2023-07-20 06:47:40 ET
Summary
- Udemy will benefit significantly from the rise of AI as job seekers and employees will look to reskill and remain competitive in the job market.
- Despite currently being unprofitable, the company is trading at a historically low valuation and is expected to see a surge in interest as AI impacts employability.
- A long-term opportunity for UDMY lies in the potential overhaul of the education system, with AI providing personalized learning experiences to every student globally.
When it comes to assessing the impact of AI on society, it's easy to go down the rabbit hole quickly. Since ChatGPT's release, there have been an astonishing number of articles breathlessly talking about how A.I. will change everything .
Many predict widespread changes across industries, including in the fields of medicine, entertainment, financial services, and more.
However, from an investment perspective, much of the impact has been localized to a handful of tech companies that have fueled the market rally this year, in names like Apple ( AAPL ), Google ( GOOGL ), Meta ( META ), Nvidia ( NVDA ), Amazon ( AMZN ), Microsoft ( MSFT ) and Tesla ( TSLA ).
Sure, there have been some other 'obvious' stocks that have rallied, like AI and SDGR , but companies in non-AI or technical fields, broadly, have seen a minimal impact from this leap in technology.
Today, we're going to explore Udemy ( UDMY ), a company that we believe stands to be a significant long-term beneficiary of AI's societal emergence. The best part? It's broadly overlooked, and could see significant appreciation from here as things develop.
Let's dive in.
AI's Impact
Quantifying AI's impact on the world is an impossible task. As systems across regions and geographies become more and more connected, the extent of impacts is difficult to fully map out.
That said, here are a few big changes that we think will be enabled by generative AI and other, new, predictive solutions that could be built on this technology.
First, AI has the potential to disrupt legal services by automating document analysis and contract review processes, saving time and improving accuracy. AI can also provide legal research and case prediction tools to assist legal professionals in their work. Additionally, virtual legal assistants powered by AI can offer basic legal advice and guidance to individuals.
As a lot of this "grunt work" is automated away, it becomes more and more difficult for new practitioners to enter the profession. This could lead to a significant reduction in the workforce over time.
Second, AI could disrupt healthcare by leveraging machine learning to improve diagnostics accuracy, assist in patient monitoring, accelerate drug discovery and development processes, and enable personalized medicine through genetic analysis and precision treatments. To some degree, the drug discovery use case is already happening.
However, if other aspects of care are outsourced to algorithms, it could have huge implications on the size of the healthcare workforce needed. Given that early studies suggest that AI may provide higher quality and more empathetic responses to patients than doctors do currently, there is room for competition from AI in the future.
Third, Retail workers seem to be at high risk of automation. AI has the potential to disrupt retail by optimizing inventory management and demand forecasting, streamlining supply chain operations, and facilitating frictionless cashier-less checkout systems through technologies like computer vision and natural language processing.
In 10 years, the checkout experience, whether in person or online, will likely be significantly different than it is today. These changes will be a direct result of AI modification.
Finally, entertainment workers in both traditional roles and on social media could be in store for a huge AI impact. AI can automate video editing and post-production processes, generate virtual actors and influencers, enhance content generation and curation, and enable immersive experiences through technologies like augmented reality.
Nearly everyone in the industry, including game designers, video editors, and script writers, are all likely to be impacted by AI.
This is just a taste. Other sectors that may also be prone to disruption include Agriculture, Finance, Manufacturing, Construction, Hospitability, and more.
Here's the main issue. Each of the sectors above employ hundreds of millions globally, and as companies look to save cost on headcount or 'get more done with less', AI solutions will become mainstream.
In fact, its already happening . Companies conducting layoffs are already citing "AI" as a primary cause, and over the next decade, it's expected that over a billion people could see their jobs disappear as a result of AI. 370 million more could see their jobs become obsolete.
This opens up significant opportunities for those in education, as employees and job seekers will need to reskill in order to remain competitive in the job market.
This is the short-term opportunity for Udemy; a tidal wave of people needing to gain more experience / credentials to stay employed. This could boost enrollment, improve revenue growth, and allow for significant free cash flow generation; a far cry from where it sits today.
Long term, there's potential for Udemy or other educational companies like Coursera ( COUR ) to participate in re-thinking how education is managed across society.
Education is vital to all modern societies. It's how we improve our quality of life, achieve more, and tackle life's big questions. In terms of AI, the main thing it needs to function is solid training data. As it stands right now, Udemy has one of the largest databases of course material around.
As education remains important well into the future, we think Udemy could be well positioned to become vertically integrated AI education company that could tackle a massive global market that's bound to see regime change in the coming years.
The Company
As it stands right now, Udemy isn't a particularly good business.
Udemy is a digital education company that provides a marketplace where students and instructors can meet. Instructors are people knowledgeable in a certain field that look to monetize their expertise in a certain skill. Students are mostly adults who are looking to improve their skills or understanding in something.
