Gaotu Techedu: Strong Growth Prospects And Lots Of Cash

In keeping with company website:

Gaotu is a technology-driven schooling firm and on-line large-class tutoring service supplier in China. The Firm provides studying providers and academic content material & digitalized studying merchandise.”

Like all different Chinese language for-profit schooling firms, Gaotu Techedu’s (NYSE:GOTU) inventory has been decimated because the Chinese language authorities’s crackdown on the Okay-9 after-school tutoring sector in 2021. Nonetheless, after two years of restructuring efforts, Gaotu Techedu has utterly remodeled into a very completely different schooling know-how firm with a really wholesome steadiness sheet and promising progress potential. I consider the inventory is extraordinarily undervalued due to GOTU is buying and selling at lower than 1.3 instances web money worth, and the market nonetheless views GOTU as a Okay-12 after-school tutoring firm and utterly ignores its progress potential.

Gaotu Techedu’s Differentiated Enterprise Mannequin

Nearly all main Chinese language for-profit schooling firms equivalent to New Oriental (EDU) and TAL Schooling (TAL) function a conventional enterprise mannequin. They principally provide offline small-class format tutoring providers. Nonetheless, Gaotu Techedu has all the time centered primarily on on-line large-class format tutoring providers. Gaotu Techedu has the potential to develop core on-line tutoring capabilities as a result of it recruited many web skills from Alibaba (BABA) and Baidu (BIDU) when it was based and subsequently, was born with a web based product mindset.

There are professionals and cons to the net large-class format. The largest benefit of the net large-class format is that it would not require any commute time and might cater to anybody who has web entry. That is very handy for college students from non tier-1 and tier-2 cities, or college students who reside in suburban areas. Secondly, the most effective instructors can theoretically take as many college students as attainable. There’s great scale benefit. Moreover, the net courses are recorded, so college students can re-watch the courses any time they need. Final however not least, on-line large-format courses are less expensive than offline courses as a result of there is not any lease and different offline bills.

Clearly, the most important drawback of the net large-class format is that usually, it’s much less efficient than offline small-format courses as a result of the student-instructor ratio is way greater, and the interplay between the trainer and the coed may be very restricted, in comparison with the offline small-class format.

The important thing to success within the on-line large-format class enterprise mannequin is to draw the most effective instructors, create top quality studying content material, and enhance on-line studying effectiveness. Gaotu Techedu is excellent in any respect three elements.

From the very starting, Gaotu Techedu attracted the most effective instructors as a result of they provide one of many highest salaries within the business, and the instructors additionally share the worth they created.

Gaotu has additionally spent closely on instructional content material growth. The corporate has a content material growth workforce, which works intently with the instructors to develop, replace and enhance course supplies. The corporate can be among the many first to include AI know-how into the content material growth system, and to enhance the productiveness and effectiveness of Gaotu’s instructors and college students.

Gaotu’s completely different enterprise mannequin ends in constantly greater gross margins. For FY 2022, Gaotu’s gross margin is nearly 72%, whereas TAL’s gross margin is 57.2% and EDU’s gross margin is simply 54.5%.

Enterprise Restructuring And Transformation

Earlier than 2021, Gaotu grew quickly, however greater than 90% of GOTU’s income got here from the Okay-12 after-school tutoring enterprise, and the Okay-9 tutoring service accounted for roughly 50% of the Okay-12 after-school tutoring enterprise.

On July 24, 2021, the Chinese language authorities got here out with the Okay-9 after-school tutoring ban. Like all different main Okay-9 tutoring gamers equivalent to EDU and TAL, GOTU reacted very quickly, saying the enterprise restructuring virtually straight away and finishing the restructuring throughout the identical quarter. Since then, the corporate has virtually fully exited the Okay-9 tutoring enterprise, which resulted in a steep income decline in 2022.

In Q1 of 2023, the impact of the Okay-9 tutoring ban has already lapsed. GOTU reported that web revenues solely decreased by 2.4% 12 months over 12 months in Q1 of 2023. In Q2 of 2023, GOTU has returned to fast progress, with income rising 30.7% 12 months over 12 months. Progress billings elevated by 44.2%, earnings from operations elevated by 171.6%, and working money stream elevated by 207.6%.

