China’s private education companies have for years been the darlings of investors from New York to Shanghai, building a $100 billion industry on the promise of the world’s largest and arguably most-competitive schooling system. Then suddenly they got caught up in the Chinese government’s sweeping efforts to rein in the country’s technology giants, ostensibly in the name of consumer protection. The regulatory clampdown on tutoring, online and in person, has walloped listed companies and forced startups with big-name backers like Tencent Holdings Ltd. to mothball plans for multibillion-dollar initial public offerings. The industry’s rise -- and potential fall -- hinges on two of the most powerful and anxiety-inducing forces in China today: the pursuit of wealth and status, and the Communist Party’s enduring obsession with maintaining social order.

1. How did tutoring become so popular?

Blame it on the Gaokao: the national college admission test, administered in June, that decides which universities one can attend, thereby determining the fates of millions. It’s considered a playing-field leveler for those aspiring to move up the social ladder. Only 1.9% of nearly 11 million students who sat for the Gaokao in 2020 made it to a top-tier institution like Peking, Fudan or Tsinghua universities. Preparations begin many years before, in some cases as early as pre-school, as parents try to give their children every possible edge. Ironically, years of government entreaties to lessen the burden of homework may have driven anxious parents to private companies. After-school tutoring flourished, supplemented by online classes that in turn exploded during the Covid-19 pandemic. China’s market for private tutoring is expected to almost double to 1.17 trillion yuan ($183 billion) in 2023, from 619.1 billion yuan in 2019, according to Macquarie Research.

2. What do the regulators say?

That some tutoring firms exploited parental paranoia. A marketing free-for-all -- sometimes with false ads and misleading campaigns -- funneled millions of kids into mind-numbing virtual classes with uncertain benefits. As student numbers exploded, venture capital investors who didn’t want to miss out joined Alibaba Group Holding Ltd., Tencent and SoftBank Group Corp. in doling out more than $10 billion of funding last year alone. That exuberance alarmed regulators, who feared tutoring firms empowered by big capital would only grow and exacerbate problems. President Xi Jinping lashed out at the industry’s “disorderly development” at a meeting in May, intensifying a clampdown from agencies including the powerful education ministry.

3. What’s the bigger picture?

Officials are also concerned about the destabilizing effects of hundreds of millions of parents plowing their life savings into online classes, while subjecting children to increasingly onerous workloads. As with past booms built on shaky ground -- say, in peer-to-peer lending, online shopping or improperly licensed wealth management products -- Beijing stepped in quickly to defuse what it perceived to be a potential time bomb that threatened to disrupt order and thus the party’s grip on power. In addition, many cite the cost and competition for better education resources as a contributor to China’s declining birthrate. China offered tax breaks -- including tax write-offs for education fees --in 2019 to promote its new two-child policy, but that didn’t help. Now it wants people to consider having up to three. A reform of the education system may seem like a good way to start.

4. What have regulators actually done?

The Ministry of Education in June created a dedicated division to oversee after-school education and tutoring. That followed a plethora of restrictions, including caps on fees firms can charge and time limits on after-school programs. Regulators have fined two of the biggest startups for false advertising: Alibaba-backed Zuoyebang and Tencent-investee Yuanfudao. The Law on Protection of Minors, which went into effect June 1, also banned tutoring institutions (and kindergartens) from offering primary school-level lessons to pre-schoolers -- not uncommon previously.

5. What’s in store?

There’s been speculation that a law or regulation specifically for tutoring could be coming to update guidelines issued in 2018, according to Zhongtai International analyst Vivien Chan. The worst-case scenario for the industry: After-school tutors might be banned from operating on weekends and holidays, their prime hours. The existing guidelines already forbid tutoring activities linked to test-taking and enrollment admission. On the flip side, tutoring services that focus on cultivating interests, innovation and practical abilities -- say piano lessons -- are encouraged. Such after-school programs are supposed to end no later than 8:30 p.m. and assign no homework, and institutions must not collect more than three months of fees. However, enforcement has been patchy, at best.

6. What’s the impact of the crackdown been?

Plans for several mega-IPOs have been halted, with Tencent-backed VIPKid and Huohua Siwei putting off U.S. listings, and Zuoyebang is said to be likely to miss its target of debuting as soon as this year. Shares of listed tutoring firms have gotten hammered, including industry bellwethers New Oriental Education & Technology Group Inc., TAL Education Group and GSX Techedu Inc. GSX also said in late May it’s closing its pre-school education business for children ages 3 to 8 and cutting staff.

7. So is it a good time to bottom fish?

Maybe not, given the prospect for more stringent controls down the road. Shares of education firms haven’t fully priced in the worst-case scenario, Zhongtai’s Chan said. While industry leaders including GSX and TAL have posted revenue growth in double-digits or higher in past years, their marketing expenses soared even more amid fierce competition. The sharp decline in cash flow coupled with more cautious investors could plunge the industry into a vicious cycle should Beijing tighten the screws further.

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