Quick Take

17 Education & Technology Group (YQ) has filed to raise $100 million in an IPO of its ADSs representing underlying Class A shares, according to an F-1 registration statement.

The firm provides offline and online K-12 education products and services in China.

YQ has done well with its ‘free razor and charge for razor blades’ business model approach, but operating losses and operating cash burn remain high.

I’ll provide a final opinion when we learn more IPO details from management.

Company & Technology

Beijing, China-based 17 Education was founded to develop an innovative hybrid offline-online model for K-12 students in China.

Management is headed by founder, Chairman and CEO Mr. Andy Chang Liu, who was previously principal of Shenyang New Oriental School, along with many years of education experience in offline schools.

The firm provides offline learning materials for free to more than 70,000 schools in China and those offline material service to onboard students into its online tutoring products, which now account for more than 90% of its revenues.

17 Education has received at least $1.37 billion from investors including Shunwei Capital, Fluency Holding, H Capital, CL Lion Investment, Esta Investments, Walden Investments Group and Long Great Holdings.

Customer/User Acquisition

The firm provides all manner of education materials free to offline schools throughout China.

The company then leverages these offline relationships to generate interest in its after-school online tutoring services.

Sales and Marketing expenses as a percentage of total revenue have been uneven but trending upward as revenues have increased, as the figures below indicate:

Sales and Marketing

Expenses vs. Revenue

Period

Percentage

Nine Mos. Ended Sept. 30, 2020

105.4%

2019

143.7%

2018

97.7%

Source: Company registration statement

The Sales and Marketing efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Sales and Marketing spend, rose to 0.7x in the most recent reporting period, as shown in the table below:

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Sales and Marketing

Efficiency Rate

Period

Multiple

Nine Mos. Ended Sept. 30, 2020

0.7

2019

0.2

Source: Company registration statement

Market

According to a 2019 market research report by ResearchAndMarkets, the market for Chinese education at all levels is forecast to reach $573 billion by 2023.

This represents an impressive forecast CAGR of 11.3% from 2018 to 2023.

The main drivers for this expected growth are an increasing urban population, growing discretionary income, increased government spending on education and growing broadband adoption.

Also, increased demand for online education along with the emergence of a two teacher model in lower-tier cities will also provide for increased educational success.

The market for ancillary K-12 education services in China remains fragmented and the company faces competition from both public and private education providers.

Financial Performance

17 Education’s recent financial results can be summarized as follows:

  • Sharply growing topline revenue

  • Increased gross profit but uneven gross margin

  • Growing operating losses but decreased negative operating margin

  • Increased cash used in operations

Below are relevant financial results derived from the firm’s registration statement:

Total Revenue

Period

Total Revenue

% Variance vs. Prior

Nine Mos. Ended Sept. 30, 2020

$ 118,944,000

278.1%

2019

$ 59,833,000

30.9%

2018

$ 45,692,059

Gross Profit (Loss)

Period

Gross Profit (Loss)

% Variance vs. Prior

Nine Mos. Ended Sept. 30, 2020

$ 71,503,000

335.2%

2019

$ 34,283,000

13.3%

2018

$ 30,255,735

Gross Margin

Period

Gross Margin

Nine Mos. Ended Sept. 30, 2020

60.11%

2019

57.30%

2018

66.22%

Operating Profit (Loss)

Period

Operating Profit (Loss)

Operating Margin

Nine Mos. Ended Sept. 30, 2020

$ (143,008,000)

-120.2%

2019

$ (147,300,000)

-246.2%

2018

$ (102,868,971)

-225.1%

Net Income (Loss)

Period

Net Income (Loss)

Nine Mos. Ended Sept. 30, 2020

$ (696,732,000)

2019

$ (230,394,000)

2018

$ (132,417,941)

Cash Flow From Operations

Period

Cash Flow From Operations

Nine Mos. Ended Sept. 30, 2020

$ (77,531,000)

2019

$ (92,978,000)

2018

$ (61,597,794)

(Glossary Of Terms)

Source: Company registration statement

As of September 30, 2020, 17 Education had $119.9 million in cash and $156.4 million in total liabilities.

Free cash flow during the twelve months ended September 30, 2020, was negative ($84 million).

IPO Details

17 Education intends to raise $100 million in gross proceeds from an IPO of its ADSs representing underlying Class A shares, although the final figure may differ.

Class A shareholders will be entitled to one vote per share while the Class B shareholder, founder Andy Chang Liu, will be entitled to 30 votes per share.

No existing shareholders have indicated an interest to purchase shares at the IPO price.

Management says it will use the net proceeds from the IPO as follows:

approximately 30% for improving the operation of our after-school tutoring services and student learning experience;

approximately 20% for enhancing the product offerings and educational content of our smart in-school classroom solution;

approximately 20% for investing in our technology infrastructure;

approximately 20% for sales and marketing and brand promotional activities; and

the balance to fund working capital and for other general corporate purposes.

Management’s presentation of the company roadshow is not available.

Listed bookrunners of the IPO are Goldman Sachs [Asia], Morgan Stanley and BofA Securities.

Commentary

17 Education is seeking U.S capital market funding to expand its operations within China.

The firm’s financials show strong revenue and gross profit growth, but also high operating losses and increasing operational cash burn.

Sales and Marketing expenses as a percentage of total revenue have been uneven but trending higher, while its Sales and Marketing efficiency rate has improved dramatically in the most recent reporting period.

The market opportunity for providing supplemental education to K-12 students in China is large, as many families place a high value on better education quality for their children than can be found in typical public education.

17 has done well with its hybrid business model of providing educational materials free of charge as a loss leader to pull in students to its pay online service.

This business model is a form of ‘giving away the razor and charging for the blades.’

However, operating losses remain quite high as does operating cash flow burn, so management’s assumptions on IPO pricing and valuation will be important.

I’ll provide a final opinion when we learn those details.

Expected IPO Pricing Date: To be announced.

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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.



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