With 49% gross profit margin and 24% revenue growth, Meten International (MEDU) will most likely have an EV/Sales ratio close to 2.5x-3.5x. Notice that other competitors with less revenue growth are selling at 0.46x-2.8x forward sales. If the total enterprise value goes below $450 million, the company will represent a buying opportunity.
With that, there are corporate governance risks. The company expects to have a dual-class ordinary share structure. Also, it may be a controlled entity after the IPO. If the Board of Directors is not independent, the market could react by pushing the price close to 0.46x forward sales.
Founded in 2006 and based in China, Meten International is a general English Language Teaching (“ELT”) service provider.
In 2018, the company’s revenue accounted for approximately 74.1% of the market revenue in China. Frost & Sullivan notes that Meten is the second-largest operator in the ELT market.
Meten offers general English courses in small groups of one to four students as well as the preparation for Universities in the United States and England. According to the company’s website, 25% of students are accepted in Universities like Harvard, Yale, and Cambridge. Note that many other schools in China offer somewhat similar services. The images below were taken from the company’s website:
Source: Company’s Website
Source: Company’s Website
Meten International also offers online courses through video conference and the company’s distance learning platforms. As shown in the image below, students can obtain TEFL certification and other distinctions online:
Let’s include opinion statements regarding the previous images and the services offered by Meten. Investors will not buy shares just because of the online courses or the preparation for universities. Apart from the company’s artificial intelligence (“AI”) technology, the company does not seem to offer extremely innovative products. Read the lines below on the company’s AI capabilities:
“We utilize the intelligent tracking and exclusive learning coaching function of our artificial intelligence-driven teaching management systems to record and analyze our students’ real-time learning process and personalize the course content to address their learning needs.” Source: Prospectus
Investors will most likely appreciate Meten International because it controls a significant market share. Besides, it is a leader in an industry that is growing at a high pace.
Frost & Sullivan Report notes that the ELT market in China grew at a CAGR of 19% from 2013 to 2018. Additionally, it expects to grow at a CAGR of 20.7% from 2018 to 2023. The market size is expected to reach RMB365.9 billion or $52.78 billion by 2023.
Meten International is interesting because it operates in a growing market. Usually, investors buy shares of the dominant players. It is the most profitable investment strategy as market leaders, many times, acquire small competitors. Notice that Meten International acquired other businesses in the past.
Most institutional investors will be interested in learning about the company’s facilities. It is impossible to do due diligence on all of them. With that, readers should check the images below. They were taken by an English teacher, who works for Meten International. The company’s classrooms look very well-equipped. Meten appears to have adequate facilities, which investors will most likely appreciate.
Anybody can write a comment on YouTube. With that, the comments about the video, the facilities and the company are valuable. As shown in the images below, many American teachers are working for the company. Besides, they seem to enjoy working for Meten International, which is quite beneficial. Some of them report that they had outstanding working experience.
The fact that foreign teachers from English-speaking countries are willing to work for Meten International is very favorable. Note that the company’s teaching staff is vital for maintaining Meten’s reputation. The company pays competitive salaries in order to retain the best teaching staff:
“There is a limited pool of teaching staff with these attributes and we implement a highly selective hiring process to ensure that the new hires possess the skills commensurate with our knowledge requirements. As a result, we must provide competitive compensation packages to attract and retain such teaching staff.” Source: Prospectus
With 136 centers, the company runs its own schools besides franchising learning centers. It is very positive. It means that entrepreneurs and other third parties appreciate the know-how accumulated by Meten. Instead of starting their own business model, they prefer paying franchise fees to Meten International.
Check the image below for further details on the location of the schools. Notice that the centers are placed all over the country:
Let’s assess the role of employees working for the organization. As shown in the table below, 43% of the total amount of employees are teachers. Besides, 35% of employees work in sales and marketing. As of March 31, 2019, only 179 employees work on research and development. It is not a large number of employees as compared to the number of employees working on sales. With this in mind, investors should not expect a large amount of innovation from Meten International. The company does own artificial intelligence technology, but it is not what matters the most here.
The company’s figures are not like that of a new start-up. The amount of employees is quite significant. With this in mind, investors should not expect dramatic revenue growth in the future. Meten will most likely grow at the same pace that the market does.
24% Revenue Growth And Positive Free Cash Flow
Revenue growth reported in 2018 and 2017 approximated 24% and 43%, respectively. 2018 Revenue approximated $212 million. In 2018, Meten International reported gross profit of $118.6 million, 16% more than that in 2017. Gross profit in 2017 approximated 49%. While the company’s growth is significant, investors will not be very impressed by the company’s figures. Other competitors of Meten International executed IPOs in the past offering larger growth.
With that, the most beneficial is the gross profit margin. In 2018, it was equal to 55%. Investors can review the top of the P&L in the image below:
The cash flow statement is also very favorable. The FCF declined by 92% in 2018 as there existed significant changes in financial liabilities from contracts with customers. It is not ideal. However, the company reported positive free cash flow and positive CFO in 2018, 2017, and 2016. Value investors will most likely appreciate the company’s free cash flow figures. They are calculated in the chart below. Note that 2018 FCF approximated $2.1 million.
