NetEase e-learning unit slashes New York IPO target to avoid fate of rival Chinese online education platforms

Only 5% of China’s online education businesses for pre-college students are profitable, according to one estimate.

Photo by J. Kelly Brito on Unsplash Photo by J. Kelly Brito on Unsplash

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

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.

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

Despite achieving 100 million monthly active users this year, Youdao recorded a net loss of USD 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 “monetize 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 USD 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 (USD 42.4 billion) this year and reach 540 billion yuan 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 in New York, reported net losses of USD 12.8 million and USD 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 spiraled from 280 million yuan in 2015 to 537 million yuan in 2017.

Privately-owned VIPKID, which connects Chinese students with language teachers in the US, finished its latest funding round of USD 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, 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 USD 100 million on marketing while Youdao’s sales and marketing expenditure accounted for nearly 3% of its total costs in the first half of the year, 5 percentage points higher than the same period last year.

Offline tutoring giants New Oriental and TAL Education have expanded online in recent years, to the detriment of their balance sheets. New Oriental’s profit slumped 33.5% to USD 43.2 million in the fiscal quarter ended May while TAL turned from a profit to loss of USD 7.3 million in the same period.

Nevertheless, the industry is becoming more crowded with new capital pouring in. E-commerce leader Alibaba Group and social media and games giant Tencent both joined at least two funding rounds of VIPKID, while TikTok owner ByteDance launched an online education platform earlier this year. It is reportedly developing an educational gadget to be unveiled in 2020. Alibaba is the parent company of the South China Morning Post.

Chengdu resident Wang Dan, mother of a 7-year-old girl, said the online courses cost less and save time because she does not have to drive her daughter to tutoring centres. Living in more remote Sichuan province, Wang said online education also gives her daughter access to the best teachers in bigger cities like Beijing and Shanghai.

But she sees a big downside: communication between teacher and students is minimal when online, especially when a well known tutor has to deal with a large number of online participants.

Wang also worries about the extra assignments given in online classes that can keep her daughter up till 10 o’clock some nights. “We can’t do anything about it because this is how our society works,” she adds.

While China’s fierce competition in education and emphasis on test scores has been widely criticized, experts say the explosion in online education may have exacerbated the situation. For example, several companies are developing AI technology to help forecast exam questions, scan for answers and recite from textbooks.

Online education isn’t going to improve the situation, according to Xiong. “What needs to change is the assessment system,” he said, adding that digital based education like live-streamed classes and pre-recorded lessons can only serve as a supplement to offline schooling, but never replace it.

This article first appeared in the South China Morning Post.