, the State Council of PRC issued guidelines on Gaokao reform and establishment of a modern selection system for higher education in China, based on fundamental principle that: 1) is transparent and fair, 2) places more emphasis on the well-rounded development of students, and 3) increases diversity in and compatibility between higher education institutes and students.

Historical and upcoming catalysts for the education sector Relative performance of Chinese education stocks vs. MSCI China Looking back at the historical performance of the 800 Title: Source: education sector, three key catalysts were: 1) relaxing of 700 the one-child policy in Oct 2015, 2) amendment of the 600 Please fill in the values above to have them entered in your report Education Law in Dec 2015, which repudiated provisions 500 that prohibited the establishment of schools for profit- 400 making purposes, and 3) amendment to the Law for 300 Promoting Private Education in Nov 2016, allowing 200 private school sponsors to choose to establish schools as 100

either non-profit or for-profit entities at their own 0

Jul-16 Jul-17

discretion. As the amended Law took effect on 1 Sep Jul-15

Apr-15 Oct-15 Apr-16 Oct-16 Apr-17

Jan-16 Jun-16 Jun-17 Jan-15 Jun-15 Jan-17

Mar-16 Feb-17 Mar-17 Feb-15 Mar-15 Feb-16

Aug-15 Nov-15 Nov-16 Dec-16 Aug-17 Sep-15 Dec-15 Aug-16 Sep-16

May-15 May-17 2017, we expect the announcement of detailed May-16 implementation measures at the provincial level to be the MSCI China EDU TAL TEDU Yuhua Maple Leaf upcoming catalysts for the industry.

SOURCE: CIMB RESEARCH, COMPANY REPORTS, BLOOMBERG, FROST & SULLIVAN, VARIOUS NEWS REPORTS

4

Navigating China│Education│September 19, 2017

Invest for a bright future

Investment summary Assume coverage with Overweight and EDU as top pick Education has always been considered a top priority for both the Chinese government and the Chinese people. As a result, the education industry in China is heavily regulated. However, from the key policies relating to the PRC education industry over the past 20 years, we note that the government has adopted a favourable stance on opening up the education industry to private investment.

Figure 2: Key policies relating to PRC education industry Year Policies Description

1995 Education Law Opened up the education industry to private sector, however for profit-making purposes are not allowed

Promotes the development of vocational education industry, encourages establishment of vocational 1996 Vocational Education Law education schools by institutes/individuals

2003 Law for Promoting Private Education Set the standards for establishment of private schools

Opens up the Chinese education investment field to attract foreign education institutions to seek 2003 Regulations on Operating Chinese-Foreign Schools cooperation with their Chinese counterparts to form and manage foreign-invested schools in China Government to arrange special employment funds in fiscal budgets to promote employment, including 2007 Employment Promotion Law providing subsidies for vocational training Outline of China's National Plan for Medium and Long-term Government first announced a plan to implement reform to divide private education entities into 1) for- 2010 Education Reform and Development (2010-2020) profit private education entities and (2) not-for-profit private education entities Implementation Opinions of the MOE on Encouraging and 2012 Proportion of foreign capital in a sino-foreign cooperative education institution shall be less than 50% Guiding the Entry of Private Capital in the Fields of Education Introduced a new "3+3" model, allows 2 attempts at English tests, and made adjustments to university 2014 Gaokao reform admission policies

2015 Amended Education Law Repudite provisions that prohibit establishement of schools for profit-making purposes

2015 Two-child Policy Liberated "One-child Policy", each family is permitted to have 2 children

Further establishes a new classification system for private schools to be classified by whether they are 2016 Amendment to Law for Promoting Private Education established and operated for profit-making purposes SOURCE: CIMB RESEARCH, COMPANY

Riding the tailwinds of favourable policy and consumption upgrade trends in China, we see education as a defensive sector with solid growth potential. We believe the recent policy reforms will further stimulate the sector and hence, assume coverage with an Overweight rating and New Oriental Education (EDU) as our top pick. Our order of preference is: 1) K-12 after-school tutoring providers, EDU and TAL Education (TAL), 2) K-12 private schools, China Yuhua and China Maple Leaf, followed by 3) vocational training provider, Tarena.

5

Navigating China│Education│September 19, 2017

Figure 3: Education sector peer comps 3-year Dividend yield Price TP Mkt cap P/E (x) EPS P/BV (x) PEG (x) (x) Company Ticker Recom. (LC$) (LC$) (US$) CY17F CY18F CY19F CAGR (%) CY17F CY18F CY17F CY18F CY17F CY18F China education ADR New Oriental Education EDU US Add 87.16 114.30 13,743 40.2 30.6 23.3 31.5% 7.1 5.8 1.3 1.0 0.5% 0.5% TAL Education TAL US Add 33.01 40.30 16,533 67.9 52.9 34.8 57.6% 18.4 12.7 na 1.0 0.0% 0.0% Bright Scholar Education BEDU US Non Rated 21.89 na 2,567 68.9 41.7 na na 20.4 16.0 na na 0.0% 0.0% Tarena International TEDU US Add 14.49 16.70 830 17.2 12.6 9.7 23.2% 2.9 2.4 0.9 0.6 1.2% 1.7% China Distance Education DL US Non Rated 6.90 na 227 12.4 13.0 na -6.0% 3.8 3.5 na na 6.5% 6.5%

China H-share education Virscend Education 1565 HK Non Rated 4.78 na 1,868 38.0 26.0 19.9 29.5% 4.6 4.1 na na 1.4% 1.7% China Maple Leaf Education 1317 HK Add 8.23 9.60 1,458 25.7 19.5 na 23.9% 4.1 3.7 1.1 0.8 1.8% 2.3% China Yuhua Education 6169 HK Add 3.80 4.50 1,518 16.8 13.9 na 19.4% 3.0 2.8 1.0 0.9 2.9% 3.0% Wisdom Education 6068 HK Non Rated 4.25 na 1,131 25.7 20.0 16.5 43.6% 3.9 3.5 na na 1.2% 1.6% Minsheng Education 1569 HK Non Rated 2.00 na 1,030 20.3 16.9 15.4 20.8% 2.0 1.8 4.1 3.4 0.6% 0.7% China New Higher Education 2001 HK Non Rated 4.56 na 831 22.1 17.6 14.3 50.9% 3.0 2.7 na na 1.3% 1.8%

International education Grand Canyon Education LOPE US Non Rated 83.23 na 4,005 21.7 20.3 18.1 14.3% na na 1.4 1.4 0.0% 0.0% Adtalem Global Education ATGE US Non Rated 34.95 na 2,170 12.6 11.5 na 10.0% na na 1.3 1.2 1.0% 1.0% Strayer Education STRA US Non Rated 83.01 na 927 24.9 22.0 19.2 11.0% na na 1.7 1.5 0.0% 0.0% Capella Education CPLA US Non Rated 68.30 na 797 19.3 18.6 15.2 7.8% na na 1.9 1.9 2.4% 2.5% Daekyo Co 019680 KS Non Rated 8300.00 na 620 17.3 17.7 16.9 9.2% 1.2 1.2 na na 2.9% 2.9% Note: As of 19th Sep 2017 SOURCE: CIMB RESEARCH, BLOOMBERG

K-12 after-school tutoring to be the key beneficiary of Gaokao reform We believe the K-12 after-school tutoring segment is the key beneficiary of Gaokao reform. We expect it to especially benefit from: 1) the extended exam preparation cycle with elective exams being taken earlier, and 2) additional sitting for the English exam. On the back of exam standardisation, we expect nationwide players EDU and TAL to record strong 3-year offline K-12 enrolment CAGR of 30.7% and 40.0% in FY17-20F, respectively, as they can expand into new cities faster and gain market shares from regional players. We forecast the K-12 after-school tutoring market size to deliver a 4-year CAGR of 12.7% to Rmb1.29tr by 2020F. This market is still quite fragmented, as the market shares of the no.1 and no.2 players, TAL and EDU, were only 0.8% and 0.7%, respectively, in 2016. This provides leading players with great potential to further consolidate the market in the near future, in our view. We estimate the market shares of TAL and EDU to reach 1.7% and 1.2%, respectively, by 2020F.

6

Navigating China│Education│September 19, 2017

Figure 4: Summary of proposed Gaokao reforms

SOURCE: CIMB RESEARCH, VARIOUS NEWS REPORTS

Top players embracing ed-tech for further market consolidation With the increased use of technology to complement education services, online education is an up-and-coming trend in the education industry. iResearch forecasts the online education market to post a 4-year CAGR of 21.8%, from Rmb122.5bn in 2015 to Rmb269.3bn in 2019F, mainly driven by increased enrolment at CAGR of 22.1% over the same time period. Nevertheless, we believe the offline classroom format will remain the preferred format for K-12 education in China. We expect education technology to continue serving as an important supplement for offline education providers to increase the quality of education and facilitate penetration into lower-tier cities, enabling market share gain, in our view. We expect EDU, TAL and Tarena to successfully expand into lower-tier cities, leveraging their dual-teaching models (live broadcast teaching) and online platforms. Besides ensuring consistent teaching quality, such models provide them with strong operating leverage to support consolidation. We forecast EDU’s and TAL’s online revenue to record CAGR of 30.7% and 72.8%, respectively, in FY17-20F.

Figure 5: Remote answering devices Figure 6: Real-time Q&A in class Figure 7: Online live classes by TAL

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

7

Navigating China│Education│September 19, 2017

Favourable government policies a boost to private education We view the amendment to the Law for Promoting Private Education that came into effect on 1 Sep 2017 as beneficial to private education providers, including Yuhua and China Maple Leaf. Private schools (except providers of compulsory education) are now allowed to be classified as profit-making entities and granted the ability to set their tuition fees without seeking prior approval from relevant authorities. We believe both Yuhua and Maple Leaf are waiting for detailed implementation rules from the local government before deciding whether to change their high schools to profit-making entities, which would give them greater flexibility in setting tuition fees. We forecast Yuhua to deliver 3-year core net profit CAGR of 19.4% yoy in FY16-19F, driven by new school openings, higher utilisation rates and rising tuition fees.

Figure 8: Non-profit vs. for-profit educational entities, as per Standing Committee of the National People’s Congress guidelines Non-profit For-profit

Operation surplus is used for operation of the schools Sponsors are entitled to retain operation surplus

Tuition fees charged must be approved by government Schools are entitled to set their own tuition fees authorities without the need to seek prior approvals Able to acquire land use rights in the form of allocation Required to purchase land use rights from government by government Assets will continue to be used for operation of non- Assets can be distributed to sponsors post liquidation profit schools post liquidation

Same tax benefits as public schools Specific provisions yet to be introduced

SOURCE: CIMB RESEARCH, VARIOUS NEWS REPORTS

According to Frost & Sullivan, revenue from private fundamental education (including preschool education, primary and secondary schools) in China is expected to post a 5-year CAGR of 12.1%, from Rmb184.2bn in 2015 to Rmb325.5bn in 2020F, due to a combination of growing wealth, increased demand for better education opportunities, supportive government policies and increasing investment, thereby creating more spaces for potential students.

Vocational education providers to benefit from further cooperation with universities Vocational education providers benefit from the fairly high youth unemployment rate in China as they help underperforming students to improve their skillsets and land a job. Many provincial governments have, in recent years, encouraged private sector education providers to partner with universities to provide practical training at colleges. We expect Tarena to cooperate more with universities moving forward to offer Tarena special classes that start in the first year of university, which would bring in recurring cash flow and lower customer acquisition costs for the company. Tarena’s IT-related K-12 courses are also a medium-term earnings growth driver, in our view. We expect Tarena to deliver 3- year non-GAAP net profit CAGR of 23.2% for FY16-19F.

8

Navigating China│Education│September 19, 2017

Figure 9: Summary of financial data of education companies under our coverage FY14 FY15 FY16 FY17F FY18F FY19F Turnover (Rmb m) China Yuhua Education 599.3 697.7 781.3 847.2 933.5 1,021.8 China Maple Leaf Education 540.3 653.0 829.8 1,052.6 1,318.0 1,635.3 New Oriental Education 6,980.7 7,717.4 9,476.2 12,226.2 15,174.5 18,550.8 TAL Education 1,921.5 2,686.0 3,928.7 6,985.3 10,986.1 15,495.6 Tarena International 836.9 1,178.0 1,579.6 1,974.4 2,476.4 3,054.4

Turnover growth (%) China Yuhua Education n.a. 16.4% 12.0% 8.4% 10.2% 9.5% China Maple Leaf Education 14.7% 20.9% 27.1% 26.9% 25.2% 24.1% New Oriental Education 18.7% 9.5% 18.6% 21.7% 27.0% 25.5% TAL Education 38.9% 38.3% 42.9% 68.3% 57.9% 45.4% Tarena International 46.6% 40.8% 34.1% 25.0% 25.4% 23.3%

Gross margin (%) China Yuhua Education 44.5% 45.6% 52.0% 51.2% 53.7% 55.6% China Maple Leaf Education 43.5% 45.7% 48.4% 49.0% 49.7% 50.2% New Oriental Education 60.3% 57.8% 58.4% 58.3% 59.1% 59.7% TAL Education 51.7% 53.2% 51.0% 49.9% 50.7% 51.3% Tarena International 71.4% 71.7% 71.8% 70.7% 71.6% 72.1%

Operating margin (%) China Yuhua Education 37.6% 16.6% 43.2% 35.0% 43.0% 48.4% China Maple Leaf Education 25.7% 26.7% 30.6% 32.2% 33.0% 33.9% New Oriental Education 19.1% 13.6% 14.6% 15.7% 16.5% 17.5% TAL Education 20.9% 19.7% 17.9% 16.4% 17.9% 19.0% Tarena International 17.1% 16.2% 18.8% 16.0% 17.6% 18.7%

Core net profit (Rmb m) China Yuhua Education 207.8 245.1 322.1 405.0 474.7 548.1 China Maple Leaf Education 40.0 205.5 307.6 399.3 488.5 614.3 New Oriental Education 1,445.2 1,291.9 1,549.3 2,002.5 2,572.4 3,295.2 TAL Education 422.1 529.8 815.7 1,010.5 1,637.4 2,561.6 Tarena International 173.3 211.7 309.7 326.0 444.0 579.4

Core net profit growth (%) China Yuhua Education n.a. 17.9% 31.4% 25.8% 17.2% 15.5% China Maple Leaf Education 20.7% 413.4% 49.6% 29.8% 22.4% 25.8% New Oriental Education 44.2% -11.5% 15.8% 21.9% 31.4% 31.5% TAL Education 65.3% 24.1% 50.4% 17.2% 62.7% 61.3% Tarena International 195.4% 22.1% 46.3% 5.3% 36.2% 30.5% *Core net profit refers to non-GAAP net profit for ADRs including New Oriental Education, TAL Education and Tarena International

China Yuhua Education: FYE Aug China Maple Leaf Education: FYE Aug New Oriental Education: FYE May TAL Education: FYE Feb Tarena International: FYE Dec SOURCE: CIMB FORECASTS, COMPANY

9

Navigating China│Education│September 19, 2017

Figure 10: Summary of operational data of education companies under our coverage FY14 FY15 FY16 FY17F FY18F FY19F No. of schools China Yuhua Education 18 24 24 25 26 27 China Maple Leaf Education 33 40 46 60 75 80

No of learning centers and service centers New Oriental Education 647 664 682 778 875 976 TAL Education 274 289 363 507 630 769 Tarena International 118 134 145 175 205 235

Student enrolments China Yuhua Education 35,431 43,579 48,220 51,898 56,075 59,370 China Maple Leaf Education 13,513 16,078 19,334 23,278 28,399 34,079 New Oriental Education 2,668,800 2,896,300 3,645,100 4,858,600 6,220,559 7,848,971 TAL Education 1,073,950 1,494,430 2,309,830 3,934,720 6,162,926 8,881,064 Tarena International 59,960 84,041 107,493 128,186 151,450 177,783

No. of teachers China Yuhua Education 2,069 2,288 2,452 2,542 2,728 2,918 China Maple Leaf Education 1,272 1,576 1,814 1,999 2,368 2,368 New Oriental Education 16,600 17,200 18,800 21,620 23,998 26,638 TAL Education 4,646 5,525 8,388 14,168 21,045 28,751 Tarena International 117 193 204 232 261 291

Student vs teachers ratio China Yuhua Education 17.1 19.0 19.7 20.4 20.6 20.3 China Maple Leaf Education 10.6 10.2 10.7 11.6 12.0 12.4 New Oriental Education 160.8 168.4 193.9 224.7 259.2 294.7 TAL Education 231.2 270.5 275.4 277.7 292.8 308.9 Tarena International 512.0 435.0 527.0 553.4 581.0 610.1

Capacity (No. of students) China Yuhua Education 55,300 62,950 71,200 71,200 76,200 79,200 China Maple Leaf Education 22,490 26,090 30,040 35,340 44,590 53,840 New Oriental Education n.a. n.a. n.a. n.a. n.a. n.a. TAL Education n.a. n.a. n.a. n.a. n.a. n.a. Tarena International n.a. 157,706 193,073 234,225 279,866 327,238

Utilisation rate China Yuhua Education 64.1% 69.2% 67.7% 72.9% 73.6% 75.0% China Maple Leaf Education 60.1% 61.6% 64.4% 65.7% 64.0% 63.6% New Oriental Education n.a. n.a. n.a. n.a. n.a. n.a. TAL Education n.a. n.a. n.a. n.a. n.a. n.a. Tarena International n.a. 65.9% 70.4% 69.0% 70.0% 71.0% China Yuhua Education: FYE Aug China Maple Leaf Education: FYE Aug New Oriental Education: FYE May TAL Education: FYE Feb Tarena International: FYE Dec

SOURCE: CIMB FORECASTS, COMPANY

10

Navigating China│Education│September 19, 2017

Informal education Key success factors According to a 2016 survey carried out by Sohu (Chinese internet company that operates a popular search engine), when considering an education provider, the key consideration for most Chinese parents’ (23.4%) is teaching quality. Educational philosophy and pricing are the second and third most important factors, respectively, featuring as key considerations among 16.8% and 13.1% of all parents surveyed.

Figure 11: Key factors in parents’ selection of an education provider for their children (as of 2016) Referrals, 3.0% Class size, 4.1% Title: Teaching materials, 7.2% Source:

Please fill in the values above to have them entered in your report Teacher, 23.4% Foreign teachers, 9.8%

Brand name, 10.2% Educational philosophy, 16.8%

Curriculum, 12.4% Pricing, 13.1% SOURCE: CIMB RESEARCH, LEARNING.SOHU.COM

In our opinion, the key success factors of an education provider are as follows:

Creating a virtuous cycle We believe the key to the success of an education provider is the ability to create a virtuous cycle, which would help the company establish solid brand reputation.

Figure 12: TAL’s virtuous cycle

SOURCE: CIMB RESEARCH, COMPANY

11

Navigating China│Education│September 19, 2017

Strong teaching line-up: Education providers should focus on building a strong teaching line-up, with overall high standards. New teaching staff hires must undergo comprehensive training and be continuously evaluated on their classroom performance and teaching results, in our view. The companies could also use attractive remuneration packages to retain high-quality teaching staff. For example, Tarena employs instructors who have industry background in global and domestic technology companies or are veterans in their respective specialised fields.

Good students: With a strong teaching line-up and high-quality teaching materials, we believe that private education companies will, in theory, be able to produce students with good results and thus, create a strong brand name. We highlight TAL’s premium branding, which is primarily due to it having produced many top students over the years who successfully gained admission into the best universities in China. Tarena has also consistently maintained a six-month post-graduation job placement rate of above 90% since its listing in 2014.

Strong branding: Helped by strong branding, education companies would be able to save on user acquisition costs as they would be able to rely mainly on word of mouth to attract new students. Also, education companies can achieve a high student retention rate and improve cross-selling across categories. For example, EDU is able to fulfil the after-school educational needs of a K-12 student, as well as provide support later in the student’s life as he/she prepares to enter higher education, whether domestically or abroad. Essentially, as long as a student is satisfied with the education quality provided by EDU, the student could be a revenue generator for the company as long as 15 years.

Central management model allows rapid expansion We believe the commitment to centralised and standardised management is essential to the success of an after-school tutoring business, as it is crucial in helping the company successfully replicate its operating model in new markets. EDU, TAL and Tarena all have centralised content development teams that work closely with experts in different subject fields to keep abreast of the changing academic and examination requirements of the Chinese education system. The team is in charge of constantly analyzing the latest market trends, and takes into consideration teaching materials from leading public schools, in developing course content. The course materials are constantly updated based on feedback from teachers, students and parents. For K-12 after school tutoring providers that face the challenge of different curricula across provinces, the curricula and course materials are mainly developed at the headquarters and later adopted and modified by teams in other locations to meet local requirements and demand.

Figure 13: TAL’s content development model

SOURCE: COMPANY

12

Navigating China│Education│September 19, 2017

Leverage on technology – online education and dual-teacher models In order to widen geographical reach, while protecting profit margins, successful education providers leverage on technology to expand. We are positive on the new dual-teacher class format, as parents and students in lower-tier cities prefer teachers from big cities as they are deemed more experienced and familiar with provincial examinations. For example, EDU plans to adopt the dual-teacher model as it expands into lower-tier cities with low demand density compared to top-tier cities. Under this new class format, instructors deliver lectures to students in different learning centres nationwide through simultaneous webcasts. Typically, an instructor will cover 10-20 classrooms at the same time. Teachers in high demand may cover even more classrooms. Meanwhile, every classroom is staffed with teaching assistants locally to tutor and supervise students in person. TAL has adopted a similar model, coupled with new expression analysis technology to analyse students’ performance during the class and provide parents with analytic feedback regarding students’ performance after class.

We expect the dual-teacher model to drive future earnings growth for K-12 after- school tutoring service providers, as it could result in: 1) higher demand from lower-tier cities, 2) better motivation and ability to retain good teachers, given that the dual-teacher model could increase their compensation, and 3) increase in utilisation rates, which would help margin expansion.

K-12 after school tutoring is a bright spot in the China education sector According to the Chinese Society of Education, the K-12 after-school tutoring market generated Rmb800bn revenue in 2016, with more than 137m students enrolled. Assuming that each student who takes up after-school tutoring is enrolled in 1.7 classes, this implies national penetration rate of 38.4% in 2016. We expect the penetration rate of after-school tutoring to continue rising, helped by the rising disposable income of middle-income families in China. We forecast that the K-12 after-school tutoring market size (revenue) will expand by a 5-year CAGR of 12.8% (2015 to 2020F) to Rmb1,290bn in 2020F.

Figure 14: K-12 after school tutoring market size

1,400 Title: 1,290 Source: 1,200 1,143 1,022 Please fill in the values above to have them entered in your report 1,000 900 800 800 707

(Rmb bn) 600

400

200

0 2015 2016 2017F 2018F 2019F 2020F

SOURCE: CIMB FORECASTS, CHINESE SOCIETY OF EDUCATION

13

Navigating China│Education│September 19, 2017

Figure 15: After-school tutoring market size, based on our estimates 2015 2016 2017F 2018F 2019F 2020F Preschool 42.6 44.1 45.7 47.3 48.9 50.7 Primary school 96.9 99.1 98.1 100.4 101.9 103.4 Middle school 43.5 43.2 43.3 42.6 41.4 42.0 High school 23.8 23.2 23.9 24.5 25.4 26.6 Total K-12 student base (million students) 206.8 209.6 211.1 214.8 217.6 222.7 yoy growth (%) 1.3% 0.7% 1.7% 1.3% 2.4% Tutoring penetration (%) 37.9% 38.4% 38.9% 39.4% 39.8% 40.2% Total K-12 after-school tutoring student base (million students) 78.5 80.6 82.2 84.7 86.7 89.6 yoy growth (%) 2.7% 2.0% 3.1% 2.4% 3.4% Class enrolment per student 1.6 1.7 1.8 1.9 2.0 2.1 yoy growth (%) 5.0% 5.0% 5.0% 5.0% 5.0% Tutoring student enrolment (million students) 127.1 137.0 146.7 158.8 170.7 185.2 yoy growth (%) 7.8% 7.1% 8.2% 7.5% 8.6% Annual tuition spending per student (Rmb) 5,561.3 5,839.4 6,131.4 6,438.0 6,695.5 6,963.3 yoy growth (%) 5.0% 5.0% 5.0% 4.0% 4.0% K-12 after school tutoring market size (Rmb bn) 706.7 800.0 899.8 1,022.3 1,142.6 1,289.9 yoy growth (%) 13.2% 12.5% 13.6% 11.8% 12.9% SOURCE: CIMB FORECASTS, CHINESE SOCIETY OF EDUCATION, MINISTRY OF EDUCATION

The Chinese Society of Education estimated that the penetration rate of K-12 after-school tutoring in China was only 37% in 2014, but may have reached 70% in top-tier cities. This is supported by a survey conducted by the Financial Times that observed 58% of urban families had a child receiving private tuition in 2013. The proportion of students receiving after-school tutoring appears consistent across school grades, with the highest proportion among high school students (61% in 2013), likely due to the imminent Gaokao. In comparison, iResearch estimates that the penetration rates of after-school tutoring among students in Korean primary schools, junior high schools and high schools were 89%, 79% and 55%, respectively.

Figure 16: K-12 student base in China Figure 17: Proportion of urban students receiving private tuition (2013 survey)

250 62% Title: Title: 61% Source: 61% Source:

Millions 200 60% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 59% 150 58% 58%

100 57%

56% 50 55% 55%

0 54% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 53%

High school students Middle school students 52% Primary school Middle school High school Primary school students Preschool students

SOURCE: CIMB RESEARCH, MINISTRY OF EDUCATION SOURCE: CIMB RESEARCH, FINANCIAL TIMES

We believe the demand for K-12 after-school tutoring will continue rising at a steady pace in the coming years, with top players especially benefiting from the favourable regulatory changes in recent years, due to the following reasons: Increased penetration: We believe the relaxing of government regulations to allow students to take the Gaokao English exam twice and the spreading out of examinations for elective subjects across the three years of high school would result in more demand for after-school tutoring services. Given the importance of the Gaokao (seen as the key stepping stone for entrance into China’s top universities), we believe students will utilise all tools available to them, including after-school tutoring, to improve their grades. The extended exam period

14

Navigating China│Education│September 19, 2017

enables after-school tutoring service providers to offer more intensive preparation sessions, which could drive penetration rates. Market consolidation: The K-12 after-school tutoring segment in China remains fragmented, in our view. Based on the Chinese Society of Education’s revenue estimate of Rmb800bn in 2016, we estimate the market shares of the two largest K-12 after-school tutoring service providers, TAL and EDU, only accounted for c.0.8% and c.0.7%, respectively. We believe the standardisation of the Gaokao exam would benefit large training institutes more than small ones, as the larger players have more resources to react faster to the new exams. At the same time, this reduces the edge of region-specific players in China as their additional insight into examination question-setting standards is rendered useless. Furthemore, parents are more likely to trust the larger education brands to keep up with the latest changes in the Gaokao examination format. Along with the formal implementation of the Law for Promoting Private Education on 1 Sep 2017, we expect the local governments to raise the licence requirements for K-12 after-school tutoring service providers as they monitor them more closely. All the abovementioned new developments will result in market consolidation among the K-12 after-school tutoring providers, in our view, which should benefit market leaders TAL and EDU. We estimate the market shares of TAL and EDU would reach 1.7% and 1.2%, respectively, by 2020F.

Comparison between EDU and TAL We highlight two key players in the K-12 after-school tutoring industry, New Oriental Education (EDU) and TAL Education (TAL). Established in 1993, New Oriental Education (EDU) is the largest provider of private educational services in China by student enrolment. It offers a wide range of educational programmes, services and products. At end-May 2017, EDU had 855 learning centres across 65 cities in China. TAL Education (TAL) was established in 2005 and is widely recognised for its high teaching quality and academic excellence. It had 567 learning centres across 35 cities nationwide at end-May 2017.

Business model: ‘One-stop shop’ vs. K-12 focused Having started as a Test of English as a Foreign Language (TOEFL) preparation service provider in Beijing, EDU has since expanded its offerings to a wide range of educational services, including K-12 after-school tutoring, domestic test preparation and language training, online education, as well as other fringe educational services. In FY5/17, K-12 after-school tutoring classes (U-can and Pop Kids) accounted for the lion’s share of EDU’s revenue (54.5%), followed by overseas test preparation and consulting classes (30.2%). Domestic test preparation and language training courses accounted for a combined 5.2% of FY17 revenue, online education accounted for 3.5% and other services (including private schools, overseas study tours and bookstores) accounted for the remaining 6.6% of EDU’s FY17 revenue.

In contrast, TAL is a pure K-12 play. After starting out as an Olympiad Mathematics tutoring service in Beijing, TAL has expanded its offerings to comprehensive tutoring services for K-12 students that cover multiple core academic subjects. It mainly offers tutoring in small class sizes, which accounted for 84.4% of FY2/17 revenue. One-on-one tutoring only accounted for 10.5% of FY17 revenue, followed by online courses that comprised 4.5%. However, with recent acquisitions like Firstleap Education and Shunshun Bida in 2016, TAL is gradually expanding its offerings to include overseas test preparation and consulting services.

15

Navigating China│Education│September 19, 2017

Figure 18: EDU’s revenue breakdown (FY17) Figure 19: TAL’s revenue breakdown (FY17) Online education, Others, 6.6% Online courses, Others, 0.6% 3.5% Language training 4.5% Title: Title: courses, 2.0% One-on-one, Source: Source: Domestic test prep, 10.5% 3.2% U-can, 37.0% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report Overseas consulting, 8.0%

Overseas test prep, 22.2% Small classes, 84.4%

Pop Kids, 17.5% Small classes One-on-one Online courses Others

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

Growth stage: Mature stage vs. rapid growth EDU has a larger learning centre network than TAL, in terms of both the number of learning centres and number of cities penetrated. At end-May 2017, EDU had established 855 learning centres across 65 cities, while TAL had 567 learning centres in 35 cities. As shown in Figure 20 below, EDU has a mature presence in many cities, with 27 cities having more than 10 learning centres each. Meanwhile, TAL only has 14 cities with more than 10 learning centres each.

Figure 20: Top 30 cities by number of learning centres (at end-May 2017) City EDU TAL Beijing 97 145 Shanghai 52 58 Wuhan 49 25 Zhengzhou 35 18 Guangzhou 31 47 Suzhou 30 12 Tianjin 28 30 Shenyang 27 14 Changsha 25 6 Chengdu 25 21 Taiyuan 25 8 Hefei 24 4 Nanchang 24 2 Hangzhou 22 24 Xi'an 22 28 Kunming 21 0 Xiamen 20 1 Nanjing 19 49 Jinan 18 3 Changchun 17 2 Shenzhen 16 31 Harbin 15 0 Chongqing 14 16 Qingdao 14 4 Fuzhou 13 2 Shijiazhuang 12 4 Wuxi 11 2 Lanzhou 10 1 Dalian 8 1 Tangshan 8 0 Subtotal 732 558 Companies total 855 567 Top 30 cities as % of total 85.6% 98.4% SOURCE: CIMB RESEARCH, COMPANY

16

Navigating China│Education│September 19, 2017

EDU is currently focusing on maintaining a healthy balance between capacity expansion and margin improvement. Based on management guidance, EDU plans to increase its number of K-12 after-school learning centres in existing cities by 10-15% in FY18F. The company also plans to continue rolling out its dual-teacher model classes to 5-10 new cities in China in FY18F. We forecast that the number of EDU learning centres will increase by a 3-year CAGR of 11.3% from 855 in FY17F to 1,180 in FY20F. Apart from increasing the number of learning centres, EDU is also actively trying to raise the utilisation rates of its existing teaching facilities. In comparison, TAL plans to increase its capacity by 30-50% yoy p.a. over the next three years through: 1) continued increase in number of learning centres in existing cities, and penetration of new cities, as well as 2) capacity expansion of existing learning centres. We forecast that the number of TAL learning centres will rise by a 3-year CAGR of 21.8%, from 507 in FY2/17 to 916 in FY20F.

Figure 21: EDU’s learning centre network Figure 22: TAL’s learning centre network

1,400 16% 1,000 Title: 45% 916 Title: 14% Source: 1,180 900 40% Source: 1,200 1,072 12% 800 769 35% 962 10% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 1,000 700 855 630 30% 8% 600 800 748 703 724 6% 507 25% 500 4% 600 20% 400 363 2% 274 289 15% 300 400 0% 10% -2% 200 200 -4% 100 5%

0 -6% 0 0% FY14 FY15 FY16 FY17 FY18F FY19F FY20F FY14 FY15 FY16 FY17 FY18F FY19F FY20F

LHS: Learning centres RHS: yoy growth (%) LHS: Learning centres RHS: yoy growth (%)

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

K-12: TAL is poised to expand at a faster pace than EDU We expect EDU’s K-12 after-school tutoring to record 3-year revenue CAGR of 33.4% from US$981m in FY17 to US$2.3bn in FY20F. Over the same time period, we expect TAL to achieve revenue CAGR of 46.2%, from US$1.04bn in FY17 to US$3.26bn in FY20F.

Figure 23: EDU’s K-12 revenue trend (US$ m) Figure 24: TAL’s K-12 revenue trend (US$ m)

2,500 2,326 40% 3,500 Title: 3,261 80% Title: Source: Source: 35% 3,000 70% 2,000 1,795 30% Please fill in the values above to have them60% entered in your report Please fill in the values above to have them entered in your report 2,500 2,395

25% 50% 1,500 1,347 2,000 20% 1,647 40% 981 1,500 1,000 15% 30% 721 1,043 549 1,000 477 10% 620 20% 500 434 5% 500 314 10%

0 0% 0 0% FY14 FY15 FY16 FY17 FY18F FY19F FY20F FY14 FY15 FY16 FY17 FY18F FY19F FY20F

LHS: EDU K-12 revenue (US$m) RHS: yoy growth (%) LHS: TAL revenue (US$m) RHS: yoy growth (%)

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB RESEARCH, COMPANY

We forecast EDU’s K-12 segment to see student enrolment growth of 26.7- 35.0% yoy in FY18-20F. This is likely to come from learning centre capacity expansion of 10-12.5% annually over the next three years and continued

17

Navigating China│Education│September 19, 2017

improvement in utilisation rate. The average utilisation rate of EDU learning centres stood at c.22% in FY17; management plans to improve it by 1.5-2.0% pts every year in FY18-20F. We forecast modest ASP hikes of 1.7-2.3% yoy in US$ terms for EDU’s K-12 after-school tutoring courses in FY18-20F. While individual EDU learning centres typically raise hourly tuition fees by 5-9% yoy in Rmb terms annually, we believe the ASP hikes would be partially offset by: 1) higher revenue contribution from lower-tier cities, which generates lower ASPs than higher-tier cities, and 2) reduced emphasis on VIP classes, which earn higher ASPs than other classes. As for TAL, given its rapid capacity expansion plans, we expect offline student enrolment to record a 3-year CAGR of 40.0%, from 3.15m in FY17 to 8.65m in FY20F. TAL typically raises its tuition fees once every two years. We forecast TAL’s small class ASP to increase by 8%/5%/4% in Rmb terms for FY18/19/20F. We expect the rapid growth of newly-acquired Firstleap to help the small group segment achieve stronger ASP growth in the near term, as Firstleap generates higher hourly rate of Rmb120-140 (vs. TAL’s small class average of Rmb60-100 in 2017), but this is likely to be offset by TAL’s continued expansion into lower- tier cities.

Figure 25: Annual K-12 student enrolment comparison (‘000) Figure 26: K-12 ASP comparison (US$)

10,000 400 Title: Title: 8,822 9,000 8,651 Source: Source: 350 8,000 6,964 300 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 7,000 6,621 250 6,000 5,334 5,000 4,751 200 3,951

Thousands 4,000 3,150 150 3,000 2,688 1,928 1,917 100 2,000 1,568 1,270 1,074 50 1,000

0 0 FY14 FY15 FY16 FY17 FY18F FY19F FY20F FY14 FY15 FY16 FY17 FY18F FY19F FY20F

EDU U-Can + POP Kids TAL small class + 1-on-1 EDU K-12 TAL small class

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

18

Navigating China│Education│September 19, 2017

Profit margin: EDU’s gross and operating margins more likely to improve in FY18-20F than TAL’s At end-FY17, EDU had more teachers employed compared to TAL. However, given TAL’s rapid expansion plan, we expect TAL to overtake EDU in terms of the number of teachers by end-FY19F.

Figure 27: Number of teachers employed Figure 28: Number of students vs. number of teachers (x)

40,000 350 332 36,840 Title: 327 Title: Source: 309 Source: 35,000 32,881 293 295 300 278 270 275 259 30,000 28,592 28,751 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 250 231 24,863 225 25,000 194 21,620 21,045 200 168 20,000 18,800 161 16,600 17,200 150 14,168 15,000

100 10,000 8,388 4,646 5,525 5,000 50

0 0 FY14 FY15 FY16 FY17 FY18F FY19F FY20F FY14 FY15 FY16 FY17 FY18F FY19F FY20F

EDU TAL EDU TAL

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

Student-to-teacher ratio in FY17 was higher for TAL (278x) than EDU (225x) due to its higher utilisation rate. However, TAL’s near-term expansion plan is more aggressive than EDU’s, which could limit potential upside to student-to-teacher ratio in the near term as new learning centres would take time to ramp-up utilisation rates. We expect EDU’s student-to-teacher ratio would improve at a faster rate than TAL’s, helped by its slower pace of expansion and the dual- teacher model rollout in lower-tier cities. In our view, gross margin (GPM) is not a fair comparison for EDU And TAL because of they have different treatments for cost allocation. Hence, we recommend that investors compare EDU’s and TAL’s operating margin (OPM) to gain a better understanding of the two companies' underlying profitability. EDU and TAL measure their utilisation rates differently. EDU defines it as a multiple of classroom time utilisation (number of scheduled hours/number of maximum usable hours) and seat utilisation (number of seats taken/number of available seats). According to management, EDU’s utilisation rate in FY17 was c.20%. We believe that EDU’s learning centres achieve breakeven at 10% utilisation rate and every 1% increase in utilisation rate would translate into 0.5- 0.7% improvement in OPM. On the other hand, TAL defines utilisation rate as a multiple of classroom utilisation (number of scheduled lessons/number of usable slots) and student attendance. As a result, TAL’s utilisation rate historically ranged between 60% and 70%.

19

Navigating China│Education│September 19, 2017

Figure 29: Gross margin (GPM) comparison Figure 30: Non-GAAP operating margin (OPM) comparison

70.0% 25.0% Title: Title: 60.3% 59.7% 60.1% 57.8% 58.4% 58.3% 59.1% 20.9% Source: 20.5% Source: 60.0% 19.7% 20.0% 19.0% Please17.9% fill in the values17.9% above to have them entered in your report Please fill in the values above to have them entered in your report 50.0% 16.4% 53.2% 19.1% 51.7% 51.0% 51.3% 52.0% 18.6% 49.9% 50.7% 17.5% 15.0% 16.6% 40.0% 15.7% 14.6% 13.6% 30.0% 10.0%

20.0% 5.0% 10.0%

0.0% 0.0% FY14 FY15 FY16 FY17 FY18F FY19F FY20F FY14 FY15 FY16 FY17 FY18F FY19F FY20F

EDU TAL EDU TAL

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

In FY17, EDU’s OPM of 15.7% was slightly lower than TAL’s 16.4%. This was likely because EDU’s selling and marketing expenses-to-sales ratio of 12.9% in FY17 was higher than TAL’s 11.8%, given that EDU offers adult courses (overseas test preparation, language training, etc.) that incur higher student acquisition cost and generate lower levels of recurring revenue than K-12 courses. However, EDU showed a clear trend of OPM improvement over the past three years as it balanced capacity expansion and increase in utilisation rates. We expect this OPM trend to continue for EDU in FY18-20F. Meanwhile, TAL saw OPM compression over the past three years as it accelerated the opening of learning centres and invested heavily in online education and education technologies. While TAL’s OPM is likely to begin recovering in FY18F, given the lower base and positive impact from utilisation rate improvement at learning centres set up over the past two years, we think OPM expansion in FY18-20F is less likely for TAL than EDU because it hinges heavily on TAL’s rate of expansion and student enrolment.

20

Navigating China│Education│September 19, 2017

Online strategy: TAL more aggressive in expansion of online segment

Figure 31: Online segment as % of total revenue Figure 32: Online revenue growth (% yoy)

8.0% 7.5% 100.0% Title: 95.0% Title: 87.0% 90.0% Source: Source: 7.0% 6.5% 80.0% 5.6% 6.0% 67.0% Please fill in the values above 68.0%to have them entered in your report Please fill in the values above to have them entered in your report 70.0% 61.0% 5.0% 4.5% 57.5% 4.1% 60.0% 4.0% 3.6% 50.0% 3.0% 3.8% 4.0% 40.0% 3.0% 3.7% 3.3% 3.5% 3.0% 30.0% 36.8% 34.6% 2.0% 2.4% 30.4% 30.0% 20.0% 29.1% 27.5% 1.0% 10.0% 18.7%

0.0% 0.0% FY14 FY15 FY16 FY17 FY18F FY19F FY20F FY14 FY15 FY16 FY17 FY18F FY19F FY20F

EDU TAL EDU TAL

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

EDU offers online courses through its 68%-owned subsidiary Beijing New Oriental Xuncheng Network Technology Co Ltd (Xuncheng, Not Rated), which was listed on the National Equities Exchange and Quotations (NEEQ) in China in Mar 2017. At end-FY16, Xuncheng offered c.5,400 online courses on its platforms www.koolearn.com and www.koo.cn, including language training courses, test preparation courses, professional certification courses and business knowledge and various skill-training courses. In FY17, EDU’s revenue contribution from online education was 3.5% of total group revenue. We forecast EDU’s online education segment to record 3-year revenue CAGR of 30.7% from US$63m in FY17 to US$141m in FY20F. Both online platforms Koolearn.com and koo.cn saw strong registration numbers and growth in the number of paid users in FY17. DONUT, EDU’s game-based mobile learning apps for children, and Le Ci, an English language vocabulary training app for mobile phones and tablets, also continued to see strong downloads in FY17. TAL also offers online courses through www.xueersi.com. TAL’s online courses mainly feature interactive, live-broadcast lectures by experienced teachers. Besides allowing existing students to access their course materials online, the platform enables TAL to better target students in lower-tier cities, beyond the reach of TAL’s existing offline network. Students from first- and second-tier cities can also enroll in the online courses as the strong demand for offline courses cannot be fully met by offline learning centres due to the limited space. TAL started out offering online courses in pre-recorded video format but since Oct 2015, TAL has upgraded its offerings to live-broadcast classes, enabling enable students to participate in more proactive and interactive learning environment. With the acceleration in online enrolment growth post the initial transformation from pre-recorded content to live broadcasting, we have become more confident on the online offerings of TAL. We expect TAL’s online education to continue to gain popularity and forecast online enrolment to record a 3-year CAGR of 62.9%, from 785k in FY17 to 3.4m in FY20F.

21

Navigating China│Education│September 19, 2017

Professional education benefiting from the high unemployment rate of youths in China Professional education services are non-degree informal education programmes that focus on helping students improve their skillsets to achieve career advancement. According to IDC, professional education services industry revenue grew from Rmb48.8bn in 2010 to Rmb67.5bn in 2013. China’s higher education sector (college, undergraduate and postgraduate programmes) produced 7.6m graduates in 2016. However, the World Bank estimated that the unemployment rate among youths in China was 13.6% in 2016, notably due to the mismatch in labour supply and demand.

Figure 33: Number of students undertaking higher education in Figure 34: Job demand-to-job supply ratio in China (x) – Job China demand is higher than supply Job demand/job supply Title: 35 1.16 Title: Source: 1.14 Source: 30

Millions Please fill in the values above to have them entered in your report 1.12 Please fill in the values above to have them entered in your report 25 1.10

20 1.08

1.06 15 1.04 10 1.02

5 1.00

0.98 0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17

Mar-12 Mar-17 Mar-13 Mar-14 Mar-15 Mar-16

Sep-11 Dec-11 Sep-12 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Sep-13 Sep-14 Sep-15 Sep-16

Postgraduate students Undergraduate and college students

SOURCE: CIMB RESEARCH, MINISTRY OF EDUCATION SOURCE: CIMB RESEARCH, CHINA HUMAN RESOURCES MARKET INFORMATION MONITORING CENTRE

The Chinese government has announced initiatives to develop a new three-pillar tertiary education system by 2020F. Under this plan, 600 universities will be transformed into application-based tertiary colleges. Going forward, tertiary education in China will be consist of: 1) universities for the development of comprehensive talents, 2) application-based tertiary colleges for the development of engineers and mid-level managers, and 3) vocational schools for the development of technicians and other frontline employees. Professional training education providers benefit from the high youth unemployment rate in China (13.6% in 2016, according to the World Bank) as they help underperforming students to improve their skillset and land a job. We believe the IT training institutions, in particular, are key beneficiaries of the rapid growth of the IT industry in China. In our view, Tarena stands out in this area due to its strong job placement record. At end-Mar 2017, Tarena maintained a six-month post-graduation job placement rate of c.95%.

Figure 35: Tarena’s revenue trend Figure 36: Tarena's course offerings Year of 3,500.0 Title: launch Subject 3,108.5 Source: 3,000.0 2002 Java 2,520.7 2007 .NETPlease fill in the values above to have them entered in your report 2,500.0 2009 C++, Software testing, Embedded 2,011.2 2,000.0 2010 PHP 1,579.6 2011 Android

(Rmb m) 1,500.0 1,178.0 2012 iOS 1,000.0 836.9 Linux and network engineering, Digital art, Online sales and 562.0 2013 marketing 354.0 500.0 2014 Accounting Big data, Web front-end development, K-12 computer programing, 0.0 FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F 2015 K-12 digital art

2016 VR/AR, K-12 robot programming, K-12 3D printing SOURCES: CIMB FORECASTS, COMPANY REPORTS SOURCES: CIMB, COMPANY REPORTS

22

Navigating China│Education│September 19, 2017

Founded in 2002, Tarena was the largest IT professional education services provider in China by revenue in 2013, according to IDC. As of end-Mar 2017, Tarena had a nationwide network of 160 directly-managed learning centres in 51 cities. It has a strong network of c.90,000 corporate employers, including Global Fortune 500 companies and leading tech companies in China. Besides providing corporate employers with candidate referral services and other recruitment- related services, Tarena offers customised courses that target specific employers with large demand for trained professionals. Under this initiative, prospective students undergo interviews by corporate employers prior to the start of courses. In addition to Tarena’s standard curriculum, students enrolled in the customised courses participate in additional training that is tailored to the skill requirements of the prospective employers. Successful graduates who pass the relevant qualifying exams then receive job offers from the associated employers. As a result of its strong track record, Tarena is able to charge a premium for its classes over those of its peers. We found that Tarena charges between Rmb18,800 and Rmb20,800 for a full Java course, which is at the higher end of the industry range (see Figure 37 below). Tarena is also typically able to raise its tuition fees by Rmb1,000 annually, i.e. 3-5% yoy.

Figure 37: Comparison of tuition fees for Java course (2016) Company Tuition fee Tarena (达内) Rmb18,800 to Rmb20,800 Aptech (北大青鸟) Rmb7,000 to Rmb 17,000 Atguigu (尚硅谷) Rmb14,800 to Rmb18,800 Heima (黑马) Rmb16,980 to Rmb19,980 Itxdl (兄弟连) Rmb12,800 Bjsxt (尚学堂) Rmb16,980 Itcast (传智播客) Rmb24,980 SOURCE: CIMB RESEARCH, COMPANY REPORTS

Professional education targets young adults, who typically have higher levels of self-discipline than K-12 students. As a result, Tarena is able to expand quickly without sacrificing teaching quality through its dual-teaching model; new centres are typically fully operational within seven weeks of opening as there is no need to recruit and train local instructors (classroom-based tutors are typically Tarena graduates). From 2011 to 2016, Tarena expanded from 34 learning centres in 11 cities to 145 learning centres in 46 cities. Its high scalability and utilisation rates (classes can be carried out for the full day from Monday to Friday) have enabled Tarena to enjoy higher GPM (above 70%) since FY14 than its local informal education peers. In FY16, Tarena reported non-GAAP GPM of 71.8% versus EDU’s 58.4% and TAL’s 51.0%.

23

Navigating China│Education│September 19, 2017

Figure 38: Gross margin comparison between local informal education peers

80.0% Title: 71.7% 71.8% 70.7% 71.6% 72.1% Source: 70.0%

58.4% 58.3% 59.1% 59.7% 60.0% 57.8% Please fill in the values above to have them entered in your report 53.2% 51.0% 49.9% 50.7% 51.3% 50.0%

40.0%

30.0%

20.0%

10.0%

0.0% FY15 FY16 FY17F FY18F FY19F

New Oriental Edu TAL Edu Tarena

Note: *Numbers reflected for EDU (FYE May) and TAL (FYE Feb) for FY17 are actual numbers; Tarena’s (FYE Dec) gross margin for FY17 is based on our forecast. SOURCES: CIMB FORECASTS, COMPANY REPORTS

However, professional education institutes such as Tarena, require high annual marketing spending due to the non-recurring nature of courses offered. In Figure 39 below, we note that the marketing expenses-to-sales ratio (FY15-16) for Tarena was significantly higher compared to K-12 peers EDU and TAL. TAL’s marketing expenses-to-sales ratio is the lowest among the three as TAL has a strong reputation and brand image and mainly uses word of mouth as a to attract new students.

Figure 39: Non-GAAP marketing expenses-to-sales ratio (%)

40.0% Title:

33.9% 33.7% Source: 35.0% 32.5% 33.0% 33.4%

30.0% Please fill in the values above to have them entered in your report

25.0%

20.0% 15.1% 15.0% 13.4% 12.9% 12.8% 12.6% 11.9% 11.5% 11.8% 12.3% 12.2% 10.0%

5.0%

0.0% FY15 FY16 FY17F FY18F FY19F

New Oriental Education TAL Education Tarena International

Note: *Numbers reflected for EDU (FYE May) and TAL (FYE Feb) for FY17 are actual numbers; Tarena’s (FYE Dec) FY17 marketing expenses-to-sales ratio is based on our forecast. SOURCE: CIMB FORECASTS, COMPANY

Tarena partially offsets the pressure of student acquisition costs by cooperating with over 690 universities and colleges in China to ensure a stable supply of student enrolment, mainly through the following three methods: 1) Joint-major programmes: Tarena offers joint-major programmes with 103 universities and colleges in China. Students are allowed to take Tarena’s courses full-time for one semester and receive academic credits upon successful completion. 2) On-campus learning sites: Tarena has established over 144 on- campus learning sites to offer students the ability to complete part of the course on-campus and the rest at its centres. Under this partnership, Tarena pays universities for the rental of classroom facilities but does not have to share revenue.

24

Navigating China│Education│September 19, 2017

3) Enrolment cooperation: Its cooperation with over 690 universities allows Tarena to organise marketing and promotional events on campus. Besides these three main forms of cooperation, Tarena has signed a strategic cooperation with Renmin University School of Continuing Education. Students who have successfully completed Tarena’s programmes can enrol in Renmin’s programmes for further studies without the need to pass college entrance exams.

Figure 40: Tarena’s student enrolment, by recruitment channel (number of students)

120,000 Title: Source: 100,000 15,880 Please fill in the values above to have them entered in your report 80,000 13,652

60,000 10,538 6,846 91,613 5,807 40,000 70,389 49,422 51,487 20,000 43,970

0 FY14 FY15 FY16 1H16 1H17

Retail channel University channel

SOURCES: CIMB, COMPANY REPORTS

As Tarena has increased its level of collaboration with universities, management guided the proportion of students recruited through these university cooperation programmes (including joint-major programmes and on-campus learning sites) has risen YTD (1H17: c.50% of students enrolled through university channels came from university cooperation programmes or c.7% of total enrolment). The joint-major programmes and on-campus learning sites are effectively business-to-business-to-consumer (B2B2C) models. Compared to Tarena’s typical business-to-consumer (B2C) recruitment model, under which it recruits individual students directly, the new business model allows Tarena to conduct bulk student recruitment through the university channel. Besides potentially lowering student acquisition costs, we believe the cooperation with universities could create significant long-term value for Tarena by strengthening its brand image. However, as the course length for such university cooperation programmes is longer (3-4 years) versus Tarena’s typical programmes (four months), this would result in slower revenue recognition for students recruited through such channels. As such, we project a short-term negative impact on revenue growth and forecast topline growth to be slightly pressured at 25.0% in FY17F before recovering slightly to 25.4% yoy in FY18F.

25

Navigating China│Education│September 19, 2017

Online education growing as a complement to offline education With the increased use of technology to complement teaching services, online education is an up-and-coming trend in the education industry. iResearch forecasts that China’s online education market (revenue) will expand by a 4-year CAGR of 21.8%, from Rmb122.5bn in 2015 to Rmb269.3bn in 2019F, mainly driven by increased enrolment (estimated CAGR of 22.1% over the same time period). The online education industry benefits from the following trends: 1) increased internet penetration and internet-related technologies, facilitating a better learning experience, and 2) widening spectrum of education needs. Furthermore, online education is able to overcome location and time barriers, giving students the flexibility to learn anytime, anywhere.

Figure 41: China online education market size (revenue) Figure 42: China online education student enrolment

300 30% 180 Title: 24% Title: 269.3 162.5 160 Source: Source: 250 25% 23% 232.1 134.9 140 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 191.7 200 20% 120 109.4 22%

156.0 100 90.0 150 15% 21% 122.5 80 73.2 99.8 60.0 100 84.0 10% 60 50.0 20% 70.1 41.5 40 50 5% 19% 20

0 0% 0 18% 2012 2013 2014 2015 2016F 2017F 2018F 2019F 2012 2013 2014 2015 2016F 2017F 2018F 2019F

LHS: Online education market size (Rmb bn) RHS: yoy growth (%) LHS: Online education student enrolment (m) RHS: yoy growth (%)

SOURCE: CIMB RESEARCH, IRESEARCH SOURCE: CIMB RESEARCH, IRESEARCH

In the online education market segment, we expect the K-12 sub-segment to expand at the fastest pace in 2017-19F. iResearch expects that the K-12 sub- segment will account for 39.9% of the total online education market in 2019F, rising from 25.3% in 2015.

Figure 43: Online education market (revenue) by sub-segment

0.8% 0.9% 0.8% 0.9% 1.0% 1.2% 100% Title:

90% 12.5% 12.9% 12.7% 12.6% 12.4% 12.3% Source:

80% Please fill in the values above to have them entered in your report 70% 22.5% 25.3% 29.0% 60% 33.0% 36.8% 50% 39.9%

40% 34.9% 32.9% 31.1% 30% 30.0% 29.9% 20% 29.7%

10% 29.3% 28.0% 26.4% 23.5% 19.9% 16.9% 0% 2014 2015 2016F 2017F 2018F 2019F

Higher education Vocational training K-12 Enterprise e-learning Early education

SOURCE: CIMB RESEARCH, IRESEARCH

26

Navigating China│Education│September 19, 2017

Figure 44: China online K-12 education market size (revenue) Figure 45: China online vocational education market size (revenue)

60 50% 70 Title: 25% Title:

45% Source: Source: 60 50 40% 20% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 35% 50 40 30% 15% 40 30 25% 30 20% 10% 20 15% 20 10% 5% 10 10 5%

0 0% 0 0% 2013 2014 2015 2016F 2017F 2018F 2019F 2013 2014 2015 2016F 2017F 2018F 2019F

LHS: Online K-12 education market size (Rmb bn) RHS: yoy growth (%) LHS: Online vocational education market size (Rmb bn) RHS: yoy growth (%)

SOURCE: CIMB RESEARCH, COMPANY, IRESEARCH SOURCE: CIMB RESEARCH, COMPANY, IRESEARCH

Nevertheless, we believe the offline classroom format will remain the preferred format for K-12 education in China. According to a 2016 survey by the Chinese Society of Education, most parents in China enrolled their children in offline tutoring centres (52.2%) in 2016, with 43.8% having enrolled their children in tutoring centres that used a combination of offline and online formats, while only 4% enrolled their children in pure online after-school classes. We believe this is mainly due to the nature of younger kids who generally have: 1) less self-discipline than adults and cannot be trusted to stay in front of a computer to complete the classes without teaching supervision, and 2) a lower ability to judge their own grasp of the subject matter.

