Deep value China small cap - China New Higher Education Group (2001:HK)

I don't expect many people would be interested in actually buying this, but I want to post it anyway as a good example of potential deep value

China New Higher Education Group owns 7 private universities/vocational colleges in various provinces of China (mainly inland).

Their financials have strong quality markers, high margin, good ROE, very stable revenues - however the growth prospects are limited and maintenance capex is moderately high.

It's current headline trailing multiples are 1.4x earnings, 1.1x FCF, and 2.6 EV/EBITDA. Even by China norms, those are incredibly low, especially for a stable, cash generative business.

For the past 2 years no cash dividend was paid as company has focussed on reducing balance sheet leverage, which they have done successfully, which D/E having shrunk from around 100% to near 50% with 9x interest coverage

Why does it appear so cheap? Because there is a lot of fear around a regulatory crackdown on private education. In 2021, China launched a crackdown on private after-hours tuition for school children, effectively making it illegal overnight, due to what they saw as a excess of exploitative capital with many tutoring companies enjoying explosive profit and stock price growth in a hot sector.

Higher education was not affected but there is a fear it might be, however the conditions which prompted the last crackdown are not present (in fact the opposite). It should also be noted the last crackdown was not a total success as it did nothing to address the demand for private tutoring and has simply shifted the industry underground with parents now finding tutors informally through WeChat rather than organised, regulated companies.

But China's regulatory landscape is unpredictable and shareholders should understand the maximum risk is 100% in the worst case.

However the upside is very high because the multiples are so low that even a re-rate to a still moderate multiple like 3-5x earnings represents a gain of 300-500%. IMO the risk-reward is strong.

Insider ownership is high with the chairman owning 50% of the stock (single class). He also has a fairly high position within the CCP

I think this year they will probably re-instate the dividend which could act as a catalyst. Even a modest payout ratio of 30% (lower end of their historical norm) would equate to a dividend yield around 30% when PE P/FCF are near 1. And in that case the stock price will very likely re-rate perhaps somewhere in the range 3-5x earnings, which would represent very significant appreciation

In a nutshell - the case is a financially high quality company trading at extremely low multiples due to fear of a threat that has not materialised, and while the threat is potentially devastating, the potential is highly asymmetric to the upside