Why Chinese Education Stocks Plummeted on Wednesday

What happened

Shares of Chinese education companies plummeted today following a report that the Chinese government is about to impose a variety of strict regulations on the sector. Fears and rumors have been swirling for months, rattling investors and weighing on Chinese education stocks. Additionally, Morgan Stanley downgraded some of the companies based on expectations of stringent rules. As of 11:15 a.m. EDT, here's how prominent Chinese education stocks were faring:

So what

Reuters reports that the government crackdown is both imminent and worse than expected. The regulations will include trial bans on vacation tutoring as well as strict rules around advertising. The rumored trial ban could crush private tutoring companies and cut off as much as 70% to 80% of revenue, according to the report. The regulations will be imposed on nine areas before being implemented more broadly across the Middle Kingdom.

A descending white arrow against a red stock chart background.

Image source: Getty Images.

"The new rules would be stricter than expected," an anonymous source told the outlet. "The industry should be preparing for the worst."

China is facing a demographic crisis as population growth has been slowing in recent years, in part due to the one-child policy that was in place for decades. The Chinese government now allows couples to have up to three children and is taking a variety of proactive steps to encourage people to have more children. The move to regulate private tutoring is a way to reduce some of the financial burdens and discretionary spending associated with having kids.

President Xi Jinping wants schools to do the heavy lifting with education instead of private tutoring companies. There will be rules regarding tuition fees as well as new restrictions around excessive advertising for both online and offline ads.

Now what

Morgan Stanley double downgraded TAL Education to underweight (equivalent to a sell rating), while dropping its rating on New Oriental Education to equal weight (equivalent to a hold). Analyst Sheng Zhong cut the price target on New Oriental Education from $20 to $8.60, based in part on the assumption that tutoring will be partially or completely disallowed during weekends and holidays.

The new regulations could be officially announced as soon as next week and be implemented next month, according to Reuters.

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Evan Niu, CFA has no position in any of the stocks mentioned. The Motley Fool recommends New Oriental Education & Technology Group and TAL Education Group. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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