The recent government crackdown on China’s after-school education sector is not only wiping out ten-figure fortunes of some ultra-wealthy founders — it’s also costing some of the world’s largest investment banks and money management firms billions of dollars.
Starting on Friday and continuing on Monday, shares of Gaotu Techedu, New Oriental Education & Tech Group and Tal Education — a trio of NYSE listed Chinese tutoring firms — crashed. On Friday, a report that the government was going to crack down on the for-profit education firms sent shares careening — Gaotu Techedu shares plummeted 98%. Then over the weekend, the Chinese government announced sweeping reforms to the sector, mandating that the firms become non-profits and that they no longer raise money from foreign investors.
Shares of Gaotu, New Oriental and Tal Education dropped 29%, 34% and 27% respectively on Monday, and the companies have lost 75%, 67% and 76% of their market value over the past week. Among those hit the most are American investment banks like Goldman Sachs, which as of the most recent SEC filings in February, owns nearly 19% of Gaotu, and Morgan Stanley, which owns a 6% stake in Gaotu and 14% stake in Tal.
Because foreign companies listed in the U.S. only have to reveal their shareholders once a year, it’s possible that these investment banks have changed their stakes since the Chinese firms filed their 2020 reports to the Securities and Exchange Commission. Of the six major non-Chinese institutional shareholders of Gaotu and Tal, Scottish money manager Baillie Gifford declined to comment, while Goldman Sachs, Morgan Stanley, UBS, Credit Suisse and Nomura did not immediately return a request for comment.
After-school tutoring was once a high-flying industry in China, spurred on by the growing demand for its virtual offerings during the Covid pandemic—and intense competition among millions of the country’s students to gain entrance into China’s top universities. Between March 2020 and March 2021, shares of Gaotu rose 155% to a market cap of roughly $30 billion, while New Oriental and Tal’s shares were up 39% and 38% respectively.
Now China is reforming the industry in an attempt to address the cost of child rearing and ameliorate excessive pressure on its students. But the underlying issue — fierce competition for spots at elite universities — remains. According to the country’s Ministry of Education, a record 10.78 million students were expected to take the national college entrance exam in 2021. However, only six Chinese universities made it to the top 100 of the Times Higher Education’s world university rankings.
A spot at one of these top institutions — Tsinghua University, Peking University, Fudan University, University of Science and Technology, Zhejiang University and Shanghai Jiao Tong University — is highly coveted, but the six universities have a combined undergraduate population of less than 100,000 students. China’s large student population and highly competitive education landscape drove the initial rise of the private education industry, but its investors now face a murky future.
Shares of the Chinese tutoring companies have been declining since early 2021. Gaotu’s second biggest shareholder, Goldman Sachs, which owns about a 19% stake per the February SEC filing. At its peak last October, Gaotu traded at nearly $115 per share, valuing Goldman’s stake at over $3.6 billion. Based on its Monday closing price of $2.50, the same Gaotu stake is now worth less than $80 million.
Other investors also suffered heavy losses. Japanese financial services group Nomura, which owns a 6% stake in Gaotu, has seen the value of its shares drop $1.2 billion from its peak, while Swiss investment bank Credit-Suisse, which owns 5% of Gaotu, has seen the value of its investments decline by $970 million since its high. (It’s possible that all of these banks trimmed their shareholdings after the February filing with the SEC.)
Morgan Stanley, with major stakes in two Chinese education firms, is possibly the biggest loser outside of the Middle Kingdom. Its 6% stake of Gaotu was worth more than $1.1 billion at its peak, while its 14% stake in Tal Education was once worth nearly $2.7 billion. Those two stakes have lost $3.7 billion of their value collectively based on Monday’s closing prices. Morgan Stanley’s stake in Tal was as of March 31.
Other big losers include another Swiss investment bank UBS Group, whose UBS Asset Management owned 9% of Tal. Those shares have lost $1.6 billion of their value since Tal shares topped $90 per share this past February; the firm is now trading at $4.40. Scottish investment manager Baillie Gifford, which owns 6% of Tal, has seen the value of its investment drop nearly $1.2 billion over the course of the stock crash. New Oriental Education, whose stock hopped over $19.50 per share in February, is now trading at $1.94, though it no longer has any major foreign investors. New York investment firm Davis Advisors used to own a 6% stake in the Chinese company, but it fell below the 5% ownership reporting threshold on New Oriental’s 2020 annual report.
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The numbers from the Department of Finance suggest they have struck taxation gold. But they’ve been wrong before
Published Apr 19, 2024 • Last updated 8 hours ago • 5 minute read
“99.87 per cent of Canadians will not pay a cent more,” the prime minister said this week, in reference to the budget announcement that his government will raise the inclusion rate on capital gains tax in June.
