DAO - Youdao's Q4 Earnings: A Successful Transformation

Summary

• Youdao's record high revenue and Op Income in Q4-22 demonstrated a successful transformation.
• Youdao is embarking on AI Generated Content (AIGC, ChatGPT-like technology) applications in education scenarios.
• DAO is a wide moat stock, but it might take time for investors to fully appreciate Youdao's value proposition around AI-powered education offerings.

Youdao (DAO) is the leading intelligent learning company in China, and DAO is a wide-moat stock in my opinion. In my previous articles, Youdao Beats Expectations, Signals Recovered Growth Post 'Double Reduction' Policy , and Youdao: A Forced Transformation May Establish A Stronger Market Leader I discussed Youdao's recovery and transformation trajectory post China's 'Double Reduction' Policy. In this article, I want to provide investors an update based on Youdao's Q4-22 earnings results.

Youdao's Q4-22 Record High Revenue and Op Income Demonstrated a Successful Transformation

Youdao (DAO) reported Q4-22 results as follow.

Revenue: RMB 1.5B, +38.6% YoY, including Learning Services revenue RMB0.8B, +39.2% YoY, Smart Devices revenue RMB 0.4B, +28.1% YoY, Online Marketing revenue RMB 0.2B, +58.6% YoY.

Operating Income : +RMB 25MM, up from-RMB 248MM in Operating Loss in Q4-21

Non-GAAP net profit : +RMB 31MM.

2023 Outlook : Revenue RMB 6B, +21% YoY.

The company attributed the strong performance to two growth drivers: Digital Contents services, and STEAM courses. As shown in the following charts, Youdao revenue in Q4-22 hit RMB 1.5B watermark, representing 53% YoY. Also in this quarter, Youdao reported Op Income (+2% Op Margin) for the first time, as compared to -16% in prior quarter, and -18% in prior Q4.

In light of China's regulation on ATS (After-class tutoring services) last year, Youdao seemed to be able to react quickly, and grow itself into a stronger leader in extra-curriculum offerings and smart devices. Its pace in launching new products and upgrading/rolling out new services appeared very impressive in Q4 - Youdao Dictionary Pen P5, Youdao Smart Learning Pad X10, Youdao Literature-Creative Writing, Champion Class of Youdao Go, adult education for postgraduate entrance exams, and finally flexible solutions from target consultation to hybrid tutoring by AI and Humans.

My take on Youdao's strong performance in Q4-22, as well as Q3-22 is that Youdao has completed a very successful transformation.

Youdao is embarking on AI Generated Content (AIGC, ChatGPT like technology) application in education scenarios

In the earnings call, the company mentioned "AIGC and large language models are going to have a significant impact on our education technology, and maybe a lot of kind of technology and product areas, business areas", and "our key strengths continues to be the unique ability to combine hardware, AI software abilities and also great learning content."

ChatGPT ( my previous article ) is changing the world, and education is one of those, or the hotly debated one (good or bad). I like Youdao's AI-centered strategy in education. As a company that can combine AI, hardware, and learning content, and can reach over 200 million users, Youdao is uniquely well positioned to transform the education scenarios.

Here is how I think about Youdao's flywheel powered by AIGC.

1. AIGC can be leveraged to a variety of products. AI tutoring service for spoken English, AI scoring and review assistant for writing, adaptive learning, and AI smart studying desk, etc. Just to name a few. All in all, this will enhance Youdao's product and service offerings, attracting more users with attractive customer life time value.

2. The popularity of various Youdao products will drive the transformation of the entire education system. It's well known that Youdao Dictionary Pen and a few other products have been best sellers for China's shopping events such as Double 11. Another very meaningful development was that Youdao products have been increasingly adopted by universities and middle/high schools, including top universities such as Tsinghua University, Renmin University of China, Naikai University, and Beijing Foreign Studies University, and middle/high schools such as Nanjing Foreign Language School, Hengshui High School of Hebei, and Chongqing No.8 Secondary School, etc. As the education system continues its digitization trajectory, I see an opportunity for Youdao to play a pivotal role.

3. As Youdao acquires more users, launches more products and services, leverages its higher pricing power (with higher value proposition), revenue will continue to grow driven by both volume and price.

4. Youdao's strong cash flow or earning power will allow it to continue its investment in AI and commercialization via new products and services (#1), which further fuels #2 and #3.

Risks and Conclusion

DAO is a wide moat stock considering its leading position in both education services and smart devices. In my opinion Youdao is well positioned to accelerate the digital transformation for the education system in China, and DAO represents an attractive long-term investment opportunity. Note that California Public Employees Retirement System reportedly acquired 13,935 DAO shares yesterday.

In terms of investment risk, I personally do not see anything alarming in its business fundamentals. The main risk investors might want to take into account is market perception as it might still take time for the market to fully appreciate Youdao's value proposition in AI-powered education.

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