Elevator Pitch
My rating for Gaotu Techedu Inc. (NYSE:GOTU) shares is a Hold.
Previously, I assessed the sell side sentiment and financial prospects for GOTU in my prior July 28, 2023, article. I draw attention to Gaotu Techedu’s latest Q3 2023 financial results and the expansion of its existing share buyback program in this update.
I choose to downgrade my rating for GOTU from a Buy to a Hold in view of the company’s below-expectations Q3 bottom line and gross billings. However, Gaotu Techedu isn’t a Sell, as its undemanding valuations are evidenced by the company’s decision to expand its existing share repurchase plan.
Investors Reacted Negatively To GOTU’s Below-Expectations Gross Billings And Bottom Line
Gaotu Techedu published a press release revealing the company’s most recent third quarter financial performance on November 22, 2023 before trading hours. GOTU’s stock price dropped by -4% at the end of the same trading day, which implied that the market wasn’t satisfied with the company’s Q3 results.
Revenue for GOTU jumped by +30% YoY to RMB789 million in Q3 2023, which beat the consensus top line projection of RMB747 million (source: S&P Capital IQ) by +6%.
But investors ignored Gaotu Techedu’s revenue beat, and they placed a greater emphasis on GOTU’s gross billings (a forward-looking indicator) and bottom line.
GOTU defines gross billings as “the total amount of cash received for the sale of course offerings” excluding “the total amount of refunds” in its Q3 2023 results release. In other words, gross billings for the third quarter offer an indication of Gaotu Techedu’s future top line performance.
The YoY growth in Gaotu Techedu’s gross billings slowed significantly from +44% for the second quarter of 2023 to +5% in the third quarter of the current year. GOTU’s actual Q3 2023 gross billings amounting to RMB639 million came in -16% lower than the market’s expectations as per S&P Capital IQ consensus data.
Also, the company reversed from positive normalized net earnings of +RMB134 million for Q1 2023 and +RMB63 million for Q2 2023 to record a non-GAAP adjusted net loss of -RMB42 million in Q3 2023. Gaotu Techedu’s normalized net loss for the recent quarter was worse than the analysts’ consensus net loss estimate of -RMB21 million (source: S&P Capital IQ).
As per management’s comments at the Q3 2023 earnings briefing, GOTU’s lower-than-expected gross billings were attributable to a “decrease in the supply of next grade students” and the fact that the company “did not reserve a sufficient supply of tutors” for its K-12 business.
At the same time, the mid-point of Gaotu Techedu’s Q4 2023 top line guidance at RMB678 million was -19% (source: S&P Capital IQ) below what the analysts had expected prior to the company’s Q3 2023 results announcement. GOTU disclosed at its third quarter results call that it has “phased out some unprofitable operational units” for its business related to “learning services for college students and adults” as part of “a strategic shift” focusing on “profitability.” This helps to explain why GOTU’s fourth quarter revenue outlook wasn’t as good as what the market anticipated.
Separately, Gaotu Techedu’s bottom line miss for the most recent quarter was the result of higher-than-expected costs. Total operating costs for the company went up by +32% YoY in Q3 2023, which was more significant than the +30% YoY revenue growth and +5% YoY increase in gross billings during the same time period. GOTU cited factors such as “increased marketing investments” and “increased investment in AI-related fees” to explain the rise in expenses at its latest quarter results briefing.
In a nutshell, GOTU’s gross billings and net loss for Q3 2023, and its Q4 2023 top line outlook fell short of expectations. As such, it is understandable that Gaotu Techedu’s shares suffered from a pullback after reporting its third quarter results.
Expansion Of Share Buyback Plan Was A Positive Surprise
In tandem with the Q3 results announcement, Gaotu Techedu revealed that it had increased the size of its existing share repurchase plan that expires on November 22, 2025 from $30 million to $80 million. It is worth noting that GOTU still has $69.2 million remaining from its current buyback authorization as of November 20 this year, and this is equivalent to a significant 10% of the stock’s current market capitalization.
Gaotu Techedu is currently valued by the market at consensus forward fiscal 2024 Enterprise Value-to-Revenue and EV/EBITDA multiples of 0.49 times and 4.5 times, respectively. It will be fair to view GOTU’s shares as undervalued, considering its mid-single digit EV/EBITDA ratio and the fact that the stock trades at half of its expected FY 2024 revenue.
In my view, GOTU has surprised the market in a positive manner by sending a strong signal (i.e. expansion of buyback plan) that it recognizes the undervaluation of its shares. In contrast, simply hoarding cash or betting on risky M&A transactions will be less desirable alternative uses of Gaotu Techedu’s cash. The company has cash and investments amounting to RMB3.5 billion or $0.5 billion on its balance sheet as of end-Q3 2023, which represents close to three-quarters of its market capitalization.
Closing Thoughts
There were both positive and negative takeaways from Gaotu Techedu’s most recent set of results. On the negative side of things, GOTU’s Q4 2023 revenue outlook and Q3 2023 bottom line performance disappointed the market. On the positive side of things, Gaotu Techedu’s share buyback authorization was increased substantially from the initial $30 million to $80 million now.
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