Gaotu: Live-Streaming Business, Financial Outlook Are Key Investment Considerations (GOTU)

Elevator Pitch

Gaotu Techedu Inc. (NYSE:GOTU) stock is awarded a Hold investment rating. My previous November 25, 2023 write-up was focused on GOTU’s third quarter results review and the increase in Gaotu Techedu’s share buyback authorization to $80 million.

GOTU’s live streaming e-commerce business has performed well, with substantial growth in followers in recent months. On the flip side, the company’s 2024 financial performance could possibly fall short of expectations taking into account risks relating to costs and regulations. After evaluating these key investment considerations for the stock, I have decided to stick to a Hold rating for Gaotu Techedu.

GOTU’s Share Price Outperformance Was Driven By Favorable Outlook For Live Streaming Business

In the two and a half months following the publication of my earlier update in late November last year, GOTU’s share price surged by +61.9% (source: Seeking Alpha price data). During this same time period, the S&P 500 rose by a relatively more modest +8.8%. Positive expectations regarding Gaotu Techedu’s new live streaming e-commerce business were the major stock price re-rating driver for the company.

Gaotu Techedu revealed at its FY 2022 earnings call in February last year that the company “started our live streaming e-commerce journey on Douyin, the Chinese version of TikTok” as its “live streaming brand, Gaotu Jiapin, debuted on the evening of December 21” 2022. Last month, Seeking Alpha News cited a research report published by Citigroup (C) that highlighted that GOTU’s livestreaming business, Gaotu Jiapin, witnessed “a recent surge in viewership” which is “likely translate into marginally higher GMV (Gross Merchandise Value).”

At the time of writing, Gaotu Jiapin boasted close to 2.6 million followers (source: Douyin website) on the Douyin platform. It is worth noting that GOTU’s live streaming business had less than 400,000 followers on December 13, 2023, according to a report issued by Mainland Chinese stock broker BOCOM International. The sharp increase in Gaotu Jiapin’s number of followers on Douyin in recent months is likely due to woes associated with its competitor. Chinese media publication Caixin Global published an article on December 21 last year mentioning that “live streaming e-commerce platform East Buy”, Gaotu Jiapin’s peer and rival, suffered from “a fan revolt this month (December 2023) sparked by a perceived slight to its star influencer, Dong Yuhui.”

According to a January 24, 2024 post (translated using Google Translate) published on broker Futu Holdings’ (FUTU) website, Mainland Chinese research firm BOCI estimates that Gaotu Techedu’s live streaming e-commerce business has the potential to generate as much as RMB12 million of income for the company this year with the substantial growth in followers. This is equivalent to 9% of GOTU’s FY 2024 consensus normalized net profit amounting to RMB135.3 million (source: S&P Capital IQ).

However, Gaotu Techedu’s stock price outperformance might not be sustained, taking into account the company’s outlook as detailed in the subsequent section.

There Are Downside Risks Associated With Gaotu Techedu’s Future Financial Performance

GOTU will report its Q4 2023 financial results on February 27, 2024. The market is currently forecasting that Gaotu Techedu’s normalized net loss will widen substantially from -RMB41.7 million in the third quarter of last year to -RMB145.5 million (source: S&P Capital IQ consensus data) for the final quarter of the prior year.

It is easy to understand why the analysts are expecting GOTU to record meaningful losses in Q4 2023. Gaotu Techedu has previously guided for its top line to expand by between +6.1% YoY and +9.3% YoY for the fourth quarter of last year, but the company’s revenue growth needs to be supported by relevant investments that will be a drag on its profitability. At its Q3 2023 results briefing, GOTU had highlighted that it has “set up multiple offline centers for post-graduate entrance exam preparation business and overseas study-related services”, while making the necessary “marketing investments to address the robust demand.” Therefore, I don’t expect Gaotu Techedu’s Q4 2023 results to exceed expectations.

Looking beyond 2023, the sell side has a very bullish view of Gaotu Techedu’s financial performance for the current year. The consensus financial estimates sourced from S&P Capital IQ point to GOTU’s top line growth in RMB terms accelerating from +16.7% for FY 2023 to +23.7% in FY 2024. The analysts also anticipate that GOTU’s normalized net income will jump from RMB12.2 million in the previous year to RMB135.3 million for the current year. The live streaming e-commerce business, Gaotu Jiapin, is expected to contribute to GOTU’s FY 2024 bottom line in a meaningful way, as outlined in the preceding section of the article.

But I think that the market’s optimism regarding GOTU’s significant earnings growth outlook for 2024 might be misplaced, and this could potentially translate into negative earnings surprises for the company this year.

One key risk factor is higher-than-expected costs and investments. Gaotu Techedu emphasized at its third quarter earnings briefing that “expanding our offline presence” is one of the company’s key priorities. It is reasonable to be concerned that GOTU’s profitability might be affected by expenses associated with its efforts to establish a larger offline center network in the future.

Another key risk factor is regulatory risks. Chinese state media China Daily published a commentary piece on January 10, 2024 citing the country’s education ministry’s comments that “more efforts should be made to address problems such as variants of out-of-school classes in disciplinary subjects and inadequate supervision of training on other subjects.” It is safe to assume that education and learning activities conducted outside of schools continue to be scrutinized closely by Chinese regulators. This means that one can’t rule out the possibility of new policies in the future that have an unfavorable impact on private education businesses operating in China, such as Gaotu Techedu.

Final Thoughts

Gaotu Techedu currently trades at a demanding consensus FY 2025 normalized P/E multiple of 28.5 times (source: S&P Capital IQ). This suggests that positives associated with the growth of its live streaming e-commerce have been factored into its valuations to a large degree. Furthermore, I think that GOTU won’t achieve a positive surprise with its Q4 results disclosure on February 27, while the sell side seems to be way too optimistic about the company’s FY 2024 prospects. As such, I have a Hold rating for GOTU.