Gaotu Grows Up With New Adult Focus, Return to Profitability

The company posted a third consecutive quarter of sequential revenue growth in its new form as a provider of education services for college students and adults

Key Takeaways:

• Gaotu recorded a third consecutive quarter of sequential revenue growth and returned to profitability in last year’s fourth quarter
• The company derived nearly a third of its latest quarterly revenue from educational services for college students and adults

By Doug Young

As the dust settles from the major shakeup of China’s education industry a year and a half ago, someone seems to think that online services provider Gaotu Techedu Inc. (GOTU.US) is poised to emerge as a new leader in the more adult-oriented sector rising from the ashes.

That’s our assessment based on Gaotu’s latest results that show it returned to profitability in the last quarter of 2022 after two quarters of losses, as well as a massive rally for the company’s shares since late last year. That rally got its latest boost on Thursday when Gaotu’s shares jumped 26% on more than triple their usual trading volume, indicating a large investor was probably taking up a new position in the company.

The stock has now risen nearly seven-fold from an all-time low at the end of last October, when it was in danger of delisting after falling well below the required $1 mark. Symbolically, the Thursday rally also put Gaotu, once an investor darling for its high-tech focus, back in the “unicorn” club with a market value of $1.1 billion.

The company’s results really do look quite impressive, showing it is making steady progress in the shift away from its former bread-and-butter K-12 tutoring services that were banned in the second half of 2021. That crackdown prompted many smaller companies to simply close up shop. Meantime, larger ones like Gaotu, New Oriental (EDU.US; 9901.HK) and Youdao (DAO.US) shifted their business, often focusing on services that weren’t affected by the crackdown, many aimed at college students and adults.

Gaotu is focusing on four major areas, namely professional education for college students and adults, vocational education, well-rounded education and digital educational products. More recently the company has also been trying its hand at livestreaming e-commerce, an area where New Oriental has found early success.

Gaotu founder and Chairman Larry Chen was absent from the company’s latest quarterly earnings call due to his engagement in a livestreaming session, though we suspect that scheduling conflict was at least partly a stunt to draw investor attention to the latest initiative. Regardless, the company’s latest results show it is certainly making steady progress in its journey to reinvent itself.

All that said, we’ll look more closely at the latest results, which include the return to profitability after two quarters of losses.

The company’s revenue totaled 630 million yuan ($91 million) for the three months to December, which was about half the 1.27 billion yuan in revenue a year earlier when the crackdown was just beginning. But the latest figure was up from 606 million yuan in the previous quarter, and represented a third consecutive quarter of growth on a sequential basis.

Gaotu said the sequential growth would continue in the current quarter, forecasting revenue of between 686 million yuan and 706 million for the three months to March. That looks quite strong when one considers the first quarter is typically slow for education companies due to the long Lunar New Year holiday that falls in that period, running from late January to early February this year.

Business momentum

While actual classes probably took a pause around the Lunar New Year, that didn’t stop people from signing up for new classes at the end of last year. Gaotu noted its gross billings – a forward gage of its future business – totaled 997 million yuan in the fourth quarter, up by a significant 64% from the previous quarter, and roughly flat from a year earlier. That shows the company’s overall business volume is growing quickly and fast approaching pre-crackdown levels.

On its investor call, the company noted that revenue from educational services for college students and adults in the fourth quarter doubled from the year-ago period, and accounted for more than 30% of revenue for the quarter. It also passed an important milestone when its post-graduate entrance exam preparation business became profitable during the period.

The company is also discovering that its current product mix is less expensive to produce than its former focus on K-12 education. Its cost of revenues fell about 59% year-on-year, which was more than the 50% drop in its revenues. As a result, the company’s gross margin improved to 74.7% from 69.7% a year earlier.

That brings us to the bottom line, which saw Gaotu post a net profit of 70.6 million yuan for the quarter. That reversed losses in each of the previous quarters, including a 61 million yuan loss in the third quarter. The fourth-quarter profit, combined with a profit in the first quarter of the year, helped Gaotu stay profitable for all of 2022, and the company said it expects to remain profitable for all of 2023 as well.

The company was also eager to point out that it is very cash flow positive, and that its net cash inflow nearly doubled to 477 million yuan in the fourth quarter from 246 million yuan a year earlier. That helped the company to boost its total cash slightly, showing it’s unlikely to face a cash crunch anytime soon.

As its prospects improve, analysts expect Gaotu’s profits to rise sharply this year, giving it a forward price-to-earnings (P/E) ratio of 40 based on their forecasts for 2023. That’s even stronger than New Oriental’s forward P/E of 36, and roughly comparable to a trailing P/E of 39 for China East Education (0667.HK), a slower-growth, more traditional provider of vocational education services.

At the end of the day, Gaotu appears to be rapidly emerging as one of the better success stories following the recent education crackdown. But the recent run-up in the company’s stock means that success is probably already factored into its share price, meaning any investors hoping to make some quick money from the company’s success have probably missed the boat, at least for now.

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