China Education Sector 9 July 2018abc 2China Education SectorP2UBS-S Research THESIS MAP a guide to our thinking and what's where in this report OUR THESIS IN PICTURES MOST FAVOUREDLEAST FAVOURED TAL and New Oriental N/APIVOTAL QUESTIONS Q: How will online education transform afterschool tutoring by 2025By 2025, we expect online classes to deliver teaching quality on par with offline classes, thanks totechnology advances (eg, AI, big data, VR, facial recognition), and to be embraced by a generationof more internet-savvy parents. In our 2025E base case, we estimate about 50% of students'afterschool tutoring (AST) time will be spent in online classes, translating into revenue ofRmb714bn. This represents significant upside from 2017E’s Rmb29bn in online K12 AST revenue.In our blue sky scenario where online outperforms offline in teaching quality, online revenue couldpotentially reach Rmb1,227bn. more Q: Will K12 online tutoring consolidate into an oligopolyYes. We expect online AST to follow in the footsteps of other online verticals in China andconsolidate into a segment with only a handful of major players. Unlike offline AST, which haslower barriers to entry, online AST requires strong R&D and operating capabilities, a solid brand andthe financial resources for marketing, putting it out of reach of smaller, less well-funded players, inour opinion. TAL and New Oriental have the brand strength, know-how and established customerbase to succeed in online AST, and are well positioned to capture the significant revenue potential. moreUBS-S VIEW We anticipate shifts in consumption preferences and technology that could propel an onlinetransformation in education in China. We expect the online K12 AST market to grow due totechnology advancement and for online education to be embraced by a generation of moreinternet-savvy parents. We expect the online AST market to become more consolidated than theoffline market due to higher entry barriers (capital strength, operating capability and brandrecognition). We consider TAL and New Oriental to be well positioned to capture the significantupside potential, a factor we believe is not priced into the shares.EVIDENCE Our recent UBS Evidence Lab survey indicates Chinese parents still predominantly prefer offline AST.iResearch and Sina Education surveys suggest parents' biggest concerns about online courses are:1) study outcomes; and 2) service quality. Leading players’ investment in AI, VR and facialrecognition technology could improve quality and parental acceptance of online education,especially since a more internet-savvy generation will become parents of K12 students by 2025.Online AST providers need to have the financial resources for R&D and marketing, which potentiallyputs the market out of reach for smaller players, thus creating a more consolidated landscape. WHAT'S PRICED IN From our conversations with investors, we think the market has yet to reach a consensus on thelong-term growth potential of online education. TAL and New Oriental are trading at slightdiscounts to listed K12 private schools, which have much less online exposure, and they are at adiscount to other early movers in online transformation; thus, we believe strong positioning forexpansion in online education is not priced into TAL and New Oriental shares. more Online AST market – revenue potential, base case (Rmb bn) Source: The Chinese Society of Education, China Youth & Children Research Center, China Institute for Educational FinanceResearch, UNPD, Haver, CEIC, Wind, Company data, UBS, UBS-S estimates 181225262298348407477554 664777866956 1,0641,1681,2651,351 346912 142029 4568 98141 227345 504714 0 500 1,000 1,500 2,000 2,500 20102011201220132014201520162017E2018E2019E2020E2021E2022E2023E2024E2025E Online OfflineChina Education Sector 9 July 2018abc 3China Education SectorUBS-S ResearchP3OUR THESIS IN PICTURESreturn Penetration among Chinese internet users (2017)Education is among the verticals with the lowest onlinepenetration—it is ripe for transformation, in our viewOnline afterschool tutoring scenarios2025E base case: high level of consumer acceptance andtechnology advancement drive strong online adoption inafterschool tutoringRevenue comparison (Rmb bn)We think online could provide significant revenueupside for the afterschool tutoring sectorPenetration of afterschool tutoring – base case We expect penetration of afterschool tutoring toincrease to 60% by 2025E as the online format makeshigh-quality tutoring available to more students0%20%40%60%80%100% Instant messagingOnline news Search EngineOnline video Online musicOnline shopping Online paymentMap query Online gamesOnline banking Online literatureTravel booking Online meal orderingWeibo E-mailOnline education Online wealth managementOnline stock or fund trading Consumer acceptance High Blue-sky DownsideBase case TechnologyadvancementLow TechnologyadvancementHigh Current state ASTDownside Consumer acceptance Low 714 584 11 0 200 400 600 800 2025E Online AST revenue - base casse 2017E total AST sector revenue TAL FY18 revenue 20% 30% 40% 50% 60% 70% 20102012201420162018E2020E2022E2024EChina Education Sector 9 July 2018abc 4Share of afterschool tutoring time spent online – base caseAs better technology enables online classes to deliverteaching on par with offline, we expect about 50% ofafterschool tutoring time to be spent online by 2025EWe expect the online afterschool tutoring market to bemore consolidated than offline… Note: R&D data for TAL and New Oriental based on FY19 guidance; revenue datafor top-7 online players are approximate for CY17.…given the financial strength required to fund initialR&D and marketing, and the higher requirement forbrand recognition; TAL and New Oriental are wellpositioned PEG comparisonTAL and EDUare trading at a slight discount to listedK12 private schools, which have much less onlineexposure; we believe their strong online positioning isnot priced inSources for exhibits above: iResearch, Sina Education, ITJuzi, Thomson Reuters, Company data, UBS-S estimates0% 10% 20% 30% 40% 50% 60% 2017E2018E2019E2020E2021E2022E2023E2024E2025E VIPKID 6.8%Zhangmen3.1% TAL 2.5%51Talk 2.0%EDU 1.7%Yuanfudao0.9%Only Hi 0.3%Others 82.7%Online K12 afterschool education market share (2017)180 85120 551 228 0 100 200 300 400 500 600 TALEDUAverage revenue of top 7 online K12 tutoring players (US$ m) TAL/New Oriental's R&D investment TAL/New Oriental's FCF TAL and New Oriental R&D expenses vs average revenue0.84x 0.78x 0.70x0.66x 0.0x 0.2x 0.4x 0.6x 0.8x K12 private schools TALK12 afterschool tutoring sector New Oriental 。。。。。。