Commoditized AI And China Policy Will Erode Pricing Power

Key Takeaways

• Rapid AI commoditization, sector regulation, and shrinking demographics threaten Youdao's pricing power, revenue growth, and long-term market expansion in education.
  
• High R&D costs and intensifying competition increase margin pressure, risking sustained profitability as free or low-cost rivals proliferate.
  
• Advanced AI integration, digital content growth, smart device innovation, global marketing gains, and operational efficiency are driving sustained profitability and diversified revenue streams.

Catalysts

An internet technology company, provides online services in the fields of content, community, communication, and commerce in China.

• The commoditization of generative AI tools is accelerating globally, making digital learning technologies less differentiated; this rapid erosion of competitive moat means Youdao's premium AI-powered learning and advertising products could lose pricing power quickly, leading to downward pressure on revenue growth and gross margins over the medium and long term.
  
• Ongoing regulatory intervention and policy volatility in China's education sector could further constrain Youdao's ability to scale new offerings or capture emerging opportunities, increasing the risk of abrupt product discontinuations or revenue declines and amplifying operational unpredictability in its core domestic market, destabilizing future earnings.
  
• Youdao's addressable market for K-12 and related educational services will continue to shrink due to China's persistent demographic decline and falling birth rates, undermining the long-term growth base and limiting sustainable expansion in learning services revenue, even as AI-driven or adult learning products see near-term uptake.
  
• The company's reliance on expensive research and development to keep pace with rapid innovation in edtech, coupled with the need for continuous content investment, will keep operating costs elevated; any slowdown in top-line growth or a new wave of free or low-cost learning platforms could severely pressure net margins and jeopardize long-term profitability.
  
• Intensifying competition from both domestic and international edtech providers, especially as advanced AI models become more accessible, will not only make it harder for Youdao to grow market share but also force greater promotional spending and technology upgrades, driving up costs and risking future declines in earnings and return on invested capital.

Youdao Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Youdao compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Youdao's revenue will grow by 10.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 2.6% today to 4.5% in 3 years time.
• The bearish analysts expect earnings to reach CN¥338.1 million (and earnings per share of CN¥2.98) by about July 2028, up from CN¥146.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 19.9x on those 2028 earnings, down from 51.6x today. This future PE is greater than the current PE for the US Consumer Services industry at 19.3x.
• Analysts expect the number of shares outstanding to grow by 0.36% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.91%, as per the Simply Wall St company report.

Youdao Future Earnings Per Share Growth

Risks

• Youdao's strategic embrace of cutting-edge AI technology, such as its proprietary Confucius large language model and integration of open-source models like DeepSeek, gives the company a clear differentiation advantage in education-specific scenarios and operational efficiency, which could drive higher user retention, product demand, and ultimately support long-term revenue and margin expansion.
  
• Rapid growth in digital content services-illustrated by AI-powered college admission advisers and programming courses with over 40% year-over-year gross billing increases-indicates that specific segments are still benefiting from secular trends in education technology adoption and paid digital learning, which can offset declines in legacy segments and stabilize or boost overall revenues.
  
• The company's successful expansion in the smart devices market, including the strong debut of new products like the AI-enabled tutoring pen and continuous revenue growth from dictionary pens, demonstrates Youdao's ability to capture additional addressable markets and create new revenue streams, supporting top-line growth and higher gross margins.
  
• Robust growth in overseas online marketing services, strategic partnerships such as newly secured Google and TikTok advertising agreements, and a rapidly growing international creator network give the company access to larger global client pools and higher-quality advertising opportunities, which could meaningfully accelerate revenue in the online marketing segment and drive earnings higher over time.
  
• Ongoing cost optimization, operational efficiency improvements driven by AI, and a sustained focus on high-margin digital content and subscription services have already resulted in record profitability, with first quarter net income attributable to shareholders rising over six-fold year-over-year, suggesting a structural shift in the company's ability to generate and sustain earnings even in the face of short-term revenue declines.

Valuation

• The assumed bearish price target for Youdao is $6.22, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Youdao's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $18.18, and the most bearish reporting a price target of just $6.22.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be CN¥7.5 billion, earnings will come to CN¥338.1 million, and it would be trading on a PE ratio of 19.9x, assuming you use a discount rate of 7.9%.
  
• Given the current share price of $8.81, the bearish analyst price target of $6.22 is 41.7% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.