Youdao Sees New Possibilities in China's Edtech Space

Sweeping regulatory changes in China's education space led many tutoring providers to turn to other possibilities in the market. Companies have been either diversifying their services, or transitioning away from K-12 tutoring altogether.  

New regulations in private tutoring aim to lessen the burden on parents and students in primary and middle school by capping after-school study time. The so-called "double-reduction" policy calls for the providers of academic tutoring in kindergarten through twelfth grade to be registered as non-profit organizations and prohibits K-12 classes on weekends, holidays, and school breaks.  

Moreover, companies are banned from raising funds through stock exchange listings or other capital-related activities. Foreign investments in school curriculum-based tutoring institutions through variable interest entity (VIE) arrangements, mergers and acquisitions or otherwise are also prohibited. Listed companies are banned from investing in businesses offering tutoring on academic subjects in compulsory education. 

For Chinese education companies listed in New York, that meant significant reduction in market value. Analysts expect education giants like New Oriental Education & Technology Group Inc. (NYSE: EDU; HKEX: 9901) and TAL Education Group (NYSE: TAL) to turn to non-academic tutoring and divest their K-9 academic tutoring segments.  

Youdao (NYSE: DAO), an intelligent learning company in China, said the impact of the new regulations will be mild as its business is already diversified. Online after school tutoring on academic subjects in compulsory education only accounts for 30% of its total business, according to local reports. Further, the company has made business upgrades and compliance considerations ahead of the new regulations coming into effect.  

As an education technology provider, Youdao has owned a diversified portfolio back in 2019, prior to the Covid-19 outbreak. In addition to K-12 tutoring, the company operates in several sectors: smart devices, STEAM courses, and higher and vocational education.  

More Smart Devices Upcoming  

Youdao's CEO, Feng Zhou, has always seen the opportunity in developing smart education gadgets, as he believes the market is massive and growing.  

According to the "2021 China Education Smart Hardware Trend Insight Report" recently released by Tencent Research Institute, the size of the smart education hardware market was 34.3 billion yuan in 2020, and it is expected to reach 45.3 billion yuan in 2021. By 2024, it is expected to grow into a 100 billion yuan industry.  

Youdao entered the market of smart devices as early as 2017, and launched a series of products such as Dictionary Pen and Pocket Translator, to enhance users' learning experience and efficiency.   

Among the latest product releases, in March 2021, Youdao introduced Dictionary Pen 3 Pro, which features bilingual translation of Japanese and Korean. That was an upgrade of the Dictionary Pen 3 revealed in December 2020, which features a super-sensing optical system that can recognize both infrared and visible light. Compared to other similar translation gadgets, Dictionary Pen 3 has shown to be faster, with an average recognition accuracy of 98.3%.   

The company also rolled out K, X, and P dictionary pens for kids, and Extreme and Professional series for adults. Youdao released a new version in Q2, the Dictionary Pen K3, which was designed exclusively for children to help improve independent reading and language learning abilities with interactive functions that help engage children for a more immersive learning experience. The new Dictionary Pen function - mental arithmetic & error correction, creates even more application scenarios for children's learning process across more subjects, including Chinese, math, and English. 

According to local media, Youdao has invested a lot in research and development, with more smart devices in the pipeline for 2021. The company's unique product matrix, combining intelligent devices with learning apps, enables Youdao to better address customer needs in innovative ways and to achieve organic growth.  

As its earnings release shows, Youdao's smart learning products are well-received and gaining popularity. In the first quarter of 2021, net revenues from learning products were 201.9 million yuan ($30.8 million), representing a 280% increase from the same period in 2020. Meanwhile, gross margin for learning product sales increased to 44.1% from 25.6% in the first quarter of 2020. The improvement was mainly attributable to the substantial growth in sales of the Dictionary Pen 3, which carried a higher gross margin profile than other learning products.  

"This product is powered by cutting-edge AI technology to meet the user's heavy search and learning needs of intelligent hardware," Yinghui Wu, the vice president of Youdao, said at the product launch conference.   

Committing to Adult Classes & AI Cloud   

In April, CW covered at length Youdao's adult division and its position in the market. In a nutshell, the company has seen fast growth in the higher education and vocational education segments, and it intends to grow its slice of the market pie. While cracking down on the K-12 space, China has been investing heavily in vocational education, aiming to raise the professional training of its large workforce.  

Powered by its proprietary AI technology, Youdao just may benefit from shifting its focus. Indeed, China is the largest vocational training market, and Youdao is an early player and well-equipped to provide the services through its platform. 

Different from the model of other players, Youdao's adult education business is not a new development, but an upgrade that is based on NetEase's existing adult tutoring system and massive traffic.   

Earlier this March, Youdao announced the establishment of Youdao Adult Education Division "and the brand upgrade of NetEase Cloud Classroom". The new division integrates the business and teams of Youdao Premium Courses for Adults, NetEase Cloud Classroom, and China University MOOC. The adult courses and services of Youdao Premium Courses for Adults will be merged under the NetEase Cloud Classroom brand.  

More importantly, the upgraded NetEase Cloud Classroom will adopt a combination of "self-development + platform selection and cooperation", positioning itself as a systematic learning platform to serve lifelong learners.  Youdao has long foreseen the huge potential of the adult education market and quickly invested in the field.  

Further, Youdao operates an AI cloud platform that provides natural language translation, text recognition OCR, and other industry solutions for developers, enterprises and government agencies  

"As an internet-based company, we believe that leveraging our advanced technology to build innovative products is our strength," Zhou said.  

In a recent statement, Youdao said it expects to see material impact on its K-12 course business performance, as well as changes to its corporate structure. The company also said it will ensure it will "improve our operations in strict compliance with all laws and regulations, fulfil our social responsibilities, provide our users with high-quality, innovative products and services, and promote the long-term development of China's education industry."  

In Industry Shake-up, the Fittest to Remain Upright 

To conclude, the industry formerly seen as one of the surest to withstand any macroeconomic turbulence, is now at a crossroads. Now coming from the very top of the pyramid, the waves are likely to rock China's K-12 tutoring space for quite a few quarters as some restructuring takes place and operational costs and expenses surge in the process.  

And still, as Chinese companies tend to say in their press releases at times like these, the regulatory changes are sure to lead to an improved and more stable market. 

For Youdao, we believe the company has the potential to come out on top in this industry shake-up. As highlighted above, Youdao's backing by Chinese tech giant NetEase (Nasdaq: NTES; HKEX: 9999) and thus high user traffic, increasing sales of edtech gadgets, advancement in the adult and vocational e-learning space, and its drive in AI cloud services to enterprises give the company a strong advantage at a turbulent time in China's tutoring market. 

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