Here's How You Can Play A Perhaps Overlooked Chinese Internet Sector

China's online education sub-segment is estimated to record a healthy revenue CAGR of 38 percent in 2015-2020, fueled in part by the rising number of Internet and smartphone users in the country, according to data published by market research firm Frost & Sullivan.

Morgan Stanley’s Claire Cao expects China's K-12 market to approach a “sweet spot,” boosted by rising disposable income. The sector is likely to witness strong enrollment growth and accelerating market consolidation.

Business Model: A Key Issue

Amidst the backdrop of rapid growth in China’s online education sub-sector, the key issue for companies is likely to be identifying a feasible business model, analyst Claire Cao commented. She added, “We expect that more efficient business models will emerge for adult online language training than for online K-12 after-class tutoring services for children.”
 

Overweight Stocks

The analyst initiated coverage of New Oriental Education & Tech Grp (ADR) EDU and TAL Education Group (ADR) XRS with Overweight ratings and price target of $43 and $58, respectively.

Despite the recent run-up in their shares versus the S&P, there is further upside from current levels, Cao commented. She enumerated the reasons for this as:

1. Strong earnings visibility underpinned by accelerating K-12 enrollment growth
2. Resilience to macro slowdown

“We expect both companies to ride on the wave of K-12 market growth and gain share from small institutions rather than face immediate head-to-head competition,” Cao wrote. She identified New Oriental as the Top Pick, citing its cheaper valuation – 35 percent discount to TAL.