Gaotu Techedu: Business Pivot Is Still In Progress (NYSE:GOTU)


Elevator Pitch

Gaotu Techedu’s (NYSE:GOTU) shares are rated as a Hold. I have a mixed view of GOTU. I like Gaotu Techedu’s QoQ revenue growth and its new share buyback plan, but I am concerned about the progress of its business pivot and compliance risks. As such, I have decided to assign a Hold rating to GOTU’s stock.

Company Description

Gaotu Techedu describes itself as a provider of “educational services for college students and adults, non-academic tutoring services, and educational contents & digitalized learning products” in its media releases.

Similar to many of its Chinese education peers, GOTU had to pivot away from its core business due to regulatory headwinds in China. In its earlier press release issued on February 16, 2022, Gaotu Techedu revealed that it will “cease offering tutoring services related to academic subjects to students in senior high schools” to be in compliant with new laws in the country.

Mixed Results

GOTU’s most recent financial performance for the third quarter of 2022 was mixed based on a review of the company’s headline numbers.

On the positive side of things, Gaotu Techedu achieved positive top line growth and gross profit margin expansion in QoQ terms.

GOTU’s revenue rose by +13% QoQ from RMB538 million in the second quarter of 2022 to RMB606 million in the third quarter of the current year. In contrast, Gaotu Techedu had suffered from a -26% QoQ top line contraction in Q2 2022. Also, the company’s gross profit margin increased by +190 basis points QoQ from 70.3% for Q2 2022 to 72.2% in Q3 2022. This suggests that Gaotu Techedu’s business pivot is progressing well and it is benefiting from positive operating leverage to some extent.

On the negative side of things, GOTU reversed from positive earnings in the prior quarter to losses in the recent quarter, and the company’s operating cash flow also decreased on a QoQ basis for Q3 2022.

Gaotu Techedu was marginally profitable in the second quarter of this year with a positive non-GAAP net income of +RMB1 million. But GOTU registered a non-GAAP net loss of -RMB45 million for the third quarter. Its operating cash flow also contracted from $94 million for the second quarter of this year to $35 million in the third quarter of 2022.

GOTU acknowledged at its Q3 2022 earnings call that “we strategically increased our investment in sales and marketing to improve our market penetration rate”, and this resulted in losses and a decline in cash flow for the company. Specifically, Gaotu Techedu’s sales and marketing expenses-to-revenue ratio went up from 50% in Q2 2022 to 56% for Q3 2022.

In the next section, I discuss how GOTU’s various businesses performed.

Divergence In The Performance Of GOTU’s Different Businesses

GOTU’s non-academic tutoring business did well in Q3 2022, as revenue from this business jumped by +69% QoQ to RMB364 million in the recent quarter. At its third quarter results briefing, Gaotu Techedu noted that “our non-academic tutoring services is one of the new businesses we focus on” and emphasized that its non-academic tutoring business is “gradually winning recognition among students and parents.” This certainly explains the good performance of its non-academic tutoring business.

On the flip side, revenue for GOTU’s educational services and digitalized learning products businesses contracted by -15% and -44%, respectively for Q3 2022 on a QoQ basis. This implies that Gaotu Techedu’s business pivot is still in progress, and not all of the company’s new businesses are performing as good as what the company would have hoped for.

Spotlight On Share Repurchases And Compliance Risks

Looking beyond Gaotu Techedu’s financial performance, there are two other corporate developments that are worth noting.

On November 22, 2022, GOTU announced a $30 million new share buyback program that will be in effect for the next three years. The amount of potential share repurchases is meaningful, as the size of the repurchase plan represents almost 11% of its current market capitalization. Taking into account GOTU’s -63% share price drop in the last one year and its current undemanding consensus forward next twelve months’ price-to-sales multiple of 0.81 times (source: S&P Capital IQ), Gaotu Techedu’s new share buyback plans sends a positive signal about the stock’s undervaluation.

However, Gaotu Techedu faces compliance risks which can’t be ignored. GOTU issued a 8-K filing earlier on November 21, 2022. In the 8-K filing, the company disclosed that the NYSE has informed GOTU that it “is below compliance standards due to the trading price of its” ADSs (American Depositary Shares). GOTU’s shares last traded at $1.06 as of November 23, 2022; if its average stock price stays below $1 for the next half-year period, Gaotu Techedu’s ADSs might be suspended for trading under NYSE regulations.

Closing Thoughts

Gaotu Techedu is a Hold. GOTU isn’t a Buy, as it has compliance risks, and the company just went into losses in Q3. The stock isn’t a Sell, as the company just announced a major buyback program, and it achieved positive QoQ top line expansion for the recent quarter.