Figure 46: After-school tutoring, by format (2016) Figure 47: Survey results for usage of after school tutoring in online/offline format Online, 4% 70% Title: 64.5% Title: Source: Source: 60% Offline + 52.2% Online, 43.80% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 50% 43.8%

40% 31.2% 30%

20%

10% 4.0% 4.3% Offline, 52.20% 0% Online Offline Offline + Online

Online Offline Offline + Online 2016 Future

*64.5% of respondents indicated that they plan to use offline + online format after school tutoring in SOURCE: CIMB RESEARCH, THE CHINESE SOCIETY OF EDUCATION the future SOURCE: CIMB RESEARCH, THE CHINESE SOCIETY OF EDUCATION

All three informal education service providers that we cover (EDU, TAL and Tarena) are actively adopting online technology to complement their existing offerings.

27

Navigating China│Education│September 19, 2017

New Oriental Education – Three-pronged education ecosystem In Sep 2014, EDU introduced its integrated online and offline education system, which has been a key success factor for the company. The three-pronged education ecosystem comprises: 1) The ‘O2O Two-way Interactive Education System’: a proprietary centralised teaching platform that consists of a series of online education modules and classroom teaching support. Key features include: Interactive in-class experience: Students are provided with a remote answering device that allows them to respond to pop-up quizzes in class. Besides enhancing the interaction between teachers and students in class, the real-time response allows teachers to adjust their pace of teaching based on the students’ performance in class. Online resources: After class, students can access EDU’s modules, programmes and information online from home. The students can then complete their homework or online modules recommended by the system to improve their learning and thus, progress at their own pace. Tracking learning progress: By recording the responses of students through the in-class answering device and tracking their progress online, the system is able to provide in-depth reports on a student’s performance. The reports are available to parents and teachers, allowing parents to have a better understanding of their children’s learning progress. 2) Koolearn.com and Koo.cn online education platforms, run by Xuncheng, EDU’s online arm. Xuncheng was listed on the NEEQ in Mar 2017. 3) EDU will also regularly invest in other online education companies (minority shareholding) to complement its online offerings.

Figure 48: Remote-answering devices Figure 49: Real-time Q&A in class Figure 50: Learning progress report

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

28

Navigating China│Education│September 19, 2017

TAL Education – Active in M&As to create an online future TAL mainly employs an online strategy to better reach students from lower-tier cities. Xueersi.com is TAL’s flagship online platform. TAL has been upgrading its offerings to live-broadcast classes since Oct 2015 to enable students to participate in a more proactive and interactive learning environment. The price of live-broadcast classes are up to 2-3 times higher than pre-recorded content.

Figure 51: Screenshot of live-broadcast class by TAL Figure 52: Screenshot of live-broadcast class by TAL

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

In the past, TAL has also carried out various acquisitions and equity investments in companies that it views as complementary to its existing business, especially in the online education and O2O sectors. Based on our observation, TAL’s investments have focused on these key areas: ● Education sub-sectors in which TAL has yet to establish an edge, including overseas study consulting and early education. Its investment in Yinghe Youshi (Unlisted) in Feb 2016, for example, has allowed TAL to expand its service offerings to online preparation of English tests for study abroad. ● Platforms that support customer acquisition, including parenting communities and academic resources websites. TAL has also invested in multiple peripheral websites, including BabyTree (Unlisted), an online parenting community. The key rationale behind this investment is for TAL to bring in new users, especially younger children that could be ushered into TAL’s Mobby and Peiyou young learner programmes. ● Technologies to boost the effectiveness of its existing tutoring services. For example, in Jan 2016, TAL invested in Knewton Inc (Unlisted), a global leader in adaptive learning software, with the aim of incorporating Knewton's adaptive learning platform into TAL's online learning environment. The technology provides students with tailored recommendations for exactly what to study, furnishes teachers with analytics to better support every student, and gives publishers content insight to develop more effective products.

29

Navigating China│Education│September 19, 2017

Figure 53: Notable M&As of TAL over the past 3 years Date Company Consideration Description Acquisitions

Feb-14 Kaoyan.com 考研网 US$8.5m Online service that helps preperation for entrance examinations for postgraduate degrees

Oct-14 Muchong.com 小木虫 US$10m Academic research platform Professional website providing university and college enrolment information for high May-15 Gaokaopai 高考派 US$0.6m school students US$37.7m cash, Jan-16 Firstleap Education 励步少儿英语 US$8.9m worth of Provider of all-subject tutoring services in English for students aged 2-15 in China stocks Feb-16 Yinghe Youshi US$12.1m cash Online preperation for English tests required to study abroad US$45.9m cash, Jul-16 Shunshun Bida 顺顺留学 US$13.6m worth of Professional counseling services to students planning to study abroad stocks Aug-16 Shanghai Yaya US$24.9m cash Online platform focusing on children, babies and maternity market Sep-16 ACESSAT 唯佳教育 Undisclosed Provider of language training for younger aged kids

Investments Online parenting community and online retailer of products for children, baby and Jan-14 BabyTree Inc. 宝宝树 US$23.5m maternity wear in China Oct-14 Minerva US$18.0m Provider of liberal arts and science education in the United States Oct-14 Guokr 果壳 US$15.0m Mobile and web-based community for science and technology education in China Apr-15, Aug-15 and Changing Education 轻轻家教 US$59.0m Customer-to-customer (C2C) mobile tutoring platform in China Nov-15 Inc Nov-15 Baby Bus 宝宝巴士 Rmb40m Provider of educational software products specifically for pre-school children Phoenix E-learning Dec-15 学科网 US$30m Online educational platform servicing public school system in China (zxxk.com) Jan-16 and Mar-16 Knewton Inc. US$11.6m Global leader in adaptive learning SOURCE: CIMB RESEARCH, COMPANY

Tarena Education – the pioneer of dual-teacher classes Capitalising on live-broadcast technology, Tarena’s classes adopt a hybrid model in which the instructor physically delivers the lecture in a classroom in Beijing, which is beamed via simultaneous webcast to students at other learning centres nationwide. Every classroom is staffed with teaching assistants locally to tutor and supervise students. Students have access to Tarena’s proprietary learning management system, Tarena Teaching System (TTS), which acts as a platform for course content distribution, instructor-student interaction and self- assessment. Tarena also launched online platform Tarena Massive Open Online Course (TMOOC) in Mar 2015. Besides offering Tarena’s proprietary content library (part-time students are allowed to complete a portion of their lessons online), this platform is available to the public through a subscription model and acts as a marketing platform for Tarena.

Figure 54: Financial data of informal education providers compared

New Oriental Education (FYE May) TAL Education (FYE Feb) Tarena (FYE Dec) (Rmb m) FY17 4Q17 FY17 1Q18 FY16 2Q17 Revenue 12,226.2 73,515.0 6,985.3 2,217.4 1,579.6 455.8 yoy growth (%) 21.70% 23.20% 68.30% 65% 34.1% 24.80% GPM (%) 58.30% 59% 49.90% 47.30% 71.8% 68.60%

non-GAAP OPM (%) 15.70% 12.50% 16.40% 12.30% 18.8% 12.10%

non-GAAP net profit 2,002.5 443.5 1,010.5 271.9 309.7 57.1 yoy growth (%) 21.9% 41.1% 17.2% 82.5% 46.3% 11.4% non-GAAP NPM (%) 16.4% 13.2% 14.5% 12.3% 19.6% 12.50% SOURCE: CIMB RESEARCH, COMPANY

30

Navigating China│Education│September 19, 2017

Figure 55: Operational data of informal education providers compared (as of latest financial year-end) New Oriental Education (FYE May) TAL Education (FYE Feb) Tarena (FYE Dec) Number of learning centres 778 507 145 Student enrolment 4,858,600 3,934,720 107,493 Number of teachers 21,620 14,168 204 Student-to-teacher ratio (x) 224.7 277.7 527.0 SOURCE: CIMB RESEARCH, COMPANY

31

Navigating China│Education│September 19, 2017

Formal education Private fundamental education on the rise with increase in demand for high-quality education According to Frost & Sullivan, revenue from private fundamental education (including preschool, primary and secondary schools) in China is expected to record a 5-year CAGR of 12.1%, from Rmb184.2bn in 2015 to Rmb325.5bn in 2020F due to a combination of rising wealth, increased demand for better education opportunities, supportive government policies and rising investment. This would create more spaces for potential students in future.

Figure 56: Total revenue from private fundamental education in Figure 57: Private fundamental education industry in China is China (2011-2020F) growing at a faster rate compared to GDP and per capita household income

350 325.5 30.0% 30% Title: Title: Source: Source: 289.5 300 25.0% 25% 258.8 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 250 232.2 20% 208 20.0% 200 184.2 166.9 15% 15.0% 146.5 150 124.1 10% 99.2 10.0% 100 5% 50 5.0% 0% 0 0.0% 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016F 2017F 2018F 2019F 2020F Private fundamental education industry growth (%) GDP growth (%) LHS: Private fundamental education revenue (Rmb bn) RHS: yoy growth (%) Per capita urban household disposable income growth (%)

*2016 figures are forecasted figures by Frost & Sullivan published in 2015 SOURCE: CIMB RESEARCH, FROST & SULLIVAN SOURCE: CIMB RESEARCH, FROST & SULLIVAN, NATIONAL BUREAU OF STATISTICS

The number of students enrolled in private education rose from 29.4m in 2011 to 37.8m in 2015 and Frost & Sullivan expects the number to reach 48.0m by 2020F, which trnaslates into a 5-year CAGR of 4.9%. It expects the bulk of the growth to come from preschools and, to a lesser degree, primary schools. Preschool education is the fastest-growing segment in the private fundamental education industry in 2011-15. This is mainly due to China’s compulsory education law, which highly regulates Grades 1-9 (primary school and middle school). Preschool education is lightly regulated and is expected to be the first area to benefit from the liberalisation of China’s one-child policy. In our opinion, parents attach great importance to preschool education as it is the first stage of a child’s education.

32

Navigating China│Education│September 19, 2017

Figure 58: Total number of student enrolments (m) in private fundamental education in China (2011-2020F)

60 Title: Source: 50 3.0 2.8 2.7 6.4 Please fill in the values above to have them entered in your report 40 2.7 6.1 2.6 5.7 2.6 5.5 2.4 5.2 9.1 Sectors 2011 - 2015 CAGR 2015 - 2020F CAGR 2.3 5.0 8.7 8.3 30 2.3 4.9 7.9 Overall 6.5% 4.9% 2.3 4.6 7.5 4.5 7.1 4.4 6.7 High Schools 2.3% 3.0% 6.3 millionstudents 6.0 20 5.7 Middle Schools 3.2% 4.9% Primary Schools 5.9% 5.1% 28.1 29.4 25.6 26.7 23.0 24.3 Preschools 8.0% 5.0% 10 19.9 21.3 16.9 18.5

0 2011 2012 2013 2014 2015 2016F 2017F 2018F 2019F 2020F

Preschools Primary Schools Middle Schools High Schools

*2016 figures are forecasted figures by Frost & Sullivan published in 2015 SOURCE: CIMB RESEARCH, FROST & SULLIVAN SOURCE: CIMB RESEARCH, FROST & SULLIVAN

The penetration rate of private schools in China fundamental education was 18.3% in 2015. With the increasing preference for private schools over public schools, Frost & Sullivan forecasts that the China penetration rate will rise to 21.3% by 2020F. With the amendment to the Law for Promoting Private Education, sponsors are allowed to establish for-profit private schoools, which entitles them to retain the profits and proceeds from the schools, with the exception of schools providing compulsory education. As a result, we expect the penetration rate of private schools to increase at a faster rate for preschools and high schools compared to primary and middle schools.

Figure 59: Penetration rate of private schools fundamental education by student enrolment in China (2011-2020F)

60.0% 55.3% Title: 54.0% 54.1% 54.6% 54.8% 55.0% 52.5% 51.1% Source: 49.5% 50.3% 50.0% Please fill in the values above to have them entered in your report 40.0%

30.0%

20.7% 21.3% 19.5% 20.1% 18.3% 18.9% 16.5% 17.4% 20.0% 15.2% 14.1% 12.9% 13.3% 13.8% 11.7% 12.2% 12.6% 10.4% 11.1% 8.7% 9.5% 12.8% 10.0% 10.8% 11.2% 11.7% 12.1% 12.5% 9.5% 9.5% 9.5% 9.9% 8.6% 8.9% 7.1% 7.4% 7.6% 7.9% 8.2% 5.7% 6.2% 6.7% 0.0% 2011 2012 2013 2014 2015 2016F 2017F 2018F 2019F 2020F

Primary School High School Middle School Overall Preschool

*2016 figures are forecasted figures by Frost & Sullivan published in 2015 SOURCE: CIMB RESEARCH, FROST & SULLIVAN

Private schools that provide fundamental education in China can be generally classified into three categories: 1) premium private international schools that offer an international curriculum, 2) premium private schools that provide PRC curriculum, and 3) mass market private schools that provide PRC curriculum. Premium private schools typically offer higher-quality education by providing advanced educational facilities and paying more attention to developing an all- rounded education curriculum for students. Such schools target students from middle-class families who are dissatisfied with public education. However, mass market private schools target students who cannot find a place in public schools due to the limited public education resources and ‘Hu Kou’ (residency permit)

33

Navigating China│Education│September 19, 2017

policies. Mass market private schools are commonly found in industrial areas that employ a large number of labourers from other provinces. According to Frost & Sullivan, the premium private schools charge higher tuition fees than other private schools and are poised to record a higher student enrolment CAGR than the overall private fundamental education industry, driven by the rising income of Chinese households and their growing expectations for the quality of education.

Listed companies that have exposure to the private fundamental education industry include: China Yuhua Education Corp (China Yuhua), China Maple Leaf Education (Maple Leaf), Wisdom Education (6068 HK, Not Rated) and Bright Scholar (BEDU US, Not Rated). ● China Yuhua is the largest provider of private education, from kindergarten to university, in China, based on student enrolment in the 2015/2016 school year, according to Frost & Sullivan. It has 24 K-12 schools and one university across nine cities in Henan Province. ● Maple Leaf is the largest K-12 international school operator (for students aged 5-18 years) in China, based on the number of students enrolled as of 2013/2014 school year. The company strives to offer its students a pathway into universities and colleges around the world. At end-Mar 2017, the company operated 56 schools across China. ● Wisdom Education is the largest private education group in South China, as measured by student enrolment as at 1 Sep 2015, according to Frost & Sullivan. It operates premium primary and secondary schools and at end-Mar 2017, the company operated six private schools (four in Guangdong, one in Liaoning and 1 in Shandong). ● Bright Scholar is the largest operator of international and bilingual schools in China in terms of student enrolment as at 1 Sep 2016, according to Frost & Sullivan. At end-May 2017, the company operated six international schools, 11 bilingual schools and 35 kindergartens and had total student enrolment of 29,613. The company collaborates with third-party real estate developers in China to operate schools on an asset-light model.

We compare the financial and operational statistics of the four listed companies that operate K-12 schools in China in Figure 60 below.

Figure 60: Financial data of K-12 school operators compared

China Yuhua Education China Maple Leaf Education Wisdom Education Bright Scholar (FYE Aug) (FYE Aug) (FYE Aug) (FYE Aug) (Rmb m) FY16 1H17 FY16 1H17 FY16 1H17 FY16 1H17 Segment revenue 486.8 261.3 829.8 483.3 700.7 498.1 1,040.3 646.2 As % of total revenue 62% 62% 100% 100% 100% 100% 100% 100% yoy growth (%) 16.6% 7.6% 27.1% 27.1% 23.2% 40.6% 39.5% 28.3% Segment GPM (%) 45.1% 43.9% 48.4% 47.0% 47.1% 46.3% 29.2% 33.4%

Segment OPM (%) 38.9% 38.4% 39.3% 40.3% 32.0% 31.8% 1.8% 17.0%

Segment profit before tax 178.3 98.5 325.9 191.6 194.5 147.8 20.8 113.5 As % of total PBT 53% 54% 100% 100% 100% 100% 100% 100% yoy growth (%) 18% 22% 50.3% 45.2% 91.6% 40.7% 130.1% 357.5% PBT margin (%) 36.6% 37.7% 39.3% 39.6% 27.8% 29.7% 2.0% 17.6% SOURCE: CIMB RESEARCH, COMPANY

34

Navigating China│Education│September 19, 2017

Figure 61: Operational data of K-12 schools compared (as of latest financial year-end)

China Maple Leaf China Yuhua Education Education Wisdom Education Bright Scholar PRC Private Education (FYE Aug) (FYE Aug) (FYE Aug) (FYE Aug) Average Number of schools 24 46 15 49 Inner Mongolia, Liaoning, Henan, Jiangsu, Zhejiang, Gansu, Jiangsu, Anhui, Shaanxi, Hubei, Shanghai, Hubei, Hunan, Guizhou, Location of campuses Henan Tianjin, Chongqing Guangdong and Liaoning Guangdong Student capacity (head)* 41,200 30,040 33,152 48,091 Student enrolment 23,157 19,334 31,788 25,863 Utilization rate 56.2% 64.4% 95.9% 53.8% Number of teachers 1,852 1,814 1,960 2,899 Student to teacher ratio 12.50 10.66 16.22 8.92

Tuition fees (Rmb) High school 19,500 - 33,500 49,000 - 81,000** 24,000 - 25,200 na 7,719 Middle school 12,000 - 33,500 21,000 - 43,000 18,000 - 23,200 na 3,289 Primary school 14,000 - 34,000 18,000 - 39,000 13,000 - 21,000 na 2,567 Kindergarten 16,000 - 32,500 12,000 - 21,600 na 28,067 3,235 *Capacity for student enrolment high schools, middle schools and primary schools is estimated based on the approximate number of students that the dormitories were designed to accommodate according to dormitory building floor plan. *Capacity for student enrolment at kindergarten is estimated based on the approximate number of beds used for naps in the kindergartens. ** Bright Scholar does not report tuition fees by level of education, its average tuition fees in FY16 for international schools and bilingual schools were Rmb77,744 and Rmb28,729 respectively. SOURCE: CIMB RESEARCH, COMPANY REPORTS

35

Navigating China│Education│September 19, 2017

Private higher education benefits from lack of public universities in China The private higher education industry presents huge growth potential, in our view. According to Frost & Sullivan, the industry is expected to deliver a 5-year revenue CAGR of 11.0%, from Rmb92.6bn in 2015 to Rmb156.3bn in 2020F, driven by: 1) favourable government policy, 2) increasing wealth and demand for higher education in China, as well as 3) growing market demand for technical talent. Enrolment in higher education in China remained low in 2015 (37%) compared to other developed countries such as the UK (56%) and the US (86%), according to Frost & Sullivan.

Figure 62: Total revenue of private higher education industry in Figure 63: Rate of enrolment in higher education, by country China (2011-2020F) (2015)

180 14.0% Title: Title:

160 China Source:37% Source: 12.0% 140 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 10.0% 120 UK 56% 100 8.0%

80 6.0%

60 France 4.0% 65% 40 2.0% 20

0 0.0% U.S. 86% 2011 2012 2013 2014 2015 2016F 2017F 2018F 2019F 2020F

LHS: China private higher education revenue (Rmb bn) RHS: yoy growth (%) 0% 20% 40% 60% 80% 100%

*2016 figures are forecasted figures by Frost & Sullivan published in 2015 SOURCE: CIMB RESEARCH, FROST & SULLIVAN SOURCE: CIMB RESEARCH, FROST & SULLIVAN

With the rising number of students choosing to attend private universities or colleges instead of public ones, Frost & Sullivan expects the penetration rate of private higher education in China to increase from 21.7% in 2015 to 27.2% in 2020F and student enrolment in private higher education to rise by a 5-year CAGR of 7.4%, from 6.1m students in 2015 to 8.7m in 2020F.

Figure 64: Student enrolment (m) in private higher education in Figure 65: Penetration rate of private higher education in China, China (2010-2020F) by student enrolment

10 29% Title: Title: Source: 9 8.7 Source: 8.2 7.7 27% 8 Please fill in the values above to have them27.2% entered in your report Please fill in the values above to have them entered in your report 7.1 26.4% 7 6.6 25% 25.4% 5.9 6.1 6 5.6 24.3% 5.1 5.3 4.8 23% 5 23.0%

4 21% 21.5% 21.7% 21.1% 20.8% 3 20.4% 19% 2 17% 1

0 15% 2010 2011 2012 2013 2014 2015 2016F 2017F 2018F 2019F 2020F 2011 2012 2013 2014 2015 2016F 2017F 2018F 2019F 2020F

*2016 figures are forecasted figures by Frost & Sullivan published in 2015 *2016 figures are forecasted figures by Frost & Sullivan published in 2015 SOURCE: CIMB RESEARCH, FROST & SULLIVAN SOURCE: CIMB RESEARCH, FROST & SULLIVAN

36

Navigating China│Education│September 19, 2017

Listed companies that have exposure to the private higher education industry in the country are China Yuhua, Minsheng Education Group (1569 HK, Not Rated) and China New Higher Education Group (2001 HK, Not Rated). ● Minsheng Education is the tenth-largest private provider of higher education in China, as measured by student enrolment as of June 30, 2016, according to Frost & Sullivan. As of end-Dec 2016, the company operated four schools located in Chongqing and Inner Mongolia. It has also invested in two schools in Singapore and Hong Kong in Jun 2014 and Nov 2015 respectively. ● New Higher Education is a leading private higher education group in China that provides high-quality higher education in a wide range of Applied Sciences fields. As of end-Dec 2016, the company operated two schools in Yunnan and Guizhou.

The private higher education industry is fragmented, with all three listed players mentioned above only accounting for less than 1% market share each. Due to the difficulties in securing regulatory approvals and obtaining suitable land for new schools, the three listed companies above prefer to employ the following growth strategies: 1) capacity expansion of existing schools, and 2) M&A.

Financial and operational statistics of the three university operators are compared in Figure 66 below:

Figure 66: Financial data of university operators compared China Yuhua Education (FYE Aug) Minsheng Education (FYE Dec) New Higher Education (FYE Dec) (Rmb m) FY16 1H17 FY16 1H17 FY16 1H17 Segment revenue 294.6 160.1 445.0 254.6 341.0 212.6 As % of total revenue 38% 38% 100% 100% 100% 100% yoy growth (%) 5.1% 8.7% 4.4% 4.9% 24.5% 19.3% Segment GPM (%) 63.3% 59.8% 58.1% 65.2% 48.0% 57.1%

Segment OPM (%) 58.5% 55.7% 57.2% 63.8% 43.7% 64.3%

Segment profit before tax 157.5 85.0 251.4 161.9 112.9 117.8 As % of total PBT 47% 46% 100% 100% 100% 100% yoy growth (%) 461.3%* 10.8% 1.9% 7.6% 2.6% 46.6% PBT margin (%) 53.5% 53.1% 56.5% 63.6% 33.1% 55.4%

*Yuhua's university segment PBT in FY16 grew 461.3% yoy, mainly due to the low base in FY15 due to a one-off fee paid to Henan Polytechnic University for the termination of a cooperation agreement, which amounted to c.Rmb153.9m. SOURCE: CIMB RESEARCH, COMPANY

37

Navigating China│Education│September 19, 2017

Figure 67: Operational data of university operators compared (as of latest financial year-end)

China Yuhua Minsheng New Higher Education Education Education PRC Private (FYE Aug) (FYE Dec) (FYE Dec) Education Average Number of campuses 1 4 2 Chongqing, Inner Location of campuses Zhengzhou Mongolia Yunnan, Guizhou Student capacity (head)* 30,000 37,771 39,320 Total enrolment 25,063 32,635 33,462 Utilization rate 83.5% 86.40% 85.10%

Tuition fees (Rmb) Undergraduate 13,100-15,100 13,500-18,000 5,000-20,000 10,840 Junior college 8,900 6,500-11,000 8,000-13,000 7,060

Initial employment rate** 83.3% 88.9% 98.3%*** 77.7% *Capacity is estimated by the companies based on the approximate number of students that the dormitories were designed to accommodate. ** Initial employment rate is defined as percentage of graduates who entered full-time employment contracts, were self-employed or accepted offer for graduate degree programmes before graduation. *** New Higher Education does not provide initial employment rate, but graduate employment rate, which is defined as percentage of graduates who entered full-time employment contracts, were self-employed or accepted offer for graduate degree programmes within six months after their graduation. SOURCE: CIMB RESEARCH, COMPANY

38

Navigating China│Education│September 19, 2017

Favourable government policy trends Education has always been considered a top priority by the Chinese government. As a result, the education industry in China is heavily regulated. However, from the key policies related to the PRC education industry over the past 20 years, we note that the government has adopted a favourable stance on opening up the education sector to private investment. Notable policies include the Education Law in 1995, which opened up the education industry to the private sector, as well as the Amended Education Law in 2015, which repudiated provisions that prohibited the establishment of schools for profit-making purposes. Other policies that we believe are favourable for the education sector include the Employment Promotion Law in 2007, Gaokao reform announced in 2014, as well as the two-child policy introduced in 2015.

Figure 68: Key policies relating to PRC education sector Year Policies Description

1995 Education Law Opened up the education industry to private sector, however for profit-making purposes are not allowed

Promotes the development of vocational education industry, encourages establishment of vocational 1996 Vocational Education Law education schools by institutes/individuals

2003 Law for Promoting Private Education Set the standards for establishment of private schools

Opens up the Chinese education investment field to attract foreign education institutions to seek 2003 Regulations on Operating Chinese-Foreign Schools cooperation with their Chinese counterparts to form and manage foreign-invested schools in China Government to arrange special employment funds in fiscal budgets to promote employment, including 2007 Employment Promotion Law providing subsidies for vocational training Outline of China's National Plan for Medium and Long-term Government first announced a plan to implement reform to divide private education entities into 1) for- 2010 Education Reform and Development (2010-2020) profit private education entities and (2) not-for-profit private education entities Implementation Opinions of the MOE on Encouraging and 2012 Proportion of foreign capital in a sino-foreign cooperative education institution shall be less than 50% Guiding the Entry of Private Capital in the Fields of Education Introduced a new "3+3" model, allows 2 attempts at English tests, and made adjustments to university 2014 Gaokao reform admission policies

2015 Amended Education Law Repudite provisions that prohibit establishement of schools for profit-making purposes

2015 Two-child Policy Liberated "One-child Policy", each family is permitted to have 2 children

Further establishes a new classification system for private schools to be classified by whether they are 2016 Amendment to Law for Promoting Private Education established and operated for profit-making purposes SOURCE: CIMB RESEARCH, COMPANY

The ‘Gaokao’ reform The Gaokao used to place great emphasis on scores, which were used to separate students into the Science or Arts streams. In 2014, the State Council of PRC issued guidelines on Gaokao reform and establishment of a modern selection system for higher education in China, based on fundamental principle that: 1) is transparent and fair, 2) places more emphasis on the well-rounded development of students, and 3) increases diversity in and compatibility between higher education institutes and students. Certain provinces, including Shanghai and Zhejiang, were assigned as pilot reform areas; the reforms are expected to be extended nationwide in 2017F. The Ministry of Education (MOE) plans to establish a new standardised system for higher education students’ admission in China by 2020F. Although the implementation details may differ from city to city during the trial period, the overall guidelines are similar. We highlight some of the key changes below, based on the Shanghai reform plans.

Introducing a new ‘3+3’ model Before the Gaokao reform, high school students were split into the Humanities or Science streams. In addition to the three compulsory subjects (Chinese, Math and English), Humanities students must take an additional Humanities paper consisting of Social Science, History and Geography subjects, while Science students are required to take an additional science paper consisting of Chemistry, Physics and Biology subjects.

39

Navigating China│Education│September 19, 2017

Post reform, there is no clear division between Humanities and Science students. Under the new ‘3+3’ model introduced, students are required to take up the same three core subjects (Chinese, Mathematics and English). The other three subjects are considered electives and students are free to choose any three of six subjects (Physics, Chemistry, Biology, Politics, History and Geography). The three core subjects will have maximum scores of 150 each. Meanwhile, elective subjects have a maximum score of 70 each, converted from a tier- grading system of A to E.

Adjustments to exam schedules Prior to the reform, examinations of all subjects took place during the Gaokao period in Jun. As part of the reform, only the exams for the three compulsory subjects will take place in Jun; the examinations for elective subjects will be spread across the three years of high school. As for the English examination, it will consist of two components – listening and writing. Students are now allowed to attempt the examination twice; once in Jan and a second time in Jun, with the higher score recorded for university admission purposes.

Changes to university admission policy Prior to the reform, university admission was solely based on Gaokao results, with bonus points for sports and academic Olympiads. With the reform, universities are alowed to restrict the elective subjects they accept for application to different majors. For example, students planning to major in Engineering may be required to take the Physics exam and achieve a score requirement. The reforms mean that other universities may not have similar requirements and students may be allowed to choose their majors without any restrictions. Scores from comprehensive quality assessments (a non-exam factor) will also be taken into account. This is based on six areas – moral, civic, learning, communication and co-operation, sports and health, aesthetic and expression ability. School teachers will assign ranking tiers from A to D. Bonus points from sports activities and academic Olympiads are removed. In Apr 2017, the Ministry of Education requested top universities to admit more students from rural or poor backgrounds. Universities were asked to enroll 10% more disadvantaged students in 2017F. Strict supervision and greater transparency will ensure the suitability and eligibility of candidates.

More standardised papers across provinces More provinces are beginning to adopt the National Standard Papers (全国卷). As of 2017, except for five provinces/municipal cities (Beijing, Shanghai, Tianjin, Suzhou and Zhejiang), the rest of the country are adopting either Version I, II or III of the National Standard Papers. The standardisation of the Gaokao exam is underway with total standardisation of all provincial tests by around 2020. We expect the standardisation of Gaokao papers to benefit large K-12 after- school tutoring providers by consolidating the market as they have a stronger capability to develop tutoring curriculums that meet national standards in order to win parents’ trust. In addition, this trend will benefit K-12 players by allowing them to expand and open more schools outside of their home provinces as they have good quality teachers with strong reputations.

40

Navigating China│Education│September 19, 2017

Figure 69: Summary of proposed Gaokao reforms

SOURCE: CIMB RESEARCH, COMPANY

Amendment to Law for Promoting Private Education In 2015, the Standing Committee of the National People’s Congress announced that the Amended Education Law repudiated provisions that prohibited the establishment of schools for profit-making purposes, which later became effective on 1 June 2016. The amendment to the Law for Promoting Private Education was later promulgated in Nov 2016 and came into force on 1 September 2017. This amendment further establishes a new classification system for private schools according to whether they are established and operated for profit-making purposes. Under this amendment, sponsors of private schools may choose to establish non-profit or for-profit private schools at their own discretion. However, private schools providing compulsory education (Grade 1-9) remain prohibited from being established as for-profit organisations. Specific provisions of the implementation have yet to be announced at the provincial level. General guidelines of the amendment are highlighted below:

Profit distribution Prior to the amendment, private schools or other educational institution were set up as ‘non-profit’ entities, which did not entitle sponsors of the schools to any distribution of profits or revenue. Operation surplus of non-profit schools were recycled. Post the implementation of the amendment, sponsors were allowed to establish private schools as ‘for-profit’ and were entitled to retain profits and proceeds.

Fee setting Tuition fees charged by a non-profit private school must be approved by the government authorities and be publicly disclosed. On the other hand, for-profit schools are entitled to set their own tuition fees without the need to seek prior approvals from or report to the relevant authorities.

Land policy and tax treatments Non-profit private schools enjoy lower costs compared to for-profit private schools. Non-profit private schools are able to acquire land use rights in the form of allocation by the government as preferential treatment. They also enjoy the same tax benefits as public schools. As tax-exempt entities in accordance with

41

Navigating China│Education│September 19, 2017

the tax laws, non-profit income will be exempt from enterprise income taxes. Electricity, water, gas and heating will also be charged at the same price as public schools. For-profit schools, on the other hand, are required to purchase land use rights at market price from the government. Taxation policies for for-profit private schools remain unclear as specific provisions have yet to be introduced.

Remaining assets post liquidation Remaining assets of non-profit private schools after liquidation shall continue to be used for the operation of non-profit schools. On the other hand, remaining assets of for-profit private schools shall be distributed to the sponsors in accordance with PRC Company Law.

Transitioning from ‘non-profit’ to ‘for-profit’ Upon the implementation of the amendment, should an originally ‘non-profit’ entity choose to become a ‘for-profit’ entity, it is first required to perform a financial liquidation procedure to authenticate various parties’ property rights. Taxes and fees accrued are to be paid before the school can be re-registered as a for-profit private school. Specific measures relating to the conversion have yet to be announced at a provincial level.

Figure 70: Non-profit vs. for-profit education entities, as per Standing Committee of the National People’s Congress guidelines Non-profit For-profit

Operation surplus is used for operation of the schools Sponsors are entitled to retain operation surplus

Tuition fees charged must be approved by government Schools are entitled to set their own tuition fees authorities without the need to seek prior approvals Able to acquire land use rights in the form of allocation Required to purchase land use rights from government by government Assets will continue to be used for operation of non- Assets can be distributed to sponsors post liquidation profit schools post liquidation

Same tax benefits as public schools Specific provisions yet to be introduced

SOURCE: CIMB RESEARCH, COMPANY

We understand that most K-12 players are adopting a wait-and-see attitude towards the new Law for Promoting Private Education and have not determined whether to convert from non-profit to for-profit entities as the detailed implementation measures have not been announced on the provincial level.

42

Navigating China│Education│September 19, 2017

Implications of recent policy changes – K-12 after-school tutoring providers are the key beneficiaries

Increased penetration: We believe the relaxing of government regulations to allow students to take the Gaokao English exam twice and the spreading out of examinations for elective subjects across the three years of high school would result in more demand for after-school tutoring services. Given the importance of the Gaokao (seen as the key stepping stone for entrance into China’s top universities), we believe students will utilise all tools available to them, including after-school tutoring, to improve their grades. The extended exam period enables after-school tutoring service providers to offer more intensive preparation sessions, which could drive penetration rates. Market consolidation: The K-12 after-school tutoring segment in China remains fragmented, in our view. Based on the Chinese Society of Education’s revenue estimate of Rmb800bn in 2016, we estimate the market shares of the two largest K-12 after-school tutoring service providers, TAL and EDU, only accounted for c.0.8% and c.0.7%, respectively. We believe the standardisation of the Gaokao exam would benefit large training institutes more than small ones, as the larger players have more resources to react faster to the new exams. At the same time, this reduces the edge of region-specific players in China as their additional insight into examination question-setting standards is rendered useless. Furthemore, parents are more likely to trust the larger education brands to keep up with the latest changes in the Gaokao examination format. Along with the formal implementation of the Law for Promoting Private Education on 1 Sep 2017, we expect the local governments to raise the licence requirements for K-12 after-school tutoring service providers as they monitor them more closely. All the abovementioned new developments will result in market consolidation among the K-12 after-school tutoring providers, in our view, which should benefit market leaders TAL and EDU. We estimate the market shares of TAL and EDU would reach 1.7% and 1.2%, respectively, by 2020F.

43

Navigating China│Education│September 19, 2017

PRC education industry overview Overview of the Chinese education system The PRC education system can be generally categorised into two: formal and informal education. Formal education includes fundamental/K-12 education (made up of preschool, nine years of compulsory primary and middle school, followed by high school) and higher education (which includes junior college, undergraduate and graduate university programmes), as illustrated in Figure 71 below. According to the Law for Compulsory Education of the PRC, compulsory education is defined as a 9-year education system, consisting of six years of primary school and three years of secondary school. Schools providing compulsory education must at minimum include state curriculum standards in their courses but may include supplementary teaching on top of the required standards. The formal education system provides students with the opportunity to obtain official certificates from the PRC government. On the other hand, informal education mainly includes after-school tutoring, exam preparation and other vocational training.

Figure 71: Illustration of China’s formal education system

SOURCE: FROST & SULLIVAN

Riding the tailwinds of favourable policy and the rising consumption trend in China, we see education as a defensive sector with solid growth potential. Potential earnings growth drivers include:

Increase in spending on education While the PRC government has continued to increase its budget on education, it still lags behind other developed countries in terms of public expenditure on education as a percentage of GDP. According to the Economist Intelligence Unit, China’s public expenditure on education in 2015 was approximately 2.3% of its GDP, which was less than that of the US (5.4%), the UK (5.4%) and Asian peers South Korea (5.0%), Japan (4.5%), Hong Kong (3.4%) and Singapore (3.4%). However, with the government’s ongoing policy support, the Economist Intelligence Unit projects that public spending on education in China will rapidly increase to 2.9% of total GDP by 2030F.

44

Navigating China│Education│September 19, 2017

Figure 72: Public expenditure on education as a % of GDP, by Figure 73: Per capita annual education expenditure (Rmb) of country urban households in China (2012-2020F)

7.00% 1,500 Title: Title: 6.1% 6.1% Source: 1,379 Source: 6.00% 1,400 5.4% 5.4% 5.2% 5.1% 5.0% 1,286 5.00% 1,300 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 4.5% 4.5% 1,212 1,200 4.00% 1,129 3.4% 3.3% 3.4% 3.1% 2.9% 1,100 1,067 3.00% 2.7% 2.3% 1,008 1,000 948 2.00% 884 900 1.00% 820 800 0.00% Australia UK US South Japan Hong Singapore China 700 Korea Kong

600 2015 2030F 2012 2013 2014 2015 2016F 2017F 2018F 2019F 2020F

SOURCE: CIMB RESEARCH, ECONOMIST INTELLIGENCE UNIT SOURCE: CIMB RESEARCH, FROST & SULLIVAN

At the same time, Frost & Sullivan also expects per capita annual education expenditure of urban households to record a 5-year CAGR of 6.5%, from Rmb1,008 in 2015 to Rmb1,379 in 2020F, displaying Chinese parents’ willingness to invest in their children’s education in the belief that academic success is the key to landing a well-paid job. A survey by iResearch found that nearly 50% of parents in China spend more than Rmb6,000 on their children’s education annually, while 29% of them spend more than Rmb10,000. Families with higher incomes are more willing to invest in education, with education accounting for a larger proportion of their total expenditure.

Figure 74: 2015 monthly education expenditure relative to household income in China 1% 100% 3% 11% 12% Title: 90% 19% 19% 7% 9% Source: 80% 16% 13% 70% 10% 24% Please fill in the values above to have them entered in your report 31% 60% 19% 38% 21% 50% 22% 12% 18% 26% 40% 17% 21% 30% 27% 23% 20% 13% 20% 20% 14% 10% 10% 24% 25% 21% 15% 4% 11% 4% 0% Below Rmb5,000 Rmb5,000 - Rmb10,001 - Rmb15,001 - Rmb20,001 - Above Rmb30,000 Rmb10,000 Rmb15,000 Rmb20,000 Rmb30,000

Below 100 Rmb100 - Rmb300 Rmb300 - Rmb500 Rmb500 - Rmb1,000 Rmb1,000 - Rmb2,000 Above Rmb2,000 SOURCE: CIMB RESEARCH, IRESEARCH

A key driver for the growth in Chinese education expenditure is the burgeoning middle class as more families are lifted into position where they can afford to seek better education opportunities for their children. A McKinsey report said that, in 2000, just 4% of urban Chinese households had an income in the range of US$9,000-$34,000 annually but, by 2012, 68% of urban Chinese households had reached this level, largely due to China's rapid economic growth. The report forecast that 75% of China’s urban consumers would attain this level by 2022F, with a broader spread across the country (87% of the middle class was located in coastal China in 2002 but McKinsey forecasts that this would fall to 61% by 2022F).

45

Navigating China│Education│September 19, 2017

Favourable demographic trends The Chinese government has gradually loosened its birth control policy (one- child policy) in recent years to tackle the issues of an ageing population, low birth rates and decline in the working age population. On 29 Oct 2015, the government announced a new policy that allowed all couples to have two children (effective 1 Jan 2016), bringing an end to China’s one-child era. We have observed early signs of the policy’s effectiveness. According to the latest National Bureau of Statistics of China (NBS) data, there were 17.86m newborn babies in 2016, the highest level since 2000 and 10% higher than the average of the past ten years. Birth rates also recovered to 12.95% in 2016, the highest since 2001.

Figure 75: China birth rates – We saw a visible uptick in birth rate in 2016

Nationwide 25 10

8

20 6

4 15 2

0 10 -2

5 -4 -6

0 -8

2006 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

LHS: Birth rate (‰) RHS: Natural growth rate (‰) RHS: Number of new born (yoy%)

SOURCE: CIMB RESEARCH, COMPANY

We believe the pick-up in the number of births of second children (or above) due to the relaxing of birth control regulations will be more pronounced in the first few years as couples who were previously ineligible rush to expand their families (before they become too old). Furthermore, we believe the national culture will alter as more families have more than one child and peer pressure to have larger families increases. We expect the increase in the number of second children to not only offset but outweigh the effects of the decrease in the number of women of childbearing age in the next 2-3 years. We expect the birth rate to continue recovering until 2019 and forecast that newborn babies will number 18m-20m p.a. in 2017-2020, relatively high levels that will translate into a mini baby boom.

Figure 76: Number of newborns in China – We forecast that Figure 77: … and newborns will number 18m-20m p.a. in 2017- China’s birth rate will recover in the near term… 2020F, of which the second child (or above) will account for more than half CIMB CIMB Nationwide Forecast Nationwide Forecast 20 10 16

18 8 14 16 6 12 14 4 10 12

10 2 8

8 0 6 6 -2 4 4 -4 2 2

0 -6 0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

2017E 2018E 2019E 2020E

2017E 2018E 2019E 2020E

LHS: Number of newborns (million) RHS: Number of newborns (yoy%) Birth rate (‰) Natural growth rate (‰)

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

46

Navigating China│Education│September 19, 2017

Desire to attend overseas universities General consensus is that a student attending private school that offers overseas high school qualifications will have a better chance of being accepted by foreign universities. According to the Ministry of Education, 140,000 students opted to travel overseas for higher education in 2007 and the number rose to 545,000 in 2016.

Figure 78: Number of Chinese students studying abroad

600 Title: 545 524 Source:

500 460 Please fill in the values above to have them entered in your report 414 400 400 340

300 280 230 180

Thousand Thousand students 200 140

100

0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

SOURCE: CIMB RESEARCH, COMPANY

47

Navigating China│Education│September 19, 2017

Valuation and top picks Riding the tailwinds of favourable policy and the rising consumption trend in China, we see education as a defensive sector with solid growth potential. We believe the recent policy reforms will further stimulate the sector and assume coverage with a sector Overweight rating and EDU as our top pick. Our order of preference is: 1) K-12 after-school tutoring providers EDU and TAL TAL, 2) K-12 private schools China Yuhua and Maple Leaf, followed by 3) vocational training provider Tarena.

Figure 79: Relative performance of Chinese education stocks vs. MSCI China

800 Title: Source: 700

600 Please fill in the values above to have them entered in your report 500

400

300

200

100

0

Jul-16 Jul-17 Jul-15

Apr-15 Oct-15 Apr-16 Oct-16 Apr-17

Jan-16 Jun-16 Jun-17 Jan-15 Jun-15 Jan-17

Mar-16 Feb-17 Mar-17 Feb-15 Mar-15 Feb-16

Aug-15 Nov-15 Nov-16 Dec-16 Aug-17 Sep-15 Dec-15 Aug-16 Sep-16

May-15 May-16 May-17

MSCI China EDU TAL TEDU Yuhua Maple Leaf

SOURCE: CIMB RESEARCH, COMPANY, BLOOMBERG

We use DCF as key valuation methodology The education companies collect cash from students upfront and revenue is realised when students attend the scheduled classes/school terms. As tuition fees are prepaid and the education companies have fairly consistent levels of capital expenditure, we believe the free cash flows of these companies are fair stable and predictable. The recurring nature of education companies (students are typically retained for multiple years) is also better reflected through the DCF methodology, given the focus on long-term value creation. As a result, we use DCF as our primary valuation method. We assume WACC of 8.8-10.0% for the education companies under our coverage and apply a terminal growth rate of 3%.

What does this imply in terms of PEG? Chinese education stocks vary widely in terms of P/E, depending on their earnings growth potential. TAL, which is the most expensive by P/E, currently trades at 52.9x CY18F P/E and we expect it to record a 2-year core net profit CAGR of 55.1% (FY18-20F). In comparison, China Yuhua only trades at 13.9x CY18F P/E but we forecast that it will record 2-year core net profit CAGR of 19.4% (FY17-19F). We use PEG as a reference when setting our target prices. We believe K-12 after-school tutoring players deserve a higher CY18F PEG of 1.25x due to the favourable macro environment (Gaokao reform and great industry consolidation potential given the current highly-fragmented market conditions), which should help leading players to gain market share as they expand rapidly into lower-tier cities in the medium term. We also expect the leading players like TAL and EDU to further consolidate the market; as the no.1 and no.2 players, respectively, with market shares of only 0.8% and 0.7% in 2016. We value private formal education players at 0.95-1.0x CY18F PEG. While we do not project rapid expansion in capacity for formal education providers, we like them for their stable recurring cash flow and potential gains from the amendment to the Law for Promoting Private Education that was implemented in Sep 2017.

48

Navigating China│Education│September 19, 2017

We assign a lower CY18F PEG of 0.68x to professional education provider Tarena. While we like the company’s earnings growth potential, the lower level of recurring income (courses typically last for four months) translates into greater uncertainty for the company relative to other education players.

Figure 80: Target price and valuation comparison Implied CY18F PEG Implied Implied 2-year (against 2 Target price Implied Implied CY17F P/E CY18F P/E revenue 2-year core year core (LC$) Upside CY17F P/E CY18F P/E (net of cash) (net of cash) CAGR EPS CAGR EPS CAGR) New Oriental Education 114.30 31.1% 51.8 39.4 46.4 35.3 24.5% 31.5% 1.25 TAL Education 40.30 22.1% 100.8 68.9 97.5 66.7 40.7% 55.1% 1.25 China Yuhua 4.50 18.4% 19.9 16.5 16.6 13.7 9.8% 16.3% 1.01 Maple Leaf Education 9.60 16.6% 30.0 22.7 25.7 19.5 24.6% 24.0% 0.95 Tarena 16.70 15.3% 20.3 14.4 15.9 11.3 15.7% 21.1% 0.68 *2-year CAGR refers to FY17-19F for China Yuhua, Maple Leaf Education and Tarena, and FY18-20F for New Oriental Education and TAL Education Note: As of 19 Sep 2017 SOURCE: CIMB RESEARCH, COMPANY

Figure 81: Education sector peer comps 3-year Dividend yield Price TP Mkt cap P/E (x) EPS P/BV (x) PEG (x) (x) Company Ticker Recom. (LC$) (LC$) (US$) CY17F CY18F CY19F CAGR (%) CY17F CY18F CY17F CY18F CY17F CY18F China education ADR New Oriental Education EDU US Add 87.16 114.30 13,743 40.2 30.6 23.3 31.5% 7.1 5.8 1.3 1.0 0.5% 0.5% TAL Education TAL US Add 33.01 40.30 16,533 67.9 52.9 34.8 57.6% 18.4 12.7 na 1.0 0.0% 0.0% Bright Scholar Education BEDU US Non Rated 21.89 na 2,567 68.9 41.7 na na 20.4 16.0 na na 0.0% 0.0% Tarena International TEDU US Add 14.49 16.70 830 17.2 12.6 9.7 23.2% 2.9 2.4 0.9 0.6 1.2% 1.7% China Distance Education DL US Non Rated 6.90 na 227 12.4 13.0 na -6.0% 3.8 3.5 na na 6.5% 6.5%

China H-share education Virscend Education 1565 HK Non Rated 4.78 na 1,868 38.0 26.0 19.9 29.5% 4.6 4.1 na na 1.4% 1.7% China Maple Leaf Education 1317 HK Add 8.23 9.60 1,458 25.7 19.5 na 23.9% 4.1 3.7 1.1 0.8 1.8% 2.3% China Yuhua Education 6169 HK Add 3.80 4.50 1,518 16.8 13.9 na 19.4% 3.0 2.8 1.0 0.9 2.9% 3.0% Wisdom Education 6068 HK Non Rated 4.25 na 1,131 25.7 20.0 16.5 43.6% 3.9 3.5 na na 1.2% 1.6% Minsheng Education 1569 HK Non Rated 2.00 na 1,030 20.3 16.9 15.4 20.8% 2.0 1.8 4.1 3.4 0.6% 0.7% China New Higher Education 2001 HK Non Rated 4.56 na 831 22.1 17.6 14.3 50.9% 3.0 2.7 na na 1.3% 1.8%

International education Grand Canyon Education LOPE US Non Rated 83.23 na 4,005 21.7 20.3 18.1 14.3% na na 1.4 1.4 0.0% 0.0% Adtalem Global Education ATGE US Non Rated 34.95 na 2,170 12.6 11.5 na 10.0% na na 1.3 1.2 1.0% 1.0% Strayer Education STRA US Non Rated 83.01 na 927 24.9 22.0 19.2 11.0% na na 1.7 1.5 0.0% 0.0% Capella Education CPLA US Non Rated 68.30 na 797 19.3 18.6 15.2 7.8% na na 1.9 1.9 2.4% 2.5% Daekyo Co 019680 KS Non Rated 8300.00 na 620 17.3 17.7 16.9 9.2% 1.2 1.2 na na 2.9% 2.9% Note: As of 19th Sep 2017 SOURCE: CIMB RESEARCH, BLOOMBERG

K-12 after-school tutoring service providers K-12 after-school tutoring services is our preferred segment in China’s education industry. We expect the segment to be the key beneficiary of Gaokao reform, especially from the: 1) extended exam preparation cycle, with elective exams taken earlier in the school year, and 2) additional attempts allowed for the English exam. On the back of exam standardisation, we expect nationwide players EDU and TAL to record strong 3-year offline K-12 enrolment CAGR of 30.7% and 40.0%, respectively, as they would be able to expand into new cities faster and gain market share from regional players.

New Oriental Education: We initiate coverage on New Oriental Education (EDU) with an Add rating, and derive our price target using a DCF-based methodology with WACC of 9.7%. Our target price of US$114.30 implies CY18F P/E of 39.4x at 1.25x PEG (0.6 s.d. above EDU’s historical average forward PEG). We believe EDU deserves to trade above its historical average PEG because of the: 1) accelerating growth in its learning centre numbers, 2) continuous improvement in its utilisation rate and margins, and 3) dual-teacher model, which could act as medium-term earnings growth driver.

49

Navigating China│Education│September 19, 2017

TAL Education: We initiate coverage on TAL Education (TAL) with an Add rating. We derive our target price using a DCF-based methodology with WACC of 9.7%. Our target price of US$40.30 implies CY18F P/E of 68.9x, at 1.25x CY18F PEG (1.5 s.d. above its historical average forward PEG). We believe TAL deserves to continue re-rating due to the: 1) continued rapid expansion of its learning centres, 2) fast growth of its dual-teacher model and online education, as well as 3) enhanced course offerings, which would drive near-term earnings growth.

Figure 82: EDU’s forward P/E trend Figure 83: TAL’s forward P/E trend

40 70 Title: Title: Source: Source: 35 60 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 28.5x 30 50 44.9x

25 23.4x 40 36.1x

18.4x 20 30 27.3x

13.4x 18.5x 15 20

10 10

Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17

Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17

Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17

Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17

Jan-15 Jan-16 Jan-17 Jan-12 Jan-13 Jan-14

Jan-15 Jan-16 Jan-17 Jan-12 Jan-13 Jan-14

P/E Ratio Average +1 s.d. +2 s.d. -1 s.d. P/E Ratio Average +1 s.d. +2 s.d. -1 s.d.

SOURCE: CIMB RESEARCH, BLOOMBERG SOURCE: CIMB RESEARCH, BLOOMBERG

While both companies have re-rated strongly over the past two years, we believe re-rating potential still exists as their combined market shares were only c.1.5% of overall industry in 2016, although they are the two largest nationwide tutoring service providers. We expect the ongoing education reforms to aid them in raising market share significantly as they expand into new cities and capture market share from region-specific players by providing higher-quality services. EDU is our top pick for the education sector as it is still cheaper than TAL in terms of PEG ratio. Based on our estimates, EDU is currently trading at CY18F PEG ratio of 0.95x, versus TAL which is trading at 1.02x.

Figure 84: EDU’s forward PEG trend Figure 85: TAL’s forward PEG trend

3 1.8 Title: Title:

1.6 Source: Source: 2.5 1.4 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 1.1x 2 1.2

0.9x 1.4x 1 1.5 0.8 0.7x 1.0x 1 0.6

0.5x 0.4 0.5 0.2

0 0

Jul-13 Jul-14 Jul-15 Jul-17 Jul-12 Jul-16

Jul-13 Jul-14 Jul-15 Jul-17 Jul-12 Jul-16

Apr-12 Oct-12 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Apr-13 Oct-13 Apr-14

Apr-12 Oct-12 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Apr-13 Oct-13 Apr-14

Jan-13 Jan-14 Jan-17 Jan-12 Jan-15 Jan-16

Jan-13 Jan-14 Jan-17 Jan-12 Jan-15 Jan-16

PEG Ratio Average +1 s.d. -1 s.d. PEG Ratio Average +1 s.d. -1 s.d.

SOURCE: CIMB RESEARCH, BLOOMBERG SOURCE: CIMB RESEARCH, BLOOMBERG

50

Navigating China│Education│September 19, 2017

Professional education providers Many provincial governments have in recent years encouraged the private sector to partner with universities to provide practical training in colleges. We expect large professional education players like Tarena to tap into such markets, which would provide more recurring cash flows and lower customer acquisition costs in the long term. We initiate coverage on Tarena with an Add rating and target price of HK$16.70. We derive our price target using a DCF-based methodology with WACC of 10.0%. Our target price implies CY18F P/E of 14.4x, 0.7 s.d. below Tarena’s historical average forward P/E. The potential triggers for Tarena’s re-rating are stronger-than-expected enrolment for the K-12 segment. Tarena de-rated significantly in Aug 2017 post-2Q17 results announcement on the back of greater-than-expected margin pressure and management’s weak revenue growth guidance for 3Q17F due to the short-term pressure arising from the structural shift in university channel recruitment. However, we believe the weak near-term earnings outlook has been priced in and we expect the stock to re-rate from its current share price level given: 1) the acceleration in its K-12 learning centre openings, and 2) the expected continued growth in enrolment numbers on the back of expansion into lower-tier cities.

Figure 86: Tarena’s forward P/E trend Figure 87: Tarena’s forward PEG trend

26 0.6 Title: Title: Source: Source: 24 0.46x 0.5 22 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 0.4 0.36x 20 18.2x 18 0.3 15.9x 16 0.27x 0.2 14

13.7x 0.1 12

10 0

P/E Ratio Average +1 s.d. -1 s.d. PEG Ratio Average +1 s.d. -1 s.d.

SOURCE: CIMB RESEARCH, BLOOMBERG SOURCE: CIMB RESEARCH, BLOOMBERG

Private formal education providers We view the amendment to the Law for Promoting Private Education that came into force on 1 Sep 2017 as beneficial to private education providers including Yuhua and Maple Leaf. Private schools (except providers of compulsory education) are now allowed to be profit-making entities and set their tuition fees without prior approval from relevant authorities.

China Yuhua Education: We initiate coverage on China Yuhua with an Add rating and target price of HK$4.50. We derive our target price using a DCF- based methodology with WACC of 8.8%. Our target price implies a CY18F core P/E of 16.5x or CY18F core PEG of 1.0x. The potential triggers for a re-rating are strong enrolment for the 2017/18F academic year. We expect the stock to continue to re-rate given: 1) the new schools in its pipeline for the next three years, 2) further earnings upside from M&A activities as the company plans to expand both organically and through acquisitions of strategically-beneficial schools, 3) potential positive earnings surprises due to benefits of scale (operational leverage), and 4) wider coverage/interest in the stock now that it has surpassed market cap of US$1bn.

