Offline Expansion And AI Spending Will Pressure Margins And Limit Long Term Earnings

Catalysts

About Gaotu Techedu

Gaotu Techedu is a technology driven education company that provides online and offline learning services for students from primary school through adulthood.

What are the underlying business or industry changes driving this perspective?

• The push into offline learning centers, which now contribute over 10% of revenues, requires ongoing site, staffing and utilization investment that could outpace local demand and weigh on operating margins if center level profitability lags the online segment.
• The broad use of AI across teaching and operations and co established AI R&D centers can require sustained capital and R&D spending, and if these tools fail to deliver matching revenue gains, the gap could limit further improvement in net margins and delay earnings break even.
• Revenue from new nonacademic tutoring initiatives in both online and offline formats is growing at around 60% year over year. If that growth rate cools while fixed instructional and content costs remain high, total revenue growth could slow sharply and compress overall profitability.
• The company is targeting approximately 15% revenue growth in 2026 with profitability as a major focus. If user enrollment or pricing power weakens in core traditional and nonacademic learning services, the trade off between growth and cost control could limit improvements in operating loss margin and net earnings.
• Extensive partnerships with universities to build a high quality educator pipeline and expanded training, assessment and incentive systems may increase long term personnel costs. If tuition and course fee growth does not keep pace, this could pressure gross margin and constrain future earnings.

Assumptions

This narrative explores a more pessimistic perspective on Gaotu Techedu compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Gaotu Techedu's revenue will grow by 22.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -6.4% today to 2.4% in 3 years time.
• The bearish analysts expect earnings to reach CN¥261.4 million (and earnings per share of CN¥1.06) by about January 2029, up from CN¥-375.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as CN¥615.4 million.
• 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 14.4x on those 2029 earnings, up from -11.5x today. This future PE is lower than the current PE for the US Consumer Services industry at 17.4x.
• The bearish analysts expect the number of shares outstanding to decline by 3.11% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.82%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The company is already reporting revenue of nearly RMB 1.6b for the quarter with 30.7% year over year growth and deferred revenue of about RMB 1.8b, which gives visibility into upcoming course delivery and could support a more resilient revenue base than a bearish view on long term demand implies, directly affecting future revenue and earnings.
• Nonacademic and traditional learning services, which together contribute more than 80% of revenue and have recorded over 55% year over year growth, along with new nonacademic initiatives growing at around 60% year over year, suggest that long term demand for Gaotu Techedu’s broader learning ecosystem may remain strong, which could support revenue growth and help move net margins closer to break even or into profit.
• Management reports that the online segment for traditional and nonacademic learning services is on track for a double digit profit margin for the full year of 2025, and that operating expenses have been reduced by 3.7% year over year with non-GAAP operating loss margin at 10.7%, which indicates improving operating leverage that could lead to better net margins and support earnings instead of a sustained decline.
• The company is integrating AI across teaching and operations, reporting efficiency gains, lower R&D and G&A as a share of revenue and improved customer acquisition efficiency by 12.8% to nearly 20% across segments, which may support structurally higher gross margin and lower operating costs, helping net margins and operating cash flow more than a bearish thesis assumes.
• Gaotu Techedu has completed a US$80m share repurchase program and started a new US$100m program, while holding over RMB 3.0b in cash and investments. In addition, management has stated explicit targets for approximately 15% revenue growth in 2026 with a focus on achieving sustainable net profitability, which could support earnings per share and shareholder returns more than a thesis centered on long term share price weakness anticipates.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Gaotu Techedu is $1.96, which represents up to two standard deviations below the consensus price target of $3.71. This valuation is based on what can be assumed as the expectations of Gaotu Techedu'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 $4.87, and the most bearish reporting a price target of just $1.96.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be CN¥10.9 billion, earnings will come to CN¥261.4 million, and it would be trading on a PE ratio of 14.4x, assuming you use a discount rate of 7.8%.
  
• Given the current share price of $2.56, the analyst price target of $1.96 is 30.9% lower. Despite analysts expecting the underlying business 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.