In the company's words:
Udemy's consumer marketplace has attracted nearly 62 million learners in over 180 countries who are looking for the knowledge and skills they need to attain in-demand jobs, further their career, and improve their well-being. We curate the highest-quality content from our marketplace for Udemy's enterprise SaaS platform, Udemy Business, which enables companies around the world to offer effective on-demand learning for employees, immersive laboratory-style learning for tech teams, and cohort-based learning focused on leadership development. Our network of over 70,000 instructors have created over 200,000 courses in nearly 75 languages that cover a wide range of topics, including technology, business, soft skills, and personal development.
This platform flywheel has driven solid revenue for Udemy, with TTM revenues up over 33% since the company went public in late 2021:
This revenue is primarily made up of two things: Enterprise Revenue, and Individual Revenue:
At the moment, these two segments contribute a similar amount of revenue, but management has expressed that enterprise revenue has a lower cost of content overall:
Our mix of business among our Enterprise and Consumer segments is shifting, and this shift will affect our financial performance. Content costs for our Enterprise segment are lower relative to our Consumer segment. The mix of customer acquisition methods in our Consumer segment will substantially impact our financial performance. We presently expect that revenue from our Enterprise segment will grow faster than our Consumer segment, which will be beneficial to our overall margins.
This enterprise growth should help to boost margins.
The company's revenue is also geographically diversified, with no country other than the U.S. making up more than 10% of revenue.
However, even with solid and diverse revenue streams, the revenue growth has not translated to bottom line profitability.
In fact, the company continues to lose more and more on a TTM net income basis, period after period:
This is primarily due to significant sales and marketing expenses which outstrip all other operating expenses combined. In Q1 alone, Udemy spent $76 million on marketing, which seems exorbitant:
As it stands, Udemy is a high growth business that lacks profitability. Theoretically, at any moment, they could turn off the marketing spend and begin generating serious cash flow. However, with a huge market in front of them and plenty of competitors around, it's tough to see when they'll actually end up turning a profit.
The Short-Term Opportunity
As discussed, the business is currently unprofitable, but it's trading at a historically cheap valuation.
The stock has gotten smashed since it came to market, down nearly 60%:
And the company is trading at a deeply depressed valuation of only 2.6x sales:
One could argue that the company never deserved to be trading where it was when it IPO'd at more than 9x revenue case. To that, we agree.
However, now trading under 3x revenue, and with substantial top line growth to boast about, they seem well positioned to capitalize on an interesting medium term business driver: AI-based unemployment.
Given that the main use case for these platforms is professional development, as AI begins making a larger and larger share of the population unemployable, we expect platforms like Udemy will see a tremendous surge in interest as professionals need to re-skill.
An increase in demand should allow for higher operating margin, as marketing spend can be slowed as organic traffic grows. In addition, more revenue should allow for better companywide cash conversion, as operating cost growth likely won't outpace top line contributions.
In short, in combination with the already-large TAM the company is chasing, AI's negative impact on white collar employability should provide a serious demand driver that improves business economics and could lead to substantial profits in the future.
We anticipate that an increase demand lead could lead to increased profitability, and that these companies could re-rate towards a double-digit sales multiple in the medium term, based on comparable growth in other sticky subscription businesses. An 6x sales multiple would mean 100%+ growth in the stock price.
Given the AI driver, progress towards improved profitability doesn't seem unreasonable, especially over the next 3-5 years.
The Long-Term Opportunity
While the majority of the opportunity in Udemy stems from their position in the ecosystem and their ability to capitalize on higher-than-usual job turnover and re-skilling, there's another long-term call option attached: Digital Aristotle .
When you begin to look out into the future, it's clear that education as a whole is in need of an overhaul. Kids are becoming less and less engaged in the classroom, and, in the United States especially, educational outcomes are, on the whole, weakening. Especially vs. other countries.
This is highly speculative, but we expect that over the next decade or two, childhood education will look a lot different than it does currently. Right now, teachers remain at the center of the educational process, teaching lessons to rooms of children. Teachers may not teach at the right rate for a chunk of their students, which causes suboptimal results on the whole.
Imagine a world where every kid gets to learn at the pace that is correct for them, led by an AI that allows them to explore their interests in the most optimal way. This is the idea behind "Digital Aristotle" a concept that's been talked about for a while in educational circles.
With the advent of generative AI, it seems as though we are closer than ever to this possibility becoming a reality.
This is relevant for Udemy because, at the end of the day, AI needs good foundational sets of data to work from.
While the internet has a lot of useful information in a general sense, the educational database that Udemy (and Coursera) are building looks like it may be a serious long-term asset. If either of these companies were able to release, or even partner, on a digital Aristotle product that improves our education system, then that could lead to serious long-term value for shareholders. It's difficult to model in this impact, which is why it should be viewed as a call-option like opportunity.
Summary
Whether or not a Digital Aristotle comes to fruition, AI and its impact on employability already provides a huge growth driver over the next decade for online education companies like Udemy.
Trading at a depressed valuation and having experienced no AI bump, we think these companies are primed to begin attracting bid pressure from those who see what's coming.
We're upgrading Udemy to a "Buy".
For further details see:
Udemy: An Overlooked AI Winner With Huge Potential Upside