Youdao Looks To Parent, Global Markets To Revive Stalling Growth

The education company's marketing services revenue flatlined in the final quarter of last year, following strong double-digit gains in the first three quarters

Key Takeaways:

• Youdao's revenue began contracting in the fourth quarter, falling 9.5% year-on-year, as its fast-growing marketing services suddenly flatlined
• The company aims to revive growth in its market services via an enhanced partnership with parent NetEase and more global sales, as its older education business shrinks

Education may be valuable, but advertising is even more so.

That's the big lesson learned over the last two years by Youdao Inc. (DAO.US), the education arm of gaming giant NetEase 9999, whose latest quarterly results show how marketing services could soon become the company's main breadwinner.

Among other things, the results showed Youdao posted its first-ever annual profit, ending years of losses since its New York listing six years ago. But that milestone was overshadowed by a few more worrisome signals, led by a sharp slowdown in the company's marketing services that were previously a fast-rising star. That came as Youdao's original core learning services also continued to show steep declines, causing its overall revenue to start contracting.

The company tried to ease concerns with discussion of a couple of new initiatives to jumpstart the marketing services business, which we'll detail shortly. Like many other Chinese tech companies, it also talked copiously about AI, noting it had already incorporated DeepSeek into many of its products.

"We are launching our AI Native strategy integrating AI more comprehensively across our business lines by, for example, automating our advertising platforms and introducing AI-driven tutoring for our course customers," noted Youdao CEO Zhou Feng on Youdao's earnings call, which included more than 30 references to AI by various company officials.

Despite its words of reassurance on reviving marketing services and greater use of AI, investors weren't convinced. Youdao's shares fell 6.8% in the two trading days since the results were announced last Friday.

Here, we should point out that this sell-off comes after a remarkable run-up that saw Youdao's shares nearly triple over the last six months, including a 40% jump this year alone. At its latest close of $9.68, the shares now trade at a four-year high, lifted by both the company's own relatively strong performance and a broader wave of bullishness towards overseas-listed Chinese stocks.

Against that backdrop, the latest two-day sell-off looks a bit like profit taking, and the next few weeks will provide a better picture of whether its rally can continue. Even at the latest levels, the stock still trades 43% below its IPO price of $17 during headier days for Chinese stocks when the company first listed in 2019.

That said, we'll take a deeper dive into Youdao's latest results to see what's happening inside this company that's part of NetEase, one of China's earliest internet companies that has also become one of its most successful gaming operators. Online learning was Youdao's original main breadwinner, but it has been scaling back that part of the business following a government crackdown that outlawed after-school tutoring services in core curriculum areas for K-12 students in 2021 and 2022.

The company's marketing services division was picking up most of the slack for its falling education business to keep overall revenue rising in the first three quarters of last year, though the growth rate was slowing throughout the year. That growth spurt ended in the fourth quarter, however, when Youdao's overall revenue fell by 9.5% to 1.3 billion yuan ($179 million) from 1.5 billion yuan in the same quarter a year earlier.

Marketing services flatline

Within the company's broader revenue pie, learning services fell 21.2% to 618 million yuan, accounting for 48% of total revenue. That part of the business accounted for about two-thirds of the company's revenue as recently as 2022, but has been shrinking rapidly since then and fell to less than half in last year's second quarter.

"Since the summer we have proactively focused on courses and services with strong demand and maintained a rational approach to customer acquisition," said CEO Zhou, explaining the reasons behind the rapid declines. "This strategy has enhanced our overall health."

Such a shift looked acceptable when the company's marketing services were posting strong growth, including a 46% year-on-year rise in the third quarter and a doubling in the first half of last year. The shift to advertising services also looked like a shrewd move strategically since such services are far less likely to fall victim to future government crackdowns than the far more sensitive education sector.

But Youdao's marketing services revenue suddenly flatlined in last year's fourth quarter, rising just slightly to 482 million yuan from 474 million yuan a year earlier, accounting for 37% of total revenue in the latest quarter. The company didn't provide a detailed explanation for the slowdown, though we should note that overall advertising spending has been sluggish in China lately due to the uncertain business climate.

Instead, Youdao executives focused on a couple of new initiatives that they hope will jumpstart growth in that part of its business. The one with the most near-term potential will probably come from an enhanced relationship with NetEase offering more services across its parent's large array of internet assets, including not only games but also music and its popular email service. To do that, Youdao and NetEase formed a formal marketing services partnership last year. That relationship now accounts for less than 10% of its advertising revenue, and CEO Zhou said "we expect this to grow considerably in 2025."

The other initiative comes from expanding its marketing services outside China. The company has been doing that through a relationship with TikTok and recently signed a new deal with Google to further that effort. Youdao President Jin Lei noted that international advertising revenue more than doubled last year to about 100 million yuan, accounting for more than one-fifth of the marketing services total.

In valuation terms, Youdao trades at a price-to-sales (P/S) ratio of 1.57, which looks relatively low compared to some of its peers. The much larger New Oriental (EDU.US; 9901.HK) trades higher with a P/S ratio of 1.8, and TAL Education (TAL.US) is even stronger with a ratio of 4.28. That suggests Youdao's stock could still have some upside potential even after the recent big run-up. But first it will need to quickly halt its revenue declines by jump-starting its marketing services.