Udemy: Focusing On Margin Improvement Over Growth

Investment Thesis - Udemy operates in a growing learning marketplace aimed at bridging the skills gap for individuals and organizations, with a focus on enterprise reskilling and training [2] - The consumer segment faces challenges due to a weaker macroeconomic environment and increased competition, while the enterprise segment shows double-digit growth and better profitability [2][3] - Management aims to improve overall profitability by prioritizing the enterprise segment, expecting adjusted EBITDA margins to reach 20% by 2027, up from 3% this year [2][6] Q2 Earnings Performance - The strategic shift towards the enterprise segment is a key takeaway from Q2 earnings, as management seeks to capture future market opportunities and improve profitability [3] - Despite rising gross margins in the enterprise segment, the Net Dollar Retention Rate (NDRR) has been declining, indicating potential challenges in customer retention [4] - The consumer segment experienced a 4% year-over-year revenue decline, attributed to a decrease in the number of monthly average buyers [4] Future Expectations - The revenue decline in the consumer segment is expected to hinder overall revenue growth, which accounted for 38% of total revenue in Q2 [5] - Management's guidance suggests only 4% overall revenue growth in H2 2024 compared to H2 2023, a significant drop from the 10% growth in the first half of the year [5] - Overall revenue growth is estimated to average around 7% in 2025 and 2026, lower than analyst expectations of 9% [5] Margin Improvements - Gross margin improvements are anticipated due to a gradual reduction in the revenue share for instructors in the enterprise segment, expected to decrease to 15% by 2026 [6] - Management plans to reduce operating expenses by cutting marketing spend and reallocating resources to lower-cost regions, with incremental margins estimated at close to 35% [6] - Margin improvement may be slower than management's target, with expectations of reaching closer to 15% rather than 20% by 2027 [6] Capital Management - With a net cash position of $420 million, management announced a $150 million share repurchase program, indicating a commitment to returning excess capital to shareholders [7] - The expectation of improved profitability suggests a significant portion of cash will be used for buybacks, especially in light of high stock-based compensation [7] Valuation Insights - Current valuation metrics indicate shares trade at EV to Sales and EV to adjusted EBITDA multiples of 0.8 and 27, respectively, suggesting the stock is undervalued [8] - Despite the attractive valuation, similar-sized peers exhibit comparable valuations, indicating sector-wide multiple compression due to increased competition and macroeconomic challenges [8] - Future earnings forecasts are conservative, with expected revenue of $891 million and adjusted EBITDA margins close to 12% by 2026, leading to an adjusted EBITDA of $107 million [8] Conclusion - The outlook for Udemy indicates weak topline growth but significant potential for margin improvement, supported by a large net cash position [12] - The current rating is a Hold until there is evidence of margin improvement and a reacceleration in revenue growth [12]