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Kindergarten scandal raises ethics questions over China's IPO rush

Company that runs Beijing school took quick profits after listing in New York

TAIPEI A child-abuse scandal involving a prominent Beijing kindergarten is raising questions about whether China's initial public offering rush has become too heated to allow sufficient screening of candidate companies.

Parents last week alleged that their children at a preschool run by RYB Education, which listed on the New York Stock Exchange on Sept. 27, were poked with needles, fed unidentified pills and forced to go naked. China's official Xinhua News Agency reported on Nov. 25 that a teacher had been detained by police in connection with the case. RYB subsequently issued a statement of apology, saying it was firing the teacher. It said it was cooperating with the authorities in their investigations and would provide doctors and psychologists to treat victims.

RYB, whose shares jumped 40% on the first day of trading after its $144.3 million IPO, is one of 15 Chinese companies that have listed in New York this year, the most in six years, according to financial data provider Dealogic. This gold rush has created several new billionaires.

Chimin Cao, co-founder and chairman of RYB Education Institution, and Yanlai Shi, co-founder and CEO, at the New York Stock Exchange for the debut of the company's shares on Sept. 27.   © Reuters

RYB investors did not strike it quite so rich, but Ascendent Capital Partners, a China-focused private equity group founded by two alumni of Yale University's MBA program, pocketed $42.6 million by selling off about a third of its holding in the preschool operator during the IPO.

RYB shares however opened 41.5% lower on Nov. 24 when trading resumed after the Thanksgiving holiday in the U.S., even though the company announced before trading started that it would spend up to $50 million over the next year buying back potentially more than a third of the stock it had sold in the IPO two months earlier.

Ascendent, which bought a 47.1% stake in RYB in late 2015, is now the company's biggest shareholder. Soon after its investment, news broke that five teachers had been detained at an RYB kindergarten in northeastern Jilin Province on allegations they had pricked children with needles. A year later, four were sentenced to prison, according to Xinhua.

"The education industry in China has grown fast and remains an attractive investment target," said Peter Fuhrman, chairman and chief of China First Capital, an investment bank based in Shenzhen active in private equity. "This high growth has perhaps sometimes come at the expense of the core fundamental: gaining the necessary expertise, focus and procedures to assure child safety."

COMMON BACKGROUNDS Aside from the Ascendent partners, Yale School of Management was also the common factor that brought RYB together with Joel Getz, the school's senior associate dean for development and alumni relations. Getz declared in a filing with the U.S. Securities and Exchange Commission on Aug. 30 that he would join RYB's board as an independent director, just a month before the company listed on the NYSE.

Speaking with the Nikkei Asian Review, Getz, who was previously director of development for the William J. Clinton Foundation and president of the Mayor's Fund to Advance New York City during Michael Bloomberg's time in office, declined to respond to questions and simply pointed to RYB's own statement on the Beijing scandal. "I think it is best not to comment further until the investigation is completed," he said in a subsequent email.

RYB's prospectus did not disclose how much Getz and two other independent directors who joined just before the listing would receive in compensation. Before they joined, the board included only three RYB executives and Ascendent Managing Partner Liang Meng. The prospectus notes that as a Cayman Islands-registered company, RYB was exempted from some requirements that the NYSE imposes on U.S. companies. One such requirement, not specifically mentioned by RYB, is that the NYSE demands that a majority of members on U.S. company boards be independent directors.

Meng and partner Kevin Zhang are co-chairmen of Yale School of Management's greater China advisory board. Meng received in 2013 a business school honor which "recognizes graduates whose personal and professional accomplishments embody the school's mission."

Ascendent's Chinese name Shangda, which means ascending or striving for better moral values, comes from a saying by Confucius, according to its website. The original saying goes: "Gentlemen would strive to ascend to the high moral ground, while petty individuals would only seek out materialistic gains."

Yale's endowment fund, the second-largest among all universities, has generated handsome returns through investing in private equity and venture capital funds active in China, most notably Hillhouse Capital Group. Zhang Lei, who previously helped manage Yale's endowment, received $20 million in seed money from the university to start Hillhouse and now manages more than $20 billion.

Hillhouse is the second-largest institutional investor in RYB, according to Thomson Reuters data. Yale was also a venture investor in JD.com, according to a recent endowment report. The School of Management operates an activity center in Beijing on behalf of the university.

It is unclear whether Yale has invested with Ascendent. Neither party responded to questions before publication. Aside from RYB, Ascendent's website highlights past investments in companies including pork producer WH Group and delivery service Meituan-Dianping. The site also republished an article on how Ascendent generated returns of five times its capital on a 40% stake it purchased in train component maker Nano Resources after a high-speed rail crash in 2012 drove down its shares.

The underwriters of RYB's IPO were China International Capital, Credit Suisse, Morgan Stanley and BNP Paribas.

According to RYB's prospectus, the company was the largest early childhood education service provider in China by revenue in 2016. As of June 30, RYB directly operated 80 kindergartens and franchised an additional 175 facilities, with some 20,463 students enrolled in its directly operated kindergartens.

Among the business risks highlighted in the listing document were that some of its centers were carrying out operations that exceeded the scope of their business licenses.

"As we continue to grow in size and broaden the scope of our curricula and services, however, it may become increasingly difficult to maintain the quality and consistency of the services we offer, which may negatively impact our brand and the popularity of our products and services offered thereunder," RYB said.

Nikkei Asian Review deputy editor Zach Coleman contributed from Hong Kong.

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