2024-01-08 23:56:45 ET
Summary
- UDMY is an online learning platform that offers a wide range of courses for both individuals and businesses.
- UDMY's historical financials have shown robust revenue growth at double-digit rates.
- UDMY is focusing on improving its profitability through cost-saving initiatives, such as reducing instructors’ subscription costs. Looking ahead, I expect its margins to improve.
- Strategic partnerships, such as the one with Docker, position UDMY well for future revenue growth.
- With superior forward revenue growth outlook vs. the competitor's median and double-digit upside potential, I am recommending a buy rating for UDMY.
Synopsis
Udemy ( UDMY ) is an online learning platform that offers a wide array of courses across various disciplines, catering to both individual learners and corporate clients.
UDMY’s historical financials have shown robust revenue growth as it continues to grow at double-digit rates. Over the years, net loss has been contracting except for 2022, where it slightly expanded due to rising expenses. However, its debt level and interest expense are healthy, so there is a low risk of defaulting. In response to its expanding net loss, management is actively taking steps to reduce its expenses in a bid to improve its margins.
Looking ahead, the strategic partnership announced by UDMY and management’s cost-cutting measures through lower instructor payment plans position it well for revenue growth and margin expansion. On top of those, my valuation model indicates double-digit upside potential. Thus, I am recommending a buy rating for UDMY.
Historical Financial Analysis
Over the last two years , although revenue growth has decreased from 2020’s level, 2021 and 2022’s growth rates are still strong and at double-digit rates. 2020 was an exceptional year as revenue was boosted by COVID 19, which drives demand for online courses off the chart due to lockdown and travel restrictions. Therefore, it creates a tough comparison period for the years after. Despite that, UDMY still manages to grow its revenue in 2021 by ~20% and by 22% in 2022.
In terms of UDMY’s gross profit margin, it has been steadily increasing over the last four years. In 2019, it was 48.07%, and by 2022, it had expanded to 56.24%. However, UDMY’s negative operating income margin and negative net income margin saw an uptick in 2022 after two consecutive years of contraction. When we look at its expenses as a percentage of revenue chart, it’s clear that both SG&A and R&D have increased in 2022, which resulted in its negative operating income and net income margin expansion as witnessed in 2022. Therefore, moving ahead, it is essential to monitor its margins and management’s response to this situation. If management is taking proactive steps to protect its margin, it might just serve as a catalyst for UDMY’s valuation.
With negative margins, it is essential to look at UDMY’s debt level and net interest expenses in order to understand its current solvency situation. When I analyse its balance sheet, its debt levels are extremely healthy, as there are barely any debts. In addition, its cash and cash equivalents are more than capable of offsetting it anytime UDMY wants to. Moving onto its net interest expense as a percentage of revenue, it was <1% throughout the years, which is very healthy, and I don’t foresee it causing any issues. Overall, UDMY’s debt levels are not a cause for concern for me, but it is still important to monitor them.
Reduction in Instructors’ Subscription Revenue Share
Let’s address the major business update. The company has announced their plan for amendments to the payment structure for its Udemy Business and subscription. Prior to 2024, instructors currently get a 25% cut in subscription sales based on consumption of their content. They will reduce the rate progressively in the upcoming few years to lower costs.
From January 2024 onwards, it will be reduced to 20%. Further reducing to 17.5% in 2025 and to 15% in the year after. This may potentially cause dissatisfaction and the loss of instructors due to their reduced immediate income. However, with improved margins, this would allow UDMY to allocate more of their resources towards their plans for product development, growth strategies, and marketing.
This includes their plans involving integrating AI for the purpose of enhancing the user experience, supporting instructors’ content creation, and boosting learners’ engagement and operational efficiency. If successful, in the long term, they will be able to expand their customer base with more traffic and volume of course enrolments. As quoted by management, this is expected to boost profit margins, and this will be essential for the funding of product innovation and initiatives.
Strategic Partnerships
In October 2023, UDMY announced a partnership with Dockers , a prominent player in application development and one of the top providers of development tools. Docker is a platform that is useful for a wide range of users in the software development and IT fields, ranging from software developers, data scientists, and DevOps engineers to educators and students.
