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Morgan Stanley downgrades Udemy to Underweight: is more trouble ahead?

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Morgan Stanley has downgraded Udemy Inc (NASDAQ: UDMY) to ‘Underweight’ from ‘Neutral’ and reduced its price target to $7.50 from $10, implying a potential downside of 7% from the current trading price.

The downgrade reflects concerns over Udemy’s strategic shift toward large enterprise customers amid weakening demand, a move that contrasts with prior expectations of near-term acceleration.

Following the announcement, Udemy’s shares fell 4.7% to $7.75 in early trading, extending the stock’s year-to-date decline to approximately 45%.

Morgan Stanley analysts argue that Udemy’s profitability targets, which rely heavily on significant operating leverage, are misaligned with the company’s lower top-line growth projections.

They anticipate continued growth deceleration due to weak web traffic and are cautious about the medium-term risks associated with the strategic pivot.

The analysts also highlight valuation concerns, noting that Udemy trades at a 31% premium in enterprise value to 2025 sales compared to its closest competitor, Coursera (NYSE: COUR), despite Udemy’s slower growth, smaller total addressable market, less differentiation, and higher transactional revenue.

On an enterprise value to 2025 free cash flow basis, Udemy trades at a 50% premium to Coursera.

Analysts cautious on Udemy amid execution concerns

This is not the first time in recent months that Udemy has faced skepticism from analysts.

In August, Bank of America downgraded the stock to “Neutral” from “Buy” and slashed its price target to $8.50 from $14, indicating an 8% downside at that time.

Bank of America cited concerns over execution missteps, ongoing strategic operational changes, and insufficient evidence that revenue trends are stabilizing.

Despite acknowledging Udemy’s potential to benefit from a secular shift toward skills training—especially in artificial intelligence—the analysts remained cautious due to these uncertainties.

Udemy misses EPS, lowers 2024 guidance as growth slows

Udemy’s second-quarter 2024 earnings report did little to assuage these concerns. The company reported a non-GAAP EPS of -$0.04, missing analyst estimates by $0.03.

Revenue reached $194.4 million, a 9.1% year-over-year increase that slightly beat consensus estimates by $0.25 million.

However, the company significantly reduced its full-year 2024 revenue guidance for the second time this year, attributing the cut to challenging macroeconomic conditions, softer marketplace conversions, tight enterprise customer budgets, and ongoing optimization of its go-to-market strategy.

The company’s fundamental performance reveals challenges in both its Consumer and Enterprise segments.

Consumer segment revenue declined by 4% year-over-year to $73.8 million, with monthly average buyers decreasing by 4% to 1.29 million.

This marks the first quarter of negative year-over-year performance and a 10% sequential decline, raising concerns about the weakening of Udemy’s flywheel effect, where a decrease in users could lead to fewer instructors and less content, further diminishing user engagement.

The Enterprise segment, known as Udemy Business (UB), grew revenue by 19% year-over-year to $120.6 million but is experiencing deceleration.

UB’s net dollar retention rate declined from 104% to 101%, and the rate for large customers dropped from 111% to 108%. Annual recurring revenue growth in UB also slowed from 22% in the first quarter to 17% in the second quarter.

Udemy refocuses on large enterprises, announces $25M cost-saving plan

In response to these challenges, Udemy announced a strategic shift to focus on large enterprise customers, aiming to enhance operational efficiency and achieve significant margin expansion.

The company plans to reallocate resources toward enterprises with over 1,000 employees, increase penetration within its existing large customer base, and expand strategic partnerships to strengthen global distribution.

As part of this initiative, Udemy unveiled a restructuring plan affecting approximately 280 global employees, about 19% of its total headcount as of fiscal year-end 2023.

This restructuring is expected to yield annualized cost savings of $25 million but will incur charges of $16 to $19 million spread across the third quarter of 2024 to the first quarter of 2025.

Udemy is targeting adjusted EBITDA in the range of $130 to $150 million for full-year 2026, up from an expected $26 million in 2024.

Despite these cost-saving measures, concerns persist regarding Udemy’s ability to achieve its profitability targets amid slowing revenue growth.

Udemy’s valuation stretched amid slow growth and high costs

The company’s valuation appears stretched when compared to peers. Udemy trades at an enterprise value to sales multiple that is a 31% premium over Coursera, despite exhibiting slower growth and lower margins.

High stock-based compensation expenses, running at approximately $95 million annually, further raise questions about earnings quality and potential shareholder dilution.

The shares currently trade at an EV/Sales multiple of around 1.04x. While this figure may seem low, it is comparable to sector peers like Coursera, suggesting industry-wide multiple compression due to increased competition and macroeconomic headwinds.

Given these developments, investors are closely monitoring how these fundamental challenges might influence Udemy’s stock price in the near term.

To better understand the stock’s potential trajectory, examining technical indicators may provide valuable insights into support and resistance levels, aiding investors in making more informed decisions.

Weak across timeframes

Udemy shares rose to a high of $32.62 a few weeks following the company’s IPO in late 2021. However, they have been in an extended downtrend ever since making their all-time low at $6.67 last month.

Source: TradingView

Despite the recent bounce back that it has seen, the stock remains weak across timeframes. Hence, investors looking to initiate a fresh long position must avoid doing so unless the stock starts trading above its recent swing high of $9.48.

Traders who are bearish on the stock can initiate a short position on a bounce back above $8 levels with a stop loss at $9.55. If the downtrend continues, the stock can fall below $5.8 levels in the coming months.

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