Summary
- Udemy is restructuring its cost structure and expects to achieve adjusted EBITDA profitability in 2H23, which is earlier than previously anticipated.
- Udemy has a superior content generating capability compared to its competitors.
- Despite macro headwinds, there is still a strong secular trend that is likely to continue, leading to long growth ahead for the online learning industry.
Investment thesis
Udemy ( UDMY ) had mixed results in their latest report, with FY23 guidance falling below consensus expectations, largely due to the business being impacted by a challenging macro environment that started affecting the enterprise side of the business in 2H of 4Q22. Consequently, Udemy is restructuring its cost structure, which includes a 10% reduction in its global workforce and prioritizing crucial R&D investments. This move is anticipated to result in adjusted EBITDA profitability in the 2H23 instead of the earlier guidance of breaking even in FY24 – This, I believe is the best news for the 4Q22 results. That said, despite having a positive outlook on UDMY's long-term market potential because of its product-market fit, it is expected that macro headwinds will persist in 2023, causing a slowdown in the core business.
As such, my updated recommendation is to hold on to existing positions, and size down to a comfortable risk level in light of the near-term uncertainties.
Path to profitability
One important point to note is that management expects to reach adj. EBITDA profitability in 2H23 and for FY24, which is earlier than what they previously announced during their investor day. The reason behind this expectation is a reduction of 10% of their staff to help realign their expenses with their revenue targets, which could help improve their profitability. I believe this news has another implicit effect, in that consensus can now model in UDMY's profitability into their own financial models, which helps with increasing estimates.
Udemy Business
Long sales cycles pushed some 4Q22 UB deals into the following quarter, according to management. NDR dropped for a third consecutive quarter, landing at 115%. However, I was heartened to see that the NDR for UDMY stock's top customers remained unchanged at 123%. Another encouraging sign of focus on learning is the 129% y/y increase in revenue from multi-year deals, which now account for 42% of total revenue.
ChatGPT
Management mentioned that there are currently approximately 150 courses related to ChatGPT available on their platform, which is significantly more than what their competitors have managed to offer so far. This supports my view that UDMY has a superior content generating capability compared to its competitors, enabling them to deliver content more quickly. It's important to note, however, that UDMY's gross margin are also structurally lower due to the revenue sharing agreements.
Reiterating the point on TAM
Despite all the current concerns and uncertainties, it's important to step back and look at the big picture. The TAM for UDMY is enormous, and more importantly, Covid along with the demand for digital transformation in businesses, has led to a surge in online learning needs. I expect this strong secular trend to continue growing as younger generations increasingly seek more innovative and interactive ways of learning, indicating long growth ahead for the online learning industry.
Guidance
FY23 revenue guidance that was given by UDMY fell significantly short of the expectations of analysts. Specifically, the revenue forecast for FY23 was estimated to be around $715 million at the midpoint, representing a 14% year-on-year growth rate that is 8 percentage points lower than the consensus estimates. The revenue for UB is predicted to slow down from the mid-40% level in 1Q23 and remain at mid-30% for the remainder of the year, while accounting for 60% of the total revenue by the end of the year. In particular, UDMY encountered delays in sales cycles in 3Q22, primarily in the low end of the market. This challenge eventually spread to the enterprise side of the business in the latter half of 4Q22, causing certain deals to be postponed to 1Q23. Although it is uncertain how many of these deals have been finalized or delayed, I would expect sales cycles to remain prolonged throughout FY23, similar to management commentary. Consequently, the management has decided to cut back on spending for go-to-market teams in regions and sectors that were most affected by the macro environment, and instead focus more on strategic R&D efforts.
Conclusion
My analysis of UDMY's business and stock performance leads me to the conclusion that investors are looking for safer, yet still high-performing, companies. Nonetheless, Q4 showed fresh signs of weakness. Net new ARR growth at UDMY slowed by 14% from the previous year as the company saw a slowdown in UB Net New ARR, NDRR, and Customer additions. Also, the commentary on SMB churn did not help with easing investors' concerns either. When taken together with the unpredictability of the consumer segment, these tendencies make it more difficult to have faith in UDMY's FY23 guidance being less risky.
For further details see:
Udemy: Sit Tight Through Near-Term Volatility