Investment thesis
Before the 1Q23 earnings, Udemy (NASDAQ:UDMY) saw its valuation multiples compressed given the weak 4Q22 performance, which has driven the share price down to a low of ~$8. However, I believe the trough is over as seen from the 1Q23 performance where things were better than expected. Both revenue and profit margins for UDMY were higher than expected. Importantly, I believe UDMY remains on track to continue reaping the benefits of market consolidation in its Business segment. On the other hand, bears might point out that UDMY is having trouble upselling because deals are taking longer across all regions and with businesses of all sizes. Certainly, this is not something to celebrate, but this cannot be seen in a vacuum. This dynamic is happening across many industries, affecting my businesses. Rather than being a structural problem that needs to be fixed, I believe this is a problem at the industry or macro level that will resolve itself as the macro environment improves. Finally, I believe many investors were concerned about the impact of generative AI (like ChatGPT), thereby adding pressure to UDMY’s stock. These investors are too pessimistic, in my opinion, because I see AI as a great opportunity for UDMY to expand and enhance its current product lines. My recommendation for UDMY has shifted to a buy.
UDMY is winning
I expect UDMY to maintain its market share growth even as sales cycles lengthen. The offline-to-online transition is still in its infancy, which is good news for Udemy’s business division. A key metric I tracked is the performance of Udemy Business [UB], which saw its revenue growing 46.7%, largely driven by customer growth and large deals coming to fruition, with the segment now representing 54% of total revenue. To give further details, the total number of Udemy Business customers grew 23.7% to 14,359, which implies a 20%+ increase in revenue per customer. Although growth has slowed from the 32.4% growth seen in 4Q22, I still find the 23.7% growth seen on top of the 32.4% growth to be impressive, especially in light of the current macro environment. Even though sales cycles lengthened for the first time in 1Q23, UDMY is clearly consolidating shares in the industry at this growth rate. Many companies compete for business in the enterprise learning market, each with their own unique catalog of courses. Still, I’m convinced that UDMY’s publishing model is unparalleled. For perspective, the percentage of multi-year deals increased, and the number of deals worth $100,000 or more rose by 80% year over year. Notable wins, according to the 1Q23 earnings transcript, included Cisco Systems, Delivery Hero, Ericsson, The Procter & Gamble Company, Royal Caribbean International, and Verizon Communications, among many others, demonstrating the growth’s broad-based nature across a variety of industries. The issue with UDMY in 1Q23, I believe, is that these wins are not reflecting effectively in the books as softness in the SMB market continues to well on net dollar retention rate, which declined 300bps to 112%.
AI impact on UDMY
The outburst in adoption of ChatGPT has probably left many investors wondering if it will disrupt the use case of UDMY, particularly in the consumer segment. I think this worry is not without any basis as it is true that you can learn many things (e.g. programming) via the “chat” with ChatGPT. However, I think UDMY 1Q23 Consumer segment performance has proven these bear case wrong as it remains resilient. Consumer revenues were essentially flat if adjusted for FX, which means either pricing or volume is strong (offsetting each other), either one is positive.
- If its pricing, it shows that UDMY can raise prices effectively or users are learning more expensive lessons
- If its volume, it shows that UDMY continues to gain traction and stay relevant
The average number of monthly purchasers has increased from 1,355,000 in 4Q22 to 1,393,000 in 1Q23, demonstrating segment resilience despite the lack of information on number of learners on the platform. In addition, the performance is not due to heavy promotions or anything similar, as the gross margin was relatively unchanged y/y at 53.8% in 1Q23. With regards to AI, I believe it benefits UDMY. As an example of how they plan to put AI to use, management has mentioned that they plan to incorporate AI into their content discovery engine in order to make recommendations for particular video clips within courses in order to encourage more rapid-fire learning. I think this will enhance the user experience, leading to a higher number of successful lessons. Speaking of lessons, the daunt of AI should also benefit UDMY as it provides courses for it, which I expect to continue garnering attention moving forward. In my opinion, the strength of the UDMY marketplace/platform sets it apart from many competitors. As such, it benefits from “new” content, like AI for instance, as it provides content creators a platform to reach learners using the most cost, time, and reach efficient route. So, even if a day comes where a technology is better than AI appears, UDMY will remain relevant, in my opinion.
Conclusion
I shift to a buy recommendation for UDMY. Despite a challenging 4Q22, UDMY has rebounded in 1Q23, with higher-than-expected revenue and profit margins. While sales cycles have lengthened across industries, UDMY continues to consolidate its market share and demonstrate impressive growth in Udemy Business. The company’s unique publishing model and success in securing large deals with prominent organizations indicate its competitive advantage. Concerns about the impact of AI is overblown, in my opinion. UDMY platform’s strength and ability to adapt to emerging technologies, like AI, make it a relevant and valuable marketplace for content creators.
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