The education unit of gaming giant NetEase reported a narrower second-quarter loss and said it expects operating profit to rise this year.
Highlights:
- Youdao reported a 14.5% increase in revenue for the first half of 2024 and a narrowing of its operating loss by more than 90%.
- The education company's revenue from online marketing services doubled in the first half of the year, but revenue from learning services and smart devices fell 4% and 20%, respectively.
Edith Terry
The past few years have been a learning period. Yodao Co., Ltd. (DAO.US) was delisted after gaming giant NetEase's (NTES.US) separately listed education unit was hit by a wave of tightening regulations on China's big tech companies. Its K-12 online education business was devastated in a crackdown on after-school tutoring companies, and Youdao sold the business in 2021.
Investors have shown little interest in the company since then: Its shares have fallen 17% so far this year and have lost roughly three-quarters of their value since listing in New York in 2019. That downward trend has continued even after the company announced it would go public. Second Quarter Results This comes despite the company's latest report last week showing that the company, which has almost always posted losses, has seen its losses narrow significantly and could turn a profit in the not-too-distant future.
Despite the relatively bright outlook, investors pushed the company's shares down 11% in the days following the release of its latest report.
Youdao thinks investors should take a fresh look at the company. A 92% reduction in first-half operating losses to 43 million yuan ($6 million) “gives us confidence that we will post positive operating profit for the full year 2024, despite fierce competition and various uncertainties,” Wayne Li, vice president of finance, told analysts at the company's earnings call last week.
Youdao said its sales rose 14.5 percent to 2.7 billion yuan in the first half of the year, while its net loss fell 83 percent to 85.9 million yuan. Its six-month operating loss fell 92 percent to 42.6 million yuan from 484.9 million yuan in the same period last year.
Youdao made a small profit in the first quarter of this year but slid back into the red in the second quarter as operating expenses soared.The latest financial report showed that profitable NetEase is continuing to fund Youdao through 878 million yuan in short-term loans and $126.5 million in long-term loans from its $300 million revolving credit facility.
Youdao appears to be inching closer to profitability, though the road has been anything but smooth, and that uneven progress is reflected in mixed results from its three core business units in the second quarter.
The company's online marketplace services were its strongest in three months, with sales rising 68.4% to 511.2 million yuan. But sales from smart devices fell 25% to 166.7 million yuan, and learning services sales fell 5.5% to 643.8 million yuan. Quarterly net loss narrowed by nearly two-thirds to 99.5 million yuan from 299.2 million yuan a year earlier.
Converting to advertising
A closer look at the results might lead one to conclude that the company is slowly moving away from its edtech roots and transforming into a platform that offers marketing services to technology companies wanting to promote their artificial intelligence (AI) tools. These marketing services, which also use AI tools, accounted for about 40% of Youdao's revenue in the second quarter of this year, up from just 15% two years ago.
Customers of these services include major companies such as ByteDance, Baidu's Ernie and NetEase. In the second quarter, net revenue from advertising by customers to promote AI tools increased by more than 100% quarter-on-quarter, Zhou Feng said in the earnings call. With the strong growth of marketing services, Youdao improved its second-quarter gross profit margin to 48.2% from 47.0% in the same period last year.
One of the main drivers of the surge in marketing services was overseas advertising by Chinese companies. “Leveraging our deep understanding of customer needs, we have accelerated the development of our international advertising infrastructure,” said Youdao President Jin Lei. “By the end of the second quarter, our international carrier database had exceeded 7 million, an increase of more than 200% year-on-year.”
The numbers suggest Youdao is taking cues from Facebook's owner. MetaYoudao generated almost all of its revenue last year from advertising, much of it driven by personalized algorithms that identify and deliver ads to consumers who are most likely to respond to them. In Youdao's case, its ads are attached to digital content such as dictionaries and a large-scale language model called Ziyue, which means “Ask Confucius.”
Youdao's learning services for children and adults are subscription or fee-based, but that part of its business has been shrinking fast, falling to about half of its total revenue in the first half of this year from 64% of its total revenue in the first half of 2022. The company's other main source of revenue, smart devices, has followed a similar trend, falling from 23% of revenue to 12.8% in the same period.
So what does this mean? First, Chinese edtech appears to be finding new outlets after being banned from offering after-school tutoring for K-12 students. Recent government calls to promote “high-quality” consumption should also work in Youdao's favor, as the company is strengthening its brand as an AI company in addition to its core business of providing learning services.
In the struggling smart device sector, Youdao has started to lower its price range to mass-market levels, but by touting its AI capabilities, its stylus pens are still priced 50 to 100 yuan more than its peers. Sales of entry-level dictionary pens grew 50% year-on-year in the second quarter, and net revenue increased 10%.
Youdao's learning services are now focused entirely on non-academic courses in Chinese literature and computing, which it allowed after the previous crackdown. “Everyone knows it's important for future careers,” Feng said of Youdao's computing courses.
Despite the ongoing losses, the analyst community remains relatively optimistic about Youdao as it transforms its business model: 9 out of 10 people following the company surveyed by Youdao Finance rate it a “strong buy” or “buy.”
Youdao's price/sales multiple (P/S) is 0.48, making it look cheap compared to other companies. Gaothu Techedu (GOTU.US) is trading at 2.48. After losing two-thirds of its business in the education crackdown, Gaotu reinvented itself as an adult education company. Recently listed corporate education services provider YXT.com (YXT.US) has an even higher P/S ratio of 8.33, suggesting that investors may want to take a closer look at Youdao.
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