New Enterprise Enlargement

On account of the enterprise restructuring, the corporate additionally modified the income classification segments. Ranging from 2022, GOTU’s income is reported by the next section classification methodology:

By Q2 of 2023, studying providers nonetheless contributed greater than 75% of GOTU’s web revenues. Nonetheless, the composition of section income has modified dramatically from 2022. Particularly, there are two new income streams for Gaotu Techedu – non-academic tutoring programs and academic providers for school college students and adults.

At the Q3 2022 earnings call, administration defined that GOTU:

at the moment provide a wide range of non-academic tutoring providers, together with programming, chess, worldwide chess, humanity and in addition science programs, and so forth., that college students like for on-line schooling and interplay.”

This can be a brand-new enterprise for Gaotu Techedu. This enterprise grew from zero to greater than 20% of web income in 2022.

Throughout the identical earnings name, administration defined that instructional providers for school college students and adults “embrace some vertical classes equivalent to Graduate Faculty Entrance Examination preparation and civil servants examination preparation and in addition like monetary and accounting qualification check preps in addition to different non-exam preparation classes.” Gaotu Techedu had this enterprise previous to the Okay-9 tutoring ban however did not deal with it. After the Okay-9 tutoring ban, Gaotu Techedu grew this enterprise from 8% of web income in 2021 to virtually 30% of web income in latest quarters.

I’ve summarized GOTU’s enterprise transformation within the following desk.

As we will see, Gaotu Techedu has fully remodeled its enterprise in two years. Beginning in 2023, all of Gaotu Techedu’s enterprise segments will see fast progress and the expansion momentum can proceed for years to come back.

Sturdy Steadiness Sheet

On the finish of Q2 of 2023, GOTU had RMB768.2 million in money, money equal and restricted money, RMB2.9 billion in short-term investments and RMB114.5 million in long-term investments. GOTU has no debt. This implies GOTU has a web money place of RMB3.7 billion, or roughly $500 million. Working money stream is optimistic, so it is foreseeable GOTU’s money steadiness will solely improve from right here.

Valuation

In search of Alpha’s analysts undertaking GOTU to develop its income from $362 million to $570 million, and EPS from $0.13 to $0.25 between 2022 and 2025.

Based mostly on the expansion momentum of the enterprise, assuming progress margin stays the identical as 2022, which is conservative as a result of GOTU’s 1H 2023’s gross margin is already greater than 75%, and assuming a web margin of 10-12%, which GOTU has already achieved in 1H 2023, we will arrive at a 2025 incomes’s energy of RMB478 million, or roughly $66 million.

If we apply 10 instances earnings a number of (implying a really conservative PEG of lower than 1) for GOTU on 2025 earnings, and add again GOTU’s web $500 million money, we’ll arrive at a valuation of just about $1.2 billion. This represents a 70% upside from at this time’s worth.

At at this time’s valuation, GOTU’s buying and selling at 2.75 instances 2025 earnings ex-cash. This is just too low cost for an organization that may nonetheless develop at double digits within the subsequent few years.

Dangers to contemplate

The largest danger going through all Chinese language for-profit schooling firms is the regulatory danger. With regard to Gaotu Techedu, the highschool tutoring enterprise has the best probability of being regulated. The non-academic tutoring enterprise and faculty and grownup schooling enterprise are much less prone to face stricter laws.

One other danger Gaotu Techedu faces is elevated competitors. Nearly all main Okay-12 after-school tutoring gamers have entered the non-academic tutoring house. Within the faculty and grownup schooling enterprise, Gaotu Techedu’s main competitor New Oriental Schooling has been acknowledged as the most effective model for a very long time. It might take some time for Gaotu to determine itself as a good model.

Lastly, as with all different Chinese language ADRs, GOTU’s inventory is extraordinarily unstable. The inventory typically drops due to rising geopolitical tensions.

Conclusion

After two years of enterprise restructuring, Gaotu Techedu has emerged as a stronger and extra resilient enterprise with robust progress potentials. The inventory appears ridiculously low cost at lower than 1.3 instances web money worth and fewer than 3 instances 2025 earnings ex-cash. Due to this fact, I give Gaotu Techedu a “purchase” score.