The move will be limited to 40,000 wealthy taxpayers. “We’re going to make them pay a little bit more,” Justin Trudeau said.
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But it’s hard to see how that number can be true when the budget document also says 307,000 corporations will also be caught in the dragnet that raises the inclusion rate on capital gains to 66 per cent from 50 per cent.
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Many of those corporations are holding companies set up by professionals and small-business owners who are relying on their portfolios for their retirement.
The budget offers the example of the nurse earning $70,000 who faces a combined federal-provincial marginal rate of 29.7 per cent on his or her income. “In comparison, a wealthy individual in Ontario with $1 million in income would face a marginal rate of 26.86 per cent on their capital gain,” it says.
Policy wonks argue that the change improves the efficiency and equity of the tax system, meaning capital gains are now taxed at a similar level to dividends, interest and paid income. The Department of Finance is an enthusiastic supporter of this view, which should have set alarm bells ringing on the political side.
That’s not to say it’s not a valid argument. But against it you could put forward the counterpoint that capital gains tax is a form of double taxation, the income having already been taxed at the individual and corporate level, which explains why the inclusion rate is not 100 per cent.
The prospect of capital gains is an incentive to invest particularly for people who, unlike wage earners, usually do not have pensions or other employment benefits.
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That was recognized by Bill Morneau, Trudeau’s former finance minister, who said increasing the capital gains rate was proposed when he was in politics but he resisted the proposal.
Morneau criticized the new tax hike as “a disincentive for investment … I don’t think there’s any way to sugar-coat it.”
Regardless of the high-minded policy explanations that are advanced about neutrality in the tax system, it is clear that the impetus for the tax increase was the need to raise revenues by a government with a spending addiction, and to engage in wedge politics for one with a popularity problem.
The most pressing question right now is: how many people are affected — or, just as importantly, think they might be affected?
One recent Leger poll said 78 per cent of Canadians would support a new tax on people with wealth over $10 million.
But what about those regular folks who stand to make a once-in-a-lifetime windfall by selling the family cottage? We will need to wait a few weeks before it becomes clear how many people feel they might be affected.
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The numbers supplied to Trudeau by the Department of Finance suggest they have struck taxation gold: plucking the largest amount of feathers ($21.9 billion in new revenues over five years) with the least amount of hissing (impacting just 0.13 per cent of taxpayers).
The worry for Trudeau and Finance Minister Chrystia Freeland is that Finance has been wrong before.
Political veterans recall former Conservative finance minister Jim Flaherty’s volte face in 2007, when he was forced to drop a proposal to cancel the ability of Canadian companies to deduct the interest costs on money they borrowed to expand abroad.
“Tax officials vastly underestimated the number of taxpayers affected when it came to corporations,” said one person who was there, pointing out that such miscalculations tend to happen when Finance has been pushing a particular policy for years.
Trudeau’s government has some experience of this phenomenon, having been obliged to reverse itself after introducing a range of measures in 2017, aimed at dissuading professionals from incorporating in order to pay less tax. It was a defensible public policy objective but the blowback from small-business owners and professionals who felt they were unfairly being labelled tax cheats precipitated an ignoble retreat.
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Speaking after the budget was delivered, Freeland was unperturbed about the prospect of blowback. “No one likes to pay more tax, even — or perhaps more particularly — those who can afford it the most,” she said.
She’d best hope such sanguinity is justified: failure to raise the promised sums will blow a hole in her budget and cut loose her fiscal anchors of declining deficits and a tumbling debt-to-GDP ratio.
That probably won’t be apparent for a year or so: the government projected that $6.9 billion in capital gains revenue will be recorded this fiscal year, largely because the implementation date has been delayed until the end of June. We are likely to see a flood of transactions before then, so that investors can sell before the inclusion rate goes up.
After that, you can imagine asset sales will be minimized, particularly if the Conservatives promise to lower the rate again (though on that front, it was noticeable that during question period this week, not one Conservative raised the new $21 billion tax hike).
The calculated nature of the timing is in line with the surreptitious nature of the narrative: presenting a blatant revenue grab as a principled fight for “fairness.” The move has the added attraction of inflicting pain on the highest earners, a desirable end in itself for an ultra-progressive government that views wealth creation as a wrong that should be punished.
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Trudeau’s biggest problem is that not many voters still associate him with principles, particularly after he sold out his own climate policy with the home heating oil exemption.
The tax hike smacks of a shift inspired by polling that indicates that Canadians prefer that any new taxes only affect the people richer than them.
Success or failure may depend on the number of unaffected Canadians being close to the 99.87-per-cent number supplied by the Finance Department.
History suggests that may be a shaky foundation on which to build a budget.
National Post
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