Chegg - EdTech COVID tailwinds

Chegg is an American education technology company that offers a learning platform as well as digital and physical textbook rentals. It’s been around since 2005 where they started as a textbook rental company and pivoted to a more subscription based model in the early 2010’s called Chegg Services. Since the investment thesis for this company is largely based on Chegg Services, I’ll focus on this part of the business.

Chegg Services offers a variety of tools to help students learn and do their homework. Their suite of tools includes: Math Solver, Chegg Study and Chegg Writing and each tool offers a freemium like model where you can get basic help for free but if you need additional help, it will cost anywhere between $9.95/month to $14.95/month. Starting in late 2019, Chegg started offering all 3 of these services together to new students (to start) in something called “Chegg Study Pack” that costs $19.95/month.

Chegg Services total subscribers have been growing pretty quickly in the past 3 years or so, going from 2.2 M subscribers at the end of 2017 to 3.9 M subscribers in 2019. On a quarterly basis, the subscriber growth rate which includes both new and returning students has been growing around 30% per quarter up until when COVID happened in late Q1 where students subscribers grew from 31% to 35% to 58%!


Services Subscriber Growth Rate				
	Q1	Q2	Q3	Q4
2018	44.00%	45.00%	45.00%	34.00%
2019	31.36%	30.43%	29.40%	31.54%
2020	34.82%	57.74%		

Per management, their TAM is approximately 54 M students and their current penetration is about 3.9 M (2019 number), so there’s a long way to go in terms of taking share. In addition, Chegg is just starting to build out their international student acquisition strategy which could provide significant dividends in the future.

From a revenue perspective, Chegg Services has been growing at a comparable rate to their subscriber growth rate of 30% per quarter for the past few years. However, in the recent few quarters, their Services revenue just started to accelerate and COVID-19 has provided an even bigger tailwind:


Services Revenue			
	Q1	Q2	Q3	Q4
2018	22.92%	31.79%	18.51%	30.15%
2019	26.59%	26.46%	26.82%	31.18%
2020	35.09%	56.90%		

In Q1, management expected Q2 overall revenue to accelerate from 35% YoY to 45% YoY which is already a continued acceleration of revenue since Q2 of last year, but in today’s earnings report, we saw 63% revenue growth! Here’s revenue for the past 5 quarters:

Q2 ‘19: 26.46%
Q3 ‘19: 26.82%
Q4 ‘19: 31.18%
Q1 ‘20: 35.09%
Q2 ‘20: 63.01%!!! (guided 45%) - 80% sequential growth
Q3 ‘20: 54.01%!! (guidance)

As you can see with Google Trends: https://trends.google.com/trends/explore?date=2019-01-01%202…, Chegg is only getting more popular and despite summer being a seasonally slower part of their business, the demand relative to last year is still remarkably higher.
So while 54% growth is the guidance (which is significantly higher than what Chegg has seen historically), I personally think revenue may grow to be 60%+ for Q3 since CFO’s have a tendency to guide conservatively. Also, given how COVID-19 still continues to be an issue in the United States and many schools are taking a hybrid approach (both in-person & online), it wouldn’t surprise me if Chegg did 60%+ in revenue for the remainder of the year since many college students will need individual help that colleges likely can’t offer as easily since most students won’t be on-campus (see below for some notes from the CEO in the most recent conference call)

Some other business financial highlights:

  • Gross Margin is in the mid-70s though they are guiding for 57% in Q3 since their business is highly seasonal and by year-end they are guiding for 68-69%

  • Operating expenses has been trending downwards as a % of total revenue, with the most recent quarter at 40.4% down from 48.9% last quarter and 50.92% in Q2 of ‘19

  • Adjusted EBITDA positive for the past few years, guiding for $195 M this year after doing $125 last year.