China Maple Leaf Education: We assume coverage on Maple Leaf with an Add rating with DCF-based target price of HK$9.60. We expect strong topline growth and margin expansion to drive earnings expansion in FY18F. Our target

51

Navigating China│Education│September 19, 2017

price implies CY17F P/E of 30.0x and CY18F P/E of 22.7x. Key positive catalysts include stronger-than-expected student enrolment and margin expansion. Downside risks include longer-than-expected ramp-up periods for new schools.

Figure 88: China Yuhua’s forward P/E trend Figure 89: China Maple Leaf’s forward P/E trend

22 35 Title: Title: Source: Source: 20 19.0x 30 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 17.9x 18 25

20.6x 16 16.8x 20 17.0x 14 13.4x 15

12

10 10 Apr-17 Jul-17

P/E Ratio Average +1 s.d. -1 s.d. P/E Ratio Average +1 s.d. -1 s.d.

SOURCE: CIMB RESEARCH, BLOOMBERG SOURCE: CIMB RESEARCH, BLOOMBERG

52

Navigating China│Education│September 19, 2017

Company Briefs…

53

Education│China│September 19, 2017

Company Note │ Alpha series

China New Oriental Education ADD Seeking balanced growth Consensus ratings*: Buy 24 Hold 1 Sell 1 ■ Established in 1993, New Oriental Education (EDU) is the largest provider of private educational services in China. Current price: US$87.16 ■ We forecast a 3-year FY17-20F revenue and net profit CAGR of 25.4% and 31.5%, Target price: US$114.3 respectively, as EDU balances its learning centre expansion and utilisation increase. Previous target: N/A ■ The dual-teacher model is expected to help drive its growth in lower-tier cities, while Up/downside: 31.1% providing high margins in the medium term. CIMB / Consensus: 19.0% ■ We initiate coverage with an Add rating and DCF-based target price of US$114.3.

Reuters: EDU.N The largest provider of private educational services in China Bloomberg: EDU US Established in 1993, EDU is the largest provider of private educational services in China. Market cap: US$13,743m Its ‘one-stop shop’ business model provides the company with significant cross-selling US$13,743m potential and allows it to enjoy a very stable and recurring revenue base. Average daily turnover: US$106.3m Adopting a balanced expansion strategy US$106.3m We forecast that EDU will record a 3-year revenue CAGR of 25.4% for FY17-20F. EDU is Current shares o/s: 157.6m embarking on its ‘Optimise the Market’ strategy, focusing on maintaining a healthy Free float: 85.4% balance between capacity expansion and margin improvement. We forecast student *Source: Bloomberg enrolment to post a 3-year CAGR of 26.0% in FY17-20F, driven by our assumption of an 11.3% CAGR for its learning centre numbers and increases in utilisation rate. Key changes in this note N/A Dual-teacher model to drive growth in lower-tier cities EDU plans to further roll out its dual-teacher model to lower-tier cities; parents and

Price Close Relative to S&P 500 (RHS) students in lower-tier cities prefer teachers from big cities as they are deemed to be more 96.0 193 experienced and clued into provincial examinations. We are positive on this initiative as it could allow EDU to expand further, while still maintaining its high teaching quality and 76.0 153 enjoying economies of scale. In the long run, we believe the dual-teacher model will be 56.0 113 able to achieve operating margins of c.5% pts higher than traditional offline classes. 36.0 73 20 Increase in utilisation to drive margin improvement 15 10 We forecast EDU’s non-GAAP operating margin widening in the coming years, from

5 15.7% in FY17 to 18.7% in FY20F, driven by 1) annual utilisation improvements of 1.5- Vol m Vol Sep-16 Dec-16 Mar-17 Jun-17 2.0% pts in learning centres, 2) stabilised spending on O2O, and 3) greater operational

Source: Bloomberg leverage. Overall, we expect EDU Education to deliver a 3-year non-GAAP net profit CAGR of 31.5% from US$294.7m in FY17 to US$669.6m in FY20F. Price performance 1M 3M 12M Absolute (%) 8.9 17.6 86.1 Why we think there is further upside We like EDU’s balanced growth strategy and are more positive than the market on EDU’s Relative (%) 5.7 14.7 69.1 margin expansion and utilisation improvement prospects. In addition, the new 2017

Major shareholders % held Private Education Promotion Law was implemented on 1 Sep 2017, following which local Mr. Michael M Yu 14.6 government will announce detailed step-by-step implementation measures. We expect the government to strengthen its monitoring of the after-school tutoring industry, which will benefit the large players like EDU, allowing them to gain market share. Initiate coverage with Add rating and TP of US$114.3 (WACC: 9.7%) We initiate coverage on EDU with an Add rating and see a 31.1% upside from the current share price. Our DCF-based TP of US$114.3 implies a CY18F P/E of 39.4x and 1.25x CY18F PEG. We expect EDU to continue to re-rate on 1) acceleration in growth of learning centres, 2) ongoing improvements in utilisation rate and margins, and 3) the dual-teacher model as a mid-term growth driver. Key risks include lower-than-expected margins on slow ramp up in new learning centres’ utilisation rates.

Financial Summary May-16A May-17A May-18F May-19F May-20F Analyst(s) Revenue (US$m) 1,478 1,800 2,285 2,868 3,544 Operating EBITDA (US$m) 242.4 312.4 408.1 530.7 692.7 Net Profit (US$m) 227.8 273.3 364.0 482.5 638.7 Core EPADS (US$) 1.56 1.87 2.46 3.23 4.25 Core EPS Growth 16.9% 19.5% 31.9% 31.5% 31.5% FD Core P/E (x) 55.81 46.66 35.45 26.96 20.51 DPADS (US$) 0.40 0.45 0.45 0.45 0.45 Dividend Yield 0.46% 0.52% 0.52% 0.52% 0.52%

EV/EBITDA (x) 53.22 40.21 29.19 21.12 14.64 Lei YANG, CFA P/FCFE (x) 65.58 28.56 19.08 17.59 12.03 T (86) 21 5047 1771 x108 Net Gearing (55%) (73%) (94%) (106%) (120%) E [email protected] P/BV (x) 9.73 8.43 7.06 5.76 4.61 ROE 18.6% 19.4% 21.7% 23.5% 25.0% ONG Khang Chuen % Change In Core EPADS Estimates T (852) 2539 1326 CIMB/consensus Core EPADS (x) 1.04 1.03 1.03 E [email protected] SOURCE: COMPANY DATA, CIMB FORECASTS

54

Education│China│New Oriental Education│September 19, 2017

Seeking balanced growth

Company outlook Adopting a balanced expansion strategy Starting in FY15, New Oriental Education (EDU) embarked on its ‘Optimise the Market’ strategy as it transitioned to focus on maintaining a healthy balance between capacity expansion and margin improvement as well as to meet the growing demand for online education in China. As of end-May 2017, EDU had established 855 learning centres across 65 cities. Management guided for an addition of 10% to 15% new learning centres for its K-12 after-school tutoring business in existing cities and planned to enter two to four new cities in FY18F. The company also plans to continue rolling out its dual- teacher model classes to about 5-10 new cities in FY18F. We forecast the number of EDU’s learning centres to post a 3-year CAGR of 11.3% from 855 in FY17F to 1,180 in FY20F. Besides increasing the number of learning centres, EDU is also actively making an effort to lift the utilisation rate of its existing teaching facilities. EDU carries out large scale promotions every summer to acquire grade 7 students before they start the first year of secondary school. In 2017, the scale of promotion further widened, with the company providing low-priced experiential courses for multiple subjects in 40 cities. According to management, the summer promotions this year saw student enrolment of 417,000 in early-July, more than double compared to the same period last year. Historically, the retention rate of students enrolled in the summer promotion programme stands at c.40%, which allows EDU to quickly grab market share in the K-12 after-school segment, in our view. Management said the retention rate has improved to 50% in the summer of 2017. We forecast student enrolment to deliver a 3-year CAGR of 26.0% from 4.86m in FY17F to 9.72m in FY20F, driven by the continued expansion of its learning centre network and higher utilisation rates.

Figure 1: EDU's learning centre network Figure 2: Student enrolment growth

1,400 16% 12,000 Title: 35% Title: 1,180 14% Source: Source: 1,200 9,718 30% 1,072 12% 10,000 962 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 1,000 10% 7,849 25% 855 8,000 8% 800 748 20% 703 724 6% 6,221 6,000 4% 4,859 600 15% 2% 4,000 3,645 400 0% 2,669 2,896 10%

-2% 2,000 200 5% -4%

0 -6% 0 0% FY14 FY15 FY16 FY17 FY18F FY19F FY20F FY14 FY15 FY16 FY17 FY18F FY19F FY20F

LHS: Learning centres RHS: yoy growth (%) LHS: Student enrolments ('000) RHS: yoy growth (%)

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

55

Education│China│New Oriental Education│September 19, 2017

Dual-teacher model to drive growth in lower-tier cities New Oriental Education began pilots of its new dual-teacher class model in July 2016. In fiscal year 2017, the offering was tested in over 20 cities with existing EDU learning centres and in six new cities. In this dual-teacher class format, instructors deliver lectures from one classroom to students in the same classroom as well as to students at other learning centres nationwide through simultaneous webcasts. Every classroom is also staffed with one teaching assistant to tutor and supervise students. Normally, one instructor can deliver lectures to 10-20 classrooms at the same time. We are positive on this new class format as parents and students in lower-tier cities prefer teachers from big cities as they are deemed to be more experienced and clued into provincial examinations. Also, this teaching model effectively allows EDU to expand further into lower-tier cities with lower demand density while ensuring high teaching quality and enjoying economies of scale at the same time. Management guided for the dual-teacher class model to be continuously rolled out in some lower-tier cities with existing EDU learning centres as well as 5-10 new cities in FY18F. In the long run, we believe the dual-teacher model will contribute positively to EDU’s margins as we expect the model to be able to achieve operating margins that are c.5% higher than those of traditional offline classes.

Breakdown by segment: K-12 to remain the key growth driver

Figure 3: Revenue growth in US$ terms by segment (%)

40.0% 37.3% Title: 35.9% 34.6% 35.0% 33.3% Source: 30.0% 29.1% 29.6% 30.0% 27.0% 27.5% 25.5% Please fill in the values above to have them entered in your report 25.0% 23.6% 21.7% 20.0% 14.4% 15.0% 13.9% 13.4%

10.0%

5.0% 3.1%

0.0% FY17 FY18F FY19F FY20F -0.5% -5.0% -2.5% -5.5% -5.5% -10.0%

K-12 after school tutoring Overseas test prep English language training Online-Koolearn Overall

SOURCE: CIMB FORECASTS, COMPANY

K-12 after-school tutoring− the main revenue driver: On the back of continued capacity expansion of learning centres, we expect EDU’s K-12 after- school tutoring programme to record 3-year revenue CAGR of 33.4% from FY17 to FY20F. We forecast K-12 student enrolment growth of 26.7-35.0% yoy from FY18F to FY20F, coming mainly from learning centre capacity expansion at a rate of between 10% and 12.5% annually over the coming 3 years, as well as continued utilisation improvements. We also forecast modest ASP expansion of 1.7-2.3% yoy for the tutoring courses. While EDU’s learning centres typically raise hourly tuition fees by 5-9% yoy in Rmb terms annually, we believe the actual ASP expansion will be partially offset by 1) higher revenue contribution from lower-tier cities, where ASP is lower, and 2) reduced emphasis on VIP classes, which contribute higher ASP but lower margins.

56

Education│China│New Oriental Education│September 19, 2017

Overseas test prep segment growth to come mainly from ASP increases: We expect EDU’s overseas test prep segment to record 3-year revenue CAGR of 13.9% from FY17 to FY20F. New Oriental Education holds a monopoly position in this industry, which is currently only recording low single-digit growth annually. We forecast enrolment growth to remain low at 2-5% yoy in FY18-20F and segment ASP to grow by 8.0% to 11.7% annually over the next 3 years. EDU is in the process of rolling out the online-to-offline (O2O) standardised teaching system for its overseas test prep courses in some larger cities in China, which we believe will positively contribute to its potential to raise prices in the near term.

Strong online growth: We believe New Oriental Education has successfully created an online education ecosystem that has gained acceptance amongst students and parents. Both online platforms Koolearn.com and koo.cn continue to see strong registrations and growth in the number of paid users. DONUT, EDU’s series of game-based mobile learning apps for children, and Le Ci, an English language vocabulary training app for mobile phones and tablets, also continue to see strong downloads. We forecast the online education segment to record 3-year revenue CAGR of 30.7% from US$63m in FY17 to US$141m in FY20F.

Language training programme may see decline: We expect the language training and domestic test preparation programme to see declines in student enrolment of 3.2-8.0% annually over FY18-20F due to 1) the relatively mature market as Chinese citizens are exposed to the English language at an earlier age, and 2) loss of market share to online education.

Figure 4: Student enrolment growth by segment (%) Figure 5: ASP breakdown by segment (Rmb)

50.0% 47.0% 14,000 Title: Title:

Source: 12,119 Source: 40.0% 12,000 11,221 35.0% 33.3% 10,201 30.6% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 28.0% 10,000 30.0% 26.2% 26.7% 9,108 23.8%

20.0% 8,000

(Rmb) 6,000 10.0% 4.0% 5.0% 2.0% 4,000 0.0% FY17 FY18F FY19F FY20F 1,796 -3.9% -3.2% 1,686 1,570 1,720 1,617 1,756 1,663 1,710 -5.2% 2,000 -10.0% -7.7% -8.0%

0 -20.0% FY17 FY18F FY19F FY20F

K-12 after school tutoring Overseas test prep English language training Overall K-12 after school tutoring Overseas test prep English language training

*ASP is derived as dividing segment revenue by segment annual student enrolment SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

57

Education│China│New Oriental Education│September 19, 2017

Increase in utilisation to drive margin improvement We believe New Oriental Education is set to record stable margin expansion in the coming years following its lowest post-IPO non-GAAP operating margin of 13.6% in 2015 (down from prior 3 years’ average of 18.0%). The notable decline in margins in FY15 was mainly due to 1) uncertainties about the implementation of new policies relating to the English test for Gaokao, which impacted student enrolment in 1QFY15, 2) introduction of a new loyalty programme, and 3) higher spending on new online initiatives. Since then, New Oriental Education has recorded 2 years of margin improvements (non-GAAP operating margin was 15.7% as of FY17), mainly due to increases in the utilisation rate as well as higher operating leverage. EDU’s plan for learning centre network expansion over the next 3 years is relatively modest, in our view, and management is determined to improve its utilisation rate by 1.5-2.0% pts annually. EDU lifted its overall utilisation rate to 22% in FY17 from 19-20% in FY16 and we expect this to further improve to 23- 24% in FY18F. We forecast that every 1% increase in utilisation rate can result in gross margin widening 0.5-0.7% pts and we forecast EDU to enjoy further GPM expansion in the coming years from 58.3% in FY17 to 60.2% in FY20F. We also expect New Oriental Education’s non-GAAP operating margin to jump in the coming years from 15.7% in FY17 to 18.7% in FY20F, driven by 1) continued utilisation increases in learning centres, 2) stabilised spending on O2O, and 3) greater operational leverage.

Figure 6: New Oriental Education's margin trends

80.0% Title: Source: 70.0% 60.3% 60.2% 57.8% 58.4% 58.3% 59.1% 59.7% 60.0% Please fill in the values above to have them entered in your report

50.0%

40.0%

30.0%

20.0% 19.1% 18.7% 10.0% 15.7% 16.5% 17.5% 13.6% 14.6%

0.0% FY14 FY15 FY16 FY17 FY18F FY19F FY20F

GPM Operating margin (non-GAAP)

SOURCE: CIMB FORECASTS, COMPANY

58

Education│China│New Oriental Education│September 19, 2017

Background The largest provider of private educational services in China Established in 1993, New Oriental Education is the largest provider of private educational services in China, offering a wide range of education programmes, services and products. As of end-May 2017, EDU had 855 learning centres across 65 cities.

Figure 7: New Oriental Education’s network of learning centres (as at end-May 2017)

*Refer to cities that adopt dual-teacher model SOURCE: CIMB RESEARCH, COMPANY

Key success factor 1: ‘One-stop shop’ business model provides high recurring revenue Having started as a TOEFL test preparation service provider in Beijing, New Oriental Education has since expanded its service offerings to a wide range of educational services, including K-12 after-school tutoring, domestic test preparation and language training, online education and other fringe educational services.

Figure 8: New Oriental Education’s course offerings (as at end-FY16)

SOURCE: CIMB RESEARCH, COMPANY

EDU’s main service offerings include:

59

Education│China│New Oriental Education│September 19, 2017

K-12 after-school tutoring courses: Accounting for 54.5% of EDU’s FY17 revenue, K-12 after-school tutoring is the largest revenue contributor for EDU. EDU offers 2 main K-12 training programmes, namely ‘U-can’ and ‘Pop Kids’. Both U-can and Pop Kids normally launch four courses a year. U-can (37% revenue contribution and 45.5% of total enrolment in FY17) targets middle and high school students from the ages 13 to 18. A typical U-can course lasts for 8 to 16 weeks with classroom instruction one to four times per week for 1.5 to 4 hours per visit. Class sizes range from 6 to 100 students per class and tuition fees range from Rmb400 to Rmb5,000 per course. Pop Kids (17.5% revenue contribution and 35.8% of total enrolment in FY17) targets children in kindergarten through grade six. Classroom instruction is one to four times per week for 1.5 to 3 hours per class. Class sizes range from 6 to 25 students per class and tuition fees range from Rmb300 to Rmb3,600 per course. EDU intends to improve its student retention rate for both U-can and Pop Kids courses. Management said the Pop Kids retention rate rose to 85% in FY17 from 75% in FY16 and that for U-can it jumped to 70% in FY17 from 60% in FY16.

Overseas preparation courses: Overseas preparation courses include overseas test preparation courses as well as overseas consulting services, which together contributed 30.2% of EDU’s revenue in FY17. EDU offers test preparation courses (22.2% of revenue contribution and 6.1% of total enrolment in FY17) for major overseas exams, including TOEFL, SAT, ACT, IELTS, GRE and GMAT. Students typically enroll in a 50- to 200-hour programme with class meetings one to six times per week for approximately 1 to 3 hours per class. Class sizes range from 6 to 50 students. Course fees for these preparation courses range from Rmb1,500 to Rmb20,000 per course. Overseas studies consulting (8% of FY17 revenue contribution) involves helping students through the application and admission process for overseas educational institutions by providing counseling advice so they can make informed choices.

Language training courses: EDU offers various types of English language training courses as well as training courses for other foreign languages. Preparation courses for domestic admission tests are also offered. Together, they contributed 5.2% of EDU’s FY17 revenue. EDU offers preparation courses for major domestic admission exams (3.2% of revenue contribution and 6.5% of enrolment in FY17), including CET 4, CET 6 and National Tests for Entrance into Master’s Degree Programmes. Language training courses (2.0% of revenue contribution and 2.8% of enrolment in FY17) refer to adult programmes offered to improve students’ writing, reading, listening and speaking skills. A typical course lasts for 6 to 12 weeks with classroom instruction 1 to 5 times per week for 1.5 to 5 hours per visit. Class sizes range from 6 to 50 students while course fees range from Rmb300 to Rmb3,600 per course.

Online education: EDU offers online courses through 68%-owned subsidiary Xun Cheng, which was listed on the National Equities Exchange and Quotations (NEEQ) in China in Mar 2017. As of end-FY16, c.5,400 online courses were offered on its platforms, www.koolearn.com and www.koo.cn, including language training courses, test preparation courses, professional certification courses and business knowledge and various skills training courses. In FY17, revenue contribution of online education stood at 3.5%.

Others: Other services include private schools (pre-schools, primary schools, secondary schools and international high schools) and overseas study tours as well as educational content, software and technology development and distribution. This segment contributed 6.6% of EDU’s revenue in FY17.

60

Education│China│New Oriental Education│September 19, 2017

Figure 9: Revenue breakdown, FY17 Figure 10: Student enrolment breakdown, FY17 Online education, Others, 6.6% Language 3.5% Others, 3.3% Language training training Title: Title: courses, 2.0% courses, 2.8% Source: Source: Domestic test prep, Domestic test 3.2% prep, 6.5% U-can, 37.0% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report Overseas Overseas test consulting, 8.0% prep, 6.1%

U-can, 45.5%

Overseas test prep, 22.2% Pop Kids, 35.8%

Pop Kids, 17.5%

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

New Oriental Education offers a huge range of courses catering to students aged as young as 4 to adults. The courses are offered in varying formats, including 1) large classes, 2) small classes, 3) 1-to-1 classes, as well as 4) online classes. As a result, EDU enjoys a very stable and recurring revenue base. Besides being able to fulfil the after-school educational needs of a K-12 student, it can provide support later in the student’s life as he/she prepares to enter higher education, whether domestically or abroad. Essentially, as long as a student is satisfied with the education quality provided by EDU, the student could be a revenue generator for as long as 15 years. The ‘one-stop shop’ business model provides New Oriental Education with enormous cross-selling potential and helps lower its student acquisition costs. EDU has proven that it is able to maintain a strong growth momentum without spending too much on brand-building activities. Its selling and marketing expenses ratio of 12.9% in FY17 is only slightly higher than the pure K-12 player TAL Education’s (TAL US, Add) 11.8% and far below that of professional IT tutoring service provider Tarena Education’s (TEDU US, Add) 33.9%.

Figure 11: Non-GAAP selling and marketing expenses ratio (%)

40.0% Title:

33.9% 33.7% Source: 35.0% 32.5% 33.0% 33.4%

30.0% Please fill in the values above to have them entered in your report

25.0%

20.0% 15.1% 15.0% 13.4% 12.9% 12.8% 12.6% 11.9% 11.5% 11.8% 12.3% 12.2% 10.0%

5.0%

0.0% FY15 FY16 FY17F FY18F FY19F

New Oriental Education TAL Education Tarena International

*Numbers reflected for New Oriental Education (Y/E May) and TAL Education (Y/E Feb) for FY17 are actual numbers; Tarena International’s (Y/E Dec) non-GAAP selling and marketing expenses ratio for FY17 is a forecasted figure. SOURCE: CIMB FORECASTS, COMPANY

61

Education│China│New Oriental Education│September 19, 2017

Key success factor 2: O2O Two-way Interactive Education System Introduced in Sep 2014, the Online to Offline (O2O) Two-way Interactive Education System is a core element in New Oriental's integrated online/offline educational offering. The system is a proprietary centralised teaching platform that consists of a series of online education modules and support classroom teaching. Key features include:

Interactive in-class experience: Students are provided with a remote answering device, which allows them to respond to pop-up quizzes in class. Besides enhancing the interaction between teachers and students in class, the real-time response provided to teachers allows them to adjust their pace of teaching based on the students’ performance in class.

Online resources: After class, students can access EDU’s modules, programmes and information online from home. The students can then complete their homework or online modules recommended by the system to improve their learning, thus progressing at their individual pace.

Tracking learning progress: Through recording the responses by students through the in-class answering device and tracking their progress in the online resources, the system is able to provide in-depth reporting on a student’s performance. The reports are available to parents and teachers, which allows parents to have a better understanding of their children’s learning progress. Through the revamped interactive teaching system, New Oriental Education was able to boost the teaching quality and efficiency of its classes well above that of its competitors, allowing it to charge a premium for the courses. Also, the availability of learning progress reports helps improve customer satisfaction as parents are able to better understand their children’s learning progress.

Currently, this O2O interactive teaching system has been successfully rolled out across all existing cities for U-can courses, 54 cities for POP Kids courses and 10 cities for overseas test prep courses. We believe the continued roll-out of the system will positively contribute to EDU’s potential to continue raising prices in the coming years.

Figure 12: Remote answering devices Figure 13: Real-time Q&A in class Figure 14: Learning progress report

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

62

Education│China│New Oriental Education│September 19, 2017

SWOT Analysis Strengths  One-stop shop business model allows EDU to enjoy highly recurring revenue and low student acquisition costs.  Outstanding teaching line-up and quality teaching content allow EDU to maintain solid reputation.  Strong presence in both offline and online markets. Weaknesses  Continued teaching centre capacity expansion plan may result in weaker margins if the utilisation rate ramps up at a slower-than-expected pace.  Further roll-out of dual-teacher teaching model may hurt brand reputation if EDU is unable to maintain its high teaching quality. Opportunities  Ample expansion opportunities given offline penetration currently only stands at 65 cities.  Established online platform and minority shareholdings in online education companies can further drive growth. Threats  Policy changes.  M&A strategy may pose risks.

63

Education│China│New Oriental Education│September 19, 2017

Financials 25.4% revenue CAGR expected for FY17-20F We forecast that New Oriental Education will achieve 3-year revenue CAGR of 25.4% from US$1.80bn in FY17 to US$3.54bn in FY20F, mainly driven by 1) continued strong enrolment growth in K-12 after-school tutoring services, 2) capacity expansion, and 3) further growth of its online business.

Figure 15: Revenue trend (US$m)

4000

3500 158 244 141 3000 86 143 212 590 2500 110 86 477 130 179 521 341 2000 85 119 88 113 144 455 1500 98 124 94 27 89 399 96 107 99 2,326 85 1000 85 100 113 387 1,795 341 365 1,347 96 500 981 721 477 549 0 FY14 FY15 FY16 FY17 FY18F FY19F FY20F K-12 after school tutoring Overseas test prep English language training Online-Koolearn Overseas consulting Others

SOURCE: CIMB FORECASTS, COMPANY

K-12 after-school tutoring the main revenue driver: On the back of continued capacity expansion of learning centres, we expect EDU’s K-12 after-school tutoring to record 3-year revenue CAGR of 33.4% from US$981m in FY17 to US$2.3bn in FY20F. We forecast the K-12 segment to see student enrolment growth of 26.7-35.0% yoy in FY18-20F. This will come from learning centre capacity expansion at a rate of 10-12.5% annually over the coming 3 years as well as continued utilisation improvements. The utilisation rate of learning centres stood at c.22% in FY17; management plans to improve it by 1.5-2% pts every year. We forecast modest ASP expansion of 1.7-2.3% yoy in US$ terms for EDU’s K- 12 after-school tutoring courses. While individual EDU learning centres typically raise hourly tuition fees by 5-9% yoy in Rmb terms annually, we believe the actual ASP expansion will be partially offset by 1) higher revenue contribution from lower-tier cities, where ASP is lower, and 2) reduced emphasis on VIP classes, which contribute higher ASP.

Overseas test prep’s growth to come mainly from ASP increases: We expect EDU’s overseas test prep segment to record 3-year revenue CAGR of 13.9% from Rmb400m in FY17 to Rmb591m in FY20F. New Oriental Education holds a monopoly position in the overseas test preparation industry, which is currently only recording low single-digit growth annually. We forecast enrolment growth of this segment to remain low at 2-5% yoy in FY18-20F, in line with industry growth. We expect the main driver of this segment to come from ASP increases, which we forecast to be between 8.0% and 11.7% annually over the next 3 years. EDU is currently rolling out the O2O standardised teaching system for its overseas test prep courses in some larger cities in China, which we believe will positively contribute to its potential to raise prices in coming years.

64

Education│China│New Oriental Education│September 19, 2017

Strong online growth: We believe the company has successfully created an online education ecosystem that has gained acceptance amongst students and parents. Both online platforms, Koolearn.com and koo.cn, continue to see strong registrations and growth in the number of paid users. DONUT, EDU’s series of game-based mobile learning apps for children, and Le Ci, an English language vocabulary training app for mobile phones and tablets, also continue to see strong downloads. We forecast the online education segment to record 3-year revenue CAGR of 30.7% from US$63m in FY17 to US$141m in FY20F.

Language training programme may see decline: We expect the language training and domestic test preparation programme to see a decline in revenues of between 0.5-5.5% annually over FY18-20F due to 1) the relatively mature market as Chinese citizens are exposed to the English language at an earlier age, and 2) loss of market share to online education.

Figure 16: Overall student enrolment trend Figure 17: Blended ASP trend (US$)

12,000 35% 440 15.0% 430.5 Title: Title: 426.7 Source: Source: 9,718 30% 10,000 420 10.0% 405.6Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 7,849 25% 8,000 400 5.0% 6,221 20% 6,000 380 4,859 370.4 15% 367.3 365.3 364.7 0.0% 4,000 3,645 360 2,669 2,896 10% -5.0% 2,000 5% 340

0 0% 320 -10.0% FY14 FY15 FY16 FY17 FY18F FY19F FY20F FY14 FY15 FY16 FY17 FY18F FY19F FY20F

LHS: Student enrolments ('000) RHS: yoy growth (%) LHS: ASP (US$) RHS: yoy growth (%)

*ASP is derived as dividing total revenue by annual student enrolment SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

Overall, we forecast EDU’s student enrolment to record growth of 23.8-28.0% per annum in FY18-20F, mainly driven by the K-12 after-school tutoring segment. However, we expect EDU’s ASP to record a decline of 0.2-0.8% annually over the same period. This is mainly due to the faster enrolment growth of the K-12 segment, which has a lower ASP compared to overseas test prep.

Figure 18: Breakdown of cost of sales (FY17) Figure 19: Gross profit margin (based on our estimates) Others, 12% 61.0% Title: Title: 60.3% Source: Source: 60.5% 60.2%

60.0% Please fill in the values above 59.7%to have them entered in your report Please fill in the values above to have them entered in your report

59.5% 59.1% 59.0% 58.4% 58.3% Rental cost, 28% 58.5% 57.8% Teacher fees and 58.0% performance- linked bonuses, 57.5% 60% 57.0%

56.5% FY14 FY15 FY16 FY17 FY18F FY19F FY20F

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

EDU’s cost of sales component is mostly made up of variable costs and has remained generally consistent over the past years. Key costs include teacher fees and performance-linked bonuses, which made up 60% of FY17 cost of sales, while rental costs make up 28%.

65

Education│China│New Oriental Education│September 19, 2017

Expect continued margin expansion Gross margin: EDU’s learning centre network expansion is relatively modest, in our view, and management is determined to improve the utilisation rate by 1.5- 2.0% pts annually. We expect EDU to enjoy further GPM expansion from 58.3% in FY17 to 60.2% in FY20F.

Figure 20: EDU's non-GAAP operating expenses ratio Figure 21: Net profit (non-GAAP) trend

35.0% 31.9% 800 Title: 50% Title: 30.4% 30.8% 30.7% 30.5% 30.1% 28.5% Source: Source: 30.0% 700 40%

25.0% 600 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 30% 19.1% 18.7% 20.0% 17.5% 500 15.7% 16.5% 13.6% 14.6% 20% 15.0% 400 14.8%

15.1% (US$ m) 10% 10.0% 13.4% 12.9% 12.8% 12.6% 12.2% 300

5.0% 0% 200

0.0% -10% FY14 FY15 FY16 FY17 FY18F FY19F FY20F 100

0 -20% Selling and marketing expenses ratio FY14 FY15 FY16 FY17 FY18F FY19F FY20F General and administrative expenses ratio Operating margin (non-GAAP) LHS: Net income (non-GAAP) RHS: yoy growth (%)

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

Non-GAAP operating margin: We expect New Oriental Education to record non-GAAP operating margin expansion in the coming years from 15.7% in FY17 to 18.7% in FY20F, driven by 1) continued utilisation increases in learning centres, 2) greater operational leverage, and 3) lowered spending on O2O. Breaking down the individual operating expenses lines, we expect the selling and marketing expenses ratio to only gradually decline as EDU spends on brand-building activities with its continued expansion into new cities. We project more significant operating leverage on the general and administrative expenses line given EDU’s central kitchen operating model.

Non-GAAP net profit: Overall, we expect the company to record a 3-year non- GAAP net profit CAGR of 31.5% from US$294.7m in FY17 to US$669.6m in FY20F.

Dividend profile: EDU does not pay a regular dividend as the company is still in its expansion phase, though it declared US$0.45 per ADS special cash dividend for the year ended FY17. We forecast EDU to maintain its dividend payout of US$0.45 per ADS in FY18-20F, which translates to dividend payout ratio of 11.1-19.5%.

66

Education│China│New Oriental Education│September 19, 2017

Figure 22: Income Statement FYE May (US$m) 2014 2015 2016 2017 2018F 2019F 2020F Net revenue 1,138.9 1,246.8 1,478.3 1,799.5 2,284.8 2,867.5 3,544.4 yoy % 18.7% 9.5% 18.6% 21.7% 27.0% 25.5% 23.6%

Cost of revenues (451.7) (526.3) (614.4) (749.6) (934.6) (1,155.6) (1,409.8) Gross profit 687.2 720.4 864.0 1,049.9 1,350.24 1,712.0 2,134.6 Gross profit margin 60.3% 57.8% 58.4% 58.3% 59.1% 59.7% 60.2%

Selling and marketing (169.1) (188.5) (197.9) (232.8) (293.33) (362.4) (433.8) As % of revenue 14.8% 15.1% 13.4% 12.9% 12.8% 12.6% 12.2% General and administrative (324.2) (378.4) (471.0) (554.9) (702.33) (875.7) (1,068.2) As % of revenue 28.5% 30.4% 31.9% 30.8% 30.7% 30.5% 30.1% Operating profit (GAAP) 197.6 153.5 198.8 262.1 354.6 473.9 632.6 Operating profit margin (GAAP) 17.3% 12.3% 13.4% 14.6% 15.5% 16.5% 17.8%

Operating profit (non-GAAP) 217.6 169.2 215.6 282.4 377.9 500.7 663.5 Operating profit margin (non-GAAP) 19.1% 13.6% 14.6% 15.7% 16.5% 17.5% 18.7%

Gain/(loss) on disposal of subsidiaries 3.6 - 3.8 - - - - Interest income 44.9 66.6 66.9 68.6 81.2 102.5 129.1 Miscellaneous income, net 0.8 0.3 1.6 - - - - Profit before tax (GAAP) 243.2 220.5 267.3 330.7 435.7 576.3 761.7 Provision for income taxes (26.0) (26.2) (37.5) (50.6) (65.4) (86.5) (114.3) Effective tax rate % 10.7% 11.9% 14.0% 15.3% 15.0% 15.0% 15.0% Loss from equity method investments (1.5) (1.5) (4.4) (3.3) (3.3) (3.3) (3.3) Loss from discontinued operations, net of tax - - - 0.0 0.0 0.0 0.0 Net loss (gain) attributable to noncontrolling interests - 0.3 (0.4) (2.3) (3.1) (4.1) (5.4) Net income attributable to shareholders (GAAP) 215.7 193.0 224.9 274.5 364.0 482.5 638.7 Net profit margin (GAAP) 18.9% 15.5% 15.2% 15.3% 15.9% 16.8% 18.0%

Net income attributable to shareholders (non-GAAP) 235.8 208.7 241.7 294.7 387.3 509.4 669.6 Net profit margin (non-GAAP) 20.7% 16.7% 16.3% 16.4% 17.0% 17.8% 18.9% SOURCE: CIMB FORECASTS, COMPANY

67

Education│China│New Oriental Education│September 19, 2017

Figure 23: Balance Sheet FYE May (US$m) 2014 2015 2016 2017 2018F 2019F 2020F Assets Current assets Cash and cash equivalents 371.6 531.3 709.2 1,118.0 1,767.0 2,476.6 3,546.9 Restricted cash 0.5 0.9 0.1 0.1 0.1 0.1 0.1 Term deposits 98.5 69.1 86.7 86.7 86.7 86.7 86.7 Short-term investments 643.4 599.9 819.2 819.2 819.2 819.2 819.2 Accounts receivable 2.8 4.2 3.7 6.1 6.4 9.3 10.1 Inventory 22.4 24.0 27.3 34.3 42.5 52.5 63.4 Deferred tax assets 12.0 18.0 0.0 0.0 0.0 0.0 0.0 Prepaid expenses and other current assets, net 78.4 97.8 99.7 99.7 99.7 99.7 99.7 Amounts due from related parties, current 4.1 3.6 4.5 4.5 4.5 4.5 4.5 Long-term investments due within one year 0.0 0.0 118.8 118.8 118.8 118.8 118.8 Total current assets 1,233.7 1,348.9 1,869.3 2,287.5 2,945.0 3,667.5 4,749.5

Non-current assets Restricted cash, non-current 1.8 2.5 3.8 3.8 3.8 3.8 3.8 Property and equipment, net 225.3 231.5 237.7 242.5 249.0 257.2 262.0 Land use rights, net 4.3 4.3 3.9 3.9 3.9 3.9 3.9 Amounts due from related parties, non-current 0.9 1.5 1.7 1.7 1.7 1.7 1.7 Long-term deposit 12.6 15.3 14.9 14.9 14.9 14.9 14.9 Long-term prepaid rent 1.1 0.4 0.2 0.2 0.2 0.2 0.2 Deferred tax assets, non-current 2.2 5.0 24.3 24.3 24.3 24.3 24.3 Intangible assets 0.7 3.9 2.6 2.6 2.6 2.6 2.6 Goodwill 3.7 11.2 10.5 10.5 10.5 10.5 10.5 Long-term investments 117.1 326.0 178.9 178.9 178.9 178.9 178.9 Other non-current assets 0.0 1.1 6.8 6.8 6.8 6.8 6.8 Total non-current assets 369.9 602.7 485.5 490.3 496.8 505.0 509.8

Total assets 1,603.5 1,951.5 2,354.8 2,777.8 3,441.8 4,172.4 5,259.4

Liabilities Current liabilities Accounts payable 8.6 17.9 21.4 29.9 34.1 45.1 51.5 Accrued expenses and other current liabilities 168.9 178.8 217.0 305.6 345.5 440.2 530.9 Income tax payable 17.7 25.4 32.8 45.9 60.6 81.7 109.5 Amounts due to related parties 0.0 2.0 0.0 0.0 0.0 0.0 0.0 Deferred revenue 380.8 501.2 646.9 733.5 1,019.2 1,180.5 1,538.5 Dividend payable 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total current liabilities 576.1 725.2 918.2 1,115.0 1,459.4 1,747.5 2,230.4

Net current asset 657.6 623.6 951.1 1,172.5 1,485.6 1,919.9 2,519.1

Non-current liabilities Deferred tax liabilities, non-current 1.7 2.5 2.0 2.0 2.0 2.0 2.0 Acquisition payable 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total non-current liabilities 1.7 2.5 2.0 2.0 2.0 2.0 2.0

Total liabilities 577.8 727.7 920.2 1,117.0 1,461.4 1,749.5 2,232.4

Equity Common shares 1.6 1.6 1.6 1.6 1.6 1.6 1.6 Treasury stock 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Additional paid-in capital 174.0 141.7 223.4 223.4 223.4 223.4 223.4 Statutory reserves 129.9 153.6 184.7 184.7 184.7 184.7 184.7 Retained earnings 654.7 824.0 931.9 1,155.8 1,472.2 1,910.7 2,509.4 Accumulated other comprehensive income 65.6 99.5 62.9 62.9 62.9 62.9 62.9 Non-controlling interests 0.0 3.5 30.1 32.4 35.5 39.6 45.0 Total equity 1,025.8 1,223.8 1,434.7 1,660.8 1,980.4 2,422.9 3,027.0 Total liabilities and equity 1,603.5 1,951.5 2,354.8 2,777.8 3,441.8 4,172.4 5,259.4 SOURCE: CIMB FORECASTS, COMPANY

68

Education│China│New Oriental Education│September 19, 2017

Figure 24: Cash flow statement FYE May (US$m) 2014 2015 2016 2017 2018F 2019F 2020F Cash flows from operating activities Net income 215.7 192.7 225.3 276.8 367.1 486.6 644.1 Adjustments: Depreciation of property and equipment 43.6 46.7 47.3 50.2 53.5 56.8 60.1 Amortization of intangible assets 0.1 0.6 1.1 0.0 0.0 0.0 0.0 Amortization of land use rights 0.1 0.1 0.1 0.0 0.0 0.0 0.0 Loss on disposal of property and equipment 2.0 2.9 2.1 0.0 0.0 0.0 0.0 Impairment of goodwill 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Gain on disposal of subsidiaries -3.6 0.0 -3.8 0.0 0.0 0.0 0.0 Share-based compensation expense 20.1 15.7 16.8 20.3 23.3 26.8 30.9 Allowance for doubtful accounts 0.3 0.7 0.9 0.0 0.0 0.0 0.0 Loss from equity method investments 1.5 1.5 4.4 0.0 0.0 0.0 0.0 Deferred income taxes -2.2 -5.5 -1.9 0.0 0.0 0.0 0.0

Changes in operating assets and liabilities Accounts receivables 0.4 -2.1 -0.2 -2.4 -0.3 -2.9 -0.8 Prepaid expenses and other current assets -20.2 -22.5 -7.7 0.0 0.0 0.0 0.0 Inventory -0.5 -1.8 -5.6 -7.0 -8.2 -10.0 -10.9 Long-term deposit -0.2 -2.6 -0.5 0.0 0.0 0.0 0.0 Long-term prepaid rent 0.2 0.7 0.2 0.0 0.0 0.0 0.0 Accounts payable 0.3 9.2 4.8 8.6 4.1 11.0 6.4 Accrued expenses and other current liabilities 44.8 11.1 47.9 88.5 39.9 94.7 90.8 Income taxes payable 1.3 7.6 7.9 13.1 14.7 21.1 27.8 Deferred revenue 60.7 117.1 179.6 86.6 285.7 161.3 357.9 Amounts due to related parties -3.0 2.0 -0.8 0.0 0.0 0.0 0.0 Net cash provided by operating activities 361.3 374.1 517.9 534.7 779.9 845.5 1206.2

Cash flows from investing activities Restricted cash paid for establishing new schools -3.3 -2.1 -5.5 0.0 0.0 0.0 0.0 Release of restricted cash for establishing new schools 2.5 1.0 4.7 0.0 0.0 0.0 0.0 Investments in bank deposits maturing over three months -72.5 -32.7 -64.5 0.0 0.0 0.0 0.0 Settlement of bank deposits maturing over three months 22.2 62.9 42.6 0.0 0.0 0.0 0.0 Investments in short-term held-to-maturity investments -1,849.1 -943.5 -1,112.2 0.0 0.0 0.0 0.0 Settlement of short-term held-to-maturity investments 1,698.6 992.1 851.3 0.0 0.0 0.0 0.0 Purchase of property and equipment -31.7 -55.3 -64.4 -55.0 -60.0 -65.0 -65.0 Proceeds from disposal of property and equipment 0.9 1.7 1.3 0.0 0.0 0.0 0.0 Purchase of investments -112.1 -197.6 36.9 0.0 0.0 0.0 0.0 Net cash used in investing activities -344.4 -173.4 -309.7 -55.0 -60.0 -65.0 -65.0

Cash flows from financing activities Repayments on borrowings 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Proceeds of IPO 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Proceeds from exercising of share option 21.8 11.3 2.2 0.0 0.0 0.0 0.0 Cash paid for shares repurchased -21.5 -59.4 0.0 0.0 0.0 0.0 0.0 Cash paid for dividend -54.5 0.0 -62.7 -70.9 -70.9 -70.9 -70.9 Capital contribution from noncontrolling interests 0.0 3.8 69.7 0.0 0.0 0.0 0.0 Repurchase shares from noncontrolling interests 0.0 0.0 -3.8 0.0 0.0 0.0 0.0 Net cash (used in) provided by financing activities -54.1 -44.3 5.5 -70.9 -70.9 -70.9 -70.9

Effects of exchange rate changes -8.4 3.3 -35.7 0.0 0.0 0.0 0.0 Net change in cash and cash equivalents -45.6 159.7 177.9 408.8 649.0 709.6 1070.3 Cash and cash equivalents at beginning of year 417.2 371.6 531.3 709.2 1118.0 1767.0 2476.6 Cash and cash equivalents at end of year 371.6 531.3 709.2 1118.0 1767.0 2476.6 3546.9 SOURCE: CIMB FORECASTS, COMPANY

69

Education│China│New Oriental Education│September 19, 2017

1QFY18F preview Project net revenue growth of 20.0% We project a net revenue growth of 20.0% yoy in 1QFY18F, at the higher end of management’s guidance of a 17-21% yoy increase. Our revenue growth forecasts for K-12 after-school tutoring/overseas test prep/online are 30%/12%/25% yoy, respectively. We believe the growth of the K-12 after-school tutoring segment will accelerate due to the success of its summer promotion this year. Management expects student enrolment of 417,000 in early-July, more than double compared to the same period last year. We expect the overseas test prep segment to benefit from the continued roll-out of the O2O interactive education system, which we believe will help ASPs increase.

Slight margin pressure in 1QFY18F We expect EDU’s GPM to decline 0.5% pt yoy in 1QFY18F to 61.4% and non- GAAP OPM to decline 0.9% pt yoy due to the highly successful summer promotion campaign, which is expected to temporarily impact margins as tuition fees collected from students under the campaign are heavily discounted for the summer period. However, we forecast margin expansion for the remaining quarters of the year as we believe the retention rate for students enrolled in the summer campaign will be high and could contribute positively to increasing the utilisation rate of EDU’s learning centres in the remaining quarters. EDU’s learning centre network expansion plan is relatively modest, in our view, and management is determined to lift utilisation by 1.5-2.0% pts annually. We expect EDU to enjoy further GPM expansion from 58.3% in FY17 to 60.2% in FY20F. We also expect the company to enjoy operational leverage and forecast a non-GAAP OPM of 16.5% in FY18F, or a 0.8% pt increase yoy.

Figure 25: 1QFY18F preview FYE May (US$m) 1Q17 2Q17 3Q17 4Q17 1Q18F 2Q18F 3Q18F 4Q18F 2017 2018F Net revenue 534.1 341.2 437.8 486.4 640.9 438.5 567.0 638.5 1,799.5 2,284.8 yoy% 16.5% 22.7% 26.2% 23.2% 20.0% 28.5% 29.5% 31.3% 21.7% 27.0% Cost of revenues (203.4) (163.4) (183.6) (199.3) (247.2) (204.7) (233.2) (249.5) (749.6) (934.6) Gross profit 330.7 177.8 254.3 287.1 393.6 233.8 333.9 389.0 1,049.9 1,350.2 Gross profit margin 61.9% 52.1% 58.1% 59.0% 61.4% 53.3% 58.9% 60.9% 58.3% 59.1% Selling and marketing (58.5) (52.2) (55.9) (66.3) (73.4) (65.3) (70.9) (83.8) (232.8) (293.3) As % of revenue 10.9% 15.3% 12.8% 13.6% 11.4% 14.9% 12.5% 13.1% 12.9% 12.8% General and administrative (119.7) (125.4) (140.9) (169.0) (147.4) (155.7) (176.9) (222.4) (554.9) (702.3) As % of revenue 22.4% 36.8% 32.2% 34.7% 23.0% 35.5% 31.2% 34.8% 30.8% 30.7% Operating profit (GAAP) 152.6 0.2 57.5 51.8 172.9 12.8 86.1 82.9 262.1 354.6 Operating profit margin (GAAP) 28.6% 0.1% 13.1% 10.7% 27.0% 2.9% 15.2% 13.0% 14.6% 15.5% Operating profit (non-GAAP) 153.5 2.4 65.8 60.8 177.9 17.8 94.1 88.2 282.4 377.9 Operating profit margin (non-GAAP) 28.7% 0.7% 15.0% 12.5% 27.8% 4.1% 16.6% 13.8% 15.7% 16.5% Other income, net 14.0 15.9 19.8 18.9 20.3 20.3 20.3 20.3 68.6 81.2 Profit before tax (GAAP) 166.6 16.1 77.3 70.7 193.2 33.1 106.4 103.1 330.7 435.7 Provision for income taxes (22.7) (2.9) (10.6) (14.5) (29.0) (5.0) (16.0) (15.5) (50.6) (65.4) Loss from equity method investments (1.8) (0.8) (0.3) (0.3) (1.8) (0.8) (0.3) (0.3) (3.3) (3.3) Net loss (gain) attributable to noncontrolling interests (1.0) (2.0) 1.2 (0.5) (1.18) (4.15) 1.65 0.6 (2.3) (3.1) Net income attributable to shareholders (GAAP) 141.1 10.4 67.6 55.4 161.2 23.1 91.8 87.9 274.5 364.0 Net profit margin (GAAP) 26.4% 3.0% 15.4% 11.4% 25.1% 5.3% 16.2% 13.8% 15.3% 15.9% Net income attributable to shareholders (non-GAAP) 141.9 12.5 75.9 64.4 166.2 28.1 99.8 93.2 294.7 387.3 Net profit margin (non-GAAP) 26.6% 3.7% 17.3% 13.2% 25.9% 6.4% 17.6% 14.6% 16.4% 17.0% SOURCE: CIMB FORECASTS, COMPANY

70

Education│China│New Oriental Education│September 19, 2017

Valuation & recommendation Initiate coverage with Add rating and TP of US$114.3 We initiate coverage on EDU with an Add rating. We derive our target price using a DCF-based methodology, with a WACC of 9.7%. Our target price implies a CY18F P/E of 39.4x and 1.25x CY18F PEG, +0.6 s.d. above EDU’s 5-year average historical forward PEG. We believe EDU deserves to trade above its historical average P/E given 1) acceleration in growth of learning centre numbers, 2) continuous improvement of utilisation rate and margins, and 3) the dual-teacher model as a mid-term growth driver.

Figure 26: DCF valuation

FCF computation (US$ m) FY17 FY18F FY19F FY20F FY21F FY22F FY23F FY24F FY25F FY26F FY27F FY28F FY29F FY30F EBIT 282.4 377.9 500.7 663.5 763.0 877.4 965.2 1,061.7 1,167.9 1,226.3 1,287.6 1,352.0 1,419.6 1,490.5 Taxes -50.6 -65.4 -86.5 -114.3 -131.4 -151.1 -166.2 -182.8 -201.1 -211.2 -221.7 -232.8 -244.4 -256.7 NOPAT 231.8 312.5 414.2 549.2 631.6 726.3 799.0 878.9 966.8 1,015.1 1,065.9 1,119.1 1,175.1 1,233.9 NOPAT growth 34.8% 32.5% 32.6% 15.0% 15.0% 10.0% 10.0% 10.0% 5.0% 5.0% 5.0% 5.0% 5.0% D&A 50.2 53.5 56.8 60.1 61.9 63.8 65.7 67.7 69.7 71.8 73.9 76.2 78.4 80.8 Funds from operation 282.0 366.1 471.0 609.3 693.5 790.1 864.7 946.5 1,036.5 1,086.9 1,139.8 1,195.3 1,253.5 1,314.7 Change in net w orking Capital 187.4 335.9 275.2 471.1 372.7 385.0 397.7 410.9 424.5 438.5 453.0 468.0 483.4 499.4 Cash flow from operation 469.5 702.0 746.3 1,080.5 1,066.2 1,175.1 1,262.4 1,357.4 1,460.9 1,525.4 1,592.8 1,663.3 1,737.0 1,814.1 Capex -55.0 -60.0 -65.0 -65.0 -67.0 -69.0 -71.0 -73.2 -75.4 -77.6 -79.9 -82.3 -84.8 -87.4 Free cash flow from operation 414.5 642.0 681.3 1,015.5 999.3 1,106.2 1,191.4 1,284.3 1,385.6 1,447.8 1,512.8 1,580.9 1,652.2 1,726.7 FCF growth 54.9% 6.1% 49.1% -1.6% 10.7% 7.7% 7.8% 7.9% 4.5% 4.5% 4.5% 4.5% 4.5%

Terminal free cash flow 26,744.4 Total discounted free cash flow 8,498.8 Present value of terminal free cash flow 8,358.4

Total present value of forecasted free cash flows 16,857.1 Less: Net Debt -1,204.7 Equity Value 18,061.9 No. Shares (millions) 158.0 Per Share Equity Value (US$) 114.3 SOURCE: CIMB FORECASTS, COMPANY

Figure 27: WACC assumptions (%) Cost of equity 9.7% Risk free 3.0% Market Risk Premium 7.0% Beta 0.95

Cost of debt 5.0% Kd (after tax) 4.5%

Target Debt / (Debt + Equity) 0% Target Equity / (Debt + Equity) 100%

WACC 9.65%

Terminal growth 3.0% SOURCE: CIMB FORECASTS, COMPANY

The WACC of 9.7% in our DCF approach uses a beta of 0.95. In addition, we use a risk-free rate of 3.0%, and market risk premium of 7.0%. We assume a perpetual growth rate of 3.0%.

71

Education│China│New Oriental Education│September 19, 2017

Figure 28: New Oriental Education’s historical forward P/E trend Figure 29: New Oriental Education’s historical forward PEG trend

40 3 Title: Title: Source: Source: 35 2.5 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 30 28.5x 2

1.4x 25 23.4x 1.5

1.0x 18.4x 20 1

0.5x 13.4x 15 0.5

10 0

Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-13 Jul-14 Jul-15 Jul-17 Jul-12 Jul-16

Apr-12 Oct-12 Apr-13 Oct-13 Apr-12 Oct-12 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Apr-13 Oct-13 Apr-14

Jan-15 Jan-16 Jan-17 Jan-13 Jan-14 Jan-17 Jan-12 Jan-13 Jan-14 Jan-12 Jan-15 Jan-16

P/E Ratio Average +1 s.d. +2 s.d. -1 s.d. PEG Ratio Average +1 s.d. -1 s.d. SOURCE: CIMB RESEARCH, BLOOMBERG SOURCE: CIMB RESEARCH, BLOOMBERG

Figure 30: Education sector peer comps 3-year Dividend yield Price TP Mkt cap P/E (x) EPS P/BV (x) PEG (x) (x) Company Ticker Recom. (LC$) (LC$) (US$) CY17F CY18F CY19F CAGR (%) CY17F CY18F CY17F CY18F CY17F CY18F China education ADR New Oriental Education EDU US Add 87.16 114.30 13,743 40.2 30.6 23.3 31.5% 7.1 5.8 1.3 1.0 0.5% 0.5% TAL Education TAL US Add 33.01 40.30 16,533 67.9 52.9 34.8 57.6% 18.4 12.7 na 1.0 0.0% 0.0% Bright Scholar Education BEDU US Non Rated 21.89 na 2,567 68.9 41.7 na na 20.4 16.0 na na 0.0% 0.0% Tarena International TEDU US Add 14.49 16.70 830 17.2 12.6 9.7 23.2% 2.9 2.4 0.9 0.6 1.2% 1.7% China Distance Education DL US Non Rated 6.90 na 227 12.4 13.0 na -6.0% 3.8 3.5 na na 6.5% 6.5%

China H-share education Virscend Education 1565 HK Non Rated 4.78 na 1,868 38.0 26.0 19.9 29.5% 4.6 4.1 na na 1.4% 1.7% China Maple Leaf Education 1317 HK Add 8.23 9.60 1,458 25.7 19.5 na 23.9% 4.1 3.7 1.1 0.8 1.8% 2.3% China Yuhua Education 6169 HK Add 3.80 4.50 1,518 16.8 13.9 na 19.4% 3.0 2.8 1.0 0.9 2.9% 3.0% Wisdom Education 6068 HK Non Rated 4.25 na 1,131 25.7 20.0 16.5 43.6% 3.9 3.5 na na 1.2% 1.6% Minsheng Education 1569 HK Non Rated 2.00 na 1,030 20.3 16.9 15.4 20.8% 2.0 1.8 4.1 3.4 0.6% 0.7% China New Higher Education 2001 HK Non Rated 4.56 na 831 22.1 17.6 14.3 50.9% 3.0 2.7 na na 1.3% 1.8%

International education Grand Canyon Education LOPE US Non Rated 83.23 na 4,005 21.7 20.3 18.1 14.3% na na 1.4 1.4 0.0% 0.0% Adtalem Global Education ATGE US Non Rated 34.95 na 2,170 12.6 11.5 na 10.0% na na 1.3 1.2 1.0% 1.0% Strayer Education STRA US Non Rated 83.01 na 927 24.9 22.0 19.2 11.0% na na 1.7 1.5 0.0% 0.0% Capella Education CPLA US Non Rated 68.30 na 797 19.3 18.6 15.2 7.8% na na 1.9 1.9 2.4% 2.5% Daekyo Co 019680 KS Non Rated 8300.00 na 620 17.3 17.7 16.9 9.2% 1.2 1.2 na na 2.9% 2.9% Note: As of 19th Sep 2017 SOURCE: CIMB RESEARCH, BLOOMBERG

Looking at comparative companies’ earnings outlook and valuations, our forecasts show EDU as having a 31.5% 3-year non-GAAP net profit CAGR, the second-fastest growth profile among fellow informal education plays, including TAL Education (TAL US, Add) and Tarena International (TEDU US, Add). In terms of CY18F PEG, New Oriental Education is currently trading at 1.0x, which appears to be in line with TAL Education’s 1.0x, while higher than Tarena’s 0.6x. We believe this is justified, given that the less recurring nature of Tarena’s courses (which typically last for 4 months) pose a higher risk than the K-12 education providers. Stripping off EDU’s cash holdings, it currently trades at 26.3x CY18F net-cash core P/E while providing a 2-year net profit CAGR of 31.5%, and at the same time providing a dividend yield of 0.5% for FY18F. The education sector is seen as relatively defensive, as students generally prefer quality education. EDU has re-rated significantly since Oct 2015, but we expect the stock to continue to re-rate given 1) the acceleration of K-12 learning

72

Education│China│New Oriental Education│September 19, 2017

centre openings, 2) continued utilisation improvements, and 3) the dual-teacher model as a mid-term growth driver.