As of December 31, 2018, Meten International reported $26 million in cash, $31 million in property and equipment, goodwill of $41 million, and total assets of $150 million. The amount of goodwill represents 27% of the total amount of assets. It is not a small figure, thus investors will appreciate due diligence on the acquisitions made by Meten International. Bear in mind that Meten may have impairment risk. If the expected synergies are not reached, the company’s valuation may decline. See more on the list of assets in the tables below:
On June 25, 2018, Meten International acquired 80% equity interests in ABC Education for a cash consideration of $20.12 million. The target provides junior English training service. See a list of assets acquired in the image below:
Meten International registered a goodwill of $32 million, which is 1.59x the purchase consideration. Determining whether the company will be able to achieve the expected synergies is quite difficult. Note that the income statement of the target company is not given in the prospectus. With that, the amount of goodwill seems significant. Some investors will see impairment risk on this name.
As of December 31, 2018, the company’s asset/liability ratio is below one, which is not ideal. With that, the most significant financial obligations are financial liabilities from contracts with customers. They approximate $63 million, 37% of the total amount of liabilities.
Besides, Meten International reports deferred revenue worth $64 million. It means that the company receives cash in advance before delivering its services. As a result, Meten does not need to contact banking institutions to finance its activities. See below a list of liabilities:
Use Of Proceeds
Meten expects to use the proceeds from the IPO to acquire other competitors in China, grow organically, support R&D activities, and increase its marketing efforts among other purposes. See more on the expected use of proceeds in the lines below:
Dual-class Ordinary Share Structure And Based In Cayman
There is a group of directors and executive officers owning 58% stake in the company. It means that the Board of Directors may be non-independent in the future. As shown in the image below, the company’s Board of Directors consists of seven members, out of which four are not independent:
That’s not all. The company expects to create a dual-class ordinary share structure, which will permit directors to maintain the control of the company. They will own class B shares, providing them ten votes per share. Read the lines below for further details on the matter:
“We will adopt a dual-class ordinary share structure which will become effective immediately prior to the completion of this Offering. All ordinary shares held by Mr. Jishuang Zhao, Mr. Siguang Peng and Mr. Yupeng Guo will be redesignated into Class B ordinary shares, and all ordinary shares other than those held by Mr. Jishuang Zhao, Mr. Siguang Peng and Mr. Yupeng Guo will be redesignated into Class A ordinary shares.
An ordinary share is entitled to one vote per share and each Class B ordinary share is entitled to ten votes per share on all matters submitted. Our Class B ordinary shares are convertible at any time by the holder thereof into Class A ordinary shares on a one-for-one basis.” Source: Prospectus
Investors should understand that the expected equity structure will not benefit minority investors. If the management does not perform, it may be difficult to execute a change of control transaction. Read the lines below on the matter:
See the table below for more on the current shareholders of Meten. Note that JZ Education Investment, AP Education Investment and RG Education Investment are companies controlled by directors of Meten International:
Additionally, the company was incorporated in the Cayman Islands, where shareholders are not as protected as in the United States. Besides, it will be difficult for investors in the United States or China to take actions against that company or directors. The lines below offer further information on this matter:
Competitors And Valuation
With revenue of $212 million, Meten International can be compared with New Oriental Education (EDU), Bright Scholar Education Holdings Ltd. (BEDU), RYB Education, Inc. (RYB), China Online Education Group (COE), and China Distance Education Holdings Ltd. (DL). As shown in the chart below, they have revenue between $155 million and $2.95 billion:
The peer group sells at 0.46x-2.8x forward sales with gross profit margin of 16-64% and revenue growth of 11-37%. Most competitors don’t report debt, but those having leverage report debt/equity ratio of 1.2x-1.4x. The charts below offer further information on the matter:
Meten International Education grows revenue at more than 20% and has a gross profit margin of 49%. With these figures in mind, the company should trade at a higher valuation than peers. Most investors will most likely accept paying 2.5x-3.5x forward revenue for Meten International Education. 2018 Revenue approximated $212 million, so let’s assume forward revenue of $254 million. With an EV/Sales ratio of 3x, Meten will have an enterprise value of $762 million.
With $26 million in cash and debt of $63 million, the market capitalization should be equal to $799 million. As per the prospectus, as of today, the number of ordinary shares outstanding amounts to 318.6 million. With these figures, the share price should be close to $2.5. A buying opportunity will arise with shares at $1.5. With that, notice that the company expects to sell American Depository Shares. The prospectus does not say how many shares will represent each ADS.
Conclusion And Risks
Operating in an industry that expects to grow at more than 20% CAGR, Meten International should be studied by institutional investors. The company has created a business model that generates positive free cash with sales growth exceeding 20% and 49% gross profit margin. With other competitors trading at 0.46x-2.8x forward revenue, Meten International could have an EV/Sales ratio of 3x and enterprise value of $762 million. With this in mind, if the enterprise value is below $450 million, Meten will represent a buying opportunity.
The major risk of Meten International is the fact that it was incorporated in the Cayman Islands. As a result, minority shareholders will not be as protected as in the United States. Additionally, the company expects to have a dual-class ordinary share structure, and it could be a controlled entity. If institutional investors don’t appreciate these facts, the EV/Forward sales ratio could go to as low as 0.46x or lower.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.