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With support from Xu Xiaoping and Lei Jun, can an IPO save 17EdTech?

©️Original content by Capital Detective

Author | Guo Fanyu

It’s neither Yuanfudao nor Zuoyebang. Amid the booming online education sector this year, the first company to step onto the US IPO path is 17 Education & Technology Group.

Beijing time on November 14, Yiqi Education officially submitted its IPO to the U.S. Securities and Exchange Commission, planning to list on Nasdaq.

This year represents a rare development window for all online education companies. Affected by the pandemic, online education, especially the K12 track, has welcomed a development boom. Many online education companies have gained more attention and favor from investors in both primary and secondary markets. Yiqi Education, which is rushing to go public, is no exception.

However, different from the current top players fiercely competing, Yiqi Education initially entered the market through an 'in-school + after-school' integrated model. This model aims to combine in-school and out-of-school scenarios, integrating online and offline products and services. In schools, its brand Yiqi Homework provides smart classroom solutions, while outside of school, Yiqi Online School serves as an online academic tutoring platform, offering live online courses and services.

This is quite different from the current K12 online players who are preparing to offer online courses.

The prospectus shows that Yiqi Education provides teaching, learning, and evaluation applications to more than 900,000 teachers, 54.3 million students, and 45.2 million parents nationwide. It currently serves 70,000 schools, covering one-third of public primary and secondary schools in China. As of September 30, 2020, the daily active users of Yiqi Homework's student app were 6.8 million, with monthly active users at 19.5 million.

In the prospectus, Yiqi Education claims to be one of the top five providers of large-scale online K12 after-school tutoring services in China.

Although its business model differs and it ranks among the top five in the industry, the challenges facing Yiqi Education are significant. How it performs in the current competition and plans to address fierce competition in the future are questions that need further answers.

The core of online courses under a differentiated approach

Based on the information disclosed in the prospectus, Yiqi Education’s performance generally aligns with the current state of the industry: high growth, high investment, and long-term losses.

According to the prospectus, Yiqi Education’s revenues for 2018 and 2019 were RMB 310 million and RMB 406 million, respectively, representing a year-over-year increase of 30.75%. The pandemic this year has significantly catalyzed Yiqi Education’s growth,For the nine months ended September 30, 2020, 17 Education & Technology Group's net revenue reached RMB 808 million, a year-over-year increase of 277.48%.

Among this, K12 online courses have gradually become the main source of its operating revenue, contributing RMB 93.88 million and RMB 360 million respectively, accounting for 30.2% and 88.5%.In the first nine months of 2020, revenue from this business reached RMB 751 million, accounting for 93%. The continuous development of K12 online courses has become an important growth direction for 17 Education & Technology Group.

In terms of gross profit, 17 Education & Technology Group’s gross profit in 2018, 2019, and the first nine months of 2020 was RMB 206 million, RMB 233 million, and RMB 485 million respectively.

During the reporting period, 17 Education & Technology Group remained entrenched in losses. According to the prospectus, in 2018, 2019, and the first nine months of 2020, the company recorded net losses of RMB 656 million, RMB 964 million, and RMB 975 million respectively, with losses showing a continued widening trend.

The persistent losses were primarily due to the continuous rise in operating expenses.First, marketing investment continued to increase.Marketing expenses for 2018, 2019, and the first nine months of 2020 were RMB 303 million, RMB 584 million, and RMB 851 million respectively, which is related to the intensifying competition within the industry. Currently, customer acquisition costs for online education remain high, and top companies continue to burn cash to attract users.

At the same time, research and development expenses remained relatively high at RMB 399 million, RMB 491 million, and RMB 423 million for 2018, 2019, and the first nine months of 2020 respectively, as the economies of scale for online dual-teacher courses have yet to fully materialize.

In terms of operational data, the number of paid course enrollments for 17 Education & Technology Group's K12 online tutoring services increased from 272,000 in 2018 to 726,000 in 2019, a growth of 166.9%, and reached 1,168,000 for the nine months ended September 30, 2020, up 188.4% from 405,000 for the nine months ended September 30, 2019.

In terms of equity structure, prior to this IPO, founder Liu Chang held 17.1% of the shares, Shunwei Capital held 20.2%, making it the largest shareholder of 17 Education & Technology Group. Fluency Holding held 13.5%, H Capital held 12.3%, CL Lion Investment III Limited held 11.6%, Esta Investments Pte. Ltd. held 11.2%, and Walden Investments Group Limited held 6.4%.

Overall, 17 Education & Technology Group’s performance has been mediocre, in line with the current state of the industry. However, it failed to provide any surprises in terms of growth, scale, or profitability.

Although it started with a differentiated model, 17 Education & Technology Group is now clearly part of the fiercely competitive K12 online education space. In the context of unabated competition, what story does its push for a US stock listing tell investors? What potential does its future hold?

Can its in-school business become a competitive weapon?

Returning to the beginning of the story, 17 Education & Technology Group had an impressive start when it was founded.