Concerns/Risk Policy changes Admission and assessment processes in China constantly undergo changes and developments in terms of subject and skill focus, question type, examination format and the manner in which processes are administrated. Failure to track and respond to the changes in a timely and cost-effective manner could materially impair New Oriental’s ability to remain an attractive choice for students. Also, regulations and policies that reduce the emphasis on scholastic competition achievements could hamper the demand for New Oriental’s after- school tutoring services and negatively impact enrolments, in our view. For example, in 2014, there was a period of uncertainty about the implementation of new policies relating to the English test for Gaokao. There were rumours that the English Gaokao was going to be easier, which resulted in a temporary decline in demand for EDU’s English courses and summer camp enrolment. This impacted EDU’s student enrolment in 1QFY15. Introduction of new policies could also lead to similar uncertainties, which could put pressure on EDU’s topline growth and margins.

Continued expansion may harm margins New Oriental Education plans to expand its learning centre network by 10-15% in FY18 and plans to implement its dual-teacher classes in 5-10 new cities in FY18F. However, lower-than-expected ramping up of utilisation in learning centres could pressure EDU’s margin and hurt earnings growth.

Unsuccessful roll-out of dual-teacher model EDU is ramping up its roll-out of the dual-teacher model post the initial pilot runs in FY16-17. In FY18F, the company is planning to implement the model in some existing centres in lower-tier cities as well as 5-10 new cities. However, should EDU fail to maintain the same level of teaching quality in the new classes, its brand reputation may be hurt, which could affect its ability to attract new students.

73

Education│China│New Oriental Education│September 19, 2017

Appendix Management profile Michael Minhong Yu – Founder, Executive Chairman. Founder of the company, Mr. Yu has served as the chairman of EDU’s board of directors since 2001. He was previously the CEO from 2001 to Sep 2016. Mr. Yu also acts as vice chairman of the Beijing Young Entrepreneurs Association and vice chairman of the Committee of Education of the Central Committee of the China Democratic League. He has 32 years of experience in school management and English language training. Prior to founding NOE, Mr. Yu was an English instructor at Peking University. Mr. Yu received his Bachelor’s degree in English from Peking University.

Chenggang Zhou – Director, Chief Executive Officer. Mr. Zhou has served as NOE’s director since Nov 2010 and CEO since Sep 2016. Prior to becoming CEO, Mr. Zhou held various positions in the company, including president and executive president for domestic business as well as executive vice president, vice president and president of Beijing and Shanghai New Oriental Schools over his 17-year stint with New Oriental. Before joining NOE, Mr. Zhou was a correspondent for the Asia Pacific region and programme host at BBC. Mr. Zhou received his Bachelor’s degree in English from Suzhou University in China and his Master’s degree in communications from Macquarie University, Australia.

Zhihui (Stephen) Yang – Chief Financial Officer. Mr. Yang has served as NOE’s CFO since Apr 2015. Since joining the firm in Apr 2006, Mr. Yang has held multiple positions including vice president of finance, deputy director of the president’s office and senior financial manager. Prior to joining NOE, Mr. Yang was a financial director at Beijing Hua De Xin Investment Co., Ltd and senior auditor at PricewaterhouseCoopers. Mr. Yang received his Bachelor’s degree in economics from Guanghua School of Management of Peking University.

Louis Hsieh – Director, Senior Advisor. Mr. Hsieh has served as NOE’s director since Mar 2007 and senior advisor since Jan 2016. He was the company’s president from May 2009 to Jan 2016 and CFO from Dec 2005 to Apr 2015. Prior to joining NOE, Mr. Hsieh was CFO of ARIO Data Networks, Inc., managing director for private equity (PE) firm Darby Asia Investors (HK) Limited and managing director and Asia-Pacific tech/media/telecoms head of UBS Capital Asia Pacific, the PE division of UBS AG. Mr. Hsieh is also an independent director of JD.com, Inc. and Nord Anglia Education. Mr. Hsieh holds a B.S. degree in Industrial Engineering and Engineering Management from Stanford University, an MBA degree from the Harvard Business School and a J.D. degree from the University of California at Berkeley.

74

Education│China│New Oriental Education│September 19, 2017

Shareholding structure

Figure 31: Shareholding structure (as at end-FY16)

SOURCE: COMPANY

75

Education│China│New Oriental Education│September 19, 2017

Key milestones Founded by Mr. Michael Yu in 1993, New Oriental started out as a TOEFL test preparation service provider in Beijing. Over the years, it expanded its service offerings from language training and test preparation to include a wide range of educational services, including K-12 after-school tutoring, overseas education consulting, schools, bookstores and online education.

Figure 32: Key milestones Year Event 1993 Beijing New Oriental School is established to offer TOEFL courses. 1995 Number of student enrolments reaches 15,000. Expanded to Shanghai and Guangzhou, and become the largest English training schools in 2000 respective regions. 2002 Expanded to Wuhan, Xi'an and Nanjing.

Established New Oriental's first international elementary education institution at Yangzhou. 2003 Expanded to Chengdu, Chongqing, Shenyang and Shenzhen. 2004 Tiger Technology Private invests US$22m for 18.9% stake. 2005 Expanded to Changsha, Jinan, Haerbin, Hangzhou, Changchun and Taiyuan. Cumulative number of registered students reaches 3m. 2006 Expanded to Fuzhou, Hefei and Shijiazhuang. Listed on New York Stock Exchange. 2007 1,000,000th student enrolment. Expanded to Nanchang, Jingzhou and Dalian. 2008 Nine new schools are opened including Lanzhou, Ningbo, Mingshitang and Qingdao. Began "Occupy the market" strategy which began rapid expansion of learning centers. 2010 Expanded to Zhenjiang, Xinagtan and Luoyang. 2011 Expanded to Nantong, Jilin, Hohhot, Guiyang, Tangshan and Urumchi. Shift of strategy to "Harvest the market", with the aim of increasing utilization rate of existing 2012 centers to improve profitability. 2015 Expanded to Wenzhou, Quanzhou and Weifang. Change of strategy to "Optimize the market" to maintain healthy balance between top and bottom line growth. Began to build up online education ecosystem. Xun Cheng, a consolidated entity that operates New Oriental's online education platform 2017 Koolearn.com, got listed on the National Equities Exchange and Quotations. SOURCE: CIMB RESEARCH, COMPANY

76

Education│China│New Oriental Education│September 19, 2017

BY THE NUMBERS

P/BV vs ROE 12-mth Fwd FD Core P/E vs FD Core EPS 8.9 26.0% 39.9 Growth 70% 7.9 24.7% 34.9 55% 6.9 23.4% 29.9 40% 5.9 22.1% 24.9 25% 4.9 20.9% 19.9 10% 3.9 19.6% 2.9 18.3% 14.9 -5% 1.9 17.0% 9.9 -20% Jan-14A Jan-15A Jan-16A Jan-17A Jan-18F Jan-19F Jan-14A Jan-15A Jan-16A Jan-17A Jan-18F Jan-19F

Rolling P/BV (x) (lhs) ROE (rhs) 12-mth Fwd Rolling FD Core P/E (x) (lhs) FD Core EPS Growth (rhs)

Profit & Loss

(US$m) May-16A May-17A May-18F May-19F May-20F Total Net Revenues 1,478 1,800 2,285 2,868 3,544 Gross Profit 864 1,050 1,350 1,712 2,135 Operating EBITDA 242 312 408 531 693 Depreciation And Amortisation (47) (50) (54) (57) (60) Operating EBIT 195 262 355 474 633 Financial Income/(Expense) 67 69 81 102 129 Pretax Income/(Loss) from Assoc. 0 0 0 0 0 Non-Operating Income/(Expense) 5 0 0 0 0 Profit Before Tax (pre-EI) 267 331 436 576 762 Exceptional Items Pre-tax Profit 267 331 436 576 762 Taxation (38) (51) (65) (86) (114) Exceptional Income - post-tax Profit After Tax 230 280 370 490 647 Minority Interests (0) (2) (3) (4) (5) Preferred Dividends FX Gain/(Loss) - post tax Other Adjustments - post-tax (2) (4) (3) (3) (3) Net Profit 228 273 364 483 639 Recurring Net Profit 245 294 387 509 670

Fully Diluted Recurring Net Profit 245 294 387 509 670

Cash Flow

(US$m) May-16A May-17A May-18F May-19F May-20F EBITDA 242.4 312.4 408.1 530.7 692.7 Cash Flow from Invt. & Assoc. Change In Working Capital 225.5 187.4 335.9 275.2 471.1 (Incr)/Decr in Total Provisions Other Non-Cash (Income)/Expense Other Operating Cashflow 50.0 34.9 35.8 39.6 42.4 Net Interest (Paid)/Received 0.0 0.0 0.0 0.0 0.0 Tax Paid Cashflow From Operations 517.9 534.7 779.9 845.5 1,206.2 Capex (64.4) (55.0) (60.0) (65.0) (65.0) Disposals Of FAs/subsidiaries 1.3 0.0 0.0 0.0 0.0 Acq. Of Subsidiaries/investments 36.9 0.0 0.0 0.0 0.0 Other Investing Cashflow (283.6) 0.0 0.0 0.0 0.0 Cash Flow From Investing (309.7) (55.0) (60.0) (65.0) (65.0) Debt Raised/(repaid) 0.0 0.0 0.0 0.0 0.0 Proceeds From Issue Of Shares 2.2 0.0 0.0 0.0 0.0 Shares Repurchased 0.0 0.0 0.0 0.0 0.0 Dividends Paid (62.7) (70.9) (70.9) (70.9) (70.9) Preferred Dividends Other Financing Cashflow 66.0 0.0 0.0 0.0 0.0 Cash Flow From Financing 5.5 (70.9) (70.9) (70.9) (70.9) Total Cash Generated 213.7 408.8 649.0 709.6 1,070.3 Free Cashflow To Equity 208.2 479.7 719.9 780.5 1,141.2 Free Cashflow To Firm 208.2 479.7 719.9 780.5 1,141.2

SOURCE: CIMB RESEARCH, COMPANY DATA

77

Education│China│New Oriental Education│September 19, 2017

BY THE NUMBERS… cont’d

Balance Sheet

(US$m) May-16A May-17A May-18F May-19F May-20F Total Cash And Equivalents 796 1,205 1,854 2,563 3,634 Total Debtors 4 6 6 9 10 Inventories 27 34 43 52 63 Total Other Current Assets 1,042 1,042 1,042 1,042 1,042 Total Current Assets 1,869 2,288 2,945 3,667 4,750 Fixed Assets 238 242 249 257 262 Total Investments 179 179 179 179 179 Intangible Assets 13 13 13 13 13 Total Other Non-Current Assets 56 56 56 56 56 Total Non-current Assets 485 490 497 505 510 Short-term Debt Current Portion of Long-Term Debt Total Creditors 238 336 380 485 582 Other Current Liabilities 680 779 1,080 1,262 1,648 Total Current Liabilities 918 1,115 1,459 1,748 2,230 Total Long-term Debt Hybrid Debt - Debt Component Total Other Non-Current Liabilities 0 0 0 0 0 Total Non-current Liabilities 0 0 0 0 0 Total Provisions 2 2 2 2 2 Total Liabilities 920 1,117 1,461 1,750 2,232 Shareholders' Equity 1,405 1,628 1,945 2,383 2,982 Minority Interests 30 32 36 40 45 Total Equity 1,435 1,661 1,980 2,423 3,027

Key Ratios

May-16A May-17A May-18F May-19F May-20F Revenue Growth 18.6% 21.7% 27.0% 25.5% 23.6% Operating EBITDA Growth 21.1% 28.9% 30.6% 30.0% 30.5% Operating EBITDA Margin 16.4% 17.4% 17.9% 18.5% 19.5% Net Cash Per ADS (US$) 5.08 7.65 11.77 16.27 23.06 BVPADS (US$) 8.96 10.34 12.34 15.13 18.93 Gross Interest Cover N/A N/A N/A N/A N/A Effective Tax Rate 14.0% 15.3% 15.0% 15.0% 15.0% Net Dividend Payout Ratio 27.5% 25.9% 19.5% 14.7% 11.1% Accounts Receivables Days 0.99 1.00 1.00 1.00 1.00 Inventory Days 15.28 15.00 15.00 15.00 15.04 Accounts Payables Days 11.70 12.50 12.50 12.50 12.53 ROIC (%) 56% 48% 108% (802%) (169%) ROCE (%) 19.7% 21.3% 23.9% 26.2% 27.9% Return On Average Assets 7.9% 8.5% 9.6% 10.5% 11.3%

SOURCE: CIMB RESEARCH, COMPANY DATA

78

Education│China│September 19, 2017

Company Note │ Alpha series

China TAL Education Group ADD Fastest-growing K-12 play in China Consensus ratings*: Buy 22 Hold 3 Sell 0 ■ Established in 2005, TAL Education is a K-12 after-school tutoring services provider in China. It is recognised for its high quality of teaching and academic excellence. Current price: US$33.01 ■ We forecast revenue/earnings CAGR of 46.2%/57.6% over FY2/17-20F. TAL's dual- Target price: US$40.30 teacher model and online education platform are potential long-term growth drivers. Previous target: N/A ■ Number of enhanced offerings, including English and Chinese classes, Firstleap and Up/downside: 22.1% Shunshun, is rising rapidly and may act as medium-term growth drivers, in our view. CIMB / Consensus: 28.8% ■ We initiate coverage with an Add rating and DCF-based target price of US$40.30.

Reuters: TAL.N K-12 after-school tutoring player with strong growth potential Bloomberg: TAL US Established in 2005, TAL is a leading K-12 after-school tutoring services provider in Market cap: US$16,533m China by student enrolment, recognised for quality teaching and academic excellence. US$16,533m Through its virtuous cycle of using high-quality teaching resources to produce superb Average daily turnover: US$102.0m student results, TAL has established a strong reputation without spending much on US$102.0m marketing. Leveraging on its centralised management model and effective expansion strategy, TAL is poised to enter a golden age of growth in the coming years, in our view. Current shares o/s: 162.5m Free float: 55.8% Three-pronged expansion strategy to drive revenue growth *Source: Bloomberg We forecast revenue CAGR of 46.2% in FY17-20F. TAL adopts a 3-pronged expansion strategy: its long-term target is to have offline learning centres in c.40 core cities, live Key changes in this note broadcast cum in-class teaching assistance in medium demand density cities and online N/A education. Online contribution has risen rapidly but offline still contributed 95% of revenue in FY2/17. We expect its dual-teacher model and online platform to be long-term growth

Price Close Relative to S&P 500 (RHS) drivers, and forecast small class/online enrolment CAGR of 40.7%/62.9% in FY17-20F. 38.9 323 Enhanced offerings to enable TAL to increase wallet share 28.9 240 TAL’s key offerings, Math and Science, currently account for the lion’s share of its 18.9 156 revenue at 60% in FY17, vs. English at c.20% and Chinese at <10%. We think TAL 8.9 73 15 shows strong potential to increase students’ wallet share as it enhances its course 10 offerings, including Chinese and English classes, all-subject tutoring in English through

5 Firstleap, and professional overseas counseling services via Shunshun. Vol m Vol Sep-16 Dec-16 Mar-17 Jun-17 How do we differ from Bloomberg consensus?

Source: Bloomberg We are more positive on TAL’s revenue growth in FY18-20F than Bloomberg consensus estimates as we believe the fast growth of its dual-teacher model and online education Price performance 1M 3M 12M platform will surprise the market and drive rapid revenue growth in next 2-3 years. TAL’s Absolute (%) 12.1 67.6 190.3 centralised management system also helps it to better design its teaching curriculum, Relative (%) 8.9 64.7 173.3 motivate teachers and provide tailor-made services to students. TAL’s investments in new technology and online education may trigger future earnings growth. Major shareholders % held Mr Bangxin Zhang 36.8 Initiate coverage with Add and TP of US$40.30 (WACC: 9.7%) Mr Yachao Liu 5.5 We initiate coverage on TAL with an Add, and see potential 22.1% upside to our DCF- based TP of US$40.30, which implies CY18F non-GAAP P/E of 68.9x, at 1.25x PEG. We expect TAL to re-rate on the back of: 1) rapid learning centre expansion, 2) fast growth of its dual-teacher model and online education, and 3) enhanced course offerings. Key risks: 1) lower-than-expected margins due to slow ramp-up of new learning centres’ utilisation, and 2) impairment losses from investments.

Financial Summary Feb-16A Feb-17A Feb-18F Feb-19F Feb-20F Analyst(s) Revenue (US$m) 620 1,043 1,647 2,395 3,261 Operating EBITDA (US$m) 103.2 163.5 277.9 429.8 632.5 Net Profit (US$m) 102.9 114.8 198.6 334.9 511.1 Core EPADS (US$) 1.61 1.86 0.50 0.80 1.19 Core EPS Growth 48.8% 15.5% 60.6% 61.3% 49.1% FD Core P/E (x) 141.0 123.8 77.5 48.0 32.2 DPADS (US$) 0.00 0.50 0.00 0.00 0.00 Dividend Yield 0.00% 0.50% 0.00% 0.00% 0.00%

EV/EBITDA (x) 151.8 97.3 56.5 34.4 21.9 Lei YANG, CFA P/FCFE (x) NA NA 47.76 20.51 21.78 T (86) 21 5047 1771 x108 Net Gearing (47%) (36%) (70%) (121%) (131%) E [email protected] P/BV (x) 36.32 25.09 18.40 12.72 8.71 ROE 34.3% 28.0% 32.1% 36.5% 37.4% ONG Khang Chuen % Change In Core EPADS Estimates T (852) 2539 1326 CIMB/consensus Core EPADS (x) 1.20 1.24 1.24 E [email protected] SOURCE: COMPANY DATA, CIMB FORECASTS

IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE END OF THIS REPORT. IF THIS REPORT IS DISTRIBUTED IN Powered by the THE UNITED STATES IT IS DISTRIBUTED BY CIMB SECURITIES (USA), INC. AND IS CONSIDERED THIRD-PARTY AFFILIATED RESEARCH. EFA Platform

Education│China│TAL Education Group│September 19, 2017

Fastest-growing K-12 play in China

Company outlook Three-pronged expansion strategy to drive revenue growth TAL Education (TAL) has adopted a three-pronged expansion strategy to drive its capacity expansion: 1) extension of its leaning centre network to further penetrate into first- and second-tier cities, 2) hybrid platforms, or a “dual-teacher” model for cities with medium demand density (mid-tier 2 and tier 3 cities), and 3) online education platform.

Expanding offline learning centre network: Management has identified 40-50 core cities suitable for establishing an offline presence, and plans to enter four new cities annually. As of end-May 2017, TAL has established 567 learning centres in 35 cities. The company plans to increase its capacity by 30-50% yoy over the next three years, through: 1) continued increase in the number of learning centres in existing cities, 2) expanding the size of existing learning centres, and 3) penetrating into new cities. We forecast that the number of TAL learning centres will increase by a 3-year CAGR of 21.8%, from 507 in FY17 to 916 in FY20F. Given management’s emphasis on the higher-margin small class business, we expect the increase in learning centres to come mainly from a rising number of small class learning centres. Apart from increasing the number of learning centres, TAL also plans to expand the capacity of its existing learning centres. Over the past three years, the average leased area per learning centre has expanded by 23.3% to 27.1% yoy. According to our analysis, TAL’s revenue growth profile is in line with leased area growth.

Figure 1: TAL's number of learning centres Figure 2: Revenue growth appears directly correlated to leased area growth

900 90.0% Title: Title: 799 77.5% 800 80.0% Source: Source:

68.3% 70.0% 700 655 Please fill in the values above to have64.3% them entered in your report Please fill in the values above to have them entered in your report 60.0% 600 54.9% 520 50.9% 50.0% 500 42.9% 38.9% 38.3% 39.7% 400 40.0% 400 31.6% 30.9% 30.0% 26.2% 25.6% 300 246 18.3% 20.0% 184 202 200 159 159 7.5% 107 110 114 117 10.0% 5.5% 101 111 96 90 87 100 76 31 0.0% 0 FY14 FY15 FY16 FY17 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18F FY19F FY20F Revenue growth Offline enrolment growth Small class One-on-one Learning center number growth Leased area growth

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB RESEARCH, COMPANY

Dual-teacher model: TAL plans to adopt a hybrid model for its penetration into cities with medium demand density (mid-tier 2 and tier 3 cities). In this new class format, instructors deliver lectures to students in different learning centres nationwide through simultaneous webcasts. Normally, an instructor will cover 10-20 classrooms at any one time. Teachers in high demand may cover even more classrooms. Meanwhile, every classroom is also staffed with teaching assistants locally to tutor and supervise students. TAL has adopted new

80

Education│China│TAL Education Group│September 19, 2017

expression analysis technology for its dual-teacher model to analyse students’ performance during the class, and will provide parents with analytic feedback on students’ performance after class. TAL is still in the early stage of developing this model. However, we are positive on the potential of this new class format, as parents and students in lower-tier cities prefer teachers from big cities as they are perceived to have more experience and are more familiar with provincial examinations. This model may enable TAL to expand beyond its initial long-term target of 40 core cities while ensuring high teaching quality and economies of scale at the same time. This model could help TAL increase utilisation rates and profit margins. Given that the better teachers are highly in demand, this model could ensure that they cover more classrooms at any one time, thus enhancing their compensation and helping TAL retain the best talent. We believe the dual-teacher model is an important long-term earnings growth driver for TAL.

Enrolment growth from online education: Online education is one of TAL’s strategies to better reach students from lower-tier cities. Xueersi.com is TAL’s flagship online platform. TAL began upgrading its offerings in Oct 2015, when it began providing live broadcasts of classes, enabling students to participate in more proactive and interactive learning experience. The prices for live broadcast classes can be up to 2-3 times higher than for pre-recorded content. We expect online enrolment growth to remain strong in FY18F at 80% yoy (vs. 99.8% in FY17). Given the ongoing transition of TAL’s online business model from pre-recorded content to live broadcasting, we also expect stronger online ASP growth of 8.3% yoy in US$ terms in FY18F (vs. -6.4% in FY17). Overall, we expect online education topline growth of 95% yoy in FY18F, bringing its revenue contribution to 5.6% (FY17: 4.5%). In contrast, we estimate TAL’s major competitor New Oriental Education’s (EDU US, Add, TP: US$114.30) online revenue contribution to be 3.7% in FY18F based on our forecasts (FY17: 3.5%).

Figure 3: Screenshot of live broadcast class by TAL Figure 4: Screenshot of live broadcast class by TAL

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

Enhanced content offerings Having started out as an Olympiad Mathematics tutoring service in Beijing in 2005, TAL has expanded rapidly and now offers comprehensive tutoring services to K-12 students covering multiple core academic subjects. However, TAL’s main offerings, Math and Science, still account for the lion’s share of group revenue (60% in FY17). We see promising earnings growth potential for TAL as it enhances its content offerings to grab larger students’ wallet share of. We expect TAL’s content enhancement to be driven by increase in number of Chinese and English classes, as well as Firstleap and Shunshun, which were acquired in 2016.

English and Chinese classes: TAL has been increasing the number of cities in which its English and Chinese classes are offered in recent years. Over the past three years, TAL’s English classes were expanded from four cities in 1QFY15 to

81

Education│China│TAL Education Group│September 19, 2017

10 cities in 4QFY17, while its Chinese classes were extended from one to five cities over the same period. Both language subjects continue to record faster enrolment growth compared to Math and Science classes in FY17. English accounted for around 20% of TAL’s FY17 revenue, while Chinese comprised less than 10%. Both English and Chinese courses have seen stronger enrolment growth than TAL’s main offerings of Math and Science, and we expect revenue contribution from English and Chinese classes to continue increasing to reach 33-34% of total revenue in FY18F.

Firstleap Education: Firstleap offers all-subject tutoring in English to students aged 2 to 15 years. Offered in 53 learning centres as of end-Feb 2017, it has a typical class size of 14 students and ASP of Rmb120 to Rmb140. In FY17, Firstleap contributed c.5% of TAL’s revenue. Leveraging on TAL’s brand name and cross-selling efforts, Firstleap grew rapidly after being acquired by TAL. Since Firstleap was acquired by TAL in Jan 2016, it has expanded from 36 self-operated centres to 53 centres at end-Feb 2017. The lower customer acquisition costs also helped Firstleap expand its margins. From a loss-making business when it was first acquired, the business saw margin improvement and achieved breakeven at operating profit level in 1QFY17. Management expects the margins to further improve moving forward, and targets Firstleap operating margins (OPM) of between 10% and 20% in two to three years’ time.

Shunshun Bida: Shunshun provides professional counseling services to students planning to study abroad. The purpose of the Shunshun acquisition was for TAL to strengthen its presence in the international education services market. Shunshun currently does not contribute materially to the topline growth of TAL, mainly due to the accounting treatment that only allows TAL to recognise revenue when students successfully accept offers and obtain visas to study abroad. As a result, Shunshun’s expenses are front-loaded, while revenue can only be recognised after a typical time lag of 10-12 months. Management expects the business to begin contributing to TAL’s topline growth in 2Q/3QFY18F.

M&A strategy to be another earnings growth booster Over the past few years, TAL has acquired and made equity investments in various companies that it deems complementary to its existing business, especially those in the online education and O2O sectors. Based on our observations, TAL’s investments are concentrated in a few key areas:  Education sub-sectors in which TAL has yet to establish a firm foothold, including overseas study consulting and early education. TAL’s investment into Yinghe Youshi (Unlisted) in Feb 2016, for example, has allowed TAL to expand its offerings to online preparation services for English tests necessary to study abroad.  Platforms that support customer acquisition, including parenting communities and academic resources websites. TAL has also invested in multiple peripheral websites, including BabyTree (Unlisted), an online parenting community. The key idea behind this investment is for TAL to bring in new users, especially younger children that can feed into TAL’s Mobby and Peiyou young learners’ programmes.  Technologies to boost the effectiveness of its existing tutoring services. For example, in Jan 2016, TAL invested in Knewton (Unlisted), a global leader in adaptive learning, with the aim of incorporating Knewton's adaptive platform into TAL's online learning environment. The technology provides students with tailored recommendations for exactly what to study, teachers with analytics to better support every student, and publishers with content insights to develop more effective products.

82

Education│China│TAL Education Group│September 19, 2017

TAL frequently made small investments prior to 2016 but since then, the company is focusing on strategic investment deals. The number of deals in which TAL participates has begun to trend down, while deal sizes for certain investments have increased. This is apparent in TAL’s two larger acquisitions in 2016, namely Firstleap Education and Shunshun Bida. We continue to see M&A as a potential growth driver for TAL.

Figure 5: Notable M&As of TAL over the past 3 years Date Company Consideration Description Acquisitions

Feb-14 Kaoyan.com 考研网 US$8.5m Online service that helps preperation for entrance examinations for postgraduate degrees

Oct-14 Muchong.com 小木虫 US$10m Academic research platform Professional website providing university and college enrolment information for high May-15 Gaokaopai 高考派 US$0.6m school students US$37.7m cash, Jan-16 Firstleap Education 励步少儿英语 US$8.9m worth of Provider of all-subject tutoring services in English for students aged 2-15 in China stocks Feb-16 Yinghe Youshi US$12.1m cash Online preperation for English tests required to study abroad US$45.9m cash, Jul-16 Shunshun Bida 顺顺留学 US$13.6m worth of Professional counseling services to students planning to study abroad stocks Aug-16 Shanghai Yaya US$24.9m cash Online platform focusing on children, babies and maternity market Sep-16 ACESSAT 唯佳教育 Undisclosed Provider of language training for younger aged kids

Investments Online parenting community and online retailer of products for children, baby and Jan-14 BabyTree Inc. 宝宝树 US$23.5m maternity wear in China Oct-14 Minerva US$18.0m Provider of liberal arts and science education in the United States Oct-14 Guokr 果壳 US$15.0m Mobile and web-based community for science and technology education in China Apr-15, Aug-15 and Changing Education 轻轻家教 US$59.0m Customer-to-customer (C2C) mobile tutoring platform in China Nov-15 Inc Nov-15 Baby Bus 宝宝巴士 Rmb40m Provider of educational software products specifically for pre-school children Phoenix E-learning Dec-15 学科网 US$30m Online educational platform servicing public school system in China (zxxk.com) Jan-16 and Mar-16 Knewton Inc. US$11.6m Global leader in adaptive learning SOURCE: CIMB RESEARCH, COMPANY

83

Education│China│TAL Education Group│September 19, 2017

Background A leading K-12 after-school tutoring services provider in China Established in 2005, TAL is a leading brand in China’s kindergarten to high school (K-12) private education market by student enrolment. TAL is widely recognised for its high teaching quality and academic excellence.

Figure 6: TAL’s network of learning centres

SOURCE: CIMB RESEARCH, COMPANY

Having started out as an Olympiad Mathematics tutoring services provider in Beijing, TAL has expanded rapidly and now offers comprehensive tutoring services to K-12 students covering multiple core academic subjects. TAL’s growth has accelerated since its listing in 2010, with its learning centre numbers increasing from 132 in six cities at end-Feb 2011 to 567 centres in 35 cities at end-May 2017. Student enrolment expanded by a 6-year CAGR of 41.7% over the same period, helping TAL achieve revenue CAGR of 45.4%, from US$110.6m in FY11 to US$1,043m in FY17.

Figure 7: Course offerings by TAL

Note: **History, political science and geography courses above are offered mainly through personalised premium tutoring services under the “Zhikang” brand. Net revenues related to these courses are not material. SOURCE: CIMB RESEARCH, COMPANY

84

Education│China│TAL Education Group│September 19, 2017

TAL offers three main types of tutoring services: Small class offerings: Accounting for c.84% of TAL’s FY17 revenue, small classes are TAL’s main business segment. The majority of the small classes are delivered through the Xueersi Peiyou programme, which covers major subjects to supplement school lessons. Xueersi Peiyou small classes typically have 12 to 60 students each for different grade levels. TAL has offered Mobby tutoring services since 2011, which focus on thinking development for young learners aged 2-12 years. These classes typically have between 12 to 16 students each. In Jan 2016, TAL acquired 100% equity interest in Firstleap Education, which offers all-subject tutoring in English to students aged 2-15 years. Offered in 56 learning centres as of end-May 2017, it has a typical class size of 14 students. In FY17, Firstleap contributed c.5% of TAL’s revenue.

Personalised premium services (1-on-1 teaching): Offered under the “Zhikang” brand, this segment aims to cater to specific student requirements, such as addressing weakness in a particular subject or topic, providing intensive examination or competition preparation and tailoring the pace of learning to accommodate students with above- or below-average learning curves. As of end-May 2017, the personalised service was offered in 109 learning centres, and accounted for c.11% of TAL’s FY17 revenue. We note that this segment is not an area of priority for TAL’s future expansion due to its low utilisation rate of teaching space and facilities and therefore, comparatively lower margins than small classes. We expect TAL’s personalised premium services revenue to rise by a CAGR of 12.7% yoy for FY17-20F, slower than group revenue CAGR of 46.2% yoy for the same period. We project group revenue contribution from personalised services to decline from 10.5% in FY17 to 4.8% in FY20F.

Online courses: In Jan 2010, TAL began offering online courses through www.xueersi.com. TAL’s online courses mainly feature interactive, live broadcast lectures by experienced teachers. Apart from enabling existing students to access course materials online, the platform enables TAL to better target students in lower-tier cities that are beyond the reach of TAL’s existing offline network. At the same time, the students from first- and second-tier cities can enroll for the online courses, given that the strong demand for offline courses cannot be fully met due to the limited space of the offline leaning centres. TAL started out by offering online courses in the pre-recorded format but since Oct 2015, TAL began upgrading its online classes to live broadcast format. The live format enables students to participate in more proactive and interactive learning experiences. The students submit their homework to the teaching assistants through WeChat and receive feedback later on.

85

Education│China│TAL Education Group│September 19, 2017

Figure 8: TAL’s revenue breakdown by course type (FY17) Figure 9: Summary of TAL's class formats (as of end-May 2017) Online courses, Others, 0.6% 4.5% Title: One-on-one, Source: 10.5% Please fill in theClass values size above to have them entered in your report Number of (number learning of Format Programme centers students) Hourly rate (Rmb/hr) Small classes Xueersi Peiyou 394 12 to 60 60-100 Firstleap 56 typically 14 120-140 Mobby 8 12 to 16 200 One-on-one Zhikang 1 Zhikang small 109 Small classes, group 2 to 7 300-400 84.4% Online xueersi.com na na 20-80

Small classes One-on-one Online courses Others

SOURCE: CIMB RESEARCH, COMPANY SOURCE: CIMB RESEARCH, COMPANY

Key success factor 1: The flywheel effect We believe one of TAL’s key success factors is its virtuous cycle, which helped to build the company’s solid brand reputation.

Figure 10: TAL’s virtuous cycle

SOURCE: CIMB RESEARCH, COMPANY

Teachers with high qualifications: TAL focuses on building a strong teaching line-up, with high overall standards. The company typically recruits university graduates from top-tier universities in China through a highly-selective process that includes several rounds of tests and interviews. TAL requires the new hires to undergo comprehensive training of up to six months, focusing on educational content and teaching skills, as well as corporate culture and values, before being allowed to teach. The teachers are continuously evaluated on classroom performance and teaching results are a large part of their key performance indicators (KPI). In fact, parents are allowed to sit in to audit most of the small classes. TAL offers attractive remuneration packages to retain high-quality teaching staff. A TAL teacher based in Beijing typically earns a base monthly salary of Rmb7,000 and a variable salary of between Rmb14,000 to Rmb17,000. TAL determines teachers’ salaries and bonuses by evaluating: 1) student enrolment, i.e. the number of students enrolled in a class as a percentage of the full capacity of a class ( 满 班 率 ); 2) the percentage of students enrolled this semester who continue to attend classes the next semester (续班率); and 3) the

86

Education│China│TAL Education Group│September 19, 2017

number of students who withdraw from the class as a percentage of total enrolled students (退课率).

Good students: TAL is selective in student admission – prior to enrolment in a TAL course, students have to complete an entrance admission assessment. Good students are prioritised and grouped into classes. TAL’s current premium branding is primarily due to it producing many top students over the years, who successfully gained admission into the best universities in China.

Strong branding: Helped by its strong branding, TAL has been able to save on user acquisition costs – it relies mainly on word of mouth to attract new students. This has allowed TAL to enjoy the lowest SG&A expense-to-sales ratio among all local education companies. TAL’s leaning centres have also generally been able to raise their tuition fees once every two years. TAL’s selling and marketing expenses-to-sales ratio of 11.8% in FY17 was lower than the 12.9% of its K-12 peer EDU and far below the 33.9% of professional IT tutoring services provider Tarena Education (TEDU US, Add, TP: US$16.70).

Figure 11: Non-GAAP selling and marketing expenses-to-sales ratio (%)

40.0% Title:

33.9% 33.7% Source: 35.0% 32.5% 33.0% 33.4%

30.0% Please fill in the values above to have them entered in your report

25.0%

20.0% 15.1% 15.0% 13.4% 12.9% 12.8% 12.6% 11.9% 11.5% 11.8% 12.3% 12.2% 10.0%

5.0%

0.0% FY15 FY16 FY17F FY18F FY19F

New Oriental Education TAL Education Tarena International

Note: *Numbers reflected for New Oriental Education (FYE May) and TAL Education (FYE Feb) for FY17 are actual numbers; Tarena International’s (FYE Dec) non-GAAP selling and marketing expenses-to-sales ratio for FY17 is based on our forecast. SOURCE: CIMB FORECASTS, COMPANY

Key success factor 2: Effective strategies for entering new markets/promotions We are particularly impressed by TAL’s effective strategies, which has driven enrolment growth while protecting margins.

Entering a new city: When TAL enters a new city, the company typically first offers classes that target the senior grades of primary school (Grades 5-6) before expanding its course offerings to high school students and the junior levels of primary school. As a result, the first batch of students that graduate from primary school and enter junior high are naturally retained through enrolment in TAL’s junior courses. Through this demand-driven expansion strategy, TAL avoids long periods of low utilisation by expanding into new cities, while building up its brand image. According to management, c.70% of students in its high school courses are students who were previously enrolled in other TAL courses. New learning centres typically require 6-9 months to ramp up before reaching a similar utilisation rate to more established learning centres (c.60%).

87

Education│China│TAL Education Group│September 19, 2017

Figure 12: Entry strategy

SOURCE: CIMB RESEARCH, COMPANY

We believe this expansion strategy allows TAL to secure strong growth in new cities for multiple years, while keeping its marketing spending to the minimum and profit margins relatively stable. In 1QFY18, TAL recorded triple-digit yoy revenue growth in 11 cities.

Figure 13: Number of TAL learning centres 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 Chongqing 3 4 4 4 8 8 9 11 13 16 Suzhou 3 3 3 3 5 6 9 9 10 12 Taiyuan 3 3 4 4 5 7 7 7 10 8 Shenyang 2 3 3 3 8 11 11 12 12 14 Qingdao 2 2 2 2 2 1 2 2 2 4 Changsha 2 2 2 3 3 4 4 5 5 6 Shijiazhuang 2 2 2 3 2 3 4 4 4 4 Jinan 1 1 1 1 1 1 1 2 3 3 SOURCE: CIMB RESEARCH, COMPANY

Promotion strategy: Since 2015, TAL has launched summer promotion campaigns in Beijing every year to raise enrolment. The company offers the promotions only to students in the first grade of junior high and first grade of senior high, in the belief that the students will enroll in other TAL courses for future years after their initial positive learning experience with TAL. TAL’s past two summer promotions were successful, with a high retention ratio of students, according to management. Following the summer promotions, TAL’s enrolment in Beijing saw robust growth across all grades and studies, not only the grades for which TAL offered the promotion. We note that the enrolment growth momentum was sustained through the subsequent quarters as well. Given that the promotions have worked effectively with lasting results in the past, we expect TAL to continue its summer promotion strategy to continue gaining market share and promoting market consolidation in mature markets such as Beijing.

Key success factor 3: Centralised management model allows for rapid expansion We believe TAL’s commitment to centralised and standardised management is crucial to the success of the business, and will continue to help the company to successfully replicate its operating model in new markets.

Content development: TAL has a centralised content development team of over 100 people who work closely with experts in different subject fields to keep abreast with the changing academic and examination requirements of the education system. The team constantly analyses the latest market trends, and takes into consideration teaching materials from leading public schools when developing course content. Important and challenging concepts are prioritised; and the team develops course materials tailored for classes of different difficulty levels based on that group’s learning curve, as well as their strengths and

88

Education│China│TAL Education Group│September 19, 2017

weaknesses. The course materials are constantly updated based on feedback from teachers, students and parents. Most of TAL’s curricula and course materials are developed at the headquarters in Beijing, and later adopted by other locations with modifications to meet local requirements and demands.

Figure 14: TAL’s content development model

SOURCE: COMPANY

Teachers: TAL places strong emphasis on providing standardised quality education, regardless of the teachers selected. Its rigorous training seeks to reduce the performance gap between teachers. Given the standardised course development and teaching performance of teachers, we believe TAL’s business model is very sustainable in the long run as scenarios where a departing teacher cannibalising student enrolment can be avoided.

Management: TAL adopts a centralised management model - learning centres are supported by the headquarters in areas of teacher training, curriculum development and administrative management, allowing the headmasters of respective cities to focus on core operations of the learning centres. This allows an efficient allocation of resources among learning centres, enhancing operating efficiency and ensuring a consistent education quality throughout the school network.

These three factors combined effectively lower the barriers to starting a new learning centre, allowing TAL to rapidly expand in cities with existing TAL learning centres and new cities.

SWOT analysis Strengths  Strong teaching capabilities and quality teaching content allow TAL to attract good students and maintain solid reputation  Centralised management model increases replicability of operating model in new markets  Strong presence in both offline and online markets Weaknesses  High investments in R&D, especially in online education segment  Aggressive expansion plan may result in weaker margins should the utilisation rate ramp-up be slower than expected Opportunities  Ample expansion opportunities given that offline penetration currently only stands at 35 cities  Expansion into other education sub-segments, including overseas study consultation and all-language tutoring in English Threats  Policy changes  M&A strategy may pose risks

89

Education│China│TAL Education Group│September 19, 2017

Financials Project 46.2% revenue CAGR for FY17-20F We forecast that TAL will achieve sustained 3-year revenue CAGR of 46.2% from US$1.04bn in FY17 to US$3.26bn in FY20F, mainly driven by strong enrolment growth fuelled by: 1) continued demand as capacity expands in existing cities, 2) penetration into new markets, and 3) further growth of the dual- teacher model and online business.

Figure 15: Revenue trend

3500 Title: 10 244 Source: 3000 157 Please fill in the values above to have them entered in your report 2500 10 155 138 2000 10 92 1500 122 2,850

47 2,092 1000 109 25 1,423 500 16 83 9 73 880 63 512 242 346 0 FY14 FY15 FY16 FY17 FY18F FY19F FY20F

Small classes One-on-one Online courses Others

SOURCE: CIMB FORECASTS, COMPANY

Offline growth continues to be capacity driven: Riding on the rapid capacity expansion of TAL, we expect offline student enrolment to record a 3-year CAGR of 40.0%, from 3.15m in FY17 to 8.65m in FY20F. Management has guided for classroom capacity expansion of 30-50% yoy over the next three years, as TAL continues to: 1) expand in cities with strong demand by building new learning centres and expanding the size of its existing learning centres, 2) raise capacity utilisation rate, and 3) selectively enter new cities with optimal localised mix of offline and online educational services. TAL had identified 40 cities suitable for offline learning centre establishment, and had presence in 35 cities as of end-May 2017. With the rapid expansion planned for the coming three years, we expect offline education services to remain TAL’s main revenue contributor.

Strong online enrolment growth: We believe TAL has successfully created an online education ecosystem that has gained the acceptance of students and parents. With the acceleration in online enrolment growth after the initial transformation from pre-recorded content to live broadcasting, we have grown more confident in the online offerings of TAL. We expect TAL’s online education platform to continue to gain popularity and forecast online enrolment to record a 3-year CAGR of 62.9%, from 785k in FY17 to 3.4m in FY20F.

90

Education│China│TAL Education Group│September 19, 2017

Figure 16: Overall student enrolment trend Figure 17: Blended ASP trend (US$)

14,000 80% 360 Title: 8.0% Title:

12,041 340 Source: 6.0% Source: 12,000 70% 320 4.0% 60% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 10,000 8,881 300 292.3 290.4 2.0% 50% 8,000 280 270.8 0.0% 268.4 265.1 267.3 269.7 6,163 40% 6,000 260 -2.0% 30% 3,935 240 -4.0% 4,000 20% 2,310 220 -6.0% 2,000 1,494 1,074 10% 200 -8.0%

0 0% 180 -10.0% FY14 FY15 FY16 FY17 FY18F FY19F FY20F FY14 FY15 FY16 FY17 FY18F FY19F FY20F

LHS: Student enrolments ('000) RHS: yoy growth (%) LHS: ASP (US$) RHS: yoy growth (%)

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

ASP growth: TAL typically raises its tuition fees once every two years. We forecast blended ASP to rise by a 3-year CAGR of 0.7% in US$ terms, from US$265.10 per enrolment in FY17 to US$270.80 in FY20F. For TAL’s small class segment, we expect the rapid growth of newly-acquired Firstleap to help the segment achieve stronger ASP growth in the near term, due to its higher hourly rate of Rmb120-140, partly offset by TAL’s continued expansion into lower-tier cities. We forecast small class ASP growth of 8%/5%/4% in Rmb terms for FY18/19/20F. However, we expect ASP (in Rmb terms) for the one-on-one segment to increase at a slower pace of 3% annually between FY18F and FY20F. Given the ongoing transition of the online business model from pre-recorded content to live broadcasting, we expect stronger online ASP growth of 10% yoy in Rmb terms in FY18F (vs. -1.1% in FY17). As the prices of live broadcast classes are up to 2-3 times higher than pre-recorded content, we expect the structural shift to boost online ASP growth to 5% yoy in Rmb terms in FY19-20F.

Figure 18: Cost of sales breakdown (FY17) Figure 19: Gross margin (GPM)

Others, 15.7% 54.0% Title: Title: 53.2% Source: Source: Teacher fees and performance- 53.0% linked bonuses, Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 46.7% 52.0% 51.7% 52.0% 51.0% 51.3%

51.0% 50.7% Rental cost, 26.6% 49.9% 50.0%

49.0%

48.0% Staff costs, 11.1% FY14 FY15 FY16 FY17 FY18F FY19F FY20F

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

TAL’s cost of sales consists primarily of variable costs and has been fairly consistent over the past few years. Key costs include: 1) teacher fees and performance-linked bonuses (47% of FY17 cost of sales), 2) staff costs (11%), and 3) rental costs (27%).

91

Education│China│TAL Education Group│September 19, 2017

Expect gradual non-GAAP gross margin recovery Gross margin: Due to the rapid learning centre network expansion, we do not expect TAL to increase its utilisation rate significantly and hence only pencil in a slight GPM expansion in FY18-20F. We forecast TAL’s GPM to expand gradually from 49.9% in FY17 to 52.0% in FY20F.

Figure 20: TAL’s non-GAAP operating expenses-to-sales ratio Figure 21: Non-GAAP net profit trend

25.0% 700 Title: 70% Title: 21.6% 22.2% 22.1% 20.9% 20.7% Source: Source: 20.1% 19.6% 590.4 19.7% 600 60% 20.0% 17.9% 20.1% 17.9% 19.0% 20.5% 16.4% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 500 50% 15.0% 12.3% 12.2% 11.9% 11.5% 11.8% 11.9% 396.0 11.0% 400 40% 10.0%

(US$ (US$ m) 300 245.5 30% 5.0% 200 150.9 20% 128.7 85.6 0.0% 100 69.0 10% FY14 FY15 FY16 FY17 FY18F FY19F FY20F

0 0% Selling and marketing expenses ratio FY14 FY15 FY16 FY17 FY18F FY19F FY20F General and administrative expenses ratio Operating margin (non-GAAP) LHS: Net income (non-GAAP) RHS: yoy growth (%)

SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

Non-GAAP operating margin: We expect TAL to record non-GAAP operating margin (OPM) expansion in the coming years, from 16.4% in FY17 to 20.5% in FY20F driven by improvement in core business operating efficiency. However, we think the OPM expansion would be partially offset by: 1) lower OPMs of the newly-acquired businesses, including Firstleap and Shunshun, and 2) continued investments in the online platform. Breaking down the operational expenses into individual lines, we expect the selling and marketing expenses-to-sales ratio to remain high in FY18-20F as TAL spends on brand-building activities to support its continued expansion into new cities. We expect general and administrative expenses to decline in FY18-20F as operating leverage improves, given TAL’s centralised management model.

Non-GAAP net profit: Overall, we expect TAL to record a non-GAAP net profit 3-year CAGR of 57.6%, from US$150.9m in FY17 to US$590.4m in FY20F.

Dividend profile: TAL does not pay regular dividends as the company is in rapid expansion phase. While the company declared a special cash dividend of US$0.50 per ADS the year ended FY17, we forecast the dividend payout ratio over the coming three years to be zero, given its aggressive capacity expansion plan.

