New Oriental (NYSE:EDU), a Chinese-based education provider, hit the public markets yesterday, and its stock price quickly surged from $15 to $20.88 as the company raised $112.5 million. But although things look good now and the business certainly has strong growth prospects, New Oriental may provide just the latest reminder that chasing IPOs can be dangerous.
Founded in 1993, New Oriental has built an education powerhouse. Originally, the company focused on test preparation, such as for law and med school, and is the dominant player in that space, with 375,000 enrolled students over the past year. In 1996, it moved into teaching practical English. This business also has gained traction, with 497,000 enrolled students over the past year.
New Oriental covers many touch points: physical classrooms, books, CD-ROMs, and online training, which has about 200,000 paid customers. It also has key relationships with major content providers such as McGraw-Hill (NYSE:MHP) and Thomson (NYSE:TOC).
No doubt, the market opportunity is huge. Roughly 457 million Chinese citizens are between ages 5 and 29. With the growth in tourism, international trade, and Internet businesses, the demand for English instruction has been strong in China. The market is expected to grow from $2.3 billion in 2006 to $3.7 billion by 2010.
And though the company does face competition, it also enjoys some key competitive advantages: a strong brand, extensive content, and 1,700 trained instructors. To build this infrastructure, management incurred almost $100 million in capital expenditures over the past three years. It was a smart move, since the business can now profitably scale its growth.
Perhaps buying shares in New Oriental is a way to get in on an early-stage Apollo Group (NASDAQ:APOL) or Blackboard (NASDAQ:BBBB) -- traditionally strong performers in this industry. Education, after all, is critical for any strong economy. And New Oriental does have similar growth characteristics. Since 2004, its revenues have increased at an annual compounded growth rate of 32% to $96.1 million. In the past year, net income was $6.2 million.
But -- and here's the bad news -- at the company's $705 million market cap, the shares are selling at more than six times revenues. And therein lies the problem with chasing hot IPOs: Individual investors like us are rarely able to get in on the opening price, and by the time we are able to buy, the shares may have run up to far-too-lofty levels.
So while New Oriental could be the next big thing, investors would certainly have to pay a fat premium for such a bet.
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Fool contributor Tom Taulli does not own shares of companies mentioned in this article.
