Initiating Coverage on EDU – Strong Sell

Published: July 18, 2012

Muddy Waters rates New Oriental Education & Technology Group (NYSE: EDU) shares a Strong Sell because it is probable that EDU will have a significant restatement and possible that its auditor will resign because:

• EDU has reported 392% revenue growth since going public. The revenue growth has been built on store growth of 338% during this time. EDU tells investors that its entire store network is company-owned, but this is a lie. As recently as last month, EDU president and CFO Louis Hsieh adamantly denied that EDU has any franchisees. This report shows Hsieh’s statements are patently false – EDU has numerous franchisees. However, these franchisees are not a hidden bonus for investors. Rather, they are part of a substantial fraud in EDU’s accounts.
• It is virtually certain that EDU uses the upfront franchise and other fees to inflate its cash balances in order to receive unqualified audit opinions from its auditor.
• EDU’s Beijing operation (which is approximately 35% of EDU’s reported revenue) has prepared financial statements for 2009 – 2011 are fraudulent. EDU has submitted these financial statements to its domestic regulator, the Civil Affairs Bureau (“CAB”). It is probable that EDU used these same financials in the preparation of its U.S. filings.
• EDU’s corporate structure is far more problematic than just a weak VIE. The schools that conduct its operations are ultimately state property. We question how EDU can consolidate them.
• We believe that as a result of our exposure of these problems with EDU’s reporting, EDU will restate historical results – likely significantly; and, that its auditor will resign.

[1] Calculation based on RMB revenue, and excludes currency fluctuations.
[2] Store count number includes schools and learning centers; it excludes book stores.

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