92

Education│China│TAL Education Group│September 19, 2017

Figure 22: Income statement FYE Feb (US$m) FY13 FY14 FY15 FY16 FY17 FY18F FY19F FY20F Net revenues 225.9 313.9 434.0 619.9 1,043.1 1,647.4 2,395.3 3,260.9 Yoy growth % 27.3% 38.9% 38.3% 42.9% 68.3% 57.9% 45.4% 36.1%

Cost of revenue (115.7) (151.5) (203.1) (303.6) (522.3) (812.2) (1,167.5) (1,566.3) Gross profit 110.2 162.4 230.9 316.3 520.8 835.2 1,227.8 1,694.6 GPM 48.8% 51.7% 53.2% 51.0% 49.9% 50.7% 51.3% 52.0%

Selling and marketing expenses (27.7) (35.8) (53.9) (73.6) (126.0) (207.2) (298.9) (393.9) As % of revenue 12.2% 11.4% 12.4% 11.9% 12.1% 12.6% 12.5% 12.1% General and administrative expenses (51.1) (70.3) (110.2) (161.0) (263.3) (382.9) (537.5) (712.2) As % of revenue 22.6% 22.4% 25.4% 26.0% 25.2% 23.2% 22.4% 21.8% Government subsidies 0.6 1.1 0.5 3.3 3.1 2.0 2.0 2.0 Impairment loss on long-term prepayment (0.6) ------Operating profit (GAAP) 31.4 57.4 67.2 85.1 134.6 247.1 393.3 590.4 EBIT margin (GAAP) 13.9% 18.3% 15.5% 13.7% 12.9% 15.0% 16.4% 18.1%

Operating profit (non-GAAP) 39.7 65.7 85.7 110.9 170.7 294.1 454.4 669.8 EBIT margin (non-GAAP) 17.6% 20.9% 19.7% 17.9% 16.4% 17.9% 19.0% 20.5%

Interest income 5.3 9.4 16.6 17.7 18.1 30.7 65.8 95.5 Interest expense - - (5.8) (7.5) (13.1) (21.0) (21.0) (21.0) Other income/(expense) 0.8 0.4 (2.0) (2.5) 23.1 6.8 - - Gain from disposal of components - - - 50.4 - - - - Gain from sales of available-for-sales securities - 0.1 ------Gain from fair value change of long-term investments - - 1.2 1.3 - - - - Impairment loss on long-term investments - - - (7.5) (8.1) (3.0) (3.0) (3.0) Profit before taxation 37.5 67.3 77.2 136.9 154.6 260.6 435.2 661.9 Income tax expense (4.1) (6.7) (9.4) (33.5) (36.2) (62.5) (106.6) (165.5) Effective tax rate 10.9% 9.9% 12.1% 24.5% 23.4% 24.0% 24.5% 25.0% Loss from equity method investments - - (0.7) (0.7) (8.0) (8.0) (8.0) (8.0) Net loss attributable to non-controlling interest - - 0.0 0.1 4.4 8.6 14.4 22.7 Net income from discontinued operations ------Net income/(loss) attributable to shareholders (GAAP) 33.4 60.6 67.2 102.9 114.8 198.6 334.9 511.1 Yoy growth % 37.5% 81.2% 10.8% 53.2% 11.6% 73.0% 68.7% 52.6% NPM (%) 14.8% 19.3% 15.5% 16.6% 11.0% 12.1% 14.0% 15.7%

Share-based compensation 8.3 8.3 18.4 25.8 36.1 46.9 61.0 79.3 Net income/(loss) attributable to shareholders (non-GAAP) 41.7 69.0 85.6 128.7 150.9 245.5 396.0 590.4 Yoy growth % 29.5% 65.3% 24.1% 50.4% 17.2% 62.7% 61.3% 49.1% NPM (%) 18.5% 22.0% 19.7% 20.8% 14.5% 14.9% 16.5% 18.1% SOURCE: CIMB FORECASTS, COMPANY

93

Education│China│TAL Education Group│September 19, 2017

Figure 23: Balance sheet FYE Feb (US$m) FY13 FY14 FY15 FY16 FY17 FY18F FY19F FY20F Assets Current assets Cash and cash equivalents 185.1 269.9 470.2 434.0 470.2 868.4 1,795.6 2,669.0 Time deposits 24.1 0.0 21.2 17.3 0.0 0.0 0.0 0.0 Restricted time deposits 2.3 0.3 0.6 1.1 2.7 2.7 2.7 2.7 Short term investments 0.4 0.0 0.8 27.5 229.5 229.5 229.5 229.5 Amounts due from related parties 0.0 0.0 0.2 2.6 3.4 3.4 3.4 3.4 Inventory 0.4 0.2 0.5 0.6 2.8 4.5 6.4 8.7 Deferred tax assets 2.3 3.3 4.6 0.7 0.0 0.0 0.0 0.0 Income tax receivable 0.0 9.8 3.2 0.0 0.1 0.1 0.1 0.1 Prepaid expenses and other current assets 11.9 16.8 38.2 32.0 160.2 160.2 160.2 160.2 Total current assets 226.4 300.4 539.4 515.9 869.0 1,268.9 2,198.0 3,073.7

Non-current assets Restricted cash 0.0 2.5 3.8 3.9 5.7 5.7 5.7 5.7 Property and equipment 76.1 78.6 93.6 114.6 154.3 168.5 177.1 180.1 Deferred tax assets 0.5 0.6 1.7 6.7 16.2 16.2 16.2 16.2 Rental deposit 5.2 7.3 11.0 17.1 32.7 32.7 32.7 32.7 Intangible assets 1.7 2.5 3.7 15.2 38.0 38.0 38.0 38.0 Goodwill 0.6 7.5 12.3 87.0 267.2 267.2 267.2 267.2 Amounts due from related parties 0.0 0.0 0.3 1.3 0.0 0.0 0.0 0.0 Long-term investments 5.5 27.1 97.4 274.4 347.7 347.7 347.7 347.7 Long-term prepayments and other non-current assets 0.0 1.0 9.2 25.3 96.1 96.1 96.1 96.1 Total non-current assets 89.6 127.2 233.0 545.5 957.8 972.0 980.6 983.5

Total assets 316.0 427.6 772.4 1,061.4 1,826.8 2,240.8 3,178.6 4,057.2

Liabilities Current liabilities Accounts payable 2.0 2.3 4.7 10.4 22.6 3.0 33.8 15.5 Deferred revenue 102.5 132.4 177.6 280.9 504.1 730.2 1,077.8 1,394.2 Amounts due to related parties 0.0 0.0 0.0 4.3 3.0 3.0 3.0 3.0 Accrued expenses and other current liabilities 17.2 27.4 44.0 70.3 116.8 61.2 194.7 148.6 Income tax payable 2.8 4.5 6.1 17.2 20.5 46.9 90.9 149.8 Deferred tax liabilities 0.0 0.1 0.1 0.1 0.0 0.0 0.0 0.0 Total current liabilities 124.5 166.8 232.6 383.2 667.1 844.2 1,400.4 1,711.2

Non-current liabilities Deferred revenue 0.0 0.0 0.0 8.3 14.7 14.7 14.7 14.7 Deferred tax liabilities 0.1 0.0 0.2 1.3 13.2 13.2 13.2 13.2 Bond payable 0.0 0.0 226.1 227.8 225.1 225.1 225.1 225.1 Long term payable 0.0 0.8 0.0 0.0 225.0 225.0 225.0 225.0 Amount due to related parties 0.0 0.0 0.0 0.0 2.8 2.8 2.8 2.8 Total non-current liabilities 0.1 0.8 226.3 237.5 480.9 480.9 480.9 480.9

Total liabilities 124.6 167.6 458.8 620.6 1,148.0 1,325.1 1,881.3 2,192.1

Convertible redeemable preferred shares 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Equity Class A ordinary shares 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Class B ordinary shares 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Additional paid-in capital 86.0 92.7 82.5 108.4 142.0 142.0 142.0 142.0 Statutory reserve 12.3 15.0 19.0 23.0 28.4 28.4 28.4 28.4 Retained earnings 86.4 144.3 207.5 306.4 415.7 661.3 1,057.2 1,647.6 Accumulated other comprehensive income/(loss) 6.6 7.8 4.2 -0.9 55.9 55.9 55.9 55.9 Total shareholders' equity 191.4 260.0 313.3 437.0 642.1 887.7 1,283.6 1,874.1 Non controlling interest 0.0 0.0 0.3 3.8 36.6 28.1 13.7 -9.0 Total equity 191.4 260.0 313.6 440.7 678.8 915.7 1,297.3 1,865.1

Total liabilities and shareholders' equity 316.0 427.6 772.4 1,061.4 1,826.8 2,240.8 3,178.6 4,057.2 SOURCE: CIMB FORECASTS, COMPANY

94

Education│China│TAL Education Group│September 19, 2017

Figure 24: Cash flow statement FYE Feb (US$m) FY13 FY14 FY15 FY16 FY17 FY18F FY19F FY20F Cash flows from operating activities Net income 33.4 60.6 67.1 102.8 112.5 190.0 320.5 488.4 Depreciation of property and equipment 7.0 9.5 11.7 18.2 28.9 30.8 36.4 42.0 Amortization of intangible assets 0.3 0.5 0.7 1.0 4.6 0.0 0.0 0.0 Loss/(gain) on disposal of property and equipment 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Share-based compensation 8.3 8.3 18.4 25.8 36.1 46.9 61.0 79.3 Provision for doubtful accounts 0.0 0.0 0.0 0.3 0.0 0.0 0.0 0.0 Impairment losses 0.6 0.0 0.0 7.5 8.1 0.0 0.0 0.0 Loss from equity method investments 0.0 0.0 0.7 0.7 8.0 0.0 0.0 0.0 Gain from fair value changes of investments 0.0 0.0 -1.2 -2.2 -24.0 0.0 0.0 0.0 Gain on disposals 0.0 -0.4 0.0 -0.2 0.0 0.0 0.0 0.0

Changes in operating assets and liabilities Inventory -0.2 0.2 -0.4 0.2 -2.2 -1.6 -2.0 -2.2 Amount due from related parties 0.0 0.0 0.0 -0.7 -2.3 0.0 0.0 0.0 Prepaid expenses and other current assets -1.7 -5.4 -8.3 1.3 -11.9 0.0 0.0 0.0 Income tax receivable 0.0 -9.8 6.6 3.2 -2.2 0.0 0.0 0.0 Deferred income taxes -0.6 -1.0 -2.3 -0.8 -3.3 0.0 0.0 0.0 Rental deposit -0.6 -2.1 -3.7 -4.9 -14.1 0.0 0.0 0.0 Other non-current assets 0.0 0.0 -0.3 -1.1 -0.5 0.0 0.0 0.0 Accounts payable -1.6 0.1 2.0 3.8 5.4 -19.7 30.9 -18.3 Deferred revenue 16.9 29.9 45.2 66.4 193.2 226.0 347.7 316.4 Amount due to related parties 0.0 0.0 0.0 4.3 -4.1 0.0 0.0 0.0 Accrued expenses and other current liabilities 1.3 8.5 10.3 3.4 24.3 -55.6 133.5 -46.1 Long-term payable 0.0 0.8 -0.8 0.0 0.0 0.0 0.0 0.0 Income tax payable 2.1 1.7 1.6 11.1 3.1 26.4 44.1 58.9 Net cash provided by discontinued operations 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net cash provided by operating activities 65.4 101.6 147.6 187.7 359.6 443.2 972.1 918.5

Cash flows from investing activities Restricted cash -2.0 -0.6 -1.5 -0.6 -3.4 0.0 0.0 0.0 Purchase of term deposits -46.1 -73.9 -43.4 -87.6 -10.2 0.0 0.0 0.0 Proceeds from maturity of term deposits 32.3 98.0 22.2 90.7 27.5 0.0 0.0 0.0 Loan to third parties 0.0 -1.3 -11.4 -18.8 -109.9 0.0 0.0 0.0 Repayment of loan to third parties 0.0 0.0 1.3 1.5 4.2 0.0 0.0 0.0 Purchase of property and equipment -6.2 -10.8 -30.7 -35.1 -71.1 -45.0 -45.0 -45.0 Purchase of short-term investments 0.0 0.0 -0.8 -27.5 -314.0 0.0 0.0 0.0 Proceeds from maturity of short-term investments 0.0 0.0 0.0 0.8 109.5 0.0 0.0 0.0 Proceeds from disposal of property and equipment 0.1 1.3 0.1 0.4 0.6 0.0 0.0 0.0 Acquisitions of businesses, net of cash acquired 0.0 -8.2 -6.0 -21.8 -27.2 0.0 0.0 0.0 Purchase of intangible assets -0.8 0.0 -0.1 0.0 0.0 0.0 0.0 0.0 Payments for long-term investments -5.5 -25.0 -75.4 -118.6 -124.2 0.0 0.0 0.0 Proceeds from sales of available-for-sale securities 0.0 0.4 0.0 0.0 0.0 0.0 0.0 0.0 Proceeds from disposal of long-term investments 0.0 2.7 0.0 1.3 0.0 0.0 0.0 0.0 Net cash provided by discontinued operations 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net cash used in investing activities -28.1 -17.4 -145.8 -215.4 -518.3 -45.0 -45.0 -45.0

Cash flows from financing activities Proceeds from IPO 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Payment of issuance cost in connection with IPO 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Proceeds from issuance of convertible bond 0.0 0.0 224.7 0.0 0.0 0.0 0.0 0.0 Dividend to shareholders -39.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Payment for share repurchase -2.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Payment for cost of Capped Call Transactions 0.0 0.0 -22.9 0.0 0.0 0.0 0.0 0.0 Net proceeds from long-term debt 0.0 0.0 0.0 0.0 238.0 0.0 0.0 0.0 Repayment of long-term debt 0.0 0.0 0.0 0.0 -25.0 0.0 0.0 0.0 Payment for previous acquisition 0.0 0.0 0.0 0.0 -16.4 0.0 0.0 0.0 Proceeds from exercise of share options 0.0 0.0 0.0 0.6 1.7 0.0 0.0 0.0 Net cash (used)/generated in financing activities -41.5 0.0 201.8 0.6 198.3 0.0 0.0 0.0

Effect of foreign currency exchange rate changes 0.7 0.7 -3.4 -9.1 -3.4 0.0 0.0 0.0 Net increase in cash and cash equivalents -3.5 84.8 200.2 -36.1 36.2 398.2 927.1 873.5 Cash and cash equivalents at beginning of year 188.6 185.1 269.9 470.2 434.0 470.2 868.4 1795.6 Cash and cash equivalents at end of year 185.1 269.9 470.2 434.0 470.2 868.4 1795.6 2669.0 SOURCE: CIMB FORECASTS, COMPANY

95

Education│China│TAL Education Group│September 19, 2017

2QFY18F preview Forecast net revenue growth of 59.5% We project net revenue growth of 59.5% yoy in 2QFY18F, at the higher end of management’s guidance range of 58-60% yoy increase. We forecast segmental revenue growth of 60% yoy for its small classes, 30% for one-on-one, and 100% for online. We believe revenue from the small class segment will continue to grow at a strong pace in 2QFY18F due to continued capacity growth and the wider scale of summer promotions this year. We think the one-on-one segment would also benefit from improved alignment between short-duration Peiyou programmes (small classes) and one-on-one teaching, resulting in higher demand for one-on- one classes. As for TAL’s online business, we expect it to continue benefiting from the segment's ongoing transformation from pre-recorded content to live broadcasting, resulting in higher ASP. We are confident of strong revenue growth for TAL’s online segment, as we have seen an acceleration in online enrolment growth following the segment's initial transformation from pre- recorded content to live broadcasting.

GPM may remain under pressure in 2QFY18F We expect TAL’s GPM to remain under pressure in 2QFY18F at 50.6%, or a 0.8% pt decline yoy. TAL added 60 learning centres in 1QFY18, and plans to add another 20-25 in 2QFY18. Given that TAL's learning centres typically take two quarters to ramp up as the facilities undergo renovations and preparations, we expect GPM to only see yoy recovery beginning in 3QFY18F.

Starting to enjoy operational leverage While we expect TAL's selling and marketing expenses ratio to remain high in 2Q as it continues to spend on brand building activities in newly-penetrated cities, we think its general and administrative expenses will decline during the quarter as operating leverage improves. In our view, this could negate some of the negative impact from the weaker GPM; we forecast TAL to record non- GAAP OPM of 21.8% in 2QFY18F, or -0.3% pt yoy.

Figure 25: 2QFY18F preview FYE Feb (US$m) 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18F 3Q18F 4Q18F FY17 FY18F Net revenues 195.1 271.1 260.6 316.3 321.9 432.4 392.1 500.9 1,043.1 1,647.4 Yoy growth % 50.8% 56.4% 83.3% 80.7% 65.0% 59.5% 50.5% 58.4% 68.3% 57.9% Cost of revenue (100.5) (131.9) (131.9) (158.1) (169.6) (213.81) (193.76) (235.0) (522.3) (812.2) Gross profit 94.6 139.2 128.7 158.2 152.3 218.6 198.4 265.9 520.8 835.2 GPM 48.5% 51.4% 49.4% 50.0% 47.3% 50.6% 50.6% 53.1% 49.9% 50.7% Selling and marketing expenses (24.1) (28.6) (35.2) (38.0) (43.5) (48.4) (55.7) (59.7) (126.0) (207.2) As % of revenue 12.4% 10.6% 13.5% 12.0% 13.5% 11.2% 14.2% 11.9% 12.1% 12.6% General and administrative expenses (53.4) (61.3) (71.7) (76.8) (80.6) (89.9) (100.8) (111.5) (263.3) (382.9) As % of revenue 27.4% 22.6% 27.5% 24.3% 25.0% 20.8% 25.7% 22.3% 25.2% 23.2% Government subsidies 0.5 2.2 0.3 0.0 0.6 0.5 0.5 0.4 3.1 2.0 Operating profit (GAAP) 17.6 51.5 22.1 43.4 28.8 80.8 42.4 95.2 134.6 247.1 EBIT margin (GAAP) 9.0% 19.0% 8.5% 13.7% 8.9% 18.7% 10.8% 19.0% 12.9% 15.0% Operating profit (non-GAAP) 26.0 59.8 31.1 53.8 39.5 94.3 55.9 104.4 170.7 294.1 EBIT margin (non-GAAP) 13.3% 22.1% 11.9% 17.0% 12.3% 21.8% 14.3% 20.8% 16.4% 17.9% Interest income 3.4 4.4 3.9 6.4 7.7 7.7 7.7 7.6 18.1 30.7 Interest expense (1.9) (2.7) (3.8) (4.8) (5.2) (5.2) (5.2) (5.3) (13.1) (21.0) Other income/(expense) (0.0) 23.8 (0.7) (0.1) 6.8 0.0 0.0 0.0 23.1 6.8 Impairment loss on long-term investments 0.0 (2.2) (3.8) (2.1) (0.7) (0.7) (0.7) (0.9) (8.1) (3.0) Profit before taxation 19.1 74.9 17.7 42.9 37.4 82.5 44.2 96.5 154.6 260.6 Income tax expense (4.5) (17.6) (3.1) (11.0) (8.4) (19.8) (9.7) (24.6) (36.2) (62.5) Loss from equity method investments (1.7) (2.2) (2.4) (1.8) (1.3) (2.5) (2.5) (1.7) (8.0) (8.0) Net loss attributable to non-controlling interest 0.3 0.6 1.3 2.2 1.1 2.0 2.5 3.0 4.4 8.6 Net income attributable to shareholders (GAAP) 13.2 55.7 13.6 32.2 28.8 62.2 34.5 73.1 114.8 198.6 GAAP NPM (%) 6.8% 20.6% 5.2% 10.2% 8.9% 14.4% 8.8% 14.6% 11.0% 12.1% Share-based compensation 8.4 8.3 9.1 10.4 10.7 13.5 13.5 9.3 36.1 46.9 Net income attributable to shareholders (non-GAAP) 21.6 64.0 22.7 42.6 39.5 75.7 48.0 82.4 150.9 245.5 Non-GAAP NPM (%) 11.1% 23.6% 8.7% 13.5% 12.3% 17.5% 12.2% 16.4% 14.5% 14.9% SOURCE: CIMB RESEARCH, COMPANY

96

Education│China│TAL Education Group│September 19, 2017

Valuation and recommendation Initiate coverage with Add rating and TP of US$40.30 We initiate coverage on TAL with an Add rating. We derive our target price (TP) using a DCF-based methodology with a WACC of 9.7%. Our TP implies a CY18F P/E of 68.9x, at 1.25x CY18F PEG (1.5 s.d. above its historical average forward PEG of 0.9x). We believe TAL deserves to continue re-rating due to: 1) the rapid, ongoing learning centre expansion, 2) the fast growth of its dual- teacher model and online education, as well as 3) enhanced course offerings that would drive near-term earnings growth.

Figure 26: DCF valuation

FCF computation FY17 FY18F FY19F FY20F FY21F FY22F FY23F FY24F FY25F FY26F FY27F FY28F FY29F FY30F EBIT 170.7 294.1 454.4 669.8 837.2 1,046.6 1,255.9 1,507.0 1,808.4 1,989.3 2,188.2 2,407.0 2,647.7 2,912.5 Taxes -36.2 -62.5 -106.6 -165.5 -206.9 -258.6 -310.3 -372.3 -446.8 -491.5 -540.6 -594.7 -654.2 -719.6 NOPAT 134.5 231.5 347.8 504.3 630.4 788.0 945.6 1,134.7 1,361.6 1,497.8 1,647.6 1,812.3 1,993.6 2,192.9 NOPAT growth 72.1% 50.2% 45.0% 25.0% 25.0% 20.0% 20.0% 20.0% 10.0% 10.0% 10.0% 10.0% 10.0% D&A -28.9 -30.8 -36.4 -42.0 -44.1 -46.4 -48.7 -51.1 -53.7 -56.3 -59.2 -62.1 -65.2 -68.5 Funds from operation 105.6 200.7 311.3 462.3 586.2 741.6 896.9 1,083.6 1,308.0 1,441.5 1,588.4 1,750.2 1,928.4 2,124.4 Change in net w orking Capital 185.2 175.4 554.2 308.6 364.7 384.3 405.0 426.8 449.8 474.0 499.5 526.3 554.6 584.5 Cash flow from operation 290.8 376.2 865.5 770.9 950.9 1,126.0 1,301.9 1,510.4 1,757.7 1,915.4 2,087.9 2,276.6 2,483.0 2,708.9 Capex -71.1 -45.0 -45.0 -45.0 -47.3 -49.6 -52.1 -54.7 -57.4 -60.3 -63.3 -66.5 -69.8 -73.3 Free cash flow from operation 219.7 331.2 820.5 725.9 903.7 1,076.3 1,249.8 1,455.7 1,700.3 1,855.1 2,024.6 2,210.1 2,413.2 2,635.6 FCF growth 50.7% 147.8% -11.5% 24.5% 19.1% 16.1% 16.5% 16.8% 9.1% 9.1% 9.2% 9.2% 9.2%

Terminal free cash flow 40,822.7 Total discounted free cash flow 9,616.4 Present value of terminal free cash flow 12,955.7

Total present value of forecasted free cash flows 22,572.0 Less: Net Debt -643.3 Equity Value 23,215.3 No. shares (m) 575.6 End-CY18F per share equity value (US$) 40.3 SOURCE: CIMB FORECASTS, COMPANY

Figure 27: Cost of capital assumptions (%) Cost of equity 9.7% Risk free 3.0% Market Risk Premium 7.0% Beta 0.95

Cost of debt 5.0% Kd (after tax) 4.5%

Target Debt / (Debt + Equity) 0% Target Equity / (Debt + Equity) 100%

WACC 9.65%

Terminal growth 3.0% SOURCE: CIMB RESEARCH, COMPANY

The WACC of 9.7% in our DCF approach uses a beta of 0.95. In addition, we use a risk-free rate of 3.0%, and market risk premium of 7.0%. We assume a perpetual growth rate of 3.0%.

97

Education│China│TAL Education Group│September 19, 2017

Figure 28: TAL’s forward P/E trend Figure 29: TAL’s forward PEG trend

70 1.8 Title: Title:

1.6 Source: Source: 60 1.4 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 1.1x 50 44.9x 1.2 0.9x 1 40 36.1x 0.8 0.7x 30 27.3x 0.6

18.5x 0.4 20 0.2

10 0

Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-13 Jul-14 Jul-15 Jul-17 Jul-12 Jul-16

Apr-12 Oct-12 Apr-13 Oct-13 Apr-12 Oct-12 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Apr-13 Oct-13 Apr-14

Jan-15 Jan-16 Jan-17 Jan-13 Jan-14 Jan-17 Jan-12 Jan-13 Jan-14 Jan-12 Jan-15 Jan-16

P/E Ratio Average +1 s.d. +2 s.d. -1 s.d. PEG Ratio Average +1 s.d. -1 s.d. SOURCE: CIMB RESEARCH, COMPANY, BLOOMBERG SOURCE: CIMB RESEARCH, COMPANY

Figure 30: Education sector peer comparison 3-year Dividend yield Price TP Mkt cap P/E (x) EPS P/BV (x) PEG (x) (x) Company Ticker Recom. (LC$) (LC$) (US$) CY17F CY18F CY19F CAGR (%) CY17F CY18F CY17F CY18F CY17F CY18F China education ADR New Oriental Education EDU US Add 87.16 114.30 13,743 40.2 30.6 23.3 31.5% 7.1 5.8 1.3 1.0 0.5% 0.5% TAL Education TAL US Add 33.01 40.30 16,533 67.9 52.9 34.8 57.6% 18.4 12.7 na 1.0 0.0% 0.0% Bright Scholar Education BEDU US Non Rated 21.89 na 2,567 68.9 41.7 na na 20.4 16.0 na na 0.0% 0.0% Tarena International TEDU US Add 14.49 16.70 830 17.2 12.6 9.7 23.2% 2.9 2.4 0.9 0.6 1.2% 1.7% China Distance Education DL US Non Rated 6.90 na 227 12.4 13.0 na -6.0% 3.8 3.5 na na 6.5% 6.5%

China H-share education Virscend Education 1565 HK Non Rated 4.78 na 1,868 38.0 26.0 19.9 29.5% 4.6 4.1 na na 1.4% 1.7% China Maple Leaf Education 1317 HK Add 8.23 9.60 1,458 25.7 19.5 na 23.9% 4.1 3.7 1.1 0.8 1.8% 2.3% China Yuhua Education 6169 HK Add 3.80 4.50 1,518 16.8 13.9 na 19.4% 3.0 2.8 1.0 0.9 2.9% 3.0% Wisdom Education 6068 HK Non Rated 4.25 na 1,131 25.7 20.0 16.5 43.6% 3.9 3.5 na na 1.2% 1.6% Minsheng Education 1569 HK Non Rated 2.00 na 1,030 20.3 16.9 15.4 20.8% 2.0 1.8 4.1 3.4 0.6% 0.7% China New Higher Education 2001 HK Non Rated 4.56 na 831 22.1 17.6 14.3 50.9% 3.0 2.7 na na 1.3% 1.8%

International education Grand Canyon Education LOPE US Non Rated 83.23 na 4,005 21.7 20.3 18.1 14.3% na na 1.4 1.4 0.0% 0.0% Adtalem Global Education ATGE US Non Rated 34.95 na 2,170 12.6 11.5 na 10.0% na na 1.3 1.2 1.0% 1.0% Strayer Education STRA US Non Rated 83.01 na 927 24.9 22.0 19.2 11.0% na na 1.7 1.5 0.0% 0.0% Capella Education CPLA US Non Rated 68.30 na 797 19.3 18.6 15.2 7.8% na na 1.9 1.9 2.4% 2.5% Daekyo Co 019680 KS Non Rated 8300.00 na 620 17.3 17.7 16.9 9.2% 1.2 1.2 na na 2.9% 2.9% Note: As of 19 Sep 2017 SOURCE: CIMB RESEARCH, BLOOMBERG

Looking at comparable companies’ earnings outlook and valuations, our forecasts show TAL with 57.6% 3-year non-GAAP net profit CAGR (FY17-20F), the fastest growth profile among its local informal education peers, including New Oriental Education (EDU US, Add, TP: US$114.30) and Tarena International (TEDU US, Add, TP: US$16.70). In terms of CY18F PEG, TAL's 1.0x appears to be in line with EDU’s 1.0x, and higher than Tarena’s 0.59x. We believe this is justified, as Tarena’s courses (typically last four months) generate less recurring income than TAL’s, resulting in greater uncertainty for Tarena compared to other K-12 education providers. TAL’s cash holdings aside, it currently trades at 52.1x CY18F P/E, with 2-year net profit CAGR of 55.1% (FY18-20F) based on our estimates. The education sector is seen by investors as fairly defensive because there are always students who will pay for high-quality education. TAL has re-rated significantly since Oct 2015, but we expect the stock to continue to re-rate given: 1) its continued rapid learning centre expansion, 2) fast growth of its dual-

98

Education│China│TAL Education Group│September 19, 2017

teacher model and online education, and 3) enhanced course offerings that could drive near term earnings growth.

Risks Regulatory risk from government policy change School admission and assessment processes in China constantly undergo changes and developments in terms of subject and skills focus, question types, examination formats and the manner in which processes are administrated. The inability to track and respond to the changes in a timely and cost-effective manner could materially impair TAL's ability to remain an attractive choice for students. Also, regulations and policies that place less emphasis on scholastic competition achievements could hamper the demand for TAL’s after-school tutoring services and negatively impact TAL’s enrolment. For example, in Jul 2015, the Beijing Municipal Education Commission issued a notice to prohibit primary and secondary schools from using Olympiad and other competition scores as the selection method for enrolment. Education authorities in Shanghai, Chengdu and Zhejiang issued similar notices and opinions from 2016 to 2017. The policies have generally resulted in a decrease in demand for Mathematical Olympiad competition courses, which in turn, negatively affected enrolment in TAL’s mathematics classes, according to management.

Rapid expansion may harm profit margins TAL plans to expand its capacity by 30-50% yoy annually for the next three years. The company also intends to enter 4-6 cities annually as part of its expansion plan. Slower-than-expected ramp-up of utilisation rates at its learning centres, however, could put pressure on TAL’s profit margins and hurt earnings growth. Also, if TAL fails to maintain its high teaching quality at the new learning centres and newly-penetrated cities, its brand reputation could be hurt and this could negatively affect its ability to attract new students.

Active M&A strategy poses risks TAL has been active in carrying out acquisitions and equity investments in companies that it deems complementary to its existing business, especially in the online education and O2O sectors. Many of the companies that TAL has invested in could be considered by investors as higher-risk investments, as they are in the early stages of the investment lifecycle and are still loss-making. If the earnings of these companies turn south and cause their valuations to de-rate, TAL may have to book impairment losses related to its investments, which could hurt group earnings.

99

Education│China│TAL Education Group│September 19, 2017

Appendix Management profile Bangxin Zhang – Founder, Chairman and Chief Executive Officer (CEO) One of the founders of TAL, Mr Zhang has served as the chairman and CEO of the firm since inception. Mr Zhang provides vision, overall management, and strategic decision-making relating to marketing, investment planning, and corporate development. Mr Zhang received his bachelor’s degree in Life Sciences from Sichuan University in 2001, was in the postgraduate programme of Life Sciences of Peking University from 2002 to 2007, and received an EMBA degree from China Europe International Business School in 2009.

Yachao Liu – Director and Chief Operating Officer (COO) Dr Liu has served as a TAL director since Oct 2016 and COO since Jun 2017. Prior to that, he served as TAL’s senior vice president from Apr 2011 to Sep 2016 and has been in charge of TAL’s Kaoyan business and certain new businesses. Since joining TAL in 2005, Dr Liu held various positions in the company, having been in charge of TAL’s strategic investments, online course offerings, enterprise planning division and information management centre, teaching and research division, teachers’ training school etc. Dr Liu received his bachelor’s degree in Mechanics from Peking University in 2003 and Ph.D. from the Institute of Mechanics of the Chinese Academy of Science in 2008.

Yunfeng Bai – President Mr Bai has served as TAL’s President since Oct 2016, prior to which he had been TAL’s senior vice-president from Apr 2011 to Sep 2016. Since joining TAL in 2005, Mr Bai has held various positions in the company, having been in charge of TAL’s personalised premium services and Beijing operations. Mr Bai received his bachelor’s degree in Engineering Automation from Beijing University of Aeronautics and Astronautics in 2003, attended the CEO class of Guanghua Management School of Peking University between 2008 and 2009 and graduated from the EMBA programme of China Europe International Business School in 2012.

Rong Luo – Chief Financial Officer (CFO) Mr Luo has served as the CFO since Nov 2014 and has been in charge of TAL’s international education business since Dec 2016. He also serves as an independent director of the Jiangsu Phoenix Pressing Media Co., Ltd. Prior to joining TAL, Mr Luo had prior experience as the CFO of Elong Inc, finance senior manager (China) for the Lenovo Group, and various positions in the finance functions of Microsoft Corporation. Mr Luo holds a double major bachelor’s degree in economics and information management & systems from Peking University, and a master’s degree in management science and engineering from Tsinghua University.

Yan Huang – Chief Technology Officer (CTO) Mr Huang joined TAL in Apr 2015 and served as CTO since Oct 2016 in charge of new product incubation and technical system management. Prior to joining TAL, Mr Huang served as Chief Architect at Baidu, director at Tencent Research, as well as co-founder and software architect of PPLive (now PPTV). Mr Huang received his bachelor’s degree and master’s degree from University of Science and Technology of China.

100

Education│China│TAL Education Group│September 19, 2017

Shareholding structure

Figure 31: Shareholding structure (as of end-FY17)

SOURCE: COMPANY

101

Education│China│TAL Education Group│September 19, 2017

Key milestones

Figure 32: Key milestones Year Event Xueersi Education was established to provide after-school tutoring services to primary and 2005 secondary school students, including Mathematics and English. 2007 Launched TAL's personalised premium services. 2008 Established presence in Tianjin, Shanghai and Wuhan. Launched zhongkao.com and gaokao.com. 2009 Expanded to Guangzhou Launched yingyu.com. 2010 Listed on New York Stock Exchange. A branch was established in Shenzhen. Online school launched. 2011 Branches were established in Chengdu, Hangzhou, Nanjing, and Xi'an Mobby, a pre-school education programme of Xueersi, was launched. 2012 Speiyou established branches in Zhengzhou and Chongqing Live online courses launched. 2013 Xueersi Education was renamed as TAL Minority investment in duobei.com 2014 Acquired kaoyan.com Minority investment in Babytree, Inc., Minerva and Guokr, Inc. Together with hujiang.com established "Weilai Zhixing" lecture series for emerging online education entrepreneurs. 2015 Minority investment in Changing Education, also invested in Phoenix E-learning. Launched "Lewaijiao", a new online education product to be the first brand for youth education delivered by foreign teachers. Speiyou established branches in Luoyang, Nanchang, Fuzhou, Hefei, Ningbo, and Wuxi. TAL fully acquired Firstleap Education, a provider of all-subject tutoring services in English 2016 for students aged 2 to 15 in China. Became controlling shareholder of Shunshun Bida. Minority investment in Knewton Inc. TAL cooperated with Didi Taxi to promote the education sharing plan. SOURCE: CIMB RESEARCH, COMPANY

102

Education│China│TAL Education Group│September 19, 2017

BY THE NUMBERS

P/BV vs ROE 12-mth Fwd FD Core P/E vs FD Core EPS 23.0 39.0% 75.0 Growth 91% 21.0 37.7% 65.0 76% 19.0 36.3% 17.0 35.0% 55.0 61% 15.0 33.7% 45.0 46% 13.0 32.3% 11.0 31.0% 35.0 31% 9.0 29.7% 25.0 16% 7.0 28.3% 5.0 27.0% 15.0 1% Jan-14A Jan-15A Jan-16A Jan-17A Jan-18F Jan-19F Jan-14A Jan-15A Jan-16A Jan-17A Jan-18F Jan-19F

Rolling P/BV (x) (lhs) ROE (rhs) 12-mth Fwd Rolling FD Core P/E (x) (lhs) FD Core EPS Growth (rhs)

Profit & Loss

(US$m) Feb-16A Feb-17A Feb-18F Feb-19F Feb-20F Total Net Revenues 619.9 1,043.1 1,647.4 2,395.3 3,260.9 Gross Profit 316.3 520.8 835.2 1,227.8 1,694.6 Operating EBITDA 103.2 163.5 277.9 429.8 632.5 Depreciation And Amortisation (18.2) (28.9) (30.8) (36.4) (42.0) Operating EBIT 85.1 134.6 247.1 393.3 590.4 Financial Income/(Expense) 10.2 5.0 9.7 44.8 74.5 Pretax Income/(Loss) from Assoc. (0.7) (8.0) (8.0) (8.0) (8.0) Non-Operating Income/(Expense) 41.6 15.0 3.8 (3.0) (3.0) Profit Before Tax (pre-EI) 136.2 146.6 252.6 427.2 653.9 Exceptional Items Pre-tax Profit 136.2 146.6 252.6 427.2 653.9 Taxation (33.5) (36.2) (62.5) (106.6) (165.5) Exceptional Income - post-tax Profit After Tax 102.8 110.4 190.0 320.5 488.4 Minority Interests 0.1 4.4 8.6 14.4 22.7 Preferred Dividends FX Gain/(Loss) - post tax Other Adjustments - post-tax 0.0 0.0 0.0 0.0 0.0 Net Profit 102.9 114.8 198.6 334.9 511.1 Recurring Net Profit 128.7 150.9 245.5 396.0 590.4

Fully Diluted Recurring Net Profit 128.7 150.9 245.5 396.0 590.4

Cash Flow

(US$m) Feb-16A Feb-17A Feb-18F Feb-19F Feb-20F EBITDA 103.2 163.5 277.9 429.8 632.5 Cash Flow from Invt. & Assoc. Change In Working Capital 86.2 185.2 175.4 554.2 308.6 (Incr)/Decr in Total Provisions Other Non-Cash (Income)/Expense Other Operating Cashflow 5.8 23.9 10.8 9.2 (1.7) Net Interest (Paid)/Received (7.5) (13.1) (21.0) (21.0) (21.0) Tax Paid Cashflow From Operations 187.7 359.6 443.2 972.1 918.5 Capex (35.1) (71.1) (45.0) (45.0) (45.0) Disposals Of FAs/subsidiaries 0.4 0.6 0.0 0.0 0.0 Acq. Of Subsidiaries/investments (165.8) (355.9) 0.0 0.0 0.0 Other Investing Cashflow (14.9) (91.8) 0.0 0.0 0.0 Cash Flow From Investing (215.4) (518.3) (45.0) (45.0) (45.0) Debt Raised/(repaid) 0.0 0.0 0.0 0.0 0.0 Proceeds From Issue Of Shares 0.0 0.0 0.0 0.0 0.0 Shares Repurchased 0.0 0.0 0.0 0.0 0.0 Dividends Paid 0.0 0.0 0.0 0.0 0.0 Preferred Dividends Other Financing Cashflow 0.6 198.3 0.0 0.0 0.0 Cash Flow From Financing 0.6 198.3 0.0 0.0 0.0 Total Cash Generated (27.0) 39.6 398.2 927.1 873.5 Free Cashflow To Equity (27.6) (158.7) 398.2 927.1 873.5 Free Cashflow To Firm (20.1) (145.6) 419.2 948.1 894.5

SOURCE: CIMB RESEARCH, COMPANY DATA

103

Education│China│TAL Education Group│September 19, 2017

BY THE NUMBERS… cont’d

Balance Sheet

(US$m) Feb-16A Feb-17A Feb-18F Feb-19F Feb-20F Total Cash And Equivalents 434.0 470.2 868.4 1,795.6 2,669.0 Total Debtors 2.6 3.4 3.4 3.4 3.4 Inventories 0.6 2.8 4.5 6.4 8.7 Total Other Current Assets 78.6 392.6 392.6 392.6 392.6 Total Current Assets 515.9 869.0 1,268.9 2,198.0 3,073.7 Fixed Assets 114.6 154.3 168.5 177.1 180.1 Total Investments 274.4 347.7 347.7 347.7 347.7 Intangible Assets 102.2 305.1 305.1 305.1 305.1 Total Other Non-Current Assets 54.3 150.6 150.6 150.6 150.6 Total Non-current Assets 545.5 957.8 972.0 980.6 983.5 Short-term Debt Current Portion of Long-Term Debt Total Creditors 14.7 25.7 6.0 36.9 18.6 Other Current Liabilities 368.5 641.5 838.2 1,363.5 1,692.7 Total Current Liabilities 383.2 667.1 844.2 1,400.4 1,711.2 Total Long-term Debt 227.8 225.1 225.1 225.1 225.1 Hybrid Debt - Debt Component Total Other Non-Current Liabilities 9.7 255.8 255.8 255.8 255.8 Total Non-current Liabilities 237.5 480.9 480.9 480.9 480.9 Total Provisions 0.0 0.0 0.0 0.0 0.0 Total Liabilities 620.6 1,148.0 1,325.1 1,881.3 2,192.1 Shareholders' Equity 437.0 642.1 887.7 1,283.6 1,874.1 Minority Interests 3.8 36.6 28.1 13.7 (9.0) Total Equity 440.7 678.8 915.7 1,297.3 1,865.1

Key Ratios

Feb-16A Feb-17A Feb-18F Feb-19F Feb-20F Revenue Growth 42.9% 68.3% 57.9% 45.4% 36.1% Operating EBITDA Growth 30.7% 58.4% 70.0% 54.6% 47.2% Operating EBITDA Margin 16.6% 15.7% 16.9% 17.9% 19.4% Net Cash Per ADS (US$) 2.58 3.02 1.30 3.18 4.95 BVPADS (US$) 5.46 7.90 1.80 2.60 3.79 Gross Interest Cover 11.34 10.24 11.77 18.73 28.12 Effective Tax Rate 24.6% 24.7% 24.8% 25.0% 25.3% Net Dividend Payout Ratio NA 35.4% NA NA NA Accounts Receivables Days - - - - - Inventory Days 0.69 1.20 1.64 1.70 1.77 Accounts Payables Days 9.11 11.54 5.75 5.75 5.77 ROIC (%) (232%) (342%) 55% 165% (121%) ROCE (%) 17.0% 19.4% 27.2% 34.5% 38.0% Return On Average Assets 10.4% 7.4% 9.0% 10.6% 12.0%

SOURCE: CIMB RESEARCH, COMPANY DATA

104

Education│China│September 19, 2017

Company Note │ Alpha series

China Tarena International Inc ADD Venturing into K-12 education Consensus ratings*: Buy 5 Hold 3 Sell 0 ■ Founded in 2002, Tarena is the largest provider of professional education services in China by 2013 revenue, according to market intelligence firm IDC. Current price: US$14.49 ■ Tarena has a successful track record of rapid expansion and we expect its unique Target price: US$16.70 dual-teacher model to continue driving strong enrolment growth. Previous target: US$ ■ The K-12 initiative, launched in Dec 2015, is expanding rapidly and is likely to act as a Up/downside: 15.3% strong growth driver in the medium term. CIMB / Consensus: -14.0% ■ We initiate coverage with an Add rating and DCF-based target price of US$16.70.

Reuters: TEDU.OQ The largest provider of professional education services in China Bloomberg: TEDU US Founded in 2002, Tarena is the largest provider of professional education services in Market cap: US$830.5m China by revenue, according to IDC. Its core strength is IT professional education US$830.5m services. It has successfully created strong barriers to entry, with: 1) up-to-date courses Average daily turnover: US$6.23m and established partnerships with universities that ensure strong enrolment, 2) high- US$6.23m quality education and solid job placement network, which give it the ability to charge premium fees, and 3) a 3-pronged teaching approach that allows for business scalability. Current shares o/s: 55.54m Free float: 27.4% Successful track record in rapid expansion *Source: Bloomberg We think Tarena’s dual-teacher teaching approach allows it to expand quickly without sacrificing quality. We forecast Tarena will add 30 centres p.a. and its seat capacity will Key changes in this note expand by 19.2% CAGR in FY16-19F. Tarena signed cooperation agreements with 60+ N/A universities in 1H17 to launch joint-major programmes, allowing it to recruit first-year university students. Although this model will affect c.7,000 enrolments in FY17F, we think

Price Close Relative to S&P 500 (RHS) it will drive recurring demand and higher margins in the medium term. 22.0 138.0 20.0 124.0 New course offerings to drive strong enrolment growth 18.0 110.0 We forecast Tarena’s student enrolment to rise between 17.4% and 19.3% yoy from 16.0 96.0 14.0 82.0 FY17F to FY19F. The company adapts quickly to market needs by offering courses that 12.0 68.0 4 are in demand. In 2H17F, Tarena will launch three new courses, including two 3 professional courses, i.e. Python and New e-commerce operation, and one for K12, i.e. 2 1 coding mathematics. We expect new and popular courses to allow Tarena to Vol m Vol continuously attract and grow student numbers. Sep-16 Dec-16 Mar-17 Jun-17

Source: Bloomberg K-12 the next growth driver In Dec 2015, Tarena started offering courses for students aged 6-18 years, including Price performance 1M 3M 12M robot programming and 3D printing. We are positive on the higher recurring income Absolute (%) -19.6 -21.5 -1 nature of K-12 courses and believe Tarena will thrive in this area, given its first-mover Relative (%) -22.8 -24.4 -18 advantage and strong IT background as parents are increasingly cognisant of the importance of exposing their children to programming at a young age. We expect K-12 to Major shareholders % held enrol 8,000/15,000 students in FY17/18F, or 6.2%/9.9% of total enrolment. Shaoyun Han 30.2 Initiate coverage with Add and TP of US$16.70 We initiate coverage on Tarena with an Add and see 15.3% upside to our DCF-based TP of US$16.70 (WACC: 10.0%), which implies 14.4x CY18F non-GAAP P/E and 0.68x PEG. We believe the weak near-term outlook is priced in, and expect it to re-rate on the back of: 1) accelerating K-12 enrolment growth, and 2) rising enrolment numbers with further expansion into lower-tier cities. Key risks include slower-than-expected ramp-up of the K-12 segment and margin erosion from penetration into lower-tier cities.

Financial Summary Dec-15A Dec-16A Dec-17F Dec-18F Dec-19F Analyst(s) Revenue (Rmbm) 1,178 1,580 1,974 2,476 3,054 Operating EBITDA (Rmbm) 212.7 302.6 355.5 499.8 658.6 Net Profit (Rmbm) 178.8 241.9 256.1 367.2 494.8 Core EPADS (Rmb) 4.46 5.67 5.83 7.88 10.29 Core EPS Growth (0.7%) 45.7% 5.3% 36.2% 30.5% FD Core P/E (x) 26.43 18.15 17.24 12.66 9.70 DPADS (Rmb) 0.94 1.10 1.14 1.63 2.20 Dividend Yield 0.99% 1.16% 1.19% 1.71% 2.31%

EV/EBITDA (x) 23.89 15.89 13.32 8.65 6.07 Lei YANG, CFA P/FCFE (x) 20.32 15.29 40.73 11.20 12.41 T (86) 21 5047 1771 x108 Net Gearing (38.4%) (50.7%) (47.6%) (58.5%) (60.8%) E [email protected] P/BV (x) 3.83 3.31 2.88 2.42 2.01 ROE 17.2% 21.1% 18.9% 21.8% 23.7% ONG Khang Chuen % Change In Core EPADS Estimates T (852) 2539 1326 CIMB/consensus Core EPADS (x) 1.09 1.10 1.11 E [email protected] SOURCE: COMPANY DATA, CIMB FORECASTS

IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE END OF THIS REPORT. IF THIS REPORT IS DISTRIBUTED IN Powered by the THE UNITED STATES IT IS DISTRIBUTED BY CIMB SECURITIES (USA), INC. AND IS CONSIDERED THIRD-PARTY AFFILIATED RESEARCH. EFA Platform

Education│China│Tarena International Inc│September 19, 2017

Venturing into K-12 education

Company outlook Further penetration into lower-tier cities Due to Tarena’s unique dual-teacher teaching approach, which utilises a combination of live distance instruction, classroom-based tutoring and online learning modules, it is able to expand quickly without sacrificing teaching quality, in our view. Beginning with Java training courses in 2002, Tarena mainly recruited senior professional engineers from large IT companies to work as teachers/trainers. Through live distance teaching, these high-quality teachers can cover around 500 students at the same time. Currently, Tarena has 248 professional teachers. Besides teaching courses (60% of working time), these teachers are also responsible for new course design and development (40% of working time), which has enabled Tarena to catch up with IT industry trends to meet students’ needs. For classroom-based tutors, there is no need for Tarena to recruit and train local instructors for every new learning centre established as the company typically recruits graduates of its classes. This allows Tarena to expand quickly – new centres are typically operational within seven weeks following the completion of construction. In 2Q17, Tarena began using existing students as teaching assistants so that one classroom-based tutor can now cover two classrooms (compared to just one previously) at the same time to save staff costs. Since its listing in 2014, Tarena has expanded its presence from 33 cities to 53 cities in 2Q17. Management plans to further its penetration into tier-2 and tier-3 cities and targets to enter 5-10 new cities annually over the next three years. Besides opening new learning centres, Tarena sometimes also carries out expansion of existing learning centres by leasing more floor area, increasing its annual seat capacity at a faster rate compared to that of the number of learning centres. We forecast Tarena to continue its rapid expansion of 30 centres per year between FY17F and FY19F and estimate its annual seat capacity to deliver a 3- year CAGR of 19.2%, from 193k in FY16 to 327k in FY19F.

Figure 1: Tarena’s annual student enrolment trend Figure 2: Number of Tarena learning centres

200,000 120% 250 Title: 235 Title: 177,783 180,000 Source: Source: 205 100% 160,000 151,450 200 Please fill in the values above175 to have them entered in your report Please fill in the values above to have them entered in your report 140,000 128,186 80% 145 120,000 107,493 150 134 100,000 60% 118 84,041 80,000 Centres 100 92 59,960 40% 60,000 46,458 57 40,000 31,940 50 20% 34 16,282 20,000

0 0% 0 FY11 FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F FY11 FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F

LHS: Student enrolments RHS: yoy growth (%) Learning centres

SOURCES: CIMB FORECASTS, COMPANY REPORTS SOURCES: CIMB FORECASTS, COMPANY REPORTS

Despite penetrating into new cities every year, Tarena is able to quickly scale up and maintain a high utilisation rate of 70-75%. The expansion allows the company to diversify its revenue base, while supporting margin expansion – gross margin (GPM) rose from 68.7% in FY12 to 71.8% in FY16. According to

106

Education│China│Tarena International Inc│September 19, 2017

management, lower-tier cities are expected to contribute higher margins on the back of lower personnel and rental costs.

Figure 3: Student enrolment, by city (2Q17)

Beijing, 14.9% Title: Source:

Hangzhou, 5.8% Please fill in the values above to have them entered in your report

Others, 43.7% Shenzhen, 5.7%

Shanghai, 5.2%

Guangzhou, 5.1%

Chengdu, 4.4% Wuhan, 4.4% Hefei, 3.3% Nanjing, 3.6% Zhengzhou, 3.9% SOURCES: CIMB, COMPANY REPORTS

New course offerings to drive enrolment growth Tarena plans to continue offering new courses every year according to market needs. In 2016, it introduced virtual reality (VR)/augmented reality (AR) courses in Beijing, Guangzhou and Chengdu. It also plans to increase student enrolment by offering more comprehensive courses across learning centres in other cities. Among Tarena’s 18 current training courses, 12 courses are IT-related, three are non-IT professional training courses, and three are K-12 courses. We forecast Tarena’s student enrolment to increase by 17.4-19.3% yoy in FY17- 19F.

Figure 4: Course offerings in various cities

SOURCES: COMPANY REPORTS

Tarena also launched an initiative called “Teaching at Appropriate Levels” to upgrade its curriculum portfolio. Under this initiative, five courses are redesigned into two levels – basic level and advanced level. Advanced level courses are priced Rmb2,000 higher than the basic level courses. Management targets for advanced level courses to account for 25% of total enrolment in FY17.

107

Education│China│Tarena International Inc│September 19, 2017

As a result, we expect Tarena’s ASP to rise 5.0% yoy in FY17F and expand at a steady pace of 4.0% yoy in FY18-19F.

K-12 to be the next earnings growth driver In Dec 2015, Tarena launched new training programmes – Tongcheng, Tongmei and Tongchuang – offering courses such as robot programming and 3D printing customised for primary to high school students aged 6-18 years. Each of these programmes has three to four levels, each level consisting of 120 learning hours spread across a 12-month period. The courses are taught by teaching assistants face-to-face in offline classrooms, supplemented by recorded courseware videos to increase the classes’ interactivity. Currently, the K-12 segment is available at 15 centres across 15 cities. We are positive on this K-12 initiative by Tarena, as: ● Lessons for children are of a more recurring nature. Compared to adult vocational courses which typically last only four months, programmes designed for K-12 students can last up to four years. ● Tarena is able to increase the utilisation rate of its classrooms with the introduction of K-12, as classes for K-12 typically take place at night and on weekends, and do not clash with adult vocational education. ● Parents increasingly understand the importance of exposing their child to programming at a young age, yet there is a lack of avenues for such exposure.

Figure 5: Tarena’s K-12 robot Figure 6: Tarena’s K-12 computer Figure 7: Tarena’s K-12 digital art class programming class programming class

SOURCES: CIMB, COMPANY WEBSITE SOURCES: CIMB, COMPANY REPORTS SOURCES: CIMB, COMPANY REPORTS

In 2016, the childhood programming courses only accounted for c.2% of Tarena’s total student enrolment. We expect K-12 to achieve student enrolment of 8,000 in FY17F, or c.6.2% of total student enrolment. Tarena recruited 2,719 students for its K-12 courses in 1H17, and management guided that another c.1,300 K-12 students were recruited in the month of Jul alone. Management targets to double its K-12 student enrolment numbers every year in the next two to three years. However, we expect K-12’s revenue contribution to remain low at c.2% in FY17F, as the courses are conducted over a longer duration (K-12: 3 hours of lessons per week; adult: c.40 hours per week). We expect the K-12 segment to achieve revenue of Rmb50m but to incur net losses of Rmb40m in FY17F due to the marketing and course development expenses at the beginning stage. Management guided for K-12 segment to contribute 4-5% of topline (i.e. Rmb100m-120m revenue) and to break even at operating profit level in FY18F as student enrolment ramps up. In terms of margins, we expect the K-12 initiative to drive margin expansion in the long run, as 1) the hourly rate for K-12 education is higher (K-12: Rmb100/hr; adult: Rmb20/hr) than for adult vocational courses, and 2) effective student-to- teacher ratio is higher despite the smaller class size, given the shorter duration of classes. Management targets for K-12 segment to achieve GPM of over 70% and operating profit margin (OPM) of c.25% in the long run (c.5 years). However, we expect the K-12 business to put pressure on profit margins in the short run, due to the lower-than-ideal utilisation rate at the beginning stage.

108

Education│China│Tarena International Inc│September 19, 2017

Management guided for high-single-digit GPM for the K-12 business in 1H17, but expects it to improve to mid-teens in 2H17F and 30% in FY18F. Overall, despite the expected margin improvement from the professional education segment as a result of greater scale, we pencil in non-GAAP GPM of 70.7% in FY17F (FY16: 71.8%) and non-GAAP OPM of 16.0% for the same period (FY16: 18.8%).

New cooperation model with universities As Tarena increases its collaboration with universities, management guided that there is a rising proportion of students recruited through cooperation programmes with university channels beginning in 2017F, including joint major programmes or on-campus learning sites. Tarena signed cooperation agreements with 60+ universities in 1H17 to start Tarena’s special classes in the first year of university. This new model (1H17: c.50% of students enrolled through university channels, or c.7% of total enrolment) allows Tarena to recruit students from the first year, with more recurring demand. Previously, Tarena only recruited students in their third or fourth year of university. As the course length for such programmes are longer at 3-4 years, versus Tarena’s typical programmes that last four months, we think this will result in slower revenue recognition for students recruited through such channels. However, this new recruitment model will lead to more recurring demand and cross-selling opportunities, which we believe will be positive for the company’s earnings growth in the medium-to-long term. This new model could also help Tarena to increase its margins, given the resulting savings on rental, marketing and student recruitment expenses. In addition, through this model, Tarena will charge its tuition fees directly to the universities, rather than students, which may help Tarena to reduce its bad debt ratio.

109

Education│China│Tarena International Inc│September 19, 2017

Background The largest IT professional education services provider in China Founded in 2002, Tarena is the largest IT professional education services provider in China by revenue in 2013, according to IDC. As of end-Mar 2017, Tarena had a nationwide network of 160 directly-managed learning centres in 51 cities. It started out by providing pure IT education courses, before expanding to non-IT education courses in 2013 and subsequently, childhood education courses in 2015. Currently, Tarena offers courses in 12 IT subjects, three non-IT subjects and three childhood education programmes.

Figure 8: Tarena’s website

SOURCE: CIMB RESEARCH, COMPANY

Students: Majority of Tarena’s students (80.6% of student enrolment in FY16) attend classes full time at Tarena’s learning centres – from 9am to 6pm every weekday. The term for a full-time class is typically 1,000 learning hours over a period of four months. As part-time students (19.4% of student enrolment in FY16) typically have full-time jobs, their classes are scheduled for weekends or a combination of weekday nights and weekends. Part-time students also complete a portion of the lessons online by watching videos available on Tarena Teaching System (TTS). Full term ranges from three to five months. After passing Tarena’s internal exams, graduates of Tarena’s IT courses are qualified to obtain the intermediate-advanced software engineer certificate issued by the Ministry of Industry and Information Technology of China.

Tuition fees: Standard tuition fees range from Rmb16,800 to Rmb20,800 per course for full-time adult students; and from Rmb15,000 to Rmb19,200 for K-12 courses. Tarena typically raises tuition fees by Rmb1,000 to Rmb2,000 annually. To facilitate students with financial difficulties, Tarena partners with five banks and financial institutions to provide financing services to students. About 55% of Tarena’s students enrolled in 2016 obtained financing from these partners. Prior to its IPO, Tarena offered a choice of instalment payments, where students only had to start paying six months after completing a course. This legacy issue caused Tarena to incur significant bad debt provisions over the past three years. Currently, instalment payments are limited to students enrolled through the university channel, and management targets to limit bad debt provision to 1% of revenue in FY17F (FY16: 2.1%). As of 1Q17, 6% of students were enrolled under the instalment payment plan.

110

Education│China│Tarena International Inc│September 19, 2017

Key success factor 1: High-quality education and solid job placement network allow Tarena to charge a premium Employs industry veterans as instructors: Tarena employs instructors who have industry background in global and domestic technology companies or are veterans in their respective specialised fields. While all the instructors are based in Beijing, Tarena is able to ensure high teaching quality as students nationwide learn the same content through simultaneous webcasts. The instructors are responsible for developing course content in their respective subject areas, as well as produce practice exercises and exam questions for monthly performance tests to evaluate students’ comprehension.

Figure 9: Instructors listed on Tarena’s website

Previously worked at Baidu, responsible for SEM account management and optimization, new staff training, and project management.

Previously worked at China Steel Network, Avatar e- commerce, Tarena International.

Possesses 6 years of work experience in marketing operations field.

SOURCES: CIMB, COMPANY REPORTS

Strong job placement record: Tarena has a strong network of c.90,000 corporate employers that include Global Fortune 500 companies and leading tech companies in China. Besides providing corporate employers with candidate referral services and other recruitment-related services, Tarena also offers customised courses that target specific employers with large demand for trained professionals. Under this initiative, prospective students undergo interviews by corporate employers prior to the start of courses. In addition to Tarena’s standard curriculum, students have to participate in additional training tailored to the particular skill requirements of the employers. Successful graduates who pass the relevant qualifying exams are then granted job offers by the employers. Tarena also has full-time career counsellors stationed at each learning centre to offer career advice, and has developed its own job search portal (www.jobshow.cn) to connect its students with corporate employers. As a result, Tarena is able to achieve a high job placement record consistently. In 2Q17, Tarena successfully maintained a six-month post-graduation job placement rate of c.95% (consistently above 90% since listing in 2014).

111

Education│China│Tarena International Inc│September 19, 2017

Figure 10: Tarena’s job search portal – www.jobshow.cn Figure 11: Java-related job postings on www.jobshow.cn

SOURCES: JOBSHOW.CN SOURCES: JOBSHOW.CN

Tuition fee premium: Due to its high-quality teachers, useful training courses and strong track record of high job placement rates, Tarena is able to charge a premium for its classes over its peers. We found that Tarena charges between Rmb18,800 and Rmb20,800 for a full Java course, which is at the higher end of the local industry range (see Figure 12 below). Tarena is also typically able to raise its tuition fees by Rmb1,000 annually, i.e. 3-5% yoy.

Figure 12: Comparison of tuition fees for Java course (2017) Company Tuition fee Tarena (达内) Rmb18,800 to Rmb20,800 Aptech (北大青鸟) Rmb7,000 to Rmb 17,000 Atguigu (尚硅谷) Rmb14,800 to Rmb18,800 Heima (黑马) Rmb16,980 to Rmb19,980 Itxdl (兄弟连) Rmb12,800 Bjsxt (尚学堂) Rmb16,980 Itcast (传智播客) Rmb24,980 SOURCE: CIMB RESEARCH, COMPANY

Key success factor 2: Unique teaching approach enables greater scalability of business Three-pronged teaching approach: Tarena’s teaching approach combines live distance instruction, classroom-based tutoring and online learning modules. For each course, instructors deliver lectures from one classroom in Beijing to students in the same classroom, as well as to students at other learning centres nationwide through simultaneous webcasts. Every classroom is staffed with teaching assistants to tutor and supervise students. Students also have access to Tarena’s proprietary learning management “Tarena Teaching System” (TTS), which acts as a platform for course content distribution, instructor-student interaction and self-assessments. Part-time students are allowed to complete a portion of their lessons online, through an online platform called “Tarena Massive Open Online Course” (TMOOC), which was launched in Mar 2015 and offers Tarena’s proprietary content library. The TMOOC platform is also available to the public through a subscription model and acts as a marketing platform for Tarena.

112

Education│China│Tarena International Inc│September 19, 2017

Figure 13: Screenshot of online learning through TMOOC

SOURCE: CIMB RESEARCH, COMPANY

Quick expansion: Due to the unique dual-teacher teaching approach, Tarena is able to expand quickly without sacrificing teaching quality – new centres are typically operational within seven weeks of opening as there is no need to recruit and train local instructors (classroom-based tutors are typically Tarena graduates). Tarena expanded from 34 learning centres in 11 cities in 2011 to 145 learning centres in 46 cities to 2016. The high scalability and utilisation rates have enabled Tarena to enjoy high gross margins in excess of 70% since FY14, above those of its peers including New Oriental Education (EDU US, Add, TP: US$114.30) and TAL Education (TAL US, Add, TP:US$40.30). In FY16, Tarena reported non-GAAP GPM of 71.8%, versus EDU’s 58.4% and TAL’s 51.0%.

Figure 14: Gross margin comparison between local informal education peers

80.0% Title: 71.7% 71.8% 70.7% 71.6% 72.1% Source: 70.0%

58.4% 58.3% 59.1% 59.7% 60.0% 57.8% Please fill in the values above to have them entered in your report 53.2% 51.0% 49.9% 50.7% 51.3% 50.0%

40.0%

30.0%

20.0%

10.0%

0.0% FY15 FY16 FY17F FY18F FY19F

New Oriental Edu TAL Edu Tarena

Note: *Numbers reflected for New Oriental Education (FYE May) and TAL Education (FYE Feb) for FY17 are actual numbers; Tarena International’s (FYE Dec) gross margin for FY17 is based on our forecast. SOURCES: CIMB FORECASTS, COMPANY REPORTS

113

Education│China│Tarena International Inc│September 19, 2017

Key success factor 3: Up-to-date courses and partnerships with universities ensure strong enrolment Course offerings: Tarena has historically been able to adapt quickly to the rapid changes in demand through the launching of new courses related to high- growth segments within the IT industry. According to management, it typically takes six months to develop a new course. Prior to developing a new course, Tarena carries out a feasibility study by collecting data on job market demand conditions and conducting a series of surveys. Instructors with appropriate industry experience and academic background will then be recruited, and course content developed. After that, the courses will be pilot tested in selected learning centres in Beijing to ensure student satisfaction and training practicality before being officially rolled out group-wide.