Liu Chang, the founder and CEO of 17 Education & Technology Group, was previously the Assistant Vice President of New Oriental Education & Technology Group and the principal of Shenyang New Oriental. After leaving New Oriental, he founded 17 Education & Technology Group, which received angel round funding from ZhenFund led by his former leaders, Wang Qiang and Xu Xiaoping.

Xu Xiaoping once said that he would continue to invest in 17 Education & Technology Group until it either made money or couldn’t make money. Wang Qiang also served as the chairman of 17 Education & Technology Group until July 2020, when he stepped down and handed the role over to Liu Chang. In 2012, after Lei Jun met Liu Chang, he described him as a “flawless” founder, following which 17 Education & Technology Group received multiple rounds of investment increases from Shunwei Capital, associated with Lei Jun.

Later on, 17 Education & Technology Group became a darling of capital, attracting numerous rounds of financing within its nine years of establishment. Behind it gathered well-known investment institutions such as Tiger Global Management, H Capital, Shunwei Capital, and ZhenFund.

The reason for being favored by investors and capital lies in the fact that 17 Education & Technology Group possessed strong genes for differentiated competition from the outset.

Unlike many educational institutions that focus on after-school tutoring markets, 17 Education & Technology Group initially targeted primary and secondary school students and teachers. By covering in-school teaching, homework, and evaluation scenarios, it transformed the way students did homework and how teachers graded assignments from offline to online, boosting teacher adoption and usage of their products, thereby driving willingness to pay among students and parents.

Source: Yiqi Education Prospectus

The prospectus shows that Yiqi Homework provides teaching, learning, and evaluation applications for more than 900,000 teachers, 54.3 million students, and 45.2 million parents nationwide. It currently serves 70,000 schools, covering one-third of the country's public primary and secondary schools.

While gradually gaining users, Yiqi Education has started exploring commercialization and monetization strategies.

Yiqi Education’s in-school business mainly adopts two monetization methods: one is charging fees for providing value-added services to public schools,the other is channeling traffic via the APP to Yiqi Online School, selling K12 online courses for commercialization.

Due to stricter regulatory policies, revenue from the former method decreased after 2018. Financial data shows that the latter has become the primary source of income, with an increasing share. As of September 30, 2020, revenue from K12 online course business reached RMB 751 million, accounting for 93%.

This latter commercial path has also directly pushed Yiqi Education into the fiercely competitive K12 online education sector.Currently, Yiqi Education offers online dual-teacher large-class live courses through Yiqi Online School, covering multi-disciplinary courses. The number of paid course enrollments increased from 272,000 in 2018 to 726,000 in 2019, a growth of 166.9%, reaching 1.168 million in the nine months ended September 30, 2020.

To a certain extent, the earlier in-school business provided a foundation for Yiqi Education’s transition to K12 online education. Based on the user base accumulated from its earlier in-school services, Yiqi Education can obtain more precise potential users. According to the prospectus, as of September 30, 2020, Yiqi Homework’s average DAU and MAU reached 6.8 million and 19.5 million respectively, providing a traffic conversion basis for the growth of paid course users.

Source: Yiqi Education official website

Another benefit provided by the in-school business is that the data obtained by 17 Education through its in-school operations can help drive the setup of paid courses and offer personalized learning. Teachers of paid courses can improve teaching quality and provide tailored tutoring by analyzing relevant data such as students' in-school performance. According to the prospectus, as of September 30, 2020, 17 Education had user data on in-school performance for over 66% of registered students in paid courses.

However, within the larger competitive environment, 17 Education’s advantages are not unassailable.

In terms of customer acquisition, although 17 Education has its in-school business as a foundation, other players have achieved very rapid growth by directing traffic through their tool-based products and making substantial market investments. In front of investors, speed is a crucial factor in deciding how much capital to allocate.

Over the past few years, with capital driving the competition, it has become increasingly fierce. This is mainly reflected in the rising penetration rate of online education, which has pushed up customer acquisition costs, making the leverage of capital even more important.

After being washed out by massive funding in 2019, smaller players lacking resources and financial reserves have largely exited the market. Since this year, the Matthew Effect in the industry has intensified, and both funding and market share will flow towards leading companies.The K12 battleground in online education has turned into a fierce competition among top players.

Although persistently high costs and ongoing losses undoubtedly place significant pressure on expansion for major institutions including 17 Education, players who fail to secure a top-tier position appear less attractive in the primary market. Once lacking financial support, mid-tier players will face further squeezed survival space.

Against this backdrop, it’s not hard to understand why 17 Education, which hasn’t announced new financing in a while, has chosen to go public first. Besides expanding brand influence, gaining access to capital through the stock market and providing an exit channel for investors are more critical considerations.

However, after listing, the secondary market will subject the company to more rigorous scrutiny. 17 Education will face greater challenges in maintaining a balance between investment and conservatism. Its own business performance will also determine whether the capital markets will buy into its vision.

It is clear that going public is not the end; 17 Education's challenges are far from over.

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