  • FCF positive, 13.7% of revenue in 2018, 17.3% of revenue in 2019 and 23.2% in Q2

  • Non-GAAP EPS is growing consistently as well, growing 69% YoY from 2019 vs. 2018

  • ARPU is currently pretty consistent at $84/subscriber but given the study pack introduction, this should increase 20%+ in the coming quarters/years since the study pack is 33% more expensive than their $15/month product


Some noteworthy management comments:

Per the Q3 ‘19 call:

Alex Fuhrman – Craig-Hallum Capital Group LLC – Analyst

Great. Thanks very much for taking my question. Looks like really nice growth expected in 2020 for Chegg Services. I’m just wondering if you can unpack that a little bit for us just in terms of how we should expect to see that play out in terms of your number of subscribers versus revenue per subscriber? Certainly, seems like there’s a lot of opportunities between the bundle and some other initiatives you have to really be getting the revenue per student up? Just curious kind of how we should be thinking about the way that you’ll get to that number for 2020 that you put out today?

Andy Brown – Chief Financial Officer

Yeah. So Alex, this is Andy, again. And yes, the way we’re looking at it right now, given the size of the business, particularly the Chegg Study business and, to some degree, the writing business. What’s really going to drive the top line of those two businesses.

And like I said in the prepared remarks, we said that subscribers are likely to be very close to what the overall Chegg services growth rates that we’re projecting for 2020. With respect to ARPU, we will start deploying the bundle to new subscribers only, like Dan said. And then, over time, potentially offer it to existing subscribers. But the big push is going to be in the fall semester.

The bottom line is our school year starts in August, and it goes through the end of May. And so, the big push will be in August. So we’re likely to see as far as ARPU increases, we may see some ARPU increases, but not significant in 2020 until it gets fully deployed toward the end of the year and then rolling into 2021. So that’s how we’re seeing things right now.

But really looking for – looking – it’s looking like a really, really nice year for 2020.

Dan Rosensweig – Co-Chairperson and Chief Executive Officer

Setting up quite nicely for '21, as Andy said, because exiting the year, we’ll not only see great subscriber growth, but we’ll begin to see noticeable ARPU growth. That’s the expectation.


Per the Q1 call:

Stephen Sheldon – William Blair and Company – Analyst

Hi. Thanks. It’s great to hear about the uptake of the bundle. I was curious if there’s any way to quantify what the uptake could look like for the Chegg’s study pack this year both with the Verizon offer and then maybe excluding it? And has there been anything notable about the types of students that are maybe signing up for the bundle so far?

Dan Rosensweig – Co-Chairperson and Chief Executive Officer
I’ll take the last one and then turn it over to Andy in terms of characterizing it, because he is more straight down the middle. So what we can tell you is, we can’t tell you that the demographics are different. But on the upside to the surprise, the take rate has been higher than we expected at this point. The take rate has been global which was better than we expected at this point and the customers that use the bundles so far.

Remember, it’s only through couple of months now. So we’ll have to see whether it sustains itself. But their engagement is as good and in some cases slightly better on the Q&A side, and that with math and writing, math seems to be the first thing that they move into and then writing it the second thing that they move into. And I don’t know if that’s because that’s when things get assigned or there is more people that need math and writing.

It’s way too early to know any of that. But what we see are the trends are better than we expected them to be at this point, we were expecting these to be the trend as we sort of got toward the end of the year, but it’s been really just surprisingly good.

Andy Brown – Chief Financial Officer

Yeah. I mean, Steven, yeah, I mean, to Dan’s point, we thought we’d have like a moderate contribution to the financial performance in the first half of the year is clearly better than that. So we starting to see the type of contribution that we would have expected maybe in Q3 or Q4 kind of accelerating into the first half, particularly as we get into Q2.

Dan Rosensweig – Co-Chairperson and Chief Executive Officer

Thank you Andy, and thank you our finance team. You do rock. As you can see from our numbers, Chegg is experiencing dramatic growth during this time. And because we serve millions of students across the globe, many people have asked us what the lessons from COVID-19 are and its impact on the future of higher education.