Figure 15: Tarena's course offerings Figure 16: Tarena’s course enrolment breakdown (number of students) Year of launch Subject 35,000 Title: 2002 Java Source: 526 1,725 2007 .NET 30,000 994 2009 C++, Software testing, Embedded 699 883 Please fill in the values above to have them entered in your report 25,000 11,218 12,861 2010 PHP 246 8,827 10,475 Android 10,060 2011 20,000 9,847 7,370 iOS 8,634 2012 9,687 Linux and network engineering, Digital art, Online sales and 15,000 2013 marketing 6,673 2014 Accounting 10,000 19,600 17,920 17,310 17,687 15,660 16,838 Big data, Web front-end development, K-12 computer 14,230 14,147 12,329 2015 programming, K-12 digital art 5,000 8,494 2016 VR/AR, K-12 robot programming, K-12 3D printing 0 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17

IT courses Non-IT courses K-12 courses

SOURCES: CIMB, COMPANY REPORTS SOURCES: CIMB, COMPANY REPORTS

Strong partnerships with universities: The university channel is an important source of student enrolment for Tarena, contributing 14.8% of total enrolment in FY16. Tarena cooperates with over 690 universities and colleges in China mainly through the following three methods: 4) Joint majors: Tarena offers joint-major programmes with 103 universities and colleges in China. Students are allowed to take Tarena’s courses full-time for one semester and receive academic credits upon successful completion of the course. 5) On-campus learning sites: Tarena established over 144 on-campus learning sites to offer students the ability to complete part of the courses on-campus and the rest at its centres. Under this partnership, Tarena pays universities for the rental of classroom facilities but does not have to share revenue. 6) Enrolment cooperation: Its cooperation with over 690 universities allows Tarena to organise marketing and promotional events on campus. Besides these three main forms of cooperation, Tarena also signed a strategic cooperation agreement with Renmin University School of Continuing Education. Students who successfully complete Tarena’s programmes can enrol in Renmin’s programmes for further studies without having to pass college entrance exams. In 2017, Tarena also entered into a cooperation agreement with Ping An Insurance to increase its attractiveness to university students. By paying an insurance premium of Rmb280 per month, students will be offered compensation of Rmb12,000 should they fail to find a job within six months of completing Tarena’s courses, effectively covering the bulk of their tuition fees.

114

Education│China│Tarena International Inc│September 19, 2017

As Tarena increases its level of collaboration with universities, management guided that a rising proportion of students are being recruited through these cooperation programmes with universities YTD, including joint-major programmes or on-campus learning sites (1H17: c.50% of students enrolled through university channels or c.7% of total enrolment). The joint major programmes and on-campus learning sites are effectively business-to-business-to-consumer (B2B2C) models. Compared to Tarena’s typical business-to-consumer (B2C) recruitment model, under which Tarena carries out individual student recruitment process, the new business model allows Tarena to conduct bulk student recruitment through the university channel. Besides potentially lowering student acquisition costs, we believe the cooperation with universities could create significant long-term value for Tarena by strengthening its brand image. However, as the course length for such programmes is longer (3-4 years) versus Tarena’s typical programmes (four months), this would result in slower revenue recognition for students recruited through such channels. As such, we expect short-term negative impact on revenue growth, and forecast topline growth to be slightly pressured at 25.0% in FY17F before reaccelerating to 25.4% yoy in FY18F.

Figure 17: Student enrolment breakdown, by recruitment channel

120000 Title: Source: 100000 15,880 Please fill in the values above to have them entered in your report 80000 13,652

60000 10,538 6,846 91,613 5,807 40000 70,389 49,422 51,487 20000 43,970

0 FY14 FY15 FY16 1H16 1H17

Retail channel University channel

SOURCES: CIMB, COMPANY REPORTS

SWOT analysis Strengths  High teaching quality, boosted by instructors with solid practical experience.  Strong reputation allows Tarena to charge fee premium over its peers.  Unique teaching approach allows great scalability of business.  Solid partnerships with universities and corporate employers. Weaknesses  Heavy marketing spending due to non-recurring nature of courses offered.  Strong seasonality – affected by changes in timing of Chinese New Year.  Provision of instalment plans exposes Tarena to bad debt risk. Opportunities  K-12 segment presents huge earnings growth potential.  Further expansion into lower-tier cities. Threats  Intensifying competition could hurt Tarena’s ability to raise prices annually.  Failure to catch up with the latest tech trends.  Lack of demand for K-12 initiative.

115

Education│China│Tarena International Inc│September 19, 2017

Financials Forecast 24.6% revenue CAGR for FY16-19F We forecast that Tarena will achieve a sustained 3-year revenue CAGR of 24.6% (FY16-19F), driven by the growth in course enrolment numbers (from 102k in FY16 to 174k in FY19F), as well as a steady increase in tuition fees.

Figure 18: Tarena's revenue trend

3,500.0 Title: 3,054.4 Source: 3,000.0 Please fill in the values above to have them entered in your report 2,476.4 2,500.0

1,974.4 2,000.0 1,579.6

(Rmb m) 1,500.0 1,178.0

1,000.0 836.9 570.8 500.0 358.5

0.0 FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F

SOURCES: CIMB FORECASTS, COMPANY REPORTS

Opening of new learning centres: We forecast that Tarena will continue its rapid expansion of 30 centres per year in FY17-19F, helped by its unique teaching approach that allows Tarena to set up a new learning centre in a short period of time. Currently, Tarena only has presence in 53 cities. Management plans to accelerate its penetration into tier-3 and tier-4 cities, and targets to enter 5-10 new cities annually. Each Tarena learning centre typically consists of 8-10 classrooms with 30-40 seats. Apart from opening new learning centres, Tarena expands existing learning centres by leasing more floor area, resulting in its annual seat capacity expanding at a faster rate than the growth in number of learning centres. We estimate Tarena’s annual seat capacity to witness a 3-year CAGR of 19.2%, from 193k in FY16 to 327k in FY19F.

Figure 19: Tarena’s learning centres Figure 20: Tarena’s annual seat capacity (determined as sum of quarterly seating capacity)

250 235 350,000 Title: 327,238 Title: Source: Source: 205 300,000 279,866 200 175 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 250,000 234,225 145 150 193,073 134 200,000 118 157,706

Centres 150,000 100 92

57 100,000 50 34 50,000

0 0 FY11 FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F FY15 FY16 FY17F FY18F FY19F

Learning centres Seat capacity

SOURCES: CIMB FORECASTS, COMPANY REPORTS SOURCES: CIMB FORECASTS, COMPANY REPORTS

116

Education│China│Tarena International Inc│September 19, 2017

Expansion-driven enrolment growth: We expect the expansion of learning centres into lower-tier cities to be the main driver of Tarena’s enrolment growth, and forecast Tarena’s student enrolment to increase 17.4-19.3% yoy in FY17- 19F. Tarena typically reports two enrolment numbers – student enrolment and course enrolment. Unlike student enrolment numbers that typically serve as a lead indicator, course enrolment numbers are more aligned with revenue recognition. This is because revenues are recognised evenly across four months of the course duration. For example, a student enrolled in Mar is recorded in the 1Q student enrolment number but only generates revenue in Apr to Jul; under the course enrolment metric, the student is counted as 0.75 course enrolment in 2Q and 0.25 course enrolment in 3Q.

Figure 21: Tarena’s student enrolment vs. course enrolment

200,000 Title: 177,783 180,000 174,228 Source:

160,000 151,450 146,907 Please fill in the values above to have them entered in your report 140,000 128,186 121,814 120,000 107,493 102,298 100,000 84,041 78,730 80,000 59,960 58,264 60,000 46,458 42,086 31,940 40,000 28,975 20,000

0 FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F

Student enrolments Course enrolments

SOURCES: CIMB FORECASTS, COMPANY REPORTS

Tuition fee increases: Tarena typically raises tuition fees by Rmb1,000 to Rmb2,000 annually. In 2016, Tarena also launched an initiative called “Teaching at Appropriate Levels”, under which five courses were redesigned into two levels – basic level and advanced level. Advanced level courses are priced at a Rmb2,000 premium over the basic level courses. Management targets for advanced level courses to account for 25% of total enrolment in FY17F. As a result, we expect Tarena’s ASP to accelerate in FY17F by 5.0%, and continue expanding at a steady pace of 4.0% yoy in FY18-19F.

Figure 22: Steady tuition fee increases

18,000 10% Title:

17,000 9% Source:

16,000 8% Please fill in the values above to have them entered in your report 15,000 7%

14,000 6%

13,000 5%

12,000 4%

11,000 3%

10,000 2%

9,000 1%

8,000 0% FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F

LHS: ASP (Rmb) RHS: yoy change (%)

SOURCES: CIMB FORECASTS, COMPANY REPORTS

117

Education│China│Tarena International Inc│September 19, 2017

Tarena’s biggest cost of sales components are variable costs, which have been generally consistent over the past years. Key costs include: 1) personnel and welfare costs (combined 39% of FY16 cost of sales), and 2) rental costs (28%).

We expect gross margin (GPM) to recover in FY18-9F after short-term pressure: We expect non-GAAP GPM to dip from 71.8% in FY16 to 70.7% in FY17F, before gradually recovering to 72.1% in FY19F. We expect a short-term dip in gross margins in FY17F due to the negative impact from the K-12 initiative ramp-up, while utilisation rate remains low. Also, we project that Tarena will continue to expand its learning centre network at a fast pace of c.30 learning centres per year, translating into c.20% increase in capacity annually. Given that the learning centres take c.2 years to achieve the company’s historical average GPM of c.70%, we expect gross margins to remain under pressure in FY17F. However, faster-than-expected ramp-up in K-12 segment enrolment or utilisation rates of existing learning centres could lead to upside surprise in GPM.

Expect operating margin (OPM) to be flattish in FY17-19F: We forecast Tarena’s non-GAAP OPM to be flattish at 18.8% in FY16 to 18.7% in FY19F, as we expect operating expenses to increase in line with revenue growth, given the non-recurring nature of Tarena’s business (courses typically last four months) limits the operational leverage that Tarena can enjoy. Specifically, we expect non-GAAP selling and marketing expenses to remain high at 33.4-33.9% of revenue in FY17-19F as Tarena spends heavily on online marketing to attract students. While Baidu (BIDU US, Not Rated) generally increases its cost-per-click (CPC) charges annually, we believe that Tarena will control CPC costs by continuously optimising the conversion ratio. Tarena’s conversion ratio improved from 8% in FY15 to 9% in FY16, and we expect it to further improve to 10% in FY17F. Furthermore, Tarena has become a key account (KA) for Baidu and as such, we expect Baidu to grant Tarena more marketing discounts going forward. We also expect Tarena’s R&D expense ratio to remain high between 4.0% and 4.5% in FY17-19F, as the group must consistently develop new courses to keep up with the advancement of technology to stay relevant.

Figure 23: Non-GAAP gross margin (GPM) Figure 24: Tarena’s non-GAAP operating expenses ratio (%)

73.0% 40.0% Title: Title:

72.1% 35.0% Source: Source: 71.8% 72.0% 71.7% 71.6% 30.0% 71.4% Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 25.0% 70.7% 71.0% 20.0%

15.0%

70.0% 10.0%

68.7% 5.0%

69.0% 68.7% 0.0% FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F

68.0% Selling and marketing expenses ratio (%) General and administrative expenses ratio (%)

67.0% Research and development expenses ratio (%) FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F OPM (non-GAAP)

SOURCES: CIMB FORECASTS, COMPANY REPORTS SOURCES: CIMB FORECASTS, COMPANY REPORTS

Effective tax rate: We expect Tarena’s effective tax rate to increase from 7.2% in FY16 to 10.0% in FY19F (Figure 25). Tarena enjoys tax benefits for some of its subsidiaries that qualify for tax exemption due to their status as “newly- established software enterprise”. As the tax exemptions and tax benefits phase out, we expect Tarena’s effective tax rate to increase gradually.

118

Education│China│Tarena International Inc│September 19, 2017

Net profit: Overall, we expect Tarena to register non-GAAP net profit 3-year CAGR of 23.2%, rising from Rmb309.7m in FY16 to Rmb579.4m in FY19F (Figure 26).

Figure 25: Effective tax rate Figure 26: Non-GAAP net profit trend

20.0% 18.9% 700 Title: 100% Title: Source: 579.4 Source: 18.0% 600 50% 500 16.0% Please fill in the values 444.0above to have them entered in your report Please fill in the values above to have them entered in your report 13.9% 400 0% 14.0% 309.7 326.0 300 12.0% 211.7 -50% 9.7% 10.0% 10.0% 200 173.3 10.0% 8.9%

(Rmb m) -100% 100 8.0% 7.2% 0 -150% 6.0% FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F -100 2.2% 4.0% -105.1 -200% -200 -178.9 2.0% -300 -250%

0.0% FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F LHS: Net profit (non-GAAP) RHS: yoy change (%)

SOURCES: CIMB FORECASTS, COMPANY REPORTS SOURCES: CIMB FORECASTS, COMPANY REPORTS

119

Education│China│Tarena International Inc│September 19, 2017

Figure 27: Income statement FYE Dec (Rmbm) 2012 2013 2014 2015 2016 2017F 2018F 2019F Net revenues 354.0 562.0 836.9 1,178.0 1,579.6 1,974.4 2,476.4 3,054.4 yoy change (%) 58.8% 48.9% 40.8% 34.1% 25.0% 25.4% 23.3%

Cost of revenue -110.7 -176.0 -240.1 -333.6 -449.1 -582.9 -706.7 -857.8 Gross profit (GAAP) 243.4 386.1 596.9 844.4 1,130.5 1,391.5 1,769.7 2,196.6 Gross margin (GAAP) 68.7% 68.7% 71.3% 71.7% 71.6% 70.5% 71.5% 71.9% Gross profit (Non-GAAP) 243.4 386.2 597.2 845.1 1,134.6 1,395.4 1,774.0 2,201.3 GPM (Non-GAAP) 68.7% 68.7% 71.4% 71.7% 71.8% 70.7% 71.6% 72.1%

Selling and marketing expenses -105.1 -183.2 -261.5 -385.0 -527.6 -674.2 -839.8 -1,025.9 As % of revenue 29.7% 32.6% 31.2% 32.7% 33.4% 34.1% 33.9% 33.6% General and administrative expenses -62.0 -98.2 -184.0 -251.3 -307.5 -374.2 -456.5 -549.4 As % of revenue 17.5% 17.5% 22.0% 21.3% 19.5% 18.9% 18.4% 18.0% Research and development expenses -11.2 -23.0 -33.5 -50.5 -65.6 -98.0 -114.0 -133.1 As % of revenue 3.2% 4.1% 4.0% 4.3% 4.2% 5.0% 4.6% 4.4% Operating profit (GAAP) 65.1 81.6 117.9 157.7 229.8 245.1 359.4 488.2 yoy% 25.5% 44.5% 33.7% 45.8% 6.7% 46.6% 35.8% Operating margin (GAAP) 18.4% 14.5% 14.1% 13.4% 14.6% 12.4% 14.5% 16.0%

Selling and marketing expenses (non-GAAP) -105.1 -182.9 -260.5 -383.0 -522.1 -668.7 -833.8 -1,019.2 As % of revenue 29.7% 32.5% 31.1% 32.5% 33.0% 33.9% 33.7% 33.4% General and administrative expenses (non-GAAP) -61.2 -94.3 -161.7 -223.0 -256.4 -323.3 -400.5 -487.9 As % of revenue 17.3% 16.8% 19.3% 18.9% 16.2% 16.4% 16.2% 16.0% Research and development expenses (non-GAAP) -11.1 -22.8 -32.2 -48.5 -58.5 -88.4 -103.5 -121.5 As % of revenue 3.1% 4.0% 3.8% 4.1% 3.7% 4.5% 4.2% 4.0% Operating profit (non-GAAP) 65.9 86.3 142.9 190.6 297.7 315.0 436.2 572.7 yoy% 31.0% 65.7% 33.4% 56.2% 5.8% 38.5% 31.3% Operating margin (non-GAAP) 18.6% 15.3% 17.1% 16.2% 18.8% 16.0% 17.6% 18.7%

Interest income 7.2 9.3 26.8 42.7 24.0 19.8 23.5 29.0 Other income 1.1 7.8 14.6 11.8 16.0 20.9 25.1 32.6 Loss on foreign currency forward contract 0.0 0.0 0.0 0.0 -12.9 0.0 0.0 0.0 Foreign currency exchange gains (losses) 0.0 0.0 7.4 -29.5 3.8 -2.3320 0.0 0.0 Profit before taxation 73.3 98.8 166.6 182.7 260.6 283.6 408.0 549.8 PBT margin 20.7% 17.6% 19.9% 15.5% 16.5% 14.4% 16.5% 18.0%

Income tax expense -13.8 -13.8 -14.8 -4.0 -18.8 -27.4 -40.8 -55.0 Effective tax rate 18.9% 13.9% 8.9% 2.2% 7.2% 9.7% 10.0% 10.0% Profit for the year 59.5 85.0 151.9 178.8 241.9 256.1 367.2 494.8 yoy change (%) 42.9% 78.6% 17.7% 35.3% 5.9% 43.4% 34.8% Accretion of convertible redeemable preferred shares -165.4 -268.6 -3.5 0.0 0.0 0.0 0.0 0.0 Profit attributable to shareholders (GAAP) -105.9 -183.5 148.3 178.8 241.9 256.1 367.2 494.8 yoy change (%) 73.3% -180.8% 20.5% 35.3% 5.9% 43.4% 34.8% Net profit margin (GAAP) -29.9% -32.7% 17.7% 15.2% 15.3% 13.0% 14.8% 16.2% Profit attributable to shareholders (non-GAAP) -105.1 -178.9 173.3 211.7 309.7 326.0 444.0 579.4 yoy change (%) 70.3% -196.9% 22.1% 46.3% 5.3% 36.2% 30.5% Net profit margin (non-GAAP) -29.7% -31.8% 20.7% 18.0% 19.6% 16.5% 17.9% 19.0% SOURCES: CIMB FORECASTS, COMPANY REPORTS

120

Education│China│Tarena International Inc│September 19, 2017

Figure 28: Balance sheet FYE Dec (Rmbm) 2012 2013 2014 2015 2016 2017F 2018F 2019F Assets Current assets Cash and cash equivalents 98.8 159.4 261.0 513.9 810.7 884.6 1,294.4 1,623.5 Time deposits 0.0 0.0 653.7 449.9 416.7 416.7 416.7 416.7 Restricted time deposits 0.0 0.0 0.0 150.0 0.0 0.0 0.0 0.0 Accounts receivable 87.3 91.5 141.9 147.0 97.4 183.9 168.9 266.3 Prepaid expenses and other current assets 22.8 30.7 53.4 66.1 126.1 157.6 197.7 243.8 Total current assets 208.9 281.6 1,110.0 1,326.9 1,450.9 1,642.8 2,077.7 2,550.3

Non-current assets Time deposits 4.8 74.1 105.9 114.2 58.7 58.7 58.7 58.7 Accounts receivable 16.3 2.5 9.1 7.8 1.2 1.2 1.2 1.2 Property and equipment 49.8 78.1 81.8 127.9 437.3 527.0 586.6 616.2 Goodwill 0.0 0.0 0.0 0.0 3.4 3.4 3.4 3.4 Long term investments 0.0 0.0 0.0 24.0 41.8 41.8 41.8 41.8 Other non-current assets 6.0 12.8 26.7 53.1 91.8 91.8 91.8 91.8 Total non-current assets 76.9 167.6 223.6 327.0 634.2 723.8 783.4 813.0

Total assets 285.8 449.2 1,333.7 1,653.9 2,085.0 2,366.6 2,861.1 3,363.3

Liabilities Current liabilities Accounts payable 0.5 1.3 2.0 4.4 4.5 6.7 6.9 9.6 Amounts due to a related party 0.6 0.0 0.0 0.9 0.1 0.1 0.1 0.1 Income taxes payable 9.3 18.4 33.0 56.3 91.2 99.9 113.3 127.4 Deferred revenue 58.9 94.4 118.0 164.5 266.1 274.9 403.6 433.2 Other current liabilities 19.6 40.3 51.6 79.8 117.9 117.9 117.9 117.9 Total current liabilities 88.7 154.5 204.6 305.9 479.7 499.4 641.7 688.2

Non-current liabilities Other non-current liabilities 1.1 1.5 10.0 9.3 7.0 7.0 7.0 7.0 Total non-current liabilities 1.1 1.5 10.0 9.3 7.0 7.0 7.0 7.0

Total liabilities 89.9 155.9 214.6 315.3 486.8 506.5 648.7 695.3

Mezzanine equity: Series A convertible redeemable preferred shares 3.0 2.6 0.0 0.0 0.0 0.0 0.0 0.0 Series B convertible redeemable preferred shares 83.4 96.0 0.0 0.0 0.0 0.0 0.0 0.0 Series C convertible redeemable preferred shares 322.7 580.5 0.0 0.0 0.0 0.0 0.0 0.0 Total mezzanine equity 409.1 679.1 0.0 0.0 0.0 0.0 0.0 0.0

Equity Class A ordinary shares 0.0 0.0 0.1 0.3 0.3 0.3 0.3 0.3 Class B ordinary shares 0.1 0.1 0.2 0.1 0.1 0.1 0.1 0.1 Treasury shares 0.0 0.0 0.0 -49.4 -93.8 -93.8 -93.8 -93.8 Additional paid-in capital 0.0 0.0 831.5 907.0 995.2 995.2 995.2 995.2 Accumulated other comprehensive income 3.0 10.0 10.4 30.2 58.2 58.2 58.2 58.2 Retained earnings -216.2 -395.9 276.9 450.3 638.2 900.1 1,252.3 1,708.0 Total shareholders' equity -213.2 -385.8 1,119.1 1,338.6 1,598.2 1,860.2 2,212.4 2,668.0 Total liabilities and shareholders' equity 285.8 449.2 1,333.7 1,653.9 2,085.0 2,366.6 2,861.1 3,363.3 SOURCES: CIMB FORECASTS, COMPANY REPORTS

121

Education│China│Tarena International Inc│September 19, 2017

Figure 29: Cash flow statement FYE Dec (Rmbm) 2012 2013 2014 2015 2016 2017F 2018F 2019F Cash flows from operating activities Net income 58.2 85.6 151.9 178.8 241.9 256.1 367.2 494.8 Depreciation 14.8 28.4 43.5 55.0 72.8 110.4 140.4 170.4 Bad debt expense 2.6 5.7 46.0 63.1 33.6 0.0 0.0 0.0 Loss on disposal of property and equipment 0.0 0.4 1.1 0.5 0.3 0.0 0.0 0.0 Deferred income tax benefit -0.1 -6.4 -4.2 -21.6 -18.9 0.0 0.0 0.0 Share based compensation expense 0.8 4.7 25.0 32.9 67.8 69.9 76.8 84.5 Other income 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Foreign currency exchange losses (gains), net 0.0 1.2 -6.6 29.5 -3.8 0.0 0.0 0.0 Changes in operating assets and liabilities Accounts receivable -67.1 6.8 -103.0 -66.9 22.9 -86.5 15.0 -97.4 Prepaid expenses and other current assets -6.1 -3.3 -15.1 -16.7 -60.4 -31.5 -40.1 -46.1 Accrued interest income on time deposits 0.0 -2.0 -17.6 -0.7 5.3 0.0 0.0 0.0 Other non-current assets -2.6 -2.9 -4.0 -3.8 -7.1 0.0 0.0 0.0 Accounts payable -0.8 0.0 -0.3 0.5 -0.2 2.2 0.2 2.7 Amounts due to a related party 0.0 0.0 0.0 0.9 -0.8 0.0 0.0 0.0 Income taxes payable 6.8 8.7 14.6 23.3 34.9 8.7 13.4 14.2 Deferred revenue 31.9 33.2 23.5 46.6 101.4 8.8 128.7 29.7 Accrued expenses and other current liabilities 6.4 20.7 12.0 27.4 36.8 0.0 0.0 0.0 Other non-current liabilities 0.5 0.3 8.6 -1.1 -2.6 0.0 0.0 0.0 Net cash provided by operating activities 45.4 181.1 175.3 347.7 524.0 338.0 701.6 652.8

Cash flows from investing activities Purchase of property and equipment -43.8 -55.5 -48.4 -100.0 -382.0 -200.0 -200.0 -200.0 Proceeds from disposal of property and equipment 0.2 0.3 0.2 1.0 0.4 0.0 0.0 0.0 Purchase of short term investments 0.0 -68.9 -622.8 -945.0 -1,937.0 0.0 0.0 0.0 Proceeds from maturity of short term investments 0.0 68.9 622.8 945.0 1,937.0 0.0 0.0 0.0 Purchase of long-term investments 0.0 0.0 0.0 -24.0 -12.8 0.0 0.0 0.0 Payment for acquisition of Hanru Hangzhou 0.0 0.0 0.0 -1.0 -4.4 0.0 0.0 0.0 Cash acquired from acquisition of Hanru Hangzhou 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.0 Purchase of time deposits -4.8 -105.4 -708.1 -639.0 -421.2 0.0 0.0 0.0 Proceeds from maturity of time deposits 4.2 39.4 22.3 690.3 678.7 0.0 0.0 0.0 Issuance of loans to employees -4.0 -2.1 -3.0 -1.2 -18.5 0.0 0.0 0.0 Proceeds from repayment of loans from employees 0.0 4.2 2.5 1.6 3.1 0.0 0.0 0.0 Net cash used in investing activities -48.3 -119.1 -734.5 -72.3 -156.4 -200.0 -200.0 -200.0

Cash flows from financing activities Proceeds from bank borrowings 1.8 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Repayment of bank borrowings -1.8 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Amounts received on behalf of a related party 4.1 0.9 0.0 1.4 0.0 0.0 0.0 0.0 Repayment of amounts received on behalf of a related party -4.5 -1.4 0.0 -1.4 0.0 0.0 0.0 0.0 Advances from a related party 1.9 0.9 0.0 0.0 0.0 0.0 0.0 0.0 Repayment of advances from a related party -1.9 -0.9 0.0 0.0 0.0 0.0 0.0 0.0 Issuance cost of convertible redeemable preferred shares -0.9 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Issuance of Class A ordinary shares 0.0 0.0 676.7 22.5 20.4 0.0 0.0 0.0 Payment of dividend 0.0 0.0 0.0 0.0 -54.0 -64.0 -91.8 -123.7 Repurchase of treasury shares 0.0 0.0 0.0 -49.4 -44.4 0.0 0.0 0.0 Payment of IPO costs 0.0 -3.0 -21.7 0.0 0.0 0.0 0.0 0.0 Net cash (used)/generated in financing activities -1.4 -3.6 655.0 -26.9 -78.0 -64.0 -91.8 -123.7

Effect of foreign currency exchange rate changes 0.3 2.2 5.8 4.4 7.2 0.0 0.0 0.0 Net increase in cash and cash equivalents -4.0 60.6 101.7 252.9 296.7 73.9 409.8 329.1 Cash and cash equivalents at beginning of year 102.7 98.8 159.4 261.0 513.9 810.7 884.6 1,294.4 Cash and cash equivalents at end of year 98.8 159.4 261.0 513.9 810.7 884.6 1,294.4 1,623.5 SOURCES: CIMB FORECASTS, COMPANY REPORTS

122

Education│China│Tarena International Inc│September 19, 2017

3Q17F preview Expect net revenue growth of 18.9% We project net revenue growth of 18.9% yoy in 3Q17F, at the higher end of management’s guidance range of 15.4-18.9% yoy increase. Our forecasts for growth in 3Q17F course enrolments and ASP are 14.3% and 4.0% yoy, respectively. Our expectation for deceleration in 3Q17F revenue growth is mainly due to the increasing proportion of students recruited through the new cooperation programmes with universities this year (1H17: c.50% of students enrolled through university channel, or c.7% of total enrolment), including joint-major programmes and on-campus learning sites. As the length of such programmes are longer (3-4 years) versus Tarena’s typical programmes (four months), we believe this would result in slower revenue recognition for students recruited through such channels. However, we believe this negative impact on revenue growth would only be short term and expect topline growth would reaccelerate to 25.4% yoy in FY18F (FY17F: 25.0%).

Margins may remain under pressure in 3Q17F We expect Tarena’s non-GAAP GPM to remain under pressure in 3Q17F at 74.7%, or a 0.4% pt decline yoy. K-12 would still be in ramp-up period during the quarter and its utilisation rate would still be low, which would have negative impact on GPM in 3Q17F, in our view. Tarena also added 26 learning centres in 1H17, which translate into net seating capacity addition of 11.6% YTD. Given that the learning centres typically take two years to reach historical group average GPM of c.70%, we expect GPM to remain under pressure for the remainder of FY17F. We also expect Tarena’s selling and marketing expenses-to-sales ratio to remain high in 3Q17F as the group continues to spend on brand-building activities in newly-penetrated cities. Tarena is also investing more on research & development as it prepares to launch three new courses in 2H17F. Overall, we forecast Tarena to record a non-GAAP OPM of 23.5% in 3Q17F, or -2.9% pts yoy.

Figure 30: 3Q17F results preview FYE Dec (Rmbm) 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17F 4Q17F 2016 2017F Net revenues 269.5 365.1 481.0 464.0 332.7 455.8 571.8 614.1 1,579.6 1,974.4 yoy% 55.8% 44.3% 29.4% 22.0% 23.5% 24.8% 18.9% 32.3% 34.1% 25.0% Cost of revenue -95.9 -108.9 -120.9 -123.4 -127.8 -143.5 -145.8 -165.8 -449.1 -582.9 Gross profit (GAAP) 173.5 256.3 360.1 340.6 204.9 312.3 426.0 448.3 1,130.5 1,391.5 Gross profit margin (GAAP) 64.4% 70.2% 74.9% 73.4% 61.6% 68.5% 74.5% 73.0% 71.6% 70.5% Gross profit (Non-GAAP) 174.0 257.1 361.1 342.5 205.1 312.6 427.2 450.5 1,134.6 1,395.4 GPM (Non-GAAP) 64.6% 70.4% 75.1% 73.8% 61.6% 68.6% 74.7% 73.4% 71.8% 70.7% Selling and marketing expenses -112.9 -126.4 -149.7 -138.5 -141.1 -162.4 -183.6 -187.2 -527.6 -674.2 As a % of revenue 41.9% 34.6% 31.1% 29.9% 42.4% 35.6% 32.1% 30.5% 33.4% 34.1% General and administrative expenses -64.5 -78.7 -79.8 -84.6 -79.8 -93.2 -95.9 -105.2 -307.5 -374.2 As a % of revenue 23.9% 21.5% 16.6% 18.2% 24.0% 20.5% 16.8% 17.1% 19.5% 18.9% Research and development expenses -15.8 -11.4 -16.8 -21.5 -18.2 -20.7 -26.0 -33.1 -65.6 -98.0 As a % of revenue 5.9% 3.1% 3.5% 4.6% 5.5% 4.5% 4.5% 5.4% 4.2% 5.0% Operating profit (GAAP) -19.7 39.7 113.8 96.0 -34.1 36.0 120.5 122.8 229.8 245.1 Operating profit margin (GAAP) -7.3% 10.9% 23.7% 20.7% -10.3% 7.9% 21.1% 20.0% 14.6% 12.4% Operating profit (non-GAAP) -3.9 54.5 127.1 120.0 -23.0 55.2 134.4 148.4 297.7 315.0 Operating profit margin (non-GAAP) -1.4% 14.9% 26.4% 25.9% -6.9% 12.1% 23.5% 24.2% 18.8% 16.0% Interest income 9.2 5.2 4.3 5.4 3.5 4.9 5.7 5.7 24.0 19.8 Other income 3.0 2.2 5.7 5.1 7.1 4.6 4.6 4.6 16.0 20.9 Loss on foreign currency forward contract -19.7 6.8 0.0 0.0 0.0 0.0 0.0 0.0 -12.9 0.0 Foreign currency exchange gains (losses) 2.8 -6.5 1.3 6.2 -0.5 -1.8 0.0 0.0 3.8 -2.3 Profit before taxation -24.4 47.3 125.0 112.6 -24.1 43.7 130.9 133.1 260.6 283.6 Income tax expense -0.1 -4.0 -4.7 -9.9 -0.5 -5.8 -10.5 -10.7 -18.8 -27.4 Effective tax rate (%) -0.6% 8.4% 3.8% 8.8% -2.1% 13.3% 8.0% 8.0% 7.2% 9.7% Profit attributable to shareholders (GAAP) -24.5 43.3 120.3 102.7 -24.6 37.9 120.4 122.5 241.9 256.1 Net profit margin (GAAP) -9.1% 11.9% 25.0% 22.1% -7.4% 8.3% 21.1% 19.9% 15.3% 13.0% Profit attributable to shareholders (non-GAAP) 10.9 51.3 133.6 126.7 -13.5 57.1 134.3 148.1 309.7 326.0 Net profit margin (non-GAAP) 4.1% 14.0% 27.8% 27.3% -4.1% 12.5% 23.5% 24.1% 19.6% 16.5% SOURCE: CIMB FORECASTS, COMPANY

123

Education│China│Tarena International Inc│September 19, 2017

Valuation and recommendation Initiate coverage with Add rating and TP of US$16.70 We initiate coverage on Tarena with an Add rating. We derive our target price of US$16.70 using DCF methodology with a WACC of 10.0%.

Figure 31: DCF valuation

FCF computation (Rmb m) FY16 FY17F FY18F FY19F FY20F FY21F FY22F FY23F FY24F FY25F FY26F FY27F FY28F FY29F EBIT 297.7 315.0 436.2 572.7 591.3 610.5 630.4 650.9 672.0 693.9 716.4 739.7 763.7 788.6 Taxes -18.8 -27.4 -40.8 -55.0 -56.8 -58.6 -60.5 -62.5 -64.5 -66.6 -68.8 -71.0 -73.3 -75.7 NOPAT 278.9 287.5 395.4 517.7 534.5 551.9 569.9 588.4 607.5 627.2 647.6 668.7 690.4 712.8 NOPAT growth 3.1% 37.5% 30.9% 3.3% 3.3% 3.3% 3.3% 3.3% 3.2% 3.3% 3.3% 3.3% 3.3% D&A 72.8 110.4 140.4 170.4 175.5 180.9 186.4 192.0 197.8 203.8 210.0 216.4 222.9 229.7 Funds from operation 351.6 397.9 535.8 688.1 710.1 732.8 756.2 780.4 805.3 831.1 857.6 885.0 913.3 942.5 Change in net w orking Capital 130.3 -98.4 117.2 -97.0 -101.8 -106.9 -112.3 -117.9 -123.8 -130.0 -136.5 -143.3 -150.4 -158.0 Cash flow from operation 482.0 299.5 653.0 591.1 608.3 625.9 643.9 662.5 681.6 701.1 721.2 741.8 762.9 784.6 Capex -382.0 -200.0 -200.0 -200.0 -210.0 -220.5 -231.5 -243.1 -255.3 -268.0 -281.4 -295.5 -310.3 -325.8 Free cash flow from operation 100.0 99.5 453.0 391.1 398.3 405.4 412.4 419.4 426.3 433.1 439.8 446.3 452.6 458.8 FCF growth -0.4% 355.2% -13.7% 1.8% 1.8% 1.7% 1.7% 1.6% 1.6% 1.5% 1.5% 1.4% 1.4%

Terminal free cash flow 6,750.8 Total discounted free cash flow 2,905.8 Present value of terminal free cash flow 2,092.1

Total present value of forecasted free cash flows 4,997.9 Less: Net Debt -1,360.0 Equity Value 6,357.9 No. shares (m) 56.3 End-CY18F per share equity value (Rmb) 112.9 Exchange rate 6.8 Target price (US$) 16.7 SOURCE: CIMB RESEARCH, COMPANY

Figure 32: WACC assumptions (%) Cost of equity 10.0% Risk free 3.0% Market Risk Premium 7.0% Beta 1.00

Cost of debt 5.0% Kd (after tax) 4.5%

Target Debt / (Debt + Equity) 0% Target Equity / (Debt + Equity) 100%

WACC 10.00%

Terminal growth 3.0% SOURCE: CIMB RESEARCH, COMPANY

The WACC of 10.0% in our DCF approach uses a beta of 1.0. In addition, we use a risk-free rate of 3.0%, and market risk premium of 7.0%. We assume a perpetual growth rate of 3.0%. Our target price implies a CY18F P/E of 14.4x, 0.7 s.d. below Tarena’s historical average forward P/E of 15.9x. We believe Tarena has been oversold following its 2QFY17 results release and deserves a re-rating due to the continued ramp- up of its K-12 programme. We believe the K-12 programme will lead to higher margins in the long run and it also offers a stronger recurring student base.

124

Education│China│Tarena International Inc│September 19, 2017

Figure 33: Tarena’s forward P/E trend Figure 34: Tarena’s forward PEG trend

26 0.6 Title: Title: Source: Source: 24 0.46x 0.5 22 Please fill in the values above to have them entered in your report Please fill in the values above to have them entered in your report 0.4 0.36x 20 18.2x 18 0.3 15.9x 16 0.27x 0.2 14

13.7x 0.1 12

10 0

P/E Ratio Average +1 s.d. -1 s.d. PEG Ratio Average +1 s.d. -1 s.d.

SOURCES: CIMB RESEARCH, BLOOMBERG SOURCE: CIMB RESEARCH, BLOOMBERG

Figure 35: Education sector peer comparison 3-year Dividend yield Price TP Mkt cap P/E (x) EPS P/BV (x) PEG (x) (x) Company Ticker Recom. (LC$) (LC$) (US$) CY17F CY18F CY19F CAGR (%) CY17F CY18F CY17F CY18F CY17F CY18F China education ADR New Oriental Education EDU US Add 87.16 114.30 13,743 40.2 30.6 23.3 31.5% 7.1 5.8 1.3 1.0 0.5% 0.5% TAL Education TAL US Add 33.01 40.30 16,533 67.9 52.9 34.8 57.6% 18.4 12.7 na 1.0 0.0% 0.0% Bright Scholar Education BEDU US Non Rated 21.89 na 2,567 68.9 41.7 na na 20.4 16.0 na na 0.0% 0.0% Tarena International TEDU US Add 14.49 16.70 830 17.2 12.6 9.7 23.2% 2.9 2.4 0.9 0.6 1.2% 1.7% China Distance Education DL US Non Rated 6.90 na 227 12.4 13.0 na -6.0% 3.8 3.5 na na 6.5% 6.5%

China H-share education Virscend Education 1565 HK Non Rated 4.78 na 1,868 38.0 26.0 19.9 29.5% 4.6 4.1 na na 1.4% 1.7% China Maple Leaf Education 1317 HK Add 8.23 9.60 1,458 25.7 19.5 na 23.9% 4.1 3.7 1.1 0.8 1.8% 2.3% China Yuhua Education 6169 HK Add 3.80 4.50 1,518 16.8 13.9 na 19.4% 3.0 2.8 1.0 0.9 2.9% 3.0% Wisdom Education 6068 HK Non Rated 4.25 na 1,131 25.7 20.0 16.5 43.6% 3.9 3.5 na na 1.2% 1.6% Minsheng Education 1569 HK Non Rated 2.00 na 1,030 20.3 16.9 15.4 20.8% 2.0 1.8 4.1 3.4 0.6% 0.7% China New Higher Education 2001 HK Non Rated 4.56 na 831 22.1 17.6 14.3 50.9% 3.0 2.7 na na 1.3% 1.8%

International education Grand Canyon Education LOPE US Non Rated 83.23 na 4,005 21.7 20.3 18.1 14.3% na na 1.4 1.4 0.0% 0.0% Adtalem Global Education ATGE US Non Rated 34.95 na 2,170 12.6 11.5 na 10.0% na na 1.3 1.2 1.0% 1.0% Strayer Education STRA US Non Rated 83.01 na 927 24.9 22.0 19.2 11.0% na na 1.7 1.5 0.0% 0.0% Capella Education CPLA US Non Rated 68.30 na 797 19.3 18.6 15.2 7.8% na na 1.9 1.9 2.4% 2.5% Daekyo Co 019680 KS Non Rated 8300.00 na 620 17.3 17.7 16.9 9.2% 1.2 1.2 na na 2.9% 2.9% Note: As of 19 Sep 2017 SOURCE: CIMB RESEARCH, BLOOMBERG

Looking at comparable companies’ earnings outlook and valuations, our forecasts show that Tarena offers a 3-year non-GAAP EPS CAGR of 23.2% (FY16-19F), which is relatively lower than those of its fellow informal education peers – New Oriental Education (EDU US, Add, TP: US$114.30) with 31.5% and TAL Education (TAL US, Add, TP: US$40.30) with 57.6%. In terms of CY18F PEG, Tarena is currently trading at 0.59x, which is much lower than EDU’s and TAL’s 1.0x. While we believe Tarena deserves to trade at a PEG discount to EDU and TAL due to its lower level of recurring revenue from its student base, we are of the view that the valuation discount implied by current market valuation is too wide. Stripping out its cash holdings, we estimate that Tarena currently trades at 9.3x ex-cash non-GAAP CY18F P/E, with potential dividend yield of 1.7% in CY18F. We believe the education sector is perceived by investors as fairly defensive, as there is always demand from students for high-quality education. In our view, an economic downturn could benefit Tarena, as unemployed graduates could be

125

Education│China│Tarena International Inc│September 19, 2017

more willing to spend time improving their skillset to increase the chances of landing a new job. Tarena de-rated significantly in Aug 2017 post-2Q17 results announcement, given the greater-than-expected margin pressure and management’s weak revenue growth guidance for 3Q17F due to the short-term pressure arising from the structural shift in university channel recruitment. However, we believe the weak near-term earnings outlook has been priced in, and expect the stock to re-rate from current levels given: 1) the anticipated acceleration of K-12 learning centre openings, 2) likely continued growth in enrolment numbers, with further expansion into lower-tier cities, and 3) wider coverage/interest in the stock now that its market cap has surpassed the US$1bn level.

126

Education│China│Tarena International Inc│September 19, 2017

Risks Increase in marketing spending that drives student enrolment numbers Tarena’s professional education course offerings are non-recurring in nature – most students study full time, and typically only enrol in one Tarena course before going on to enter the workforce. As a result, Tarena heavily invests in advertising to increase its student enrolment numbers. Average advertising spend per student enrolled was Rmb1,994 in 2Q17. Online channels contributed the bulk of student enrolments (last reported figure in 4Q16: 61%). Therefore, we think Tarena is susceptible to increasing online advertising costs, especially due to the revision in Baidu’s advertising policy.

Difficulty in raising tuition fees Tarena typically raises its tuition fees by Rmb1,000 to Rmb2,000 annually, which has minimal impact on student enrolment growth due to its strong reputation as an IT professional training provider. However, Tarena may not be able to implement annual tuition fee hikes if: 1) it fails to adjust the curriculum to changes in market demand, or 2) its reputation is tarnished. Furthermore, the lower average salary in lower-tier cities compared to higher-tier cities may mean that Tarena may find it challenging to raise tuition fees annually in those cities.

Slower-than expected K-12 initiative ramp-up Tarena launched its childhood education programmes – Tongcheng (computer programming) and Tongmei (digital art training) –for K-12 students in Dec 2015. These were followed by the Tongchuang (robotics programming) course. As Tarena has been primarily engaged in adult vocational training programmes prior to the launch of such courses, it has limited experience in providing courses that cater to children. Given that Tarena has yet to establish its reputation in this area, enrolment in its K-12 initiative may rise more slowly than expected.

Expansion into lower-tier cities may harm margins Tarena plans to expand into 5-10 cities annually in FY17-19F. While management guided that learning centres in lower-tier cities could contribute higher margins than in higher-tier cities due to lower personnel costs and rental costs, we are concerned about the speed of utilisation ramp-up at learning centres located in lower-tier cites, given the lower supply of IT-related job opportunities and the time needed for Tarena to establish its reputation in new cities.

127

Education│China│Tarena International Inc│September 19, 2017

Appendix Management profile Han Shaoyun – Founder, Chairman and Chief Executive Officer. Mr Han has served as the Chairman and CEO of Tarena since its inception. Prior to founding Tarena in Sep 2002, Mr Han was the deputy chief engineer and director of the software division of AsiaInfo-Linkage between 1995 and 2002, responsible for software research and development and corporate management. Mr Han received his bachelor’s degree in computer application from Jilin University in China.

Yang Yuduo – Chief Financial Officer. Mr Yang served as Tarena’s co-CFO since Nov 2015, and CFO since Apr 2016. Prior to joining Tarena, Mr Yang gained finance-related experience in Beijing Fengshun Lubao Car Auction, Bybon Group, South Beauty Group, Google and Lucent Technologies. Mr Yang received his bachelor’s degree in economics from Renmin University of China, as well as an MBA degree from Fordham University.

Sun Ying – Vice President. Ms Sun has served as a vice president in Tarena since Dec 2009, and is responsible for the company’s nationwide operations. She joined Tarena in Jun 2005 as the general manager of Beijing learning centres, and was later the general manager in charge of Tarena’s operations in northern regions of China between 2007 and 2009. Prior to joining Tarena, Ms Sun served in various sales and human resources related roles in Gloria Hotels and Resorts. Ms Sun received her bachelor’s degree in tourism economics management from Dongbei University of Finance and Economics in China.

Qi Yinan – Vice President. Mr Qi has served as a vice president in Tarena since Sep 2013, and is responsible for student recruitment through retail channels. Mr Qi joined Tarena in Mar 2007, and rotated between various roles including general manager in charge of Tarena’s operations in northern regions of China, deputy general manager of northern regions, deputy general manager of Beijing learning centres and director of Hangzhou learning centre. Prior to joining Tarena, Mr Qi had experience in Beijing GAMFE Tech Co and Zhonghe Wangxun (Beijing) Information Technology Co Ltd. Mr Qi received his bachelor’s degree in optoelectronic technology from China Jiliang University and his master’s degree in multimedia technologies from University of Science and Technology Beijing.

128

Education│China│Tarena International Inc│September 19, 2017

Shareholding structure

Figure 36: Tarena’s shareholding structure (as of end-FY16)

SOURCE: COMPANY REPORTS

129

Education│China│Tarena International Inc│September 19, 2017

BY THE NUMBERS

P/BV vs ROE 12-mth Fwd FD Core P/E vs FD Core EPS 4.70 50% 34.0 Growth 1,560%

4.20 27% 29.0 1,200% 3.70 3% 24.0 840% 3.20 -20% 19.0 480% 2.70 -43% 2.20 -67% 14.0 120% 1.70 -90% 9.0 -240% Jan-13A Jan-14A Jan-15A Jan-16A Jan-17F Jan-18F Jan-13A Jan-14A Jan-15A Jan-16A Jan-17F Jan-18F

Rolling P/BV (x) (lhs) ROE (rhs) 12-mth Fwd Rolling FD Core P/E (x) (lhs) FD Core EPS Growth (rhs)

Profit & Loss

(Rmbm) Dec-15A Dec-16A Dec-17F Dec-18F Dec-19F Total Net Revenues 1,178 1,580 1,974 2,476 3,054 Gross Profit 844 1,131 1,391 1,770 2,197 Operating EBITDA 213 303 356 500 659 Depreciation And Amortisation (55) (73) (110) (140) (170) Operating EBIT 158 230 245 359 488 Financial Income/(Expense) 43 24 20 23 29 Pretax Income/(Loss) from Assoc. 0 0 0 0 0 Non-Operating Income/(Expense) (18) 7 19 25 33 Profit Before Tax (pre-EI) 183 261 284 408 550 Exceptional Items Pre-tax Profit 183 261 284 408 550 Taxation (4) (19) (27) (41) (55) Exceptional Income - post-tax Profit After Tax 179 242 256 367 495 Minority Interests Preferred Dividends FX Gain/(Loss) - post tax Other Adjustments - post-tax Net Profit 179 242 256 367 495 Recurring Net Profit 212 310 326 444 579

Fully Diluted Recurring Net Profit 212 310 326 444 579

Cash Flow

(Rmbm) Dec-15A Dec-16A Dec-17F Dec-18F Dec-19F EBITDA 212.7 302.6 355.5 499.8 658.6 Cash Flow from Invt. & Assoc. Change In Working Capital 13.3 137.4 (98.4) 117.2 (97.0) (Incr)/Decr in Total Provisions Other Non-Cash (Income)/Expense (3.8) (7.1) 0.0 0.0 0.0 Other Operating Cashflow 125.5 91.1 80.8 84.6 91.2 Net Interest (Paid)/Received 0.0 0.0 0.0 0.0 0.0 Tax Paid Cashflow From Operations 347.7 524.0 338.0 701.6 652.8 Capex (100.0) (382.0) (200.0) (200.0) (200.0) Disposals Of FAs/subsidiaries 946.0 1,937.5 0.0 0.0 0.0 Acq. Of Subsidiaries/investments (970.0) (1,954.1) 0.0 0.0 0.0 Other Investing Cashflow 51.6 242.1 0.0 0.0 0.0 Cash Flow From Investing (72.3) (156.4) (200.0) (200.0) (200.0) Debt Raised/(repaid) 0.0 0.0 0.0 0.0 0.0 Proceeds From Issue Of Shares 22.5 20.4 0.0 0.0 0.0 Shares Repurchased (49.4) (44.4) 0.0 0.0 0.0 Dividends Paid 0.0 (54.0) (64.0) (91.8) (123.7) Preferred Dividends Other Financing Cashflow Cash Flow From Financing (26.9) (78.0) (64.0) (91.8) (123.7) Total Cash Generated 248.5 289.5 73.9 409.8 329.1 Free Cashflow To Equity 275.4 367.6 138.0 501.6 452.8

Free Cashflow To Firm 275.4 367.6 138.0 501.6 452.8 SOURCE: CIMB RESEARCH, COMPANY DATA

130

Education│China│Tarena International Inc│September 19, 2017

BY THE NUMBERS… cont’d

Balance Sheet

(Rmbm) Dec-15A Dec-16A Dec-17F Dec-18F Dec-19F Total Cash And Equivalents 514 811 885 1,294 1,623 Total Debtors 147 97 184 169 266 Inventories Total Other Current Assets 666 543 574 614 661 Total Current Assets 1,327 1,451 1,643 2,078 2,550 Fixed Assets 128 437 527 587 616 Total Investments 24 42 42 42 42 Intangible Assets 0 3 3 3 3 Total Other Non-Current Assets 175 152 152 152 152 Total Non-current Assets 327 634 724 783 813 Short-term Debt Current Portion of Long-Term Debt Total Creditors 5 5 7 7 10 Other Current Liabilities 301 475 493 635 679 Total Current Liabilities 306 480 499 642 688 Total Long-term Debt Hybrid Debt - Debt Component Total Other Non-Current Liabilities 9 7 7 7 7 Total Non-current Liabilities 9 7 7 7 7 Total Provisions 0 0 0 0 0 Total Liabilities 315 487 506 649 695 Shareholders' Equity 1,339 1,598 1,860 2,212 2,668 Minority Interests Total Equity 1,339 1,598 1,860 2,212 2,668

Key Ratios

Dec-15A Dec-16A Dec-17F Dec-18F Dec-19F Revenue Growth 40.8% 34.1% 25.0% 25.4% 23.3% Operating EBITDA Growth 31.8% 42.3% 17.5% 40.6% 31.8% Operating EBITDA Margin 18.1% 19.2% 18.0% 20.2% 21.6% Net Cash Per ADS (Rmb) 9.56 14.60 15.70 22.98 28.82 BVPADS (Rmb) 24.90 28.78 33.02 39.28 47.37 Gross Interest Cover N/A N/A N/A N/A N/A Effective Tax Rate 2.17% 7.20% 9.68% 10.00% 10.00% Net Dividend Payout Ratio 28.4% 25.3% 25.0% 25.0% 25.0% Accounts Receivables Days 44.75 28.31 26.00 26.00 26.00 Inventory Days - - - - - Accounts Payables Days 3.48 3.63 3.50 3.50 3.50 ROIC (%) 17.8% 26.3% 29.4% 34.4% 49.7% ROCE (%) 16.3% 17.3% 15.3% 18.8% 21.2% Return On Average Assets 9.2% 11.7% 10.7% 13.2% 15.1%

SOURCE: CIMB RESEARCH, COMPANY DATA

131

Education│Hong Kong│September 19, 2017

Company Note │ Alpha series

Hong Kong China Yuhua Education Corp ADD Leading all-round K12 player Consensus ratings*: Buy 8 Hold 1 Sell 0 ■ Yuhua is the largest provider of the full-range of private education (from kindergarten to university) in China, based on enrolments in the 2015/16 school year. Current price: HK$3.80 ■ We forecast topline growth to accelerate by 10.2%/9.5% yoy in FY18/19F, driven by Target price: HK$4.50 the opening of three new high schools and an increase in university tuition fees. Previous target: N/A ■ Yuhua’s prudent expansion plan provides high visibility for strong margin expansion Up/downside: 18.4% and earnings growth, driven by increasing utilisation rates. CIMB / Consensus: 30.0% ■ We also believe that Yuhua’s high-quality teaching staff bodes well for the company’s plan to expand outside of Henan Province in the medium term. Reuters: 6169.HK ■ We initiate coverage with an Add rating and DCF-based TP of HK$4.50. Bloomberg: 6169 HK Market cap: US$1,459m No. 1 private education player in Henan HK$11,400m As operator of 25 schools in Henan, Yuhua is the largest provider of the full-range of Average daily turnover: US$3.23m private education (from kindergarten to university) in China, based on enrolments in the HK$25.22m 2015/16 school year, according to Frost & Sullivan. Yuhua’s high-quality all-rounded education services have supported good student enrolment numbers. Also, its strong Current shares o/s: 2,180m track record of university admission (21.7% admission rate to key universities in 2017) Free float: 25.0% has helped Yuhua capture the growing demand for premium education services from *Source: Bloomberg China’s growing middle class. Key changes in this note Tuition fee increases to boost revenue growth in FY18-19F N/A Yuhua typically raises its university tuition fees every three years and K-12 fees by c.3- 5% p.a., subject to government approval. After four years of no hikes in university tuition

Price Close Relative to HSI (RHS) fees, Yuhua raised them by an average of Rmb2,000 in the 2017/18 school year. While 4.30 173 this will only be applicable to incoming students, we expect the university segment’s ASP 3.80 157 3.30 141 to rise by 4.0% in FY18F and 3.5% in FY19F. Driven by higher tuition fees and enrolment 2.80 125 growth, we project 10.2%/9.5% yoy revenue growth in FY18F/FY19F (FY17F: 8.4%). 2.30 109 1.80 93 150 Increasing utilisation rate to aid margin expansion 100 We expect Yuhua to raise student capacity to 79,200 in 2018/19F, from 71,200 in the 50 2016/17 school year, by raising the utilisation of existing schools and adding new high

Vol m Vol schools within existing campuses. We expect one new high school in Xuchang in FY18F Feb-17 Apr-17 Jun-17 Aug-17 and one each in Kaifeng and Jiyuan in FY19F and FY20F. Given half of Yuhua’s existing Source: Bloomberg K-12 schools were established within the past 5 years, we expect overall utilisation to rise

Price performance 1M 3M 12M to 75% in FY19F (FY16: 67.7%), and GPM to improve to 55.6% in FY19F (FY16: 52.0%). Absolute (%) 34.8 34.3 High quality teaching staff to help Yuhua expand beyond Henan Relative (%) 30.7 24.4 Yuhua plans to expand its school network beyond Henan Province in the medium term. We expect its high-quality teaching staff to help support Yuhua’s future expansion. Yuhua Major shareholders % held normally recruits good quality university graduates and trains them internally. With its Li Guangyu 75.0 premium compensation, Yuhua has managed to keep a low staff turnover rate. For K12 schools, Yuhua plans to use a variety of expansion measures like greenfield projects, M&A, JVs, etc., while for university expansion, Yuhua plans to only use the M&A route. Insert Initiate coverage with Add rating and TP of HK$4.50 (WACC: 8.8%) We forecast Yuhua delivering a 3-year core net profit CAGR of 19.4% in FY16-19F, driven by new school openings, higher utilisation rates, rising tuition fees and operational leverage. We believe education is one of China’s most defensive sectors, given the commitment by families to their children’s future. Initiate coverage on Yuhua with an Add rating and a DCF-based TP of HK$4.50, which implies 16.5x CY18F core P/E, or CY18F PEG of 1.0x. Key risks include longer-than-expected ramp-up periods for new schools.

