Via SeekingAlpha.com

Overview of the online education market

There are literally hundreds of online educators these days, so, for an investor, deciding where to put hard-earned cash to work in the right company is quite a challenge. The choice, however, is made somewhat easier than one might imagine as there is a modest number of listed organisations serving this market.

An investor could be forgiven for thinking that these listed organisations compete by offering similar services, yet they mainly focus on distinct niche areas. Although, this situation is rapidly changing as many of these companies are now seeking to broaden their offerings, either through acquisition or expansion of existing service lines.

To begin with, let’s take a brief view of 2U’s (TWOU) target segment. The company boasts 73 contracts with some of the world’s most renowned and respected universities. In the main, the company enables these universities to offer their degree programs, lectures and ancillary services online. Additionally, 2U provides premium online short courses and technical, skills-based “bootcamps” through relationships with non-profit colleges and universities. It is important to note that 2U does not endeavour to compete with their client universities by actively marketing their services to the general public.

Providing online services to a different segment are K12 Inc. (LRN). This company, according to their last annual report, “facilitate individualized learning for students primarily in kindergarten through 12th grade, or K-12”; hence the company name. It’s interesting to note that K12 acquired Galvanize to increase the range of their customer base. In fact, the services offered by Galvanize compete to some extent with those offered by Chegg.

There are a plethora of unlisted organisations endeavouring to satisfy different demands. For instance, study materials and online instructional systems are provided by such enterprises as Udemy and Khan Academy. “Bootcamp” options are given by General Assembly and Galvanize; now via K12. Wyzant can connect students to individual tutors for a variety of subjects online, primarily with US-based tutors. Needless to say, there are others too numerous to mention.

Key advantages of Chegg

One element of Chegg’s market is the provision of individual tutors for students anxious to improve their skills in a host of academic skills. These days, it need hardly be said that students of all ages are keeping a close eye on costs. Upon comparing the cost of this offering with a key competitor, Wyzant, I was immediately struck by the difference in cost. For example, if you wish to study advanced calculus with a Wyzant tutor, it may set you back between $60 and $200 an hour. Alternatively, an equivalent course of study with a Chegg teacher will start from around $20 an hour. How is this possible? Well, tutors employed by Wyzant are almost exclusively based in the US, whereas, Chegg offers lower cost but well-qualified teachers from around the world.

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An abundant assortment of free or at minimal cost video-based courses of study are available from either the Khan Academy or Udemy. So why buy from Chegg? To begin with, the cost is also low to access Chegg’s video-based educational content. Furthermore, the material is indexed according to precise topics that students may need help with. So, if you imagine that you have a very specific question on linear algebra, then, you may not want to plough through a whole video in the hope of discovering the answer. Far better to find a targeted answer to your question via Chegg.

What does the market think?

At the end of April, the share price was around $42.00 a share and at the time of writing, it’s $59. This represents an increase of around 40%; not too shabby. The main driver of this increase was the respectable quarterly result released in May.

In addition to the sharp rise in the share price, there has been a significant decrease in the short interest, as the chart below illustrates.

Chart courtesy shortvolume.com

It ought to be remembered that the short volume is limited to the aggregate volume traded that has been reported to FINRA. Nevertheless, if these figures are assumed to be reasonably accurate, there has been a fall of around 1,000,000 in the short interest over the period shown, in other words, an approximately 70% decline. I do believe that there is a message in these numbers.

Financials

Prior to taking the plunge, and buying stock in a company, many seasoned investors check figures for the return on equity (ROE) as a measure of a company’s performance. As a guide, a reasonable figure for this ratio is between 15% and 20% and it reveals the rate at which shareholders may earn income on their shares. For Chegg, the figure currently stands at -2.47%, which you may feel is hardly inspiring. However, looking at the present-day ROE in isolation isn’t enough. The investor should view the ROE from the past five to 10 years to analyse historical performance. The chart below exposes a nice upward trend.

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Chart courtesy of Seeking Alpha

Cash is also important for investors since it later enables a company to return money to shareholders. From the table below dear reader, you may also notice an encouraging rise in both revenue and cash flow over the last five quarters.

Chegg

Q 1 2019

Q2

Q3

Q4

Q1 2020

Percentage change Q1 1990 Vs. Q1 2020

Q4 Vs. Q1

Revenue (Millions USD)

97.4

93.9

94.2

125.5

131.6

35%

5%

Cash from operations (millions USD)

17.9

29.9

38.7

26.8

63.0

252%

135%

Table produced by author

Finally, it is evident that the gross margin for Chegg’s services are healthy relative to other companies operating in a similar industry.

Chegg

K12

2U

Gross Margin

74.50%

32.73%

51.69%

Table produced by author from figures obtained from quarterly reports

The future

In September 2019, Chegg telegraphed their plan to acquire Bootcamp course provider Thinkful and give further evidence of astute management. In the announcement, Dan Rosensweig, CEO of Chegg, stated that the addition of Thinkful to Chegg will expand the service offerings and make it easier for students to accelerate their path from learning to earning. In this statement, the first clear benefit of this acquisition is apparent. Typical Thinkful clients are university graduates and those graduates in employment and seeking to improve their employment prospects. Thus, giving Chegg ample opportunity to cross-sell Thinkful services to existing subscribers.

At this stage, Chegg has a global reach and has subscribers in many countries. Again, it seems that Chegg may now seek clients for Thinkful’s service beyond the shores of the United states. Finally, since the services of both companies are complementary, there are evident options for cost savings in areas such as administration or tutoring staff.

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It is interesting to compare Chegg’s purchase of Thinkful with K12’s copycat purchase of Galvanize in February of this year. As noted earlier, K12’s customers are primarily kindergartens, elementary schools and high schools. Whereas, Galvanize targets corporate customers for their technology-related Bootcamp courses. It is difficult to see how there can be a great deal of cross-selling amongst the clients of Galvanize and K12.

It would have been far better for K12 to copy Chegg’s recent purchase of Mathway. Upon reading the press release it is a straightforward matter to understand the rationale behind this addition to the stable of Chegg’s services. To quote, “Mathway is used across the academic spectrum for both learning and instruction; approximately half of its users are in high school, while 1 in 10 are teachers, professors or parents. Mathway’s ‘Ask an Expert – Live’ feature allows those still struggling with a concept to get immediate support.” One can easily envisage Chegg cross-selling this service to current subscribers both in the US and around the world. Furthermore, since Mathway has subscribers in approximately 100 countries, so Chegg has significantly extended its reach for its other offerings.

Through the purchase of both Thinkful and Mathway, the management at Chegg have demonstrated a shrewd business vision and an excellent ability to increase shareholder value. They also have the money to add further value in this way due to the approximately $1 billion available in cash.

Recommendation

The share price leapt up following the release of their quarterly results and at time of writing, there has been a modest pullback. For me, this is would appear to be an opportune time to invest. The company is on the cusp of further rapid growth following the addition of both Thinkful and Mathway.

Disclosure: I am/we are long CHGG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.