Our belief is that in every industry, a crisis often accelerates the inevitable. And that is what we are seeing happening now in higher education. The reality is students who are already learning online or under supported by their schools who had diminishing budget. So that the need for virtual learning support was already expanded.

But almost overnight, when schools around the world had to move 100% online, that trend accelerated. And has revealed the true potential and the value of what Chegg has to offer. The numbers say it best. And what they reflect is that students have an even greater need for high-quality, low cost, personalized and adaptive online education to help them learn and master their curriculum.

As we think about the lasting impact on the future of higher education globally, we see these trends continuing. The student population is more diverse and more global. They have different socioeconomic backgrounds and are of many different ages. They also come with various skills and experiences, but what they have in common is the need for more online support because the fact is they are increasingly learning on their own, with less support from their schools.

Jeff Silber – BMO Capital Markets – Analyst

Thank you so much. I’m just wondering if we could just drill down a bit within Chegg Services beyond Thinkful, if you can just tell us what the impact has been on some of the different products, whether it’s Chegg Study, Chegg Tutor or your writing tool, your math tool, any color would be great?

Dan Rosensweig – Co-Chairperson and Chief Executive Officer

Sure. So everything is accelerated and so we’re seeing with the exception of ad which is a small part of that business. And we talked about it once before as quarter came down in March, they stabilized in April and we’ll see whether or not they pick up through the course of the year. But if you look at Chegg Services, Chegg Study accelerated growth.

Second is the Chegg bundle has accelerated two to three quarters ahead of where we expected it to be at this point. As you may recall, we said that we were really going to see the impact of it beginning in Q4, but the demand has been significantly higher than we anticipated. International is growing. We are always going at record rates because it was coming from a small base.

But it has really accelerated and not just for the English speaking countries for countries all around the world, the rest of the world business is about the size of England, France, England, U.K. and Australia. So we’re seeing a pickup from everywhere. On the engagement side, we’ve seen more students overall subscribed as you can tell by the numbers.

We’ve seen renewals go up, cancels go down, and utilization of this services themselves pick up quite significantly. So every metric that we look at that we would want to bet on for the future is going up into the right.

Jeff Silber – BMO Capital Markets – Analyst
OK. That’s great to hear. Let me just push back a little bit on the engagement metrics.

Do you think it’s sustainable? I know it’s going to take some time to kind of, quote-unquote, normalize, but as you know, higher education goes back to where it was maybe you never thought. Do you think the type of interest in engagement that you’ve seen is sustainable if we kind of return to some kind of normalcy?

Dan Rosensweig – Co-Chairperson and Chief Executive Officer

I do. And the reason I do is because our product is great and we continue to invest significantly in it. We expand the number of subjects. We expand the way people can learn.

We kept the price at $14.95 for nearly 10 years. It’s on demand. You can do step-by-step solution. You can watch videos on the subjects that you want to master, you can ask expert Q&A which now has access to 40 million questions.

We’re seeing a record number of questions and a record number of subjects from a record number of countries. And so once you’ve experienced the power of Chegg’s learning tools, there is no reason not to use it more. If the question is on the subscriber growth, what we believe is that we’ve hit another inflection point in our business particularly internationally which is the way we built the business in the U.S. as it was a very carefully crafted by word of mouth school-by-school.

And what this situation has presented to us is when international also closed all their schools, their students for the first time started to look for online tools. They just covered Chegg and they’re using it at the same level that domestic students are using it. So my belief is as we add more subjects, as we add more content, as we go for higher grade, lower grades, as where response time continues to go up, our quality is topnotch, there’s be no reason for the engagement to go down. Now, there are students that we believe that we picked up who used to use on-campus services like labs, tutors and other things.

Unfortunately, if you look at the state of higher education, every budget is being cut and sadly those will be among the first services that will be cut. But even if they weren’t, once you’ve used the experience Chegg and once you’ve learned how it can help you, and