Financial Summary Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Analyst(s) Revenue (Rmbm) 698 781 847 933 1,022 Operating EBITDA (Rmbm) 181.8 411.7 372.5 488.1 593.4 Net Profit (Rmbm) 91.2 311.7 293.3 412.2 508.0 Normalised EPS (Rmb) 0.04 0.14 0.13 0.19 0.23 Normalised EPS Growth (56%) 242% (6%) 41% 23% FD Normalised P/E (x) 76.61 22.42 23.82 16.95 13.75 DPS (Rmb) 0.00 0.00 0.09 0.10 0.11 Dividend Yield 0.00% 0.00% 2.91% 3.00% 3.46%

EV/EBITDA (x) 40.22 16.94 14.90 11.04 8.72 Lei YANG, CFA P/FCFE (x) NA 46.41 68.25 18.50 14.89 T (86) 21 5047 1771 x108 Net Gearing 58.1% 1.1% (60.9%) (63.1%) (65.6%) E [email protected] P/BV (x) 11.65 7.66 3.00 2.79 2.55 ROE 16.5% 41.3% 18.2% 17.1% 19.5% ONG Khang Chuen % Change In Normalised EPS Estimates T (852) 2539 1326 Normalised EPS/consensus EPS (x) 1.22 1.28 1.32 E [email protected] SOURCE: COMPANY DATA, CIMB FORECASTS

IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE END OF THIS REPORT. IF THIS REPORT IS DISTRIBUTED IN Powered by the THE UNITED STATES IT IS DISTRIBUTED BY CIMB SECURITIES (USA), INC. AND IS CONSIDERED THIRD-PARTY AFFILIATED RESEARCH. EFA Platform

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Leading all-round K12 player

Company outlook Strong visibility for near-term growth Further development on existing campuses: Yuhua plans to add three more high schools in Xuchang, Kaifeng and Jiyuan over the next three years to meet the strong demand from students graduating from its middle schools. All three schools will be built on vacant land within existing school campuses, as Yuhua has already launched middle schools in these three cities. Yuhua is also consistently increasing the capacity of its university by building additional learning facilities. We forecast Yuhua’s effective capacity to increase from 71,200 in 2015/2016 academic year to 79,200 in 2018/2019F academic year. According to the management, a new campus with 5,000 student seat capacity typically requires an investment of c.Rmb200m. The Rmb200m capital will normally be invested in two phases – phase 1 with an investment of Rmb120m- 150m and phase 2 with Rmb50m-80m. New schools take approximately 2-3 years to achieve EBITDA breakeven (with c.28% utilisation rate), and the payback period is typically 5-7 years. When Yuhua enters a new city, it will normally first open primary and middle schools (or also kindergartens), and then expand to high school, so it can guarantee good student resources from its own middle school to enter its high school.

Figure 1: Total capacity (number of students) and overall utilization rate (%)

90,000 76.0% Title: 79,200 80,000 76,200 74.0% Source: 71,200 71,200 70,000 62,950 72.0% Please fill in the values above to have them entered in your report 60,000 55,300 70.0%

50,000 68.0%

40,000 66.0%

30,000 64.0%

20,000 62.0%

10,000 60.0%

0 58.0% FY14 FY15 FY16 FY17F FY18F FY19F

Total capacity Utilization rate

SOURCE: CIMB FORECAST, COMPANY

Boosting utilisation of existing schools: 12 out of Yuhua’s 24 existing K-12 schools were established over the past five years (starting from 2012/2013 academic year), and have much room for further upside in terms of utilisation rates. According to the management, optimal utilisation of a school is around 85%, above which management will consider a 2nd phase of expansion to increase capacity. We forecast Yuhua’s overall utilisation rate to rise to 75.0% in FY19F, from 67.7% in FY16.

133

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Figure 2: Utilization rates of schools Utilisation rate Commence ment date University of operation Location 2013/2014 2014/2015 2015/2016 2016/2017F 2017/2018F 2018/2019F Zhengzhou Technology and Business University Sep-09 Zhengzhou 72.5% 87.7% 83.5% 89.5% 91.5% 94.5% Subtotal 72.5% 87.7% 83.5% 89.5% 91.5% 94.5%

High School Zhengzhou YuHua Elite School Sep-01 Zhengzhou 84.5% 86.3% 88.5% 89.5% 90.5% 91.5% Jiaozuo YuHua Elite School Sep-11 Jiaozuo 49.4% 72.4% 92.3% 92.3% 92.3% 92.3% Luohe YuHua Elite School Sep-16 Luohe 0.0% 0.0% 0.0% 15.0% 30.0% 45.0% Xuchang YuHua Elite School Sep-17 Xuchang 0.0% 0.0% 0.0% 0.0% 10.0% 30.0% Kaifeng YuHua Elite School TBC Kaifeng 0.0% 0.0% 0.0% 0.0% 0.0% 10.0% Jiyuan YuHua Elite School TBC Jiyuan 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Subtotal 73.2% 81.8% 67.0% 71.3% 57.6% 54.1%

Middle School Zhengzhou YuHua Elite School Sep-01 Zhengzhou 101.5% 97.8% 82.2% 81.2% 80.2% 79.2% Xingyang YuHua Shengshi Elite School Sep-11 Xingyang 34.8% 45.0% 41.1% 42.0% 42.0% 42.0% Jiaozuo YuHua Elite School Sep-11 Jiaozuo 92.9% 77.4% 78.1% 80.0% 81.0% 84.0% Kaifeng YuHua Elite School Sep-12 Kaifeng 18.0% 33.7% 38.7% 40.0% 42.0% 44.0% Luohe YuHua Elite School Sep-13 Luohe 16.9% 37.3% 48.8% 52.0% 55.0% 58.0% Xuchang YuHua Elite School Sep-14 Xuchang 0.0% 21.5% 30.1% 40.0% 45.0% 50.0% Jiyuan YuHua Elite School Sep-14 Jiyuan 0.0% 8.5% 13.9% 20.0% 25.0% 30.0% Subtotal 45.5% 43.8% 44.2% 47.3% 49.3% 51.4%

Primary School Zhengzhou YuHua Elite Primary School Sep-05 Zhengzhou 84.7% 83.1% 87.3% 88.0% 88.0% 88.0% Jiaozuo YuHua Elite School Sep-11 Jiaozuo 63.7% 58.7% 68.7% 75.0% 76.0% 78.0% Kaifeng YuHua Elite School Sep-12 Kaifeng 42.8% 61.5% 58.7% 70.0% 75.0% 80.0% Luohe YuHua Elite School Sep-13 Luohe 12.6% 56.8% 50.9% 63.0% 73.0% 80.0% Xuchang YuHua Elite School Sep-14 Xuchang 0.0% 42.5% 50.4% 60.0% 70.0% 80.0% Jiyuan YuHua Elite School Sep-14 Jiyuan 0.0% 27.5% 33.4% 40.0% 45.0% 50.0% Subtotal 54.1% 54.7% 60.8% 68.4% 73.5% 78.3%

Kindergarten Zhengzhou YuHua Elite Bilingual Kindergarten Sep-05 Zhengzhou 90.4% 90.1% 94.8% 96.0% 98.0% 100.0% Xingyang YuHua Elite Kindergarten Sep-11 Xingyang 92.8% 92.4% 94.0% 95.0% 96.0% 97.0% Xinxiang Weibin District YuHua Elite Kindergarten Sep-11 Xinxiang 72.9% 83.1% 88.6% 90.0% 92.0% 94.0% Hebi Qibin District YuHua Elite Bilingual Kindergarten Sep-11 Hebi 83.7% 86.0% 87.4% 90.0% 92.0% 94.0% Jiaozuo Urbanisation Pilot Zone YuHua Elite Kindergarten Sep-11 Jiaozuo 69.0% 84.5% 89.0% 90.0% 92.0% 94.0% Luohe YuHua Elite Bilingual Kindergarten Sep-13 Luohe 11.3% 39.8% 61.5% 70.0% 80.0% 90.0% Xuchang Weidu District YuHua Elite Bilingual Kindergarten Sep-14 Xuchang 0.0% 28.0% 63.4% 70.0% 80.0% 90.0% Jiyuan YuHua Elite Bilingual Kindergarten Sep-14 Jiyuan 0.0% 27.8% 29.8% 30.0% 32.5% 35.0% Subtotal 72.3% 66.6% 76.6% 79.3% 83.3% 87.3%

Total 64.1% 69.2% 67.7% 72.9% 73.6% 75.0% SOURCE: CIMB FORECASTS, COMPANY

Tuition fee increases: Yuhua typically raises its university tuition fees once every three years. As it has not raised its tuition fees for the past four years, the management plans to raise the university tuition fees by an average of Rmb2,000 in the 2017/2018 school year. Given the price increase will only be applicable to new incoming students, we forecast the university ASP to increase by 4.0% in FY18F and 3.5% in FY19F. Yuhua normally raises K-12 tuition fees by c.3-5% every year, subject to government approval. However, Yuhua typically charges lower tuition fees for new campuses to attract student enrollment. Also, given Yuhua expanded into lower-tier cities with lower tuition fees in the last five years, we expect the average ASP growth for Grade 1-12 schools to be c.1-2% yoy for FY17-19F. We also expect kindergarten ASP to grow by 3% yoy p.a. between FY17F and FY19F. We believe Yuhua enjoys more flexibility in price changes in the kindergarten segment, as it no longer has to obtain approvals from the government on fee changes, due to changes in the price reform policy by the Henan government in Jun 2015.

134

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Figure 3: Historical tuition fee (Rmb) 2013/2014 2014/2015 2015/2016 2016/2017 University Bachelor's degree programmes 13,100~15,100 13,100~15,100 13,100~15,100 13,100~15,100 Junior college diploma programmes 8,900 8,900 8,900 8,900 High schools 20,000~33,000 21,000~31,500 19,500~33,500 20,500~35,500 Middle schools 8,000~33,000 11,000~31,500 12,000~33,500 13,000~35,500 Primary schools 8,000~30,000 14,500~32,000 14,000~34,000 15,000~39,000 Kindergartens 17,000~26,500 16,000~28,500 16,000~32,500 17,000~35,000 *Tuition fees shown above include boarding fees (for University and Grade 1-12 schools) and meal fees (for kindergartens and certain primary schools). **Beginning academic year 2015/2016, tuition fee range for Grade 1-12 schools fell yoy due to exclusion of meal fees from tuition fees of certain schools SOURCES: CIMB, COMPANY REPORTS

High quality teaching staff to help Yuhua’s strategic expansion out of Henan Yuhua plans to expand its school network into other developed regions with attractive market opportunities in the medium term. According to the management, it prefers regions with 1) a large young population, 2) high GDP, 3) local government with welcoming attitude towards private education, and 4) undersupply of public schools. We expect its high-quality teaching staff to support Yuhua’s future expansion. Yuhua normally recruits good quality university graduates and trains them by itself. With 3-5 years on-the-job training, these university graduates form part of Yuhua’s core teaching staff. With premium compensation, Yuhua maintains a low turnover rate. Management said it normally eliminates c.5% underperforming teachers every year, and the turnover rate is reasonably low at 3% every year. To ensure the quality of teaching staff in new schools, prior to the opening of a new school, Yuhua’s existing schools will recruit new teachers in advance and make them undergo mandatory training programmes. Upon completion of the construction of a new campus, experienced teachers from these existing schools will then be relocated to the new school; while the new teachers who have completed their training programmes will gradually take over the teaching positions of relocated teachers in the existing schools. Yuhua believes that this results in consistently high teaching quality across its school network. We believe Yuhua’s high-quality teaching staff bodes well for the company’s plan to expand into other regions outside of Henan Province. For the expansion of K12 schools, Yuhua plans to use flexible measures, e.g. green-field projects, M&A, cooperation, etc. While for the university expansion, Yuhua plans to only use M&A, given the new university licences are difficult to obtain now.

Potential M&A and cooperation with renowned foreign educational institutions Management is also looking for M&A opportunities to expand the university segment, given the difficulties in obtaining new licences. According to the management, potential targets should meet the following criteria: 1) no less than 10,000 enrolled students, 2) located in preferred regions, and 3) preference towards medical schools or institutes of education. Yuhua believes that with its extensive operational experience in private university management, the acquired universities will be able to achieve rapid expansion through higher operational efficiency. Yuhua is also exploring the possibility of partnering with foreign universities to set up international campuses in China. Management believes that such a move will boost Yuhua’s brand image and allow the school network to attract quality students globally. Currently, Yuhua is working on broadening its international course offerings and overseas exchange programmes with foreign educational institutes. A foreign education counselling office is also being planned to offer guidance to students interested in pursuing further education overseas.

135

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Transition towards asset-light model Yuhua currently has 25 schools, among which one is a university and the remaining 24 are K12 schools plus kindergartens. Among these 25 schools, 19 schools are located on Yuhua’s own land, while the remaining six schools are on rented campuses. Yuhua is also planning to selectively transition from its existing asset-heavy model to an asset-light model to expand its K-12 school network. Potential partners include local governments, property developers and other public and private school owners. This will allow Yuhua to reduce capital outlay and speed up expansion of its school network, in our view.

136

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Background Largest provider of private education, from kindergarten to university, in China Established in 2001, China Yuhua is the largest provider of private education, from kindergarten to university, in China, based on student enrolments in the 2015/2016 school year, according to Frost & Sullivan. China Yuhua has 24 K-12 schools and one university across nine cities, all located in the Henan Province. As of 2015/2016 school year, Yuhua had an aggregate of 48,220 students enrolled, including 25,063 students in its university and 23,157 students in K-12 schools.

Figure 4: Yuhua’s school network as at initial public offering in Feb 2017

SOURCES: CIMB, COMPANY REPORTS

Yuhua’s K-12 schools cover the full range of private fundamental education, from kindergarten to high school, providing it with the ability to attract students at an early age and maintain high quality and stable student resources for its higher level schools. Typically, students who have completed a phase of K-12 education prefer to stay on and continue their next phase of education in Yuhua’s school network. According to the management, around 50% of Yuhua’s middle school students enter its own high schools, accounting for 80% of its high schools’ total student numbers.

137

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Figure 5: Zhengzhou YuHua Elite School Figure 6: Zhengzhou YuHua Elite Bilingual Kindergarten

SOURCES: CIMB SOURCES: CIMB

Yuhua’s university – Zhengzhou Technology and Business University - offers comprehensive tertiary level education aimed at equipping students with the practical knowledge and skills to prosper in their careers. The university achieved the fastest growth among the five largest private higher education institutions in terms of student enrolment in the PRC over its seven years of development.

Figure 7: Zhengzhou Technology and Business University Figure 8: Zhengzhou Technology and Business University

SOURCES: CIMB SOURCES: CIMB

Key success factor #1: Quality education which focuses on nurturing all-rounded students Yuhua’s K-12 schools focus on providing high-quality education services to families in the middle- and upper-middle classes. Its dynamic and multifaceted education philosophy, as well as essential-qualities-oriented schools, differentiates it from public schools in China, which predominantly focus on preparing students for standardised tests. Academic achievements of Yuhua’s schools are well recognised. Since inception in 2001, a total of 12 students from Yuhua schools have been recognised as Zhuangyuan (状元), i.e. obtaining the highest score in provincial or city level university enrollment examinations (Gaokao, 高考). For the Gaokao administered examinations between 2014 and 2016, 14-18% of Yuhua’s participating high school students were admitted into “Key Universities” in China (重点本科大学), above Henan’s average of 8-9%. 87 of Yuhua’s students have also been successfully admitted to well-recognised overseas colleges and universities over the past three years.

138

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Figure 9: Admission rate into “Key Universities”

20% Title: 17.7% 18% Source:

16% 14.2% Please fill in the values above to have them entered in your report 14%

12% 11.4%

10% 9.1% 8.1% 8.2% 8%

6%

4%

2%

0% 2014 2015 2016

Yuhua's high schools Henan Province

“Key Universities”, or “Tier-one universities” refer to universities that were listed as participating universities in Project 211 and Project 985 initiated by the Ministry of Education (MOE) and the PRC government, with the intent of raising the standards and promoting the development of higher education in China. SOURCES: CIMB, COMPANY REPORTS, FROST & SULLIVAN

Yuhua’s K-12 school curriculum also includes diverse elective course offerings, which are designed to foster well-rounded personalities and nourish the individual talents of the students. The elective courses include a variety of art courses as well as international language courses. This has helped 471 Yuhua high school graduates get accepted into art or physical education schools, or art or physical education majors of reputable PRC universities over the past three years. Yuhua’s university, on the other hand, emphasises the practical application of knowledge so that students stand out in the job market upon graduation. Around 850 courses are offered currently, with many specifically tailored to cater to current and foreseeable job market trends. This has helped Yuhua’s graduates to achieve a higher initial employment rate versus average colleges and universities in China over the past three years, according to Frost & Sullivan.

Figure 10: Initial employment rates of university graduates

95% Title:

91.3% 91.0% Source: 90% Please fill in the values above to have them entered in your report

85% 83.3%

80% 77.4% 77.5% 77.7%

75%

70% 2014 2015 2016

Yuhua's university Colleges and universities in China SOURCES: CIMB, COMPANY REPORTS, FROST & SULLIVAN

Key success factor #2: Strong reputation leads to high business visibility and ability to charge premium fees The high-quality education provided by Yuhua allows the company to maintain a healthy student pipeline, as 1) existing students prefer continuing with Yuhua schools upon completion of each phase of K-12 education, and 2) strong student demand.

139

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

According to management’s estimates, the percentage of students graduating from Yuhua’s kindergartens who continued to attend Yuhua’s primary schools, and from Yuhua’s primary schools to Yuhua’s middle schools ranges from c.90% to 95%. From Yuhua’s middle schools to Yuhua’s high schools, the rate was around 50% (calculated based on schools located on the same or adjacent campuses). In Zhengzhou city where Yuhua has the longest operating history (and relatively more established reputation), the number of admission applications consistently exceed Yuhua’s seat capacity. For the 2015/2016 school year, the admission rates for Zhengzhou YuHua Elite School (high school), Zhengzhou YuHua Elite School (middle school), Zhengzhou YuHua Elite Primary School (primary school) and Zhengzhou YuHua Elite Bilingual Kindergarten (kindergarten) were 20.0%, 23.0%, 30.0% and 35.0%, respectively (these acceptance rates reflect the percentage accepted from the outside applicant pool, which excludes existing students applying to move up into the next school). As the China Yuhua brand gains wider recognition, we believe the company will be able to gain stronger pricing power with its customers due to 1) scarcity of seats in high-quality schools; 2) increasing spending power of the middle class; and 3) parents/families of new students willing to pay more for a perceived better education system.

Figure 11: 2015/2016 school year – Yuhua’s tuition fees vs. peers (Rmb) PRC Private Yuhua Wisdom Education China Maple Leaf Education University Bachelor's Degree (Henan Province) 13,100 - 15,100 na na 10,840 Junior College (Henan Province) 8,900 na na 7,060 High School 19,500 - 33,500 20,400 - 25,200 49,000 - 81,000** 7,719 Middle School 12,000 - 33,500 18,000 - 23,200 21,000 - 43,000 3,289 Primary School 14,000 - 34,000 13,000 - 21,000 18,000 - 39,000 2,567 Kindergarten 16,000 - 32,500 na 12,000 - 21,600 3,235 **China Maple Leaf utilises BC-certified programme for its high schools, which allows it to charge a premium SOURCES: CIMB, COMPANY REPORTS, FROST & SULLIVAN

Key success factor #3: Highly scalable business model We believe Yuhua’s commitment to centralised and standardised management is essential to the success of the business, and will continue to help the company successfully replicate its operating model in new markets. A set of detailed policies and guidelines is provided to assist principals of the schools with the management of daily operations and teaching activities of schools. The principals are required to report to Yuhua’s senior management on a weekly basis, providing them with direct access to the information critical to day-to-day operations. Meanwhile, the core aspects of schools’ operations, including finance, marketing, human resources, procurement, assets, outsourcing services and student enrolments, are managed centrally by the company. This allows an efficient allocation of resources among schools, enhancing operating efficiency and ensuring a consistent education quality throughout the school network.

140

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

SWOT Analysis Strengths  Strong academic track record; provides quality education which focuses on nurturing all-rounded students;  Strong reputation leads to high business visibility and ability to charge fee premium; and  Centralised and standardised management increases replicability of operating model in new markets. Weaknesses  Tuition fees increase is subject to necessary governmental approvals;  No prior experience of expanding outside of Henan; and  “Yuhua” brand still relatively young. Opportunities  Ample expansion opportunities both within and outside of Henan;  Growing brand will enable the company to steadily increase tuition fee; and  Unused land in existing campuses allows room for expansion on top of existing capacity. Threats  Regulatory risks to the education sector, notably the Decision on Amending the Law for Promoting Private Education of the PRC; and  Rebranding of schools may impact student enrolment.

141

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Financials Expect 9.4% revenue CAGR in FY16-19F We forecast that Yuhua will achieve a sustained 3-year revenue CAGR of 9.4% (FY16-19F), driven by the growth in student numbers (from 48,220 in 2015/2016 academic year to c.59,370 by 2018/19F), as well as a steady increase in tuition fees.

Figure 12: Revenue trend

1,200.0 Title: Source: 1,000.0 63.6 58.9 Please fill in the values above to have them entered in your report 800.0 54.4 51.0 42.5 577.6 600.0 518.5 32.3 478.8

(Rmb m) 435.8 375.0 400.0 331.1

200.0 380.6 314.0 356.1 235.9 280.2 294.6

0.0 FY14 FY15 FY16 FY17F FY18F FY19F

University Grade 1-12 schools Kindergartens

SOURCES: CIMB FORECASTS, COMPANY REPORTS

Utilisation improvement: 12 out of Yuhua’s 24 existing K-12 schools were established over the past five years (starting from 2012/2013 academic year), and have much room for further upside in terms of utilisation rates. Given the parents are typically more reluctant to transfer their kids to different schools before the end of a study cycle (Grade 6, Grade 9 and Grade 12), we are especially confident on utilisation improvement of the primary school segment (6 years of study programme) over the next three years. We forecast Yuhua’s overall utilisation rate to rise to 75.0% in FY19F, from 67.7% in FY16.

Further capacity expansion: Yuhua plans to add three more high schools in Xuchang, Kaifeng and Jiyuan over the next two to three years to meet the demands of graduating students from its middle schools. All these three schools will be built on vacant land within existing school campuses, as Yuhua has already launched middle schools in these three cities. Yuhua is also consistently increasing the capacity of its university by building additional learning facilities. We forecast Yuhua’s effective capacity to increase from 71,200 in 2015/2016 academic year to 79,200 in 2018/2019F academic year.

Figure 13: Yuhua’s student enrolment, total capacity and utilisation rate

90,000 75.0% 80% 72.9% 73.6% Title: 69.2% 80,000 67.7% 79,200 Source: 64.1% 76,200 70% 71,200 71,200 70,000 60% 62,950 Please fill in the values above to have them entered in your report 59,370 60,000 55,300 56,075 51,898 50% 50,000 48,220 43,579 40% 40,000 35,431 30% 30,000 20% 20,000

10,000 10%

0 0% FY14 FY15 FY16 FY17F FY18F FY19F

Student enrolment Total capacity Utilization rate

SOURCES: CIMB FORECASTS, COMPANY REPORTS

142

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Tuition fee increases: University: Yuhua typically raises its university tuition fees once every three years, subject to necessary governmental approvals. Management raised tuition fees by an average of Rmb2,000 in the 2017/2018 school year for new incoming students, post four years of not raising fees. We forecast university ASP to increase by 4.0% in FY18F and 3.5% in FY19F. Grade 1-12 schools: While Yuhua typically raises its K-12 tuition fees by c.3- 5% every school year, we pencil in a rather conservative 1-2% ASP growth for FY17-19F. We believe ASP growth for Grade 1-12 schools will be relatively muted as: 1) the mix of tuition fees has changed after it opened new schools in lower-tier cities, and 2) Yuhua typically charges lower tuition fees for new campuses to attract student enrolment. Kindergartens: We forecast kindergarten ASP to grow by 3% p.a. in FY17-19F. Yuhua enjoys more flexibility in price changes in the kindergarten segment, as it no longer has to obtain approvals from the government on fee changes, due to the changes in the price reform policy by the Henan government in Jun 2015.

Figure 14: ASP assumptions (Rmb)

25,000 23,740 Title: 22,227 21,438 21,361 21,575 21,791 Source:

20,000 Please fill in the values above to have them entered in your report 19,628 20,216 18,501 19,056 17,748 15,000 16,855 12,587 12,057 11,827 11,752 11,694 12,161

10,000

5,000

0 FY14 FY15 FY16 FY17F FY18F FY19F

University Grade 1-12 schools Kindergartens

*ASP refers to annual tuition fee per student SOURCES: CIMB FORECASTS, COMPANY REPORTS

Increase in utilisation rate to aid margin expansion Majority of Yuhua’s cost of revenue components are fixed costs (teaching staff costs account for c.50% of cost of revenue; depreciation and amortisation account for c.18%, and canteen expenses account for c.14-15%). Helped by increased utilisation of campuses and tuition fee increases, we expect Yuhua’s GPM to improve from 52.0% in FY16 to 55.6% in FY19F. Due to the introduction of share options for teaching staff post Yuhua’s IPO, we expect GPM in FY17F to be temporarily impacted by share-based compensation expenses. However, the negative impact will alleviate over the future years as bulk of the expenses are front-loaded.

143

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Figure 15: GPM assumptions

75% Title: 69.0% Source: 70% 66.0% 63.3% 65% 62.3% Please fill in the values above to have them entered in your report

60% 55.6% 53.7% 55% 52.0% 51.2% 49.2% 50% 45.3% 47.9% 46.4% 44.5% 45.6% 45.4% 44.9% 45.3% 44.4% 43.4% 44.3% 45% 42.2% 42.7% 42.5% 40.0% 40%

35% 2014 2015 2016 2017F 2018F 2019F

University Grade 1-12 schools Kindergartens Overall

SOURCES: CIMB FORECASTS, COMPANY REPORTS

Share-based compensation will hurt margins in near term We expect selling expenses of Yuhua to remain low at 0.5% of revenue as we believe the strong brand reputation of Yuhua allows it to attract students without the need for extensive marketing costs. Administrative costs are likely to increase in FY17F due to IPO costs and front- loaded share-based compensation expenses. With share-based compensation expenses set to ease and operating leverage set to increase with the increasing utilisation at newer schools, we expect administration costs to fall to 9.7% of revenues in FY19F after peaking at 17.9% in FY17F. Overall, we expect operating margin to be hurt by IPO related expenses and share based compensation in FY17F with an 8.2% pts drop to 35.0%, before recovering to 48.4% in FY19F.

Figure 16: Operating costs and margin

60.0% Title: Source: 48.4% 50.0% 43.2% 43.0% Please fill in the values above to have them entered in your report 37.6% 40.0% 35.0%

30.0%

17.9% 20.0% 16.6% 12.4% 9.7% 7.7% 7.8% 9.0% 10.0% 0.7% 0.6% 0.5% 0.5% 0.5% 0.5% 0.0% FY14 FY15 FY16 FY17F FY18F FY19F

Selling expenses Administrative expenses Operating margin

SOURCES: CIMB FORECASTS, COMPANY REPORTS

144

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Figure 17: Income statement FYE Aug (Rmbm) FY14 FY15 FY16 FY17F FY18F FY19F 1H16 2H16 1H17 2H17F Revenue 599.3 697.7 781.3 847.2 933.5 1,021.8 390.2 391.2 421.4 425.8 y/y % chg 16.4% 12.0% 8.4% 10.2% 9.5% 8.0% 8.8%

Cost of revenue -332.5 -379.4 -375.1 -413.5 -431.8 -453.7 -192.0 -183.1 -211.0 -202.5 Gross profit 266.8 318.3 406.2 433.7 501.7 568.1 198.2 208.0 210.4 223.3 Gross margin 44.5% 45.6% 52.0% 51.2% 53.7% 55.6% 50.8% 53.2% 49.9% 52.4%

Selling expenses -4.0 -4.4 -4.2 -4.2 -4.7 -5.1 -2.7 -1.5 -2.1 -2.1 As % of revenue 0.7% 0.6% 0.5% 0.5% 0.5% 0.5% 0.7% 0.4% 0.5% 0.5% Administrative expenses -46.3 -54.3 -70.4 -151.8 -115.5 -98.8 -34.1 -36.3 -90.3 -61.5 As % of revenue 7.7% 7.8% 9.0% 17.9% 12.4% 9.7% 8.7% 9.3% 21.4% 14.4% Other income 7.9 9.5 6.4 19.0 20.0 30.0 2.3 4.1 9.8 9.2 Other gains/(losses) 0.9 -153.6 -0.3 0.0 0.0 0.0 0.5 -0.8 0.0 0.0

Operating profit 225.3 115.5 337.7 296.6 401.5 494.2 164.1 173.6 127.8 168.9 Operating margin 37.6% 16.6% 43.2% 35.0% 43.0% 48.4% 42.1% 44.4% 30.3% 39.7%

Finance income 2.8 3.6 1.3 9.4 16.7 18.5 1.2 0.1 1.0 8.4 Finance expenses -20.3 -27.9 -27.3 -12.8 -6.0 -4.8 -15.2 -12.1 -6.8 -6.0 Profit before taxation 207.8 91.2 311.7 293.3 412.2 508.0 150.1 161.6 122.0 171.3 PBT margin 34.7% 13.1% 39.9% 34.6% 44.2% 49.7% 38.5% 41.3% 28.9% 40.2%

Income tax expense 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Effective tax rate 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Profit for the year 207.8 91.2 311.7 293.3 412.2 508.0 150.1 161.6 122.0 171.3 y/y % chg -56.1% 241.8% -5.9% 40.5% 23.2% -18.7% 6.0%

Extraordinary items 0.0 153.9 10.4 111.7 62.5 40.1 0.0 10.4 73.3 38.5 Adjusted Net Profit 207.8 245.1 322.1 405.0 474.7 548.1 150.1 172.0 195.2 209.8 y/y % chg 17.9% 31.4% 25.8% 17.2% 15.5% 30.1% 22.0% SOURCES: CIMB FORECASTS, COMPANY REPORTS

145

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Figure 18: Balance sheet FYE Aug (Rmbm) FY14 FY15 FY16 FY17F FY18F FY19F Assets Non-current assets Prepaid land lease payments 224.9 230.6 224.7 219.7 214.7 209.7 Property, plant and equipment 1,299.1 1,408.8 1,465.0 1,539.2 1,632.6 1,733.4 Intangible assets 1.2 1.5 1.8 1.6 1.4 1.2 Other non-current assets 22.8 24.1 20.6 20.6 20.6 20.6 Total non-current assets 1,547.9 1,665.0 1,712.1 1,781.1 1,869.2 1,964.8

Current assets Trade and other receivables 9.7 18.4 11.3 16.2 17.9 19.6 Financial instruments at fair 0.0 60.2 0.0 0 0 0 Cash and cash equivalents 259.4 154.3 305.0 1523.1 1663.4 1858.5 Restricted cash 0.0 58.0 0.0 0 0 0 Total current assets 269.1 291.0 316.3 1,539.4 1,681.3 1,878.1

Total assets 1,817.1 1,956.0 2,028.4 3,320.4 3,550.5 3,842.9

Liabilities Non-current liabilities Borrowings 0.0 140.0 195.0 60.0 50.0 40.0 Other non-current liabilities 62.8 54.6 37.9 37.9 37.9 37.9 Total non-current liabilities 62.8 194.6 232.9 97.9 87.9 77.9

Current liabilities Accruals and other payables 670.1 210.0 156.7 203.9 212.9 223.7 Deferred revenue 557.5 591.5 609.2 649.9 716.1 783.8 Borrowings 20.0 362.0 120.0 50.0 40.0 30.0 Total current liabilities 1,247.6 1,163.5 885.9 903.8 969.0 1,037.6

Total liabilities 1,310.4 1,358.1 1,118.8 1,001.7 1,056.9 1,115.5

Equity Combined capital 0.0 0.0 0.1 1318.3 1318.3 1318.3 Reserves 260.8 298.6 386.6 386.6 386.6 386.6 Retained earnings 245.9 299.3 523.0 613.8 788.7 1,022.6 Total equity 506.7 597.9 909.6 2,318.7 2,493.6 2,727.5

Total equity and liabilities 1,817.1 1,956.0 2,028.4 3,320.4 3,550.5 3,842.9 SOURCES: CIMB FORECASTS, COMPANY REPORTS

146

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Figure 19: Cash flow statement FYE Aug (Rmbm) FY14 FY15 FY16 FY17F FY18F FY19F Cash flows from operating activities Profit before income tax 207.8 91.2 311.7 293.3 412.2 508.0 Adjustments for: — Amortisation of prepaid land lease payments 4.1 5.0 5.1 5.0 5.0 5.0 — Depreciation of property, plant and equipment 52.6 61.1 68.7 75.8 86.6 99.2 — Amortisation of intangible assets 0.2 0.2 0.2 0.2 0.2 0.2 — Provision for impairment of trade receivables 1.0 0.1 0.0 0.0 0.0 0.0 — (Gains)/losses on disposal of property, plant and equipment -1.6 0.2 1.2 0.0 0.0 0.0 — Gains on disposal of prepaid land lease payments -0.3 0.0 -0.2 0.0 0.0 0.0 — Fair value gains on financial instruments at fair value through profit or loss 0.0 0.0 0.0 0.0 0.0 0.0 — Gains on disposal of financial instruments at fair value through profit or -0.2 -0.1 -1.5 0.0 0.0 0.0 — Fair value (gains)/losses on derivative instruments 0.0 -0.2 0.0 0.0 0.0 0.0 — Finance expenses — net 17.5 24.3 26.0 3.3 -10.7 -13.7 — Loss on disposal of a subsidiary 0.0 0.0 0.8 0.0 0.0 0.0 Changes in working capital: — Trade and other receivables 16.0 -1.1 2.0 -4.9 -1.7 -1.7 — Other non-current assets -12.2 -3.6 2.0 0.0 0.0 0.0 — Deferred revenue 146.5 34.0 19.8 40.7 66.2 67.7 — Accruals and other payables 33.7 -15.8 11.0 47.2 9.0 10.8 Cash generated from operations 465.1 195.3 446.8 460.7 566.9 675.5 Interest paid -19.7 -27.0 -26.7 -12.8 -6.0 -4.8 Net cash generated from operating activities 445.4 168.3 420.1 447.9 560.9 670.7

Cash flows from investing activities Disposal of a subsidiary, net of cash paid 0.0 0.0 -2.2 0.0 0.0 0.0 Purchases of property, plant and equipment -175.7 -176.7 -162.5 -150.0 -180.0 -200.0 Purchases of prepaid land lease payments -64.2 -11.5 0.0 0.0 0.0 0.0 Proceeds from disposal of property, plant and equipment 4.4 0.0 0.4 0.0 0.0 0.0 Proceeds from disposal of prepaid land lease payments 2.6 0.0 1.0 0.0 0.0 0.0 Purchases of intangible assets -0.3 -0.5 -0.6 0.0 0.0 0.0 Purchases of financial instruments at fair value through P&L -2.6 -100.0 -45.0 0.0 0.0 0.0 Disposal of financial instruments at fair value through P&L 18.6 40.1 106.7 0.0 0.0 0.0 Restricted bank deposits 90.0 -58.0 58.0 0.0 0.0 0.0 Interest received 3.4 2.9 2.0 9.4 16.7 18.5 Net cash used in investing activities -123.8 -303.7 -42.1 -140.6 -163.3 -181.5

Cash flows from financing activities Capital contribution from Owner 20.0 0.0 0.1 1318.3 0.0 0.0 Proceeds from borrowings 70.0 599.0 280.0 0.0 0.0 0.0 Repayments of borrowings -357.0 -117.0 -467.0 -205.0 -20.0 -20.0 Borrowings from Owner 75.5 96.7 65.5 0.0 0.0 0.0 Repayments of borrowings to Owner -92.7 -560.3 -58.6 0.0 0.0 0.0 Borrowings from related parties 10.0 347.0 80.0 0.0 0.0 0.0 Repayments of borrowings to related parties 0.0 -347.0 -90.0 0.0 0.0 0.0 Borrowings from third parties 25.0 36.8 4.0 0.0 0.0 0.0 Repayments of borrowings to third parties -17.3 -25.0 -40.8 0.0 0.0 0.0 Professional expenses paid in connection with issuance of new shares during listing process 0.0 0.0 -0.7 0.0 0.0 0.0 Dividend paid 0.0 0.0 0.0 -202.5 -237.4 -274.0 Net cash (used)/generated in financing activities -266.5 30.3 -227.5 910.8 -257.4 -294.0

Net increase/(decrease) in cash and cash equivalents 55.1 -105.1 150.6 1218.1 140.2 195.2 Cash and cash equivalents at beginning of year 204.3 259.4 154.3 305.0 1523.1 1663.4 Exchange gains on cash and cash equivalent 0.0 0.0 0.0 0.0 0.0 0.0 Cash and cash equivalents at end of year 259.4 154.3 305.0 1523.1 1663.4 1858.5 SOURCES: CIMB FORECASTS, COMPANY REPORTS

147

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Valuation & recommendation Initiate coverage with Add rating and TP of HK$4.50 We initiate coverage on China Yuhua with an Add rating. We derive our target price using the DCF methodology, with a WACC of 8.8%. Our target price implies a 16.5x CY18F core P/E or CY18F core PEG of 1.0x. The potential triggers for a re-rating are strong enrolment for the 2017/18 academic year.

Figure 20: DCF valuation

FCF computation (Rmb m) FY16 FY17F FY18F FY19F FY20F FY21F FY22F FY23F FY24F FY25F FY26F FY27F FY28F FY29F EBIT 337.7 296.6 401.5 494.2 511.5 529.4 548.0 567.1 587.0 607.5 628.8 650.8 673.6 697.2 Taxes 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 NOPAT 337.7 296.6 401.5 494.2 511.5 529.4 548.0 567.1 587.0 607.5 628.8 650.8 673.6 697.2 NOPAT growth -12.2% 35.4% 23.1% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% D&A 74.0 75.8 86.6 99.2 102.2 105.2 108.4 111.7 115.0 118.5 122.0 125.7 129.4 133.3 Funds from operation 411.7 372.5 488.1 593.4 613.7 634.7 656.4 678.8 702.0 726.0 750.8 776.5 803.0 830.5 Change in net w orking Capital 34.8 83.0 73.6 76.8 77.9 79.0 80.0 81.1 82.2 83.4 84.5 85.7 86.8 88.0 Cash flow from operation 446.5 455.5 561.7 670.3 691.6 713.6 736.4 759.9 784.2 809.4 835.3 862.1 889.9 918.5 Capex -162.5 -150.0 -180.0 -200.0 -200.0 -200.0 -200.0 -200.0 -200.0 -200.0 -200.0 -200.0 -200.0 -200.0 Free cash flow from operation 283.9 305.5 381.7 470.3 491.6 513.6 536.4 559.9 584.2 609.4 635.3 662.1 689.9 718.5 FCF growth 7.6% 25.0% 23.2% 4.5% 4.5% 4.4% 4.4% 4.3% 4.3% 4.3% 4.2% 4.2% 4.2%

Terminal free cash flow 8,390.9 Total discounted free cash flow 4,246.5 Present value of terminal free cash flow 3,049.7

Total present value of forecasted free cash flows 7,296.2 Less: Net Debt -1,413.1 Equity Value 8,709.4 No. Shares (millions) 2,186.7 Per Share Equity Value (Rmb) 4.0 Exchange rate 0.9 Target price (HK$) 4.5 SOURCE: CIMB RESEARCH, COMPANY

Figure 21: WACC assumptions (%) Cost of equity 9.3% Risk free 3.0% Market Risk Premium 7.0% Beta 0.90

Cost of debt 6.0% KD (after tax) 4.5%

Target Debt / (Debt + Equity) 10.0% Target Equity / (Debt + Equity) 90.0%

WACC 8.8%

Terminal growth 3.0% SOURCE: CIMB RESEARCH, COMPANY

The WACC of 8.8% in our DCF approach uses a beta of 0.9. In addition, we use a risk-free rate of 3.0%, and market risk premium of 7.0%. We assume a perpetual growth rate of 3.0%.

148

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Figure 22: Education sector peer comps 3-year Dividend yield Price TP Mkt cap P/E (x) EPS P/BV (x) PEG (x) (x) Company Ticker Recom. (LC$) (LC$) (US$) CY17F CY18F CY19F CAGR (%) CY17F CY18F CY17F CY18F CY17F CY18F China education ADR New Oriental Education EDU US Add 87.16 114.30 13,743 40.2 30.6 23.3 31.5% 7.1 5.8 1.3 1.0 0.5% 0.5% TAL Education TAL US Add 33.01 40.30 16,533 67.9 52.9 34.8 57.6% 18.4 12.7 na 1.0 0.0% 0.0% Bright Scholar Education BEDU US Non Rated 21.89 na 2,567 68.9 41.7 na na 20.4 16.0 na na 0.0% 0.0% Tarena International TEDU US Add 14.49 16.70 830 17.2 12.6 9.7 23.2% 2.9 2.4 0.9 0.6 1.2% 1.7% China Distance Education DL US Non Rated 6.90 na 227 12.4 13.0 na -6.0% 3.8 3.5 na na 6.5% 6.5%

China H-share education Virscend Education 1565 HK Non Rated 4.78 na 1,868 38.0 26.0 19.9 29.5% 4.6 4.1 na na 1.4% 1.7% China Maple Leaf Education 1317 HK Add 8.23 9.60 1,458 25.7 19.5 na 23.9% 4.1 3.7 1.1 0.8 1.8% 2.3% China Yuhua Education 6169 HK Add 3.80 4.50 1,518 16.8 13.9 na 19.4% 3.0 2.8 1.0 0.9 2.9% 3.0% Wisdom Education 6068 HK Non Rated 4.25 na 1,131 25.7 20.0 16.5 43.6% 3.9 3.5 na na 1.2% 1.6% Minsheng Education 1569 HK Non Rated 2.00 na 1,030 20.3 16.9 15.4 20.8% 2.0 1.8 4.1 3.4 0.6% 0.7% China New Higher Education 2001 HK Non Rated 4.56 na 831 22.1 17.6 14.3 50.9% 3.0 2.7 na na 1.3% 1.8%

International education Grand Canyon Education LOPE US Non Rated 83.23 na 4,005 21.7 20.3 18.1 14.3% na na 1.4 1.4 0.0% 0.0% Adtalem Global Education ATGE US Non Rated 34.95 na 2,170 12.6 11.5 na 10.0% na na 1.3 1.2 1.0% 1.0% Strayer Education STRA US Non Rated 83.01 na 927 24.9 22.0 19.2 11.0% na na 1.7 1.5 0.0% 0.0% Capella Education CPLA US Non Rated 68.30 na 797 19.3 18.6 15.2 7.8% na na 1.9 1.9 2.4% 2.5% Daekyo Co 019680 KS Non Rated 8300.00 na 620 17.3 17.7 16.9 9.2% 1.2 1.2 na na 2.9% 2.9% Note: As of 19th Sep 2017 SOURCE: CIMB RESEARCH, BLOOMBERG

Looking at comparative companies’ earnings outlooks and valuations, our forecasts show that Yuhua offers a 3-year core net profit CAGR for FY16-19F of 19.4%, which is relatively lower than its fellow formal education plays like China Maple Leaf (1317 HK, Add), Virscend (1565 HK, Not Rated) and Wisdom Education (6068 HK, Not Rated). We believe this is due to Yuhua’s more conservative expansion plan over the next three years. Nevertheless, the stock is also trading at a cheaper valuation than its peers. Stripping off Yuhua’s cash holdings, it currently trades at an attractive valuation of 11.1x CY18F ex-cash core P/E, and at the same time providing a comfortable dividend yield of 3.1% in CY18F. The education sector is also seen as relatively defensive, as parents generally want to provide the best possible education accessible to them and are unlikely to withdraw from the system even during an economic downturn. The stock has enjoyed a strong run since its listing at end-Feb 2017; however, we expect the stock to continue to re-rate given 1) the expansion of new schools in the pipeline over the next three years, 2) further earnings upside from M&A activity as the company looks to grow both organically and through acquisitions of strategically- beneficial schools, 3) possible earnings surprises due to benefits of scale (operational leverage), and 4) wider coverage/interest in the stock now that it has surpassed the US$1bn market cap level.

149

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Concerns/Risks Regulatory risks to the education sector In Nov 2016, the Decision on Amending the Law for Promoting Private Education of the PRC was approved by the Standing Committee of the National People’s Congress, which came into effect on 1 Sep 2017. According to the decision, private schools can be established as not-for-profit or for-profit entities, with the exception of schools providing compulsory education, which can only be established as not-for-profit entities. There are substantial uncertainties regarding the interpretation and application of the decision, which may affect the private school industry as a whole, in our view.

Ability to raise tuition fees Yuhua’s tuition rates are generally subject to approvals from relevant government pricing authorities. While the People’s Government of Henan Province published a policy in Jun 2015 which provides that the government administration should gradually deregulate its control over education related fees charged by private schools and abolish the requirement for record-filing for tuition fees charged by privately-run kindergartens, there can be no assurance that Yuhua will be able to maintain or raise the tuition fee level it charges at it schools in the future.

Rebranding of some schools may impact student enrolment Yuhua operated a total of 16 K-12 schools under the brand name “the Affiliated High School of Peking University” prior to the completion of unification of its brand under “YuHua” in the second quarter of 2016. The phase-out and rebranding began in Sep 2014. The discontinuation of the operation of schools under the “Affiliated High School of Peking University” brand may result in a diminished interest from potential students and their parents.

Supply risk Yuhua plans to further expand its school network in other attractive markets by 1) building and acquiring additional schools, and 2) through an asset-light approach by cooperating with third-party partners. This will depend on agreements with local partners in new cities/provinces or building its own schools, which is a slow and asset-draining option. Failure to develop new schools at a steady pace could have a negative impact on its earnings.

150

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Appendix Management profile Li Guangyu – Chairman of the Board, Executive Director. Founder of the company, Mr. Li has more than 15 years of experience in the education industry. He established the first school of the company in Zhengzhou in 2001, and has since led the expansion of the school network from a single high school to one university and 24 K-12 schools. He serves as a representative of the National People’s Congress of the PRC, the vice chairman of the China Association for Non-Government Education, and has been awarded the title of National Outstanding Worker Award from the State Council of the PRC. He received his master’s degree in Business Administration from the Guanghua School of Management, Peking University.

Li Hua – Vice Chairman of the Board, Chief Executive Officer and Executive Director. Ms. Li joined the group in Jul 2009. She has more than seven years of experience in the education industry. Ms. Li currently serves as a representative of the Zhengzhou Municipal People’s Congress, a member of the National Committee of the All-China Youth Federation and a representative of the National Representative Conference of the Communist Youth League of China. Ms. Li received her bachelor’s degree in Philosophy from Peking University in Jul 2010.

Qiu Hongjun – Executive Director, Financial Controller, Vice President. Ms. Qiu joined Yuhua in Jul 2004, and is responsible for overseeing the company’s financial affairs. She has more than 12 years of experience in the education industry. Prior to joining Yuhua, Ms. Qiu was the deputy branch president of Nanjing branch of Shenzhen Development Bank (currently known as Pingan Bank). Ms. Qiu received her diploma in Finance from the Open University of China (distance learning) in Oct 2003.

Xu Bin – Chief Financial Officer. Mr. Xu Bin has served as Yuhua’s CFO since Jan 2016, and is responsible for overseeing the financial operations of the company. Prior to joining Yuhua, Mr. Xu was the vice president and co-chief financial officer of China Maple Leaf Education (1317.HK), from Feb 2013 to Jun 2015. Mr. Xu holds a master’s degree in Finance from the University of Cambridge, United Kingdom and a bachelor’s degree in Economics and Finance from the University of Toronto, Canada.

151

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Shareholding structure

Figure 23: Yuhua’s shareholding structure as at initial public offering in Feb 2017

SOURCES: CIMB, COMPANY REPORTS

Key Milestones

Figure 24: Key milestones Year Event 2001 First school, Zhengzhou YuHua Elite School, began operation under the name "the Affiliated High School of Peking University, Henan Branch 2005 First primary school and kindergarten, Zhengzhou YuHua Elite Primary School and Zhengzhou YuHua Elite Bilingual Kindergarten, began operation 2009 Began offering higher education services as YuHua's first university, Wanfang College, commenced operations under the Group Completed full education of K-12 and higher education 2011 Expanded operations outside Zhengzhou 2012 Began centralized management of the "YuHua" brand name 2014 Entered into the PKU Termination Agreement to terminate the use of "the Affiliated High School of Peking University" brand name 2016 The Ministry of Education (MOE) granted approval for the conversion of Wanfang College to Zhengzhou Technology and Business University SOURCES: CIMB, COMPANY REPORTS

Yuhua established its first school (currently known as Zhengzhou YuHua Elite School) in 2001 under the name of “the Affiliated High School of Peking University, Henan Branch”. The school network was later expanded to offer primary and secondary kindergarten education in 2005. In 2009, Yuhua began offering higher education through Wanfang College (currently known as Zhengzhou Technology and Business University) in cooperation with Henan Polytechnic University. 16 of Yuhua’s K-12 schools operated under the brand name “the Affiliated High School of Peking University” prior to Yuhua entering into a PKU Termination Agreement to terminate the use of the brand name in Sep 2014. Yuhua later completed the rebranding of its K-12 schools under the “YuHua” brand in the second quarter of 2016.

152

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

Yuhua’s Wanfang College also terminated its Cooperation Agreement with Henan Polytechnic University in July 2015, and has since ceased any affiliation with Henan Polytechnic University.

153

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

BY THE NUMBERS

P/BV vs ROE 12-mth Fwd FD Normalised P/E vs FD 3.10 44.0% 17.0 Normalised EPS Growth 260% 3.00 40.7% 16.0 210% 2.90 37.3% 15.0 160% 2.80 34.0% 2.70 30.7% 14.0 110% 2.60 27.3% 13.0 60% 2.50 24.0% 12.0 10% 2.40 20.7% 2.30 17.3% 11.0 -40% 2.20 14.0% 10.0 -90% Jan-13A Jan-14A Jan-15A Jan-16A Jan-17F Jan-18F Jan-13A Jan-14A Jan-15A Jan-16A Jan-17F Jan-18F

Rolling P/BV (x) (lhs) ROE (rhs) 12-mth Fwd Rolling FD Normalised P/E (x) (lhs) Diluted Normalised EPS Growth (rhs)

Profit & Loss

(Rmbm) Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Total Net Revenues 697.7 781.3 847.2 933.5 1,021.8 Gross Profit 379.9 475.2 504.5 583.3 662.3 Operating EBITDA 181.8 411.7 372.5 488.1 593.4 Depreciation And Amortisation (66.3) (74.0) (75.8) (86.6) (99.2) Operating EBIT 115.5 337.7 296.6 401.5 494.2 Financial Income/(Expense) (24.3) (26.0) (3.3) 10.7 13.7 Pretax Income/(Loss) from Assoc. 0.0 0.0 0.0 0.0 0.0 Non-Operating Income/(Expense) 0.0 0.0 0.0 0.0 0.0 Profit Before Tax (pre-EI) 91.2 311.7 293.3 412.2 508.0 Exceptional Items Pre-tax Profit 91.2 311.7 293.3 412.2 508.0 Taxation 0.0 0.0 0.0 0.0 0.0 Exceptional Income - post-tax Profit After Tax 91.2 311.7 293.3 412.2 508.0 Minority Interests Preferred Dividends FX Gain/(Loss) - post tax Other Adjustments - post-tax Preference Dividends (Australia) Net Profit 91.2 311.7 293.3 412.2 508.0 Normalised Net Profit 91.2 311.7 293.3 412.2 508.0 Fully Diluted Normalised Profit 91.2 311.7 293.3 412.2 508.0

Cash Flow

(Rmbm) Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F EBITDA 181.8 411.7 372.5 488.1 593.4 Cash Flow from Invt. & Assoc. (90.6) (100.0) (79.1) (75.9) (85.5) Change In Working Capital 13.6 34.8 83.0 73.6 76.8 (Incr)/Decr in Total Provisions Other Non-Cash (Income)/Expense 90.5 100.4 84.3 81.1 90.7 Other Operating Cashflow Net Interest (Paid)/Received (27.9) (27.3) (12.8) (6.0) (4.8) Tax Paid Cashflow From Operations 167.3 419.5 447.9 560.9 670.7 Capex (188.2) (162.5) (150.0) (180.0) (200.0) Disposals Of FAs/subsidiaries 40.1 106.0 0.0 0.0 0.0 Acq. Of Subsidiaries/investments (100.5) (45.6) 0.0 0.0 0.0 Other Investing Cashflow (55.1) 60.0 9.4 16.7 18.5 Cash Flow From Investing (303.7) (42.1) (140.6) (163.3) (181.5) Debt Raised/(repaid) 30.3 (226.8) (205.0) (20.0) (20.0) Proceeds From Issue Of Shares 0.0 0.1 1,318.3 0.0 0.0 Shares Repurchased Dividends Paid 0.0 0.0 (202.5) (237.4) (274.0) Preferred Dividends Other Financing Cashflow 0.0 (0.7) 0.0 0.0 0.0 Cash Flow From Financing 30.3 (227.5) 910.8 (257.4) (294.0) Total Cash Generated (106.1) 149.9 1,218.1 140.2 195.2 Free Cashflow To Equity (106.1) 150.5 102.4 377.6 469.2 Free Cashflow To Firm (108.4) 404.7 320.1 403.6 494.0

SOURCE: CIMB RESEARCH, COMPANY DATA

154

Education│Hong Kong│China Yuhua Education Corp│September 19, 2017

BY THE NUMBERS… cont’d

Balance Sheet

(Rmbm) Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Total Cash And Equivalents 154 305 1,523 1,663 1,859 Total Debtors 18 11 16 18 20 Inventories Total Other Current Assets 118 0 0 0 0 Total Current Assets 291 316 1,539 1,681 1,878 Fixed Assets 1,409 1,465 1,539 1,633 1,733 Total Investments 0 0 0 0 0 Intangible Assets 1 2 2 1 1 Total Other Non-Current Assets 255 245 240 235 230 Total Non-current Assets 1,665 1,712 1,781 1,869 1,965 Short-term Debt 362 120 50 40 30 Current Portion of Long-Term Debt Total Creditors 210 157 204 213 224 Other Current Liabilities 592 609 650 716 784 Total Current Liabilities 1,164 886 904 969 1,038 Total Long-term Debt 140 195 60 50 40 Hybrid Debt - Debt Component Total Other Non-Current Liabilities 55 38 38 38 38 Total Non-current Liabilities 195 233 98 88 78 Total Provisions 0 0 0 0 0 Total Liabilities 1,358 1,119 1,002 1,057 1,115 Shareholders' Equity 598 910 2,319 2,494 2,727 Minority Interests Total Equity 598 910 2,319 2,494 2,727

Key Ratios

Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Revenue Growth 16.4% 12.0% 8.4% 10.2% 9.5% Operating EBITDA Growth (36%) 126% (10%) 31% 22% Operating EBITDA Margin 26.1% 52.7% 44.0% 52.3% 58.1% Net Cash Per Share (Rmb) (0.16) (0.00) 0.65 0.72 0.82 BVPS (Rmb) 0.27 0.42 1.06 1.14 1.25 Gross Interest Cover 4.1 12.4 23.3 66.9 103.0 Effective Tax Rate 0% 0% 0% 0% 0% Net Dividend Payout Ratio NA NA 69.0% 57.6% 53.9% Accounts Receivables Days 7.35 6.96 5.94 6.68 6.70 Inventory Days - - - - - Accounts Payables Days - - - - - ROIC (%) 35.0% 33.8% 31.0% 42.6% 51.6% ROCE (%) 14.6% 29.2% 16.8% 16.7% 19.1%

Return On Average Assets 6.1% 17.0% 11.1% 11.7% 13.4%

Key Drivers

Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Growth In Number Of Students (%) 23.0% 10.6% 7.6% 8.0% 5.9% Average Student Fee Change (%) -2.1% 1.1% 1.2% 2.7% 2.8% Campus Utilisation Rates (%) 69.2% 67.7% 72.9% 73.6% 75.0%

SOURCE: CIMB RESEARCH, COMPANY DATA

155

Education│Hong Kong│September 19, 2017

Company Note

Insert Insert Hong Kong China Maple Leaf Educational ADD (no change) School additions to facilitate enrolment ramp-up Consensus ratings*: Buy 18 Hold 3 Sell 0 ■ Maple Leaf added 15 new campuses in FY17 and plans to add c.8 in FY18F. Current price: HK$8.23 ■ Student enrolment likely maintained healthy growth of 20.4% in FY17F and we expect Target price: HK$9.60 22.0% yoy growth in FY18F, driven by new campuses and increase in utilisation rate. ■ Maple Leaf raised tuition fees in Wuhan, Tianjin and Shanghai in 2017. Average Previous target: HK$8.14 tuition fees likely increased by 4.5% in FY17F, and we expect +2.0% yoy in FY18F. Up/downside: 16.6% ■ We raise FY17-19F core EPS forecasts by 1.4-12.0% to reflect higher revenue growth CIMB / Consensus: 23.3% assumptions. Reuters: 1317.HK ■ Maintain Add, as we expect strong topline growth and margin expansion to drive Bloomberg: 1317 HK earnings growth in FY18F.

