China’s Unexpected Ban of For-Profit Digital Schools Poses Threat to Higher Cap Tech Firms

China’s crackdown on crypto currencies mining has grown into something even bigger – namely, the handful of leading public companies that China is going to ban. Hot discussions ignited on various social media platforms as to what was the main issue behind such a swift sporadic move that left many private investors significantly truncated. But whether for the right reason or wrong, that poses a big question of whether investments into the Chinese instruments are worth this kind of non-quantifiable risk and the ultimate conclusion is that many of us must rethink the entire China portfolio exposures.

On Friday Shanghai Composite Index plunged as China confirmed that the country is banning for-profit school tutoring companies citing their unwarranted interference with normal educational programs. The report sent shares of online tutoring firms such as TAL Education (TAL), New Oriental (EDU) and Gaotu Techu (GOTU) tailspin. TAL plunged 71% during the last trading session of the past week, while New Oriental dropped 54% and Gaotu, formerly known as GSX, shed 63%. The following names should be put under review: 1041394D CH (Beijing Yuanli Education Technology Co), 1531423D CH (Xiaochuanchuhai Education Technology Beijing Co), 1769 HK (Scholar Education Group), 1797 HK (Koolearn Technology Holding Ltd), 700 HK (Tencent Holdings Ltd), DIDI US (DiDi Global Inc), EDU US (New Oriental Education & Technology Group Inc), GOTU US (Gaotu Techedu Inc), ZME US (Zhangmen Education Inc). Other Chinese educations stocks that declined included 17 Education & Technology (YQ), China Online Education (COE), OneSmart International (ONE), Bright Scholar Education (BEDU), Rise Education (REDU), Youdao (DAO), Tarena International (TEDU) and Hailiang Education (HLG).

According to a Bloomberg report, online education companies that teach school subjects can no longer accept overseas investments, which was largely perceived en-masse as a crackdown campaign on nongovernmental commercial organizations. Some of the above listed firms can no longer raise capital through stock markets and vacation and weekend tutoring is prohibited.

Speculation that China is about to start the full fledged “a-la Bitcoin mining crackdown” crusade prompted JPMorgan to downgrade Tal, New Oriental and Gaotu to underweight ratings, which is essentially a sell recommendation.

TAL on its official Weibo site stated over the weekend that it would “fully implement the CPC’s education policy,". Also, reportedly, China's antitrust watchdog has ordered Tencent Music Entertainment (TME) to give up its exclusive music licensing rights for online music within 30 days. The antitrust agency also imposed a fine of 500,000 yuan ($77,141) on the company.

Earlier this week, DiDi (DIDI) fell on a report of impending "unprecedented" penalties in China.

These companies were also barred from providing online or academic classes to children under the age of six, a segment of China's new generation that had increasingly been pushed to start studying early. According to Bloomberg, China’s education technology sector had grown to $100 billion as companies targeted “digitized” parents seeking to give their children every advantage of remote education that lurs best global tutors. Beijing’s reforms once implemented will fundamentally alter their entire business models, while according to one “extreme scenario”, overseas investment will be outright prohibited in companies that teach school subjects and any China-based company in violation will be held legally responsible, according to a notice released by the State Council, the country’s most powerful administrative authority.

We expect that this, seemingly prominent, but isolated story, has a well pronounced potential of spilling over to the wider Chinese tech sector that may include such big names as Alibaba (BABA), ByteDance (1774397D) and Bidu (BIDU).