Its Knuckles Rapped, Recovering Gaotu Springs Back To The black

Among the hardest hit in China's regulatory crackdown in 2021, the educator is staging a comeback that will see it return to profitability in the current quarter

Key Takeaways:

• Gaotu's revenue rose 53.8% last year, including accelerating gains throughout the year that culminated with 82.5% growth in the fourth quarter
• The educator's operating loss narrowed 20.6% for the year despite a steep increase in operating expenses, as it forecast a return to net profitability in the current quarter

If at first you don't succeed, then at least you can learn from your mistakes. Gaotu Techedu Inc. (GOTU.US) has taken that message to heart, reporting fourth quarter and full-year results that show it's well on the road to recovery as it and other key players in China's edtech sector build new AI-based product portfolios that are getting a warm government reception.

Gaotu's latest report, released last week, showed its revenue rose 53.8% to 4.5 billion yuan ($627 million) last year from 2.9 billion yuan in 2023. Its growth accelerated throughout the year, rising from 33.9% in the first quarter to a turbocharged 82.5% in the fourth.

The company has been losing money since the third quarter of 2023, and it continued that trend with a 135.8 million yuan loss in last year's fourth quarter that was up 13.5% year-on-year. But its operating loss in the latest quarter trended better, narrowing 20.6% to 149.2 million yuan.

CFO Shen Nan said that trail of red ink was set to end soon, forecasting on the company's earnings call that Gaotu would return to profitability in the current quarter while maintaining "fast revenue growth momentum." A big reason for the year and a half of losses appears to be ramped up marketing spending for its new products, as well as hiring of more teachers, which we'll describe in more detail below.

Gaotu's American depository shares (ADS) leapt 31% the day of the report's release and continued to rise after that, up 45% through Wednesday. But even after that rally, it still trades at a price to sales (P/S) ratio of just 1.4, similar to the 1.58 for New Oriental Education (9901.HK; EDU.US) and 1.35 for Youdao (DAO.US). Those numbers show investors have yet to fully re-embrace the sector following a brutal regulatory crackdown dating back to 2021.

Nine analysts canvassed by Yahoo Finance also have mixed views on the company, though the overall outlook is positive. Six give it a "strong buy" or "buy," while two rate it a "hold" and one rates it an "underperform." The group sees Gaotu's revenue continuing to grow this year, though at a slower rate of about 30%.

The company forecast revenue growth of about 50% in this year's first quarter to between 1.41 billion yuan and 1.43 billion yuan.

The crackdown that nearly crushed Gaotu and its peers did so by banning for-profit tutoring in core primary and secondary school subjects. It also crushed their stocks, with Gaotu's crashing from more than $100 to $2.50 in just six months, wiping out both billions of dollars in market value and thousands of jobs industrywide.

The tutoring industry has quietly begun to grow again, even without any formal change in government policy, by shifting to other subject areas not included in the ban. In August, China's State Council included education services in a 20-point plan to boost consumption, as part of efforts to address China's economic slowdown, leading to a boost in shares of listed education companies.

While many companies folded in the crackdown, the survivors have re-invented themselves by focusing on areas that are still allowed, such as vocational training, study abroad and providing instructional materials to accredited schools.

Comeback kid

Gaotu is one of the edtech comeback kids as it slowly rebuilds its business. Its student enrollment hit a record high in 2024, according to Shen, and its revenue reached 1.39 billion yuan in the fourth quarter, up from 946.9 million yuan in the first quarter. Its gross billings, a metric that is a signpost for future earnings, totaled 2.16 billion yuan for the fourth quarter alone, up 69% year-on-year, and equal to nearly 40% of the year's total of 5.6 billion yuan.

Gaotu and its peers have all been rushing to incorporate AI into their products and are eagerly adopting homegrown DeepSeek. Founder and Chairman Chen Xiangdong said AI is already embedded into "basically all aspects of our operations," including to automatically generate educational content such as exercises, course outlines and video lectures.

The main spoiler to an otherwise upbeat report was the company's 52.2% increase in operating expenses in the fourth quarter to just over 1 billion yuan. On an annual basis, operating expenses were up by an even bigger 84.5% to 4.2 billion yuan. Selling expenses for the year nearly doubled to 2.9 billion, equaling 65% of revenues, as the company aggressively marketed its new businesses post-crackdown.

But the increase in operating expenses also tells a positive story. Like its peers, Gaotu has been back in hiring mode after steep job cuts during the crackdown. The fastest-growing component of its operating expenses was its general and administrative expenses, which rose 87.6% for the year. CFO Shen attributed the jump to "proactive talent acquisition efforts to support the expansion of our product portfolio, including onboarding industry professionals with extensive experience and strong management capabilities."

Shen noted that Gaotu's cash position stood at 4.1 billion yuan by the end of last year, up by 184 million yuan compared to the end of 2023. Chairman Chen also pointed out the company was cash flow positive in the fourth quarter, providing "a solid foundation for future strategic plans and long-term sustainable growth."

Like its peers, Gaotu has become a very different company since 2021, when its focus was on after-school tutoring for primary and secondary school students. While learning services still account for most of its revenue, 85% of that came from non-academic tutoring and "traditional learning" services in the fourth quarter. The company's current courses range from test preparation for study abroad to training for job hunting.

"This year, we successfully helped students gain admission to Harvard, Columbia, Cornell and other Ivy League schools and other prestigious international universities," Shen said. "By introducing new products and diverse interactive course formats, we are constantly igniting students' interest in learning, fostering cognitive growth, improving practical skills, cultivating critical thinking and instilling lifelong learning abilities."

Another 15% of learning services revenue during the fourth quarter came from educational services for college students and adults, Shen said. She added that gross billings for the segment grew by high double-digits, with the segment achieving profitability on an annual basis and generating operating cash flow that was 3.5 times the previous year. "This marks a major milestone in our path towards more sustainable operations," Shen said.

The bottom line seems to show that Gaotu has learned its lesson, successfully undergoing a brutal transition. More good news may also lie ahead for its stock if the company meets its target of returning to the black this year.