TAL Education: A Real Business With Fake Financials – Part I
Muddy Waters is short TAL Education Group. Investors might recall the dark days of 2010 and 2011, during which numerous U.S.-listed China companies went down as frauds. According to the recent documentary, the China Hustle, there were approximately 400 frauds from China listed on U.S. exchanges. Out of literally hundreds of blatant frauds, almost no company chairman did any prison time. Charlie Munger is fond of saying “Show me the incentive, and I’ll show you the outcome”. Defrauding U.S. investors from China has proven to be a “heads I win, tails you lose” proposition. So, it does not shock us when we see that TAL began fraudulently creating profits as early as FY2016. Since the beginning of FY2016, the value of Chairman Zhang’s shares have skyrocketed from $900 million to close to $7.5 billion. The prospect of becoming Bobby Axelrod rich is a powerful incentive, especially when you have no downside if caught.
- Although TAL is a “real business”, it has been fraudulently overstating its profits since at least FY2016.
- We estimate that during FY2016 through FY2018, TAL has overstated net income by at least 43.6%. Our estimates of profit inflation are based only on what we are able to quantify – fraudulent profit inflation likely exceeds this estimate.
- We estimate that TAL’s cumulative net income margin during this period was only 8.8% (versus 12.4% reported); we estimate its FY2018 net income margin was only 10.4% (versus 11.6% reported).
- We believe the fraud pervades the core Peiyou business and is migrating into TAL’s online businesses.
- This is Part I in a series of reports. In this report, we cover two sets of fraudulent transactions that we estimate inflated TAL’s FY2016-FY2018 pre-tax profits by up to $153.2 million, or 28.4%.
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