Why NetEase’s e-learning unit slashed New York IPO target

When the e-learning unit of Chinese internet giant NetEase slashed its New York Stock Exchange initial public offering target by half, it might have seemed like another casualty of the ongoing trade war between the world’s two biggest economies.

But the real reason was closer to home: China’s online education sector has expanded rapidly in recent years, but providers are having a hard time making money.

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Youdao Inc., of which NetEase owns more than 60%, is set to price its shares at between US$15 and US$18 each, according to a recently updated filing with the US Securities and Exchange Commission. That adds up to about US$116 million in IPO funds, down from a target of US$300 million three weeks ago.

Despite achieving 100 million monthly active users this year, Youdao recorded a net loss of US$24 million in the first half, more than double its loss a year earlier.

Youdao said in the filing that one of its main challenges was to “monetise the user bases.” Ahead of the listing, expected to take place as early as Friday, Youdao does not want to repeat the experience of New York-listed rivals that have been trading far below their debut prices and have struggled to turn profitable.

Nonetheless, NetEase chief executive William Lei Ding told the World Internet Conference in China on Sunday that education is expected to be an important growth engine for the company. He has expressed interest in personally purchasing up to US$20 million worth of Youdao shares.

Driven by an expanding middle class and Chinese parents’ obsession with providing their kids with the best education, the online education industry in China is expected to be worth 300 billion yuan (US$42.4 billion) this year and reach 540 billion yuan (US$76.3 billion) by 2022, according to the Qianzhan Industry Research Institute.

Liulishuo and 51Talk, Youdao’s major rivals which trade as Laix and China Online Education Group, respectively, in New York, reported net losses of US$12.8 million and US$4.7 million, respectively, in the second quarter. While both losses narrowed slightly from a year earlier, each stock is trading more than 60% below their IPO price.

Language teacher specialist Hujiang Education & Technology, which filed for a Hong Kong IPO last year, has indefinitely postponed its flotation. Net losses spiralled from 280 million yuan (US$40 million) in 2015 to 537 million yuan (US$76 million) in 2017.

Privately-owned VIPKid, which connects Chinese students with language teachers in the US, finished its latest funding round of US$150 million in September, but has not expressed any intention to go public.

Only 5% of China’s online education businesses targeting pre-college students are profitable, estimates Xiong Bingqi, deputy director of the 21st Century Education Research Institute in Beijing.

While online businesses save costs on property rentals associated with traditional classrooms, they face much higher outlays in marketing and research and development, which drags on profits, said Neil Wang, the greater China president of consulting firm Frost & Sullivan.

Last year alone, 51 Talk spent more than US$100 million on marketing, while Youdao’s sales and marketing expenditure accounted for nearly 34% of its total costs in the first half of the year, 5 percentage points higher than the same period last year.