This partnership supports aspiring developers within the Dockers community, which has a size of over 20 million. Providing this large community with access to 350 of UDMY's Docker courses. This strategic partnership introduces millions of new learners to UDMY, expanding its audience reach.
Similar partnerships, such as the one with AWS , have shown significant success. There was a 214% surge in contract value booking through AWS, and deals transacted have risen over fivefold year-over-year. Udemy Business has also continued to expand their business globally with new customer acquisitions and partnerships such as Bank of Yokohama, Daiwa Securities, and Tokyo Electric Power Company Holdings ( OTCPK:TKECF ), Inc. UDMY continues to support the rising global demand for education and workforce upskilling.
Comparable Valuation Model
The four competitors I listed in my valuation model operate in the same education service industry as UDMY. Therefore, it makes it suitable for comparison. When it comes to market size, UDMY is slightly larger than its competitors. UDMY’s market capitalization is ~$2 billion vs. the median of ~$1.8 billion. UDMY is ~7% larger than its competitor’s median size.
Despite being only 7% larger, UDMY’s forward revenue growth outlook of 16.96% significantly outperformed its competitor’s median of 2.66%. Please take note that 2 out of 4 competitors have negative forward revenue growth rates.
When it comes to net income margin TTM, both UDMY and the competitor’s median are negative. However, UDMY’s net income margin TTM of -19.75% is higher than the median of -11.44%. However, as discussed above, I believe UDMY’s focus on cost reduction will bolster its future margins. If successfully executed, it will be the catalyst that drives its multiple higher. In terms of gross profit margin TTM, UDMY reported 56.88%, slightly lower than the median of 61.18%.
Currently, UDMY’s forward EV/Sales of 2.12 trades higher than its competitor’s median of 1.78. Given its significant outperformance in the forward revenue growth outlook and the growth catalyst discussed in depth above, the premium is justified.
The market estimates that UDMY’s 2023 revenue will reach $725.43 million, while in 2024 it will be $829.11 million. In terms of EPS, 2023 will see significant improvements to $-0.03 per share, while for 2024, it is expected to turn positive to $0.04 per share.
By taking its 2024 revenue estimate and applying that to its current forward EV/Sales, my 2024 target price is $14.53. This represents an upside potential of 11% when compared to its last share price. With double-digit upside potential, I am recommending a buy rating for UDMY.
Risk
The downside of my buy recommendation is regarding the potential impact of UDMY’s strategy of reducing instructors’ subscription revenue share to improve its margins. There is a risk that it might potentially impact content quality and variety. In addition, it might cause dissatisfaction among creators, causing some to leave UDMY to search for higher profits. As a result, it might reduce the number and quality of courses on UDMY, which in turn might hurt revenue.
Conclusion
In conclusion, UDMY’s past financial performance has shown robust revenue growth. In addition, gross profit margins have been gradually expanding over the years, while net income loss is slowly contracting. However, in 2022, I noticed an increase in its net loss as a result of rising costs for SG&A and R&D. Although UDMY is reporting net losses, its extremely low D/E ratio, low interest expense, and high cash and cash equivalents remove my worries about any default risk.
In response to its expanding net losses, management has announced a new payment structure for its Udemy Business and subscription. This cost-saving initiative is expected to incrementally increase over the next few years.
Apart from focusing on margins, UDMY is also making strategic partnerships in order to position itself well for future growth. One such partnership is with Dockers. On top of this, the resources saved through its new payment structure will also be redirected to product development and future growth plans. Therefore, these initiatives position UDMY well for future revenue growth.
In my valuation model, UDMY significantly outperformed its competitors in terms of forward growth outlook, although it is weaker in terms of profitability. However, I believe its cost-saving initiatives, as mentioned above, will strengthen its future profitability, and the general market consensus also echoes the same sentiment. With double-digit upside potential, I am recommending a buy rating for UDMY.
For further details see:
Udemy: Focus On Profitability Via Reduction In Instructor Incentive