Market cap: US$1,453m Management guides for c.8 new campuses in FY18F HK$11,353m Maple Leaf added 15 new campuses in FY17, which will start revenue contribution from Average daily turnover: US$5.18m FY18F. Management guided for c.8 school additions in FY18F. Currently, it plans to build HK$40.44m a new school in Wuhan and expand the existing school in Australia. The company is also Current shares o/s: 1,334m considering entering Beijing and Shenzhen through M&As. We forecast that student Free float: 43.2% capacity likely increased by 17.6% in FY17F and we expect another 31.1% yoy increase *Source: Bloomberg in FY18F to 35,340 and 46,340 students, respectively (excluding the Haikou school). Healthy growth in student enrolment Key changes in this note With its strong brand name and quality education, we believe Maple Leaf can quickly FY17F core EPS increased by 12.0%. ramp up the enrolment in new schools. We estimate that enrolment maintained healthy FY18F core EPS increased by 9.7%. growth of 20.4% in FY17F and we expect another 22.0% yoy increase in FY18F, keeping FY19F core EPS increased by 1.4%. the overall utilisation relatively high at 65.9% and 61.3%, respectively.

Price Close Relative to HSI (RHS) Continuous ASP increase 8.90 109.0 Maple Leaf raised tuition fees in Wuhan, Tianjin and Shanghai in FY17. Average tuition 7.90 100.0 fess likely increased by 4.5% in FY17F, and we expect a 2.0% yoy rise in FY18F. For the 6.90 91.0 5.90 82.0 newly acquired Haikou school, Maple Leaf obtained the international school licence in 4.90 73.0 Jul, and started to recruit students from kindergarten through high school in Sep 2017. 3.90 64.0 60 The average tuition fees are approximately Rmb30,000/year for the international school 40 programme, vs. c.Rmb15,000/year for the Haikou school’s existing programmes. 20

Vol m Vol Strong growth in other revenue Sep-16 Dec-16 Mar-17 Jun-17 With the strong increase in demand for summer/winter camps, we forecast it to report Source: Bloomberg other revenue growth of 32.6% yoy in both FY17F and FY18F, accounting for 17% and 18% of total revenue (FY16: 16.3%). Overall, we expect total revenue likely increased by Price performance 1M 3M 12M Absolute (%) 27.2 19.3 24.3 26.7% and 26.9% yoy in 2H17 and FY17, respectively, driven by 1) ramp-up in Relative (%) 23.1 9.4 3.6 enrolment, 2) increase in tuition fees and 3) strong growth in other revenue. GPM to expand further Major shareholders % held We expect Maple Leaf to report GPM of 49.0% and 49.7% in FY17F and FY18F (FY16: Sherman Jen 54.5 48.4%), respectively, driven by 1) higher ASP, 2) more new schools adopting an asset-

light model, and 3) lower average teacher costs due to more primary and middle schools.

Maple Leaf mainly hires local teachers (annual salary of Rmb80k-120k) for its primary Insert and middle schools, and British Columbia (B.C.) teachers (annual salary of CAD50k-60k) for its high schools. Assume coverage with Add rating and DCF-based TP of HK$9.60 We assume coverage on Maple Leaf with a higher DCF-based TP of HK$9.60. We expect strong topline growth and margin expansion to drive earnings growth in FY18F. Key positive catalysts include stronger-than-expected student enrolment and margin expansion. Downside risks include longer-than-expected ramp-up periods for new schools.

Financial Summary Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Analyst(s) Revenue (Rmbm) 653 830 1,053 1,318 1,635 Operating EBITDA (Rmbm) 174.5 254.0 338.5 434.5 554.5 Net Profit (Rmbm) 205.5 307.6 399.3 488.5 614.3 Normalised EPS (Rmb) 0.15 0.23 0.30 0.37 0.46 Normalised EPS Growth 413% 50% 30% 22% 26% FD Normalised P/E (x) 44.91 30.02 23.12 18.90 15.03 DPS (Rmb) 0.08 0.09 0.13 0.16 0.20 Dividend Yield 1.10% 1.25% 1.84% 2.25% 2.83% EV/EBITDA (x) 46.48 31.48 22.46 16.32 11.68 Lei YANG, CFA P/FCFE (x) NA 96.83 17.52 13.21 10.74 T (86) 21 5047 1771 x108 Net Gearing (61.9%) (61.2%) (72.5%) (84.9%) (96.3%) E [email protected] P/BV (x) 5.09 4.57 4.11 3.67 3.22 ONG Khang Chuen ROE 18.0% 16.0% 18.7% 20.5% 22.8% T (852) 2539 1326 % Change In Normalised EPS Estimates 12.0% 9.7% 1.4% Normalised EPS/consensus EPS (x) 1.05 1.06 1.09 E [email protected] SOURCE: COMPANY DATA, CIMB FORECASTS

IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE END OF THIS REPORT. IF THIS REPORT IS DISTRIBUTED IN THE Powered by the UNITED STATES IT IS DISTRIBUTED BY CIMB SECURITIES (USA), INC. AND IS CONSIDERED THIRD-PARTY AFFILIATED RESEARCH. EFA Platform

Education│Hong Kong│China Maple Leaf Educational│September 19, 2017

Facilitate enrolment ramp-up

Figure 1: 2H17F preview (Rmb m) 1H17 1H16 yoy 2H17F 2H16 yoy FY17F FY16 yoy Revenue 483.3 380.3 27.1% 569.4 449.5 26.7% 1,052.6 829.8 26.9% Cost of sales -255.9 -201.2 27.2% -280.9 -226.8 23.9% -536.9 -428.0 25.4% Gross profit 227.4 179.1 27.0% 288.4 222.7 29.5% 515.8 401.7 28.4% Gross margin 47.0% 47.1% 0.0% pts 50.7% 49.5% 1.1% pts 49.0% 48.4% 0.6% pts Marketing expenses -11.1 -10.0 10.8% -18.8 -16.0 17.2% -29.9 -26.0 14.7% Administrative expenses -69.9 -53.8 29.9% -77.4 -67.9 14.0% -147.4 -121.7 21.0% Operating profit 146.3 115.2 27.0% 192.2 138.8 38.5% 338.5 254.0 33.3% Operating margin 30.3% 30.3% 0.0% pts 33.8% 30.9% 2.9% pts 32.2% 30.6% 1.6% pts Finance income 21.0 22.3 -5.8% 16.1 10.1 59.3% 37.1 32.4 14.5% Other income/expenses 24.3 -5.5 -539.2% 24.8 45.0 -44.9% 49.1 39.5 24.2% PBT 191.6 132.0 45.2% 233.1 193.9 20.2% 424.7 325.9 30.3% Taxation -10.9 -7.0 56.3% -14.5 -11.3 28.4% -25.5 -18.3 39.1% Net profit 180.7 125.0 44.5% 218.6 182.6 19.7% 399.3 307.6 29.8% SOURCE: CIMB FORECASTS, COMPANY

It aims to add c.8 new campuses in FY18F Maple Leaf added 15 new campuses in FY17, which should begin to contribute positively to revenue from FY18F. Management guided for c.8 school additions in FY18F. Currently, there are plans to build a new school in Wuhan and expand the existing school in Australia. The company is also considering entering Beijing and Shenzhen through M&As. Maple Leaf’s student capacity likely increased by 17.6% in FY17F and we expect an increase of 31.1% yoy in FY18F to 35,340 and 46,340 students, respectively (excluding the Haikou school).

Figure 2: Student capacity trend

70,000 35% Title: Source: 60,000 57,940 30% 52,140 Please fill in the values above to have them entered in your report 50,000 46,340 25%

40,000 35,340 20% 30,040 30,000 26,090 15% 22,490 20,000 10%

10,000 5%

0 0% FY14 FY15 FY16 FY17F FY18F FY19F FY20F

Student capacity yoy change %

SOURCE: CIMB FORECASTS, COMPANY

Healthy growth in student enrolment With its strong brand name and quality education, we believe Maple Leaf can quickly ramp-up the enrolment in new schools. We expect the company to report healthy enrolment growth of 20.4% and 22.0% yoy in FY17F and FY18F, keeping the overall utilisation rate relatively high at 65.9% and 61.3% over the same time period, respectively.

157

Education│Hong Kong│China Maple Leaf Educational│September 19, 2017

Figure 3: Student enrolment trend

45,000 25% Title: 40,213 40,000 Source: 34,079 20% 35,000 Please fill in the values above to have them entered in your report 30,000 28,399 15% 25,000 23,278 19,334 20,000 16,078 10% 15,000 13,513

10,000 5% 5,000

0 0% FY14 FY15 FY16 FY17F FY18F FY19F FY20F

Student enrolment yoy change %

SOURCE: CIMB FORECASTS, COMPANY

Continuous ASP increase Maple Leaf raised tuition fees in Wuhan, Tianjin and Shanghai in FY17. Average tuition fess likely increased by 4.5% in FY17F, and we expect a 2.0% yoy rise in FY18F. For the newly acquired Haikou school, Maple Leaf obtained the international school licence in Jul, and started to recruit students from kindergarten through high school in Sep 2017. The average tuition fees are approximately Rmb30,000/year for the international school programme, vs. c.Rmb15,000/year for the Haikou school’s existing programmes.

Figure 4: Tuition fees increase in FY17 Rmb Schools Previous tuition fee Increased tuition fee % change Wuhan primary school 22,000 29,000 31.8% Wuhan middle school 26,000 34,000 30.8% Tianjin primary school 33,000 43,000 30.3% Tianjin middle school 38,000 48,000 26.3% Tianjin high school 58,000 73,000 25.9% Shanghai high school 81,000 100,000 23.5% SOURCE: CIMB RESEARCH, COMPANY

Strong growth in other revenue With the strong increase in demand for summer/winter camps, we expect the company to report other revenue growth of 32.6% yoy in both FY17F and FY18F, accounting for 17% and 18% of total revenue, respectively (FY16: 16.3%). Overall, we expect it to report total revenue increase of 26.7% and 26.9% yoy in 2H17 and FY17, respectively, driven by 1) ramp-up in enrolment, 2) increase in tuition fees and 3) strong growth in other revenue.

GPM to expand further We expect the company to report GPM of 49.0% and 49.7% in FY17F and FY18F (FY16: 48.4%), driven by 1) higher ASP, 2) more new schools adopting an asset-light model, and 3) lower average teacher cost due to more openings of primary and middle schools. Maple Leaf mainly hires local teachers (annual salary of Rmb80k-120k) for its primary and middle schools, and BC teachers (annual salary of CAD50k-60k) for its high schools.

158

Education│Hong Kong│China Maple Leaf Educational│September 19, 2017

Assume coverage with an Add rating and DCF-based TP of HK$9.60 We raise our FY17-19F net profit forecasts by 0.3-1.7% to reflect higher revenue growth assumptions for Maple Leaf. Our core net profit is adjusted upwards by 1.4-12.0%, mainly due to a reclassification of “other income” from extraordinary income to recurring income post transfer of coverage.

Figure 5: Earnings revision table FY17F FY18F FY19F Old New % change Old New % change Old New % change Revenue (Rmb m) 1,038.2 1,052.6 1.4% 1,272.9 1,318.0 3.5% 1,575.5 1,635.3 3.8% GPM 48.9% 49.0% 0.1% 49.5% 49.7% 0.1% 50.2% 50.2% 0.0% SG&A expenses ratio 17.0% 16.8% -0.2% 16.6% 16.7% 0.1% 16.3% 16.3% 0.0% OPM 31.9% 32.2% 0.2% 32.9% 33.0% 0.0% 33.9% 33.9% 0.0% Net profit (Rmb m) 398.1 399.3 0.3% 481.8 488.5 1.4% 604.0 614.3 1.7% Core net profit (Rmb m) 356.5 399.3 12.0% 445.3 488.5 9.7% 605.9 614.3 1.4% *Our core net profit is adjusted upwards by 1.4-12.0% mainly due to a reclassification of “other income” from extraordinary income to a recurring income post transfer of coverage. SOURCE: CIMB FORECASTS, COMPANY

We assume coverage on Maple Leaf with a higher DCF-based TP of HK$9.60. We expect strong topline growth and margin expansion to drive earnings growth in FY18F. Key positive catalysts include stronger-than-expected student enrolment and margin expansion. Downside risks include longer-than-expected ramp-up periods for new schools.

Figure 6: DCF valuation table Figure 7: WACC assumptions (%) Cost of equity 9.3% Discounted Cash Flow Valuation Rmb Risk free 3.0% Value of Phase 1: Explicit -651.5 Market Risk Premium 7.0% Value of Phase 2: Value Driver 3,937.7 Beta 0.90 Value of Phase 3: Fade 5,424.2 Terminal Value 1,317.2 Cost of debt 6.0% Enterprise Value 10,027.5 Kd (after tax) 4.5% Less: Net Debt -1,628.1 Equity Value 11,655.7 Target Debt / (Debt + Equity) 10% No. Shares (millions) 1,379.5 Target Equity / (Debt + Equity) 90% Per Share Equity Value (Rmb) 8.4 Exchange rate 0.9 WACC 8.8% Target price (HK$) 9.6 Terminal growth 3.0% SOURCE: CIMB FORECASTS, COMPANY SOURCE: CIMB FORECASTS, COMPANY

159

Education│Hong Kong│China Maple Leaf Educational│September 19, 2017

Figure 8: Education sector peer comps 3-year Dividend yield Price TP Mkt cap P/E (x) EPS P/BV (x) PEG (x) (x) Company Ticker Recom. (LC$) (LC$) (US$) CY17F CY18F CY19F CAGR (%) CY17F CY18F CY17F CY18F CY17F CY18F China education ADR New Oriental Education EDU US Add 87.16 114.30 13,743 40.2 30.6 23.3 31.5% 7.1 5.8 1.3 1.0 0.5% 0.5% TAL Education TAL US Add 33.01 40.30 16,533 67.9 52.9 34.8 57.6% 18.4 12.7 na 1.0 0.0% 0.0% Bright Scholar Education BEDU US Non Rated 21.89 na 2,567 68.9 41.7 na na 20.4 16.0 na na 0.0% 0.0% Tarena International TEDU US Add 14.49 16.70 830 17.2 12.6 9.7 23.2% 2.9 2.4 0.9 0.6 1.2% 1.7% China Distance Education DL US Non Rated 6.90 na 227 12.4 13.0 na -6.0% 3.8 3.5 na na 6.5% 6.5%

China H-share education Virscend Education 1565 HK Non Rated 4.78 na 1,868 38.0 26.0 19.9 29.5% 4.6 4.1 na na 1.4% 1.7% China Maple Leaf Education 1317 HK Add 8.23 9.60 1,458 25.7 19.5 na 23.9% 4.1 3.7 1.1 0.8 1.8% 2.3% China Yuhua Education 6169 HK Add 3.80 4.50 1,518 16.8 13.9 na 19.4% 3.0 2.8 1.0 0.9 2.9% 3.0% Wisdom Education 6068 HK Non Rated 4.25 na 1,131 25.7 20.0 16.5 43.6% 3.9 3.5 na na 1.2% 1.6% Minsheng Education 1569 HK Non Rated 2.00 na 1,030 20.3 16.9 15.4 20.8% 2.0 1.8 4.1 3.4 0.6% 0.7% China New Higher Education 2001 HK Non Rated 4.56 na 831 22.1 17.6 14.3 50.9% 3.0 2.7 na na 1.3% 1.8%

International education Grand Canyon Education LOPE US Non Rated 83.23 na 4,005 21.7 20.3 18.1 14.3% na na 1.4 1.4 0.0% 0.0% Adtalem Global Education ATGE US Non Rated 34.95 na 2,170 12.6 11.5 na 10.0% na na 1.3 1.2 1.0% 1.0% Strayer Education STRA US Non Rated 83.01 na 927 24.9 22.0 19.2 11.0% na na 1.7 1.5 0.0% 0.0% Capella Education CPLA US Non Rated 68.30 na 797 19.3 18.6 15.2 7.8% na na 1.9 1.9 2.4% 2.5% Daekyo Co 019680 KS Non Rated 8300.00 na 620 17.3 17.7 16.9 9.2% 1.2 1.2 na na 2.9% 2.9% As of 19th Sep 2017 SOURCE: CIMB RESEARCH, BLOOMBERG

160

Education│Hong Kong│China Maple Leaf Educational│September 19, 2017

BY THE NUMBERS

P/BV vs ROE 12-mth Fwd FD Normalised P/E vs FD 4.40 24.0% 23.6 Normalised EPS Growth 480% 3.90 21.4% 21.6 413% 19.6 347% 3.40 18.9% 17.6 280% 2.90 16.3% 15.6 213% 2.40 13.7% 13.6 147% 11.6 80% 1.90 11.1% 9.6 13% 1.40 8.6% 7.6 -53% 0.90 6.0% 5.6 -120% Jan-13A Jan-14A Jan-15A Jan-16A Jan-17F Jan-18F Jan-13A Jan-14A Jan-15A Jan-16A Jan-17F Jan-18F

Rolling P/BV (x) (lhs) ROE (rhs) 12-mth Fwd Rolling FD Normalised P/E (x) (lhs) Diluted Normalised EPS Growth (rhs)

Profit & Loss

(Rmbm) Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Total Net Revenues 653.0 829.8 1,052.6 1,318.0 1,635.3 Gross Profit 298.7 401.7 515.8 654.6 821.1 Operating EBITDA 174.5 254.0 338.5 434.5 554.5 Depreciation And Amortisation 0.0 0.0 0.0 0.0 0.0 Operating EBIT 174.5 254.0 338.5 434.5 554.5 Financial Income/(Expense) 13.2 32.4 37.1 48.8 64.2 Pretax Income/(Loss) from Assoc. 0.0 0.0 0.0 0.0 0.0 Non-Operating Income/(Expense) 29.2 39.5 49.1 41.9 49.1 Profit Before Tax (pre-EI) 216.9 325.9 424.7 525.3 667.8 Exceptional Items Pre-tax Profit 216.9 325.9 424.7 525.3 667.8 Taxation (11.4) (18.3) (25.5) (36.8) (53.4) Exceptional Income - post-tax Profit After Tax 205.5 307.6 399.3 488.5 614.3 Minority Interests Preferred Dividends FX Gain/(Loss) - post tax Other Adjustments - post-tax Preference Dividends (Australia) Net Profit 205.5 307.6 399.3 488.5 614.3 Normalised Net Profit 205.5 307.6 399.3 488.5 614.3 Fully Diluted Normalised Profit 205.5 307.6 399.3 488.5 614.3

Cash Flow

(Rmbm) Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F EBITDA 174.5 254.0 338.5 434.5 554.5 Cash Flow from Invt. & Assoc. Change In Working Capital 204.8 165.2 375.3 370.2 442.7 (Incr)/Decr in Total Provisions Other Non-Cash (Income)/Expense Other Operating Cashflow 61.2 48.5 57.4 68.3 80.3 Net Interest (Paid)/Received 5.0 18.2 37.1 48.8 64.2 Tax Paid (1.4) (1.8) (18.3) (25.5) (36.8) Cashflow From Operations 444.0 484.1 790.0 896.4 1,105.0 Capex (212.3) (146.7) (263.2) (197.7) (245.3) Disposals Of FAs/subsidiaries Acq. Of Subsidiaries/investments Other Investing Cashflow (27.2) 0.0 0.0 0.0 0.0 Cash Flow From Investing (239.5) (146.7) (263.2) (197.7) (245.3) Debt Raised/(repaid) (223.5) (242.0) 0.0 0.0 0.0 Proceeds From Issue Of Shares 761.1 0.0 0.0 0.0 0.0 Shares Repurchased (59.0) 0.0 0.0 0.0 0.0 Dividends Paid (26.7) (124.8) (175.7) (214.9) (270.3) Preferred Dividends Other Financing Cashflow (18.4) (19.9) (32.8) (41.1) (51.7) Cash Flow From Financing 433.6 (386.7) (208.5) (256.0) (322.0) Total Cash Generated 638.1 (49.3) 318.4 442.7 537.7 Free Cashflow To Equity (19.0) 95.3 526.9 698.7 859.7

Free Cashflow To Firm 208.6 337.3 526.9 698.7 859.7 SOURCE: CIMB RESEARCH, COMPANY DATA

161

Education│Hong Kong│China Maple Leaf Educational│September 19, 2017

BY THE NUMBERS… cont’d

Balance Sheet

(Rmbm) Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Total Cash And Equivalents 1,122 1,238 1,628 2,139 2,755 Total Debtors 32 37 53 66 82 Inventories 1 9 5 7 8 Total Other Current Assets 0 0 0 0 0 Total Current Assets 1,156 1,285 1,686 2,211 2,845 Fixed Assets 1,398 1,506 1,722 1,866 2,053 Total Investments 58 0 0 0 0 Intangible Assets 13 13 13 13 13 Total Other Non-Current Assets 191 423 423 423 423 Total Non-current Assets 1,660 1,942 2,157 2,302 2,489 Short-term Debt 0 0 0 0 0 Current Portion of Long-Term Debt Total Creditors 955 1,140 1,526 1,911 2,371 Other Current Liabilities 27 44 51 62 79 Total Current Liabilities 982 1,184 1,577 1,973 2,450 Total Long-term Debt 0 0 0 0 0 Hybrid Debt - Debt Component Total Other Non-Current Liabilities 0 0 0 0 0 Total Non-current Liabilities 0 0 0 0 0 Total Provisions 22 21 21 21 21 Total Liabilities 1,004 1,205 1,598 1,995 2,471 Shareholders' Equity 1,812 2,021 2,245 2,519 2,863 Minority Interests Total Equity 1,812 2,021 2,245 2,519 2,863

Key Ratios

Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Revenue Growth 20.9% 27.1% 26.9% 25.2% 24.1% Operating EBITDA Growth 25.6% 45.5% 33.3% 28.4% 27.6% Operating EBITDA Margin 26.7% 30.6% 32.2% 33.0% 33.9% Net Cash Per Share (Rmb) 0.84 0.93 1.22 1.60 2.07 BVPS (Rmb) 1.36 1.52 1.68 1.89 2.15 Gross Interest Cover 42.67 N/A N/A N/A N/A Effective Tax Rate 5.23% 5.62% 6.00% 7.00% 8.00% Net Dividend Payout Ratio 49.3% 37.3% 44.0% 44.0% 44.0% Accounts Receivables Days 15.85 15.32 15.60 16.41 16.48 Inventory Days 0.72 4.62 5.03 3.30 3.31 Accounts Payables Days 597.7 625.5 630.8 652.2 662.0 ROIC (%) 23% 36% 39% 62% 124% ROCE (%) 15.1% 14.8% 17.4% 20.1% 22.8%

Return On Average Assets 8.0% 9.2% 10.3% 10.6% 11.3%

Key Drivers

Aug-15A Aug-16A Aug-17F Aug-18F Aug-19F Growth In Number Of Students (%) 19.0% 20.3% 20.4% 22.0% 20.0% Average Student Fee Change (%) 1.2% 4.7% 4.5% 2.0% 2.0% Campus Utilisation Rates (%) N/A N/A N/A N/A N/A

SOURCE: CIMB RESEARCH, COMPANY DATA

162

Navigating China│Education│September 19, 2017

DISCLAIMER #03 The content of this report (including the views and opinions expressed therein, and the information comprised therein) has been prepared by and belongs to CIMB and is distributed by CIMB. This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. By accepting this report, the recipient hereof represents and warrants that he is entitled to receive such report in accordance with the restrictions set forth below and agrees to be bound by the limitations contained herein (including the “Restrictions on Distributions” set out below). Any failure to comply with these limitations may constitute a violation of law. This publication is being supplied to you strictly on the basis that it will remain confidential. No part of this report may be (i) copied, photocopied, duplicated, stored or reproduced in any form by any means or (ii) redistributed or passed on, directly or indirectly, to any other person in whole or in part, for any purpose without the prior written consent of CIMB. The information contained in this research report is prepared from data believed to be correct and reliable at the time of issue of this report. CIMB may or may not issue regular reports on the subject matter of this report at any frequency and may cease to do so or change the periodicity of reports at any time. CIMB is under no obligation to update this report in the event of a material change to the information contained in this report. CIMB has no, and will not accept any, obligation to (i) check or ensure that the contents of this report remain current, reliable or relevant, (ii) ensure that the content of this report constitutes all the information a prospective investor may require, (iii) ensure the adequacy, accuracy, completeness, reliability or fairness of any views, opinions and information, and accordingly, CIMB, or any of their respective affiliates, or its related persons (and their respective directors, associates, connected persons and/or employees) shall not be liable in any manner whatsoever for any consequences (including but not limited to any direct, indirect or consequential losses, loss of profits and damages) of any reliance thereon or usage thereof. In particular, CIMB disclaims all responsibility and liability for the views and opinions set out in this report. Unless otherwise specified, this report is based upon sources which CIMB considers to be reasonable. Such sources will, unless otherwise specified, for market data, be market data and prices available from the main stock exchange or market where the relevant security is listed, or, where appropriate, any other market. Information on the accounts and business of company(ies) will generally be based on published statements of the company(ies), information disseminated by regulatory information services, other publicly available information and information resulting from our research. Whilst every effort is made to ensure that statements of facts made in this report are accurate, all estimates, projections, forecasts, expressions of opinion and other subjective judgments contained in this report are based on assumptions considered to be reasonable as of the date of the document in which they are contained and must not be construed as a representation that the matters referred to therein will occur. Past performance is not a reliable indicator of future performance. The value of investments may go down as well as up and those investing may, depending on the investments in question, lose more than the initial investment. No report shall constitute an offer or an invitation by or on behalf of CIMB or its affiliates to any person to buy or sell any investments. CIMB, its affiliates and related companies, their directors, associates, connected parties and/or employees may own or have positions in securities of the company(ies) covered in this research report or any securities related thereto and may from time to time add to or dispose of, or may be materially interested in, any such securities. Further, CIMB, its affiliates and its related companies do and seek to do business with the company(ies) covered in this research report and may from time to time act as market maker or have assumed an underwriting commitment in securities of such company(ies), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform significant investment banking, advisory, underwriting or placement services for or relating to such company(ies) as well as solicit such investment, advisory or other services from any entity mentioned in this report. CIMB or its affiliates may enter into an agreement with the company(ies) covered in this report relating to the production of research reports. CIMB may disclose the contents of this report to the company(ies) covered by it and may have amended the contents of this report following such disclosure. The analyst responsible for the production of this report hereby certifies that the views expressed herein accurately and exclusively reflect his or her personal views and opinions about any and all of the issuers or securities analysed in this report and were prepared independently and autonomously. No part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations(s) or view(s) in this report. CIMB prohibits the analyst(s) who prepared this research report from receiving any compensation, incentive or bonus based on specific investment banking transactions or for providing a specific recommendation for, or view of, a particular company. Information barriers and other arrangements may be established where necessary to prevent conflicts of interests arising. However, the analyst(s) may receive compensation that is based on his/their coverage of company(ies) in the performance of his/their duties or the performance of his/their recommendations and the research personnel involved in the preparation of this report may also participate in the solicitation of the businesses as described above. In reviewing this research report, an investor should be aware that any or all of the foregoing, among other things, may give rise to real or potential conflicts of interest. Additional information is, subject to the duties of confidentiality, available on request. Reports relating to a specific geographical area are produced by the corresponding CIMB entity as listed in the table below. The term “CIMB” shall denote, where appropriate, the relevant entity distributing or disseminating the report in the particular jurisdiction referenced below, or, in every other case, CIMB Group Holdings Berhad ("CIMBGH") and its affiliates, subsidiaries and related companies.

Country CIMB Entity Regulated by Hong Kong CIMB Securities Limited Securities and Futures Commission Hong Kong India CIMB Securities (India) Private Limited Securities and Exchange Board of India (SEBI) Indonesia PT CIMB Securities Indonesia Financial Services Authority of Indonesia Malaysia CIMB Investment Bank Berhad Securities Commission Malaysia Singapore CIMB Research Pte. Ltd. Monetary Authority of Singapore South Korea CIMB Securities Limited, Korea Branch Financial Services Commission and Financial Supervisory Service Thailand CIMB Securities (Thailand) Co. Ltd. Securities and Exchange Commission Thailand

(i) As of September 18, 2017, CIMB has a proprietary position in the securities (which may include but not limited to shares, warrants, call warrants and/or any other derivatives) in the following company or companies covered or recommended in this report:

163

Navigating China│Education│September 19, 2017

(a) - (ii) As of September 19, 2017, the analyst(s) who prepared this report, and the associate(s), has / have an interest in the securities (which may include but not limited to shares, warrants, call warrants and/or any other derivatives) in the following company or companies covered or recommended in this report: (a) -

This report does not purport to contain all the information that a prospective investor may require. CIMB or any of its affiliates does not make any guarantee, representation or warranty, express or implied, as to the adequacy, accuracy, completeness, reliability or fairness of any such information and opinion contained in this report. Neither CIMB nor any of its affiliates nor its related persons shall be liable in any manner whatsoever for any consequences (including but not limited to any direct, indirect or consequential losses, loss of profits and damages) of any reliance thereon or usage thereof. This report is general in nature and has been prepared for information purposes only. It is intended for circulation amongst CIMB and its affiliates’ clients generally and does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. The information and opinions in this report are not and should not be construed or considered as an offer, recommendation or solicitation to buy or sell the subject securities, related investments or other financial instruments or any derivative instrument, or any rights pertaining thereto. Investors are advised to make their own independent evaluation of the information contained in this research report, consider their own individual investment objectives, financial situation and particular needs and consult their own professional and financial advisers as to the legal, business, financial, tax and other aspects before participating in any transaction in respect of the securities of company(ies) covered in this research report. The securities of such company(ies) may not be eligible for sale in all jurisdictions or to all categories of investors. Australia: Despite anything in this report to the contrary, this research is provided in Australia by CIMB Securities (Singapore) Pte. Ltd. and CIMB Securities Limited. This research is only available in Australia to persons who are “wholesale clients” (within the meaning of the Corporations Act 2001 (Cth) and is supplied solely for the use of such wholesale clients and shall not be distributed or passed on to any other person. You represent and warrant that if you are in Australia, you are a “wholesale client”. This research is of a general nature only and has been prepared without taking into account the objectives, financial situation or needs of the individual recipient. CIMB Securities (Singapore) Pte. Ltd. and CIMB Securities Limited do not hold, and are not required to hold an Australian financial services licence. CIMB Securities (Singapore) Pte. Ltd. and CIMB Securities Limited rely on “passporting” exemptions for entities appropriately licensed by the Monetary Authority of Singapore (under ASIC Class Order 03/1102) and the Securities and Futures Commission in Hong Kong (under ASIC Class Order 03/1103). Canada: This research report has not been prepared in accordance with the disclosure requirements of Dealer Member Rule 3400 – Research Restrictions and Disclosure Requirements of the Investment Industry Regulatory Organization of Canada. For any research report distributed by CIBC, further disclosures related to CIBC conflicts of interest can be found at https://researchcentral.cibcwm.com . China: For the purpose of this report, the People’s Republic of China (“PRC”) does not include the Hong Kong Special Administrative Region, the Macau Special Administrative Region or Taiwan. The distributor of this report has not been approved or licensed by the China Securities Regulatory Commission or any other relevant regulatory authority or governmental agency in the PRC. This report contains only marketing information. The distribution of this report is not an offer to buy or sell to any person within or outside PRC or a solicitation to any person within or outside of PRC to buy or sell any instruments described herein. This report is being issued outside the PRC to a limited number of institutional investors and may not be provided to any person other than the original recipient and may not be reproduced or used for any other purpose. France: Only qualified investors within the meaning of French law shall have access to this report. This report shall not be considered as an offer to subscribe to, or used in connection with, any offer for subscription or sale or marketing or direct or indirect distribution of financial instruments and it is not intended as a solicitation for the purchase of any financial instrument. Germany: This report is only directed at persons who are professional investors as defined in sec 31a(2) of the German Securities Trading Act (WpHG). This publication constitutes research of a non-binding nature on the market situation and the investment instruments cited here at the time of the publication of the information. The current prices/yields in this issue are based upon closing prices from Bloomberg as of the day preceding publication. Please note that neither the German Federal Financial Supervisory Agency (BaFin), nor any other supervisory authority exercises any control over the content of this report. Hong Kong: This report is issued and distributed in Hong Kong by CIMB Securities Limited (“CHK”) which is licensed in Hong Kong by the Securities and Futures Commission for Type 1 (dealing in securities), Type 4 (advising on securities) and Type 6 (advising on corporate finance) activities. Any investors wishing to purchase or otherwise deal in the securities covered in this report should contact the Head of Sales at CIMB Securities Limited. The views and opinions in this research report are our own as of the date hereof and are subject to change. If the Financial Services and Markets Act of the United Kingdom or the rules of the Financial Conduct Authority apply to a recipient, our obligations owed to such recipient therein are unaffected. CHK has no obligation to update its opinion or the information in this research report. This publication is strictly confidential and is for private circulation only to clients of CHK. CIMB Securities Limited does not make a market on other securities mentioned in the report. None of the analyst(s) or the associates serve as an officer of the listed corporation mentioned in this report. CIMB does not have an officer serving in any of the listed corporation mentioned in this report CIMB does not receive any compensation or other benefits from any of the listed corporation mentioned, relating to the production of research reports. India: This report is issued and distributed in India by CIMB Securities (India) Private Limited (“CIMB India”) which is registered with the National Stock Exchange of India Limited and BSE Limited as a trading and clearing member under the Securities and Exchange Board of India (Stock Brokers and Sub-Brokers) Regulations, 1992. In accordance with the provisions of Regulation 4(g) of the Securities and Exchange Board of India (Investment Advisers) Regulations, 2013, CIMB India is not required to seek registration with the Securities and Exchange Board of India (“SEBI”) as an Investment Adviser. CIMB India is registered with SEBI as a Research Analyst pursuant to the SEBI (Research Analysts) Regulations, 2014 ("Regulations").

164

Navigating China│Education│September 19, 2017

This report does not take into account the particular investment objectives, financial situations, or needs of the recipients. It is not intended for and does not deal with prohibitions on investment due to law/jurisdiction issues etc. which may exist for certain persons/entities. Recipients should rely on their own investigations and take their own professional advice before investment. The report is not a “prospectus” as defined under Indian Law, including the Companies Act, 2013, and is not, and shall not be, approved by, or filed or registered with, any Indian regulator, including any Registrar of Companies in India, SEBI, any Indian stock exchange, or the Reserve Bank of India. No offer, or invitation to offer, or solicitation of subscription with respect to any such securities listed or proposed to be listed in India is being made, or intended to be made, to the public, or to any member or section of the public in India, through or pursuant to this report. The research analysts, strategists or economists principally responsible for the preparation of this research report are segregated from the other activities of CIMB India and they have received compensation based upon various factors, including quality, accuracy and value of research, firm profitability or revenues, client feedback and competitive factors. Research analysts', strategists' or economists' compensation is not linked to investment banking or capital markets transactions performed or proposed to be performed by CIMB India or its affiliates. CIMB Securities (India) Pte Ltd has not received any investment banking related compensation from the companies mentioned in the report in the past 12 months. CIMB Securities (India) Pte Ltd has not received any compensation from the companies mentioned in the report in the past 12 months. Indonesia: This report is issued and distributed by PT CIMB Securities Indonesia (“CIMBI”). The views and opinions in this research report are our own as of the date hereof and are subject to change. If the Financial Services and Markets Act of the United Kingdom or the rules of the Financial Conduct Authority apply to a recipient, our obligations owed to such recipient therein are unaffected. CIMBI has no obligation to update its opinion or the information in this research report. Neither this report nor any copy hereof may be distributed in Indonesia or to any Indonesian citizens wherever they are domiciled or to Indonesian residents except in compliance with applicable Indonesian capital market laws and regulations. This research report is not an offer of securities in Indonesia. The securities referred to in this research report have not been registered with the Financial Services Authority (Otoritas Jasa Keuangan) pursuant to relevant capital market laws and regulations, and may not be offered or sold within the territory of the Republic of Indonesia or to Indonesian citizens through a public offering or in circumstances which constitute an offer within the meaning of the Indonesian capital market law and regulations. Ireland: CIMB is not an investment firm authorised in the Republic of Ireland and no part of this document should be construed as CIMB acting as, or otherwise claiming or representing to be, an investment firm authorised in the Republic of Ireland. Malaysia: This report is issued and distributed by CIMB Investment Bank Berhad (“CIMB”) solely for the benefit of and for the exclusive use of our clients. If the Financial Services and Markets Act of the United Kingdom or the rules of the Financial Conduct Authority apply to a recipient, our obligations owed to such recipient therein are unaffected. CIMB has no obligation to update, revise or reaffirm its opinion or the information in this research reports after the date of this report. New Zealand: In New Zealand, this report is for distribution only to persons who are wholesale clients pursuant to section 5C of the Financial Advisers Act 2008. Singapore: This report is issued and distributed by CIMB Research Pte Ltd (“CIMBR”). CIMBR is a financial adviser licensed under the Financial Advisers Act, Cap 110 (“FAA”) for advising on investment products, by issuing or promulgating research analyses or research reports, whether in electronic, print or other form. Accordingly CIMBR is a subject to the applicable rules under the FAA unless it is able to avail itself to any prescribed exemptions. Recipients of this report are to contact CIMB Research Pte Ltd, 50 Raffles Place, #19-00 Singapore Land Tower, Singapore in respect of any matters arising from, or in connection with this report. CIMBR has no obligation to update its opinion or the information in this research report. This publication is strictly confidential and is for private circulation only. If you have not been sent this report by CIMBR directly, you may not rely, use or disclose to anyone else this report or its contents. If the recipient of this research report is not an accredited investor, expert investor or institutional investor, CIMBR accepts legal responsibility for the contents of the report without any disclaimer limiting or otherwise curtailing such legal responsibility. If the recipient is an accredited investor, expert investor or institutional investor, the recipient is deemed to acknowledge that CIMBR is exempt from certain requirements under the FAA and its attendant regulations, and as such, is exempt from complying with the following : (a) Section 25 of the FAA (obligation to disclose product information); (b) Section 27 (duty not to make recommendation with respect to any investment product without having a reasonable basis where you may be reasonably expected to rely on the recommendation) of the FAA; (c) MAS Notice on Information to Clients and Product Information Disclosure [Notice No. FAA-N03]; (d) MAS Notice on Recommendation on Investment Products [Notice No. FAA-N16]; (e) Section 36 (obligation on disclosure of interest in securities), and (f) any other laws, regulations, notices, directive, guidelines, circulars and practice notes which are relates to the above, to the extent permitted by applicable laws, as may be amended from time to time, and any other laws, regulations, notices, directive, guidelines, circulars, and practice notes as we may notify you from time to time. In addition, the recipient who is an accredited investor, expert investor or institutional investor acknowledges that a CIMBR is exempt from Section 27 of the FAA, the recipient will also not be able to file a civil claim against CIMBR for any loss or damage arising from the recipient’s reliance on any recommendation made by CIMBR which would otherwise be a right that is available to the recipient under Section 27 of the FAA, the recipient will also not be able to file a civil claim against CIMBR for any loss or damage arising from the recipient’s reliance on any recommendation made by CIMBR which would otherwise be a right that is available to the recipient under Section 27 of the FAA. CIMB Research Pte Ltd ("CIMBR"), its affiliates and related companies, their directors, associates, connected parties and/or employees may own or have positions in securities of the company(ies) covered in this research report or any securities related thereto and may from time to time add to or dispose of, or may be materially interested in, any such securities. Further, CIMBR, its affiliates and its related companies do and seek to do business with the company(ies) covered in this research report and may from time to time act as market maker or have assumed an underwriting commitment in securities of such company(ies), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform significant investment banking, advisory, underwriting or placement services for or relating to such company(ies) as well as solicit such investment, advisory or other services from any entity mentioned in this report.

165

Navigating China│Education│September 19, 2017

As of September 18, 2017, CIMBR does not have a proprietary position in the recommended securities in this report. CIMB Research Pte Ltd does not make a market on other securities mentioned in the report. CIMB Securities Singapore Pte Ltd does not make a market on other securities mentioned in the report. CIMB Bank Berhad, Singapore branch does not make a market on other securities mentioned in the report. South Korea: This report is issued and distributed in South Korea by CIMB Securities Limited, Korea Branch (“CIMB Korea”) which is licensed as a cash equity broker, and regulated by the Financial Services Commission and Financial Supervisory Service of Korea. In South Korea, this report is for distribution only to professional investors under Article 9(5) of the Financial Investment Services and Capital Market Act of Korea (“FSCMA”). Spain: This document is a research report and it is addressed to institutional investors only. The research report is of a general nature and not personalised and does not constitute investment advice so, as the case may be, the recipient must seek proper advice before adopting any investment decision. This document does not constitute a public offering of securities. CIMB is not registered with the Spanish Comision Nacional del Mercado de Valores to provide investment services. Sweden: This report contains only marketing information and has not been approved by the Swedish Financial Supervisory Authority. The distribution of this report is not an offer to sell to any person in Sweden or a solicitation to any person in Sweden to buy any instruments described herein and may not be forwarded to the public in Sweden. Switzerland: This report has not been prepared in accordance with the recognized self-regulatory minimal standards for research reports of banks issued by the Swiss Bankers’ Association (Directives on the Independence of Financial Research). Thailand: This report is issued and distributed by CIMB Securities (Thailand) Company Limited (“CIMBS”) based upon sources believed to be reliable (but their accuracy, completeness or correctness is not guaranteed). The statements or expressions of opinion herein were arrived at after due and careful consideration for use as information for investment. Such opinions are subject to change without notice and CIMBS has no obligation to update its opinion or the information in this research report. If the Financial Services and Markets Act of the United Kingdom or the rules of the Financial Conduct Authority apply to a recipient, our obligations owed to such recipient are unaffected. CIMB Securities (Thailand) Co., Ltd. may act or acts as Market Maker, and issuer and offerer of Derivative Warrants and Structured Note which may have the following securities as its underlying securities. Investors should carefully read and study the details of the derivative warrants in the prospectus before making investment decisions. AAV, ADVANC, AMATA, ANAN, AOT, AP, BA, BANPU, BBL, BCH, BCP, BCPG, BDMS, BEAUTY, BEC, BEM, BJC, BH, BIG, BLA, BLAND, BPP, BTS, CBG, CENTEL, CHG, CK, CKP, COM7, CPALL, CPF, CPN, DELTA, DTAC, EA, EGCO, EPG, GFPT, GLOBAL, GLOW, GPSC, GUNKUL, HMPRO, INTUCH, IRPC, ITD, IVL, KBANK, KCE, KKP, KTB, KTC, LH, LHBANK, LPN, MAJOR, MALEE, MEGA, MINT, MONO, MTLS, PLANB, PSH, PTL, PTG, PTT, PTTEP, PTTGC, QH, RATCH, ROBINS, S, SAWAD, SCB, SCC, SCCC, SIRI, SPALI, SPRC, STEC, STPI, SUPER, TASCO, TCAP, THAI, THANI, THCOM, TISCO, TKN, TMB, TOP, TPIPL, TRUE, TTA, TU, TVO, UNIQ, VGI, WHA, WORK. Corporate Governance Report: The disclosure of the survey result of the Thai Institute of Directors Association (“IOD”) regarding corporate governance is made pursuant to the policy of the Office of the Securities and Exchange Commission. The survey of the IOD is based on the information of a company listed on the Stock Exchange of Thailand and the Market for Alternative Investment disclosed to the public and able to be accessed by a general public investor. The result, therefore, is from the perspective of a third party. It is not an evaluation of operation and is not based on inside information. The survey result is as of the date appearing in the Corporate Governance Report of Thai Listed Companies. As a result, the survey result may be changed after that date. CIMBS does not confirm nor certify the accuracy of such survey result.

Score Range: 90 - 100 80 - 89 70 - 79 Below 70 or No Survey Result Description: Excellent Very Good Good N/A

United Arab Emirates: The distributor of this report has not been approved or licensed by the UAE Central Bank or any other relevant licensing authorities or governmental agencies in the United Arab Emirates. This report is strictly private and confidential and has not been reviewed by, deposited or registered with UAE Central Bank or any other licensing authority or governmental agencies in the United Arab Emirates. This report is being issued outside the United Arab Emirates to a limited number of institutional investors and must not be provided to any person other than the original recipient and may not be reproduced or used for any other purpose. Further, the information contained in this report is not intended to lead to the sale of investments under any subscription agreement or the conclusion of any other contract of whatsoever nature within the territory of the United Arab Emirates. United Kingdom: In the United Kingdom and European Economic Area, this report is being disseminated by CIMB Securities (UK) Limited (“CIMB UK”). CIMB UK is authorized and regulated by the Financial Conduct Authority and its registered office is at 27 Knightsbridge, London, SW1X7YB. Unless specified to the contrary, this report has been issued and approved for distribution in the U.K. and the EEA by CIMB UK. Investment research issued by CIMB UK has been prepared in accordance with CIMB Group’s policies for managing conflicts of interest arising as a result of publication and distribution of investment research. This report is for distribution only to, and is solely directed at, selected persons on the basis that those persons: (a) are eligible counterparties and professional clients of CIMB UK; (b) have professional experience in matters relating to investments falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (as amended, the “Order”), (c) fall within Article 49(2)(a) to (d) (“high net worth companies, unincorporated associations etc”) of the Order; (d) are outside the United Kingdom subject to relevant regulation in each jurisdiction, or (e) are persons to whom an invitation or inducement to engage in investment activity (within the meaning of section 21 of the Financial Services and Markets Act 2000) in connection with any investments to which this report relates may otherwise lawfully be communicated or caused to be communicated (all such persons together being referred to as “relevant persons”). This report is directed only at relevant persons and must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this report relates is available only to relevant persons and will be engaged in only with relevant persons. Where this report is labelled as non-independent, it does not provide an impartial or objective assessment of the subject matter and does not constitute independent “investment research” under the applicable rules of the Financial Conduct Authority in the UK. Consequently, any such non- independent report will not have been prepared in accordance with legal requirements designed to promote the independence of investment

166

Navigating China│Education│September 19, 2017

research and will not subject to any prohibition on dealing ahead of the dissemination of investment research. Any such non-independent report must be considered as a marketing communication. United States: This research report is distributed in the United States of America by CIMB Securities (USA) Inc, a U.S. registered broker-dealer and a related company of CIMB Research Pte Ltd, CIMB Investment Bank Berhad, PT CIMB Securities Indonesia, CIMB Securities (Thailand) Co. Ltd, CIMB Securities Limited, CIMB Securities (India) Private Limited, and is distributed solely to persons who qualify as “U.S. Institutional Investors” as defined in Rule 15a-6 under the Securities and Exchange Act of 1934. This communication is only for Institutional Investors whose ordinary business activities involve investing in shares, bonds, and associated securities and/or derivative securities and who have professional experience in such investments. Any person who is not a U.S. Institutional Investor or Major Institutional Investor must not rely on this communication. The delivery of this research report to any person in the United States of America is not a recommendation to effect any transactions in the securities discussed herein, or an endorsement of any opinion expressed herein. CIMB Securities (USA) Inc, is a FINRA/SIPC member and takes responsibility for the content of this report. For further information or to place an order in any of the above-mentioned securities please contact a registered representative of CIMB Securities (USA) Inc. CIMB Securities (USA) Inc does not make a market on other securities mentioned in the report. Neither CIMB Securities (USA) Inc., nor its affiliates have managed or co-managed a public offering of any of the securities mentioned in the past 12 months. Neither CIMB Securities (USA) Inc., nor its affiliates have received compensation for investment banking services from any of the company mentioned in the past 12 months. Neither CIMB Securities (USA) Inc., nor its affiliates expects to receive or intends to seek compensation for investment banking services from any of the company mentioned within the next 3 months. Other jurisdictions: In any other jurisdictions, except if otherwise restricted by laws or regulations, this report is only for distribution to professional, institutional or sophisticated investors as defined in the laws and regulations of such jurisdictions. Distribution of stock ratings and inv estment banking clients for quarter ended on 30 June 2017 1288 companies under cov erage for quarter ended on 30 June 2017 Rating Distribution (%) Inv estment Banking clients (%) Add 51.2% 5.5% Hold 35.7% 3.1% Reduce 11.9% 0.1%

Corporate Governance Report of Thai Listed Companies (CGR). CG Rating by the Thai Institute of Directors Association (Thai IOD) in 2016, Anti-Corruption 2016 AAV – Very Good, n/a, ADVANC – Very Good, Certified, AEONTS – Good, n/a, AMATA – Excellent, Declared, ANAN – Very Good, Declared, AOT – Excellent, Declared, AP – Very Good, Declared, ASK – Very Good, Declared, ASP – Very Good, Certified, BANPU – Very Good, Certified, BAY – Excellent, Certified, BBL – Very Good, Certified, BCH – not available, Declared, BCP - Excellent, Certified, BEM – Very Good, n/a, BDMS – Very Good, n/a, BEAUTY – Good, Declared, BEC - Good, n/a, BH - Good, Declared, BIGC - Excellent, Declared, BJC – Good, n/a, BJCHI – Good, Declared, BLA – Very Good, Certified, BPP – not available, n/a, BR - Good, n/a, BTS - Excellent, Certified, CBG – Good, n/a, CCET – not available, n/a, CENTEL – Very Good, Certified, CHG – Very Good, n/a, CK – Excellent, n/a, COL – Very Good, Declared, CPALL – not available, Declared, CPF – Excellent, Declared, CPN - Excellent, Certified, DELTA - Excellent, Declared, DEMCO – Excellent, Certified, DIF – not available, n/a, DTAC – Excellent, Certified, EA – Very Good, Declared, ECL – Good, Certified, EGCO - Excellent, Certified, EPG – Good, n/a, GFPT - Excellent, Declared, GLOBAL – Very Good, Declared, GLOW – Very Good, Certified, GPSC – Excellent, Declared, GRAMMY - Excellent, n/a, GUNKUL – Very Good, Declared, HANA - Excellent, Certified, HMPRO - Excellent, Declared, ICHI – Very Good, Declared, INTUCH - Excellent, Certified, ITD – Good, n/a, IVL - Excellent, Certified, JAS – not available, Declared, JASIF – not available, n/a, JUBILE – Good, Declared, KAMART – not available, n/a, KBANK - Excellent, Certified, KCE - Excellent, Certified, KGI – Good, Certified, KKP – Excellent, Certified, KSL – Very Good, Declared, KTB - Excellent, Certified, KTC – Excellent, Certified, LH - Very Good, n/a, LPN – Excellent, Declared, M – Very Good, Declared, MAJOR - Good, n/a, MAKRO – Good, Declared, MALEE – Very Good, Declared, MBKET – Very Good, Certified, MC – Very Good, Declared, MCOT – Excellent, Declared, MEGA – Very Good, Declared, MINT - Excellent, Certified, MTLS – Very Good, Declared, NYT – Excellent, n/a, OISHI – Very Good, n/a, PLANB – Very Good, Declared, PLAT – Good, Declared, PSH – not available, n/a, PSL - Excellent, Certified, PTT - Excellent, Certified, PTTEP - Excellent, Certified, PTTGC - Excellent, Certified, QH – Excellent, Declared, RATCH – Excellent, Certified, ROBINS – Very Good, Declared, RS – Very Good, n/a, SAMART - Excellent, n/a, SAPPE - Good, n/a, SAT – Excellent, Certified, SAWAD – Good, n/a, SC – Excellent, Declared, SCB - Excellent, Certified, SCBLIF – not available, n/a, SCC – Excellent, Certified, SCN – Good, Declared, SCCC - Excellent, Declared, SIM - Excellent, n/a, SIRI - Good, n/a, SPA - Good, n/a, SPALI - Excellent, Declared, SPRC – Very Good, Declared, STA – Very Good, Declared, STEC – Excellent, n/a, SVI – Excellent, Certified, TASCO – Very Good, Declared, TCAP – Excellent, Certified, THAI – Very Good, Declared, THANI – Very Good, Certified, THCOM – Excellent, Certified, THRE – Very Good, Certified, THREL – Very Good, Certified, TICON – Very Good, Declared, TIPCO – Very Good, Certified, TISCO - Excellent, Certified, TK – Very Good, n/a, TKN – Good, n/a, TMB - Excellent, Certified, TNR – not available, n/a, TOP - Excellent, Certified, TPCH – Good, n/a, TPIPP – not available, n/a, TRUE – Very Good, Declared, TTW – Very Good, Declared, TU – Excellent, Declared, TVO – Very Good, Declared UNIQ – not available, Declared, VGI – Excellent, Declared, WHA – not available, Declared, WHART – not available, n/a, WORK – not available, n/a. Companies participating in Thailand’s Private Sector Collective Action Coalition Against Corruption programme (Thai CAC) under Thai Institute of Directors (as of October 28, 2016) are categorized into: - Companies that have declared their intention to join CAC, and

- Companies certified by CAC

167

Navigating China│Education│September 19, 2017

CIMB Recommendation Framework Stock Ratings Definition: Add The stock’s total return is expected to exceed 10% over the next 12 months. Hold The stock’s total return is expected to be between 0% and positive 10% over the next 12 months. Reduce The stock’s total return is expected to fall below 0% or more over the next 12 months. The total expected return of a stock is defined as the sum of the: (i) percentage difference between the target price and the current price and (ii) the forward net dividend yields of the stock. Stock price targets have an investment horizon of 12 months.

Sector Ratings Definition: Overweight An Overweight rating means stocks in the sector have, on a market cap-weighted basis, a positive absolute recommendation. Neutral A Neutral rating means stocks in the sector have, on a market cap-weighted basis, a neutral absolute recommendation. Underweight An Underweight rating means stocks in the sector have, on a market cap-weighted basis, a negative absolute recommendation.

Country Ratings Definition: Overweight An Overweight rating means investors should be positioned with an above-market weight in this country relative to benchmark. Neutral A Neutral rating means investors should be positioned with a neutral weight in this country relative to benchmark. Underweight An Underweight rating means investors should be positioned with a below-market weight in this country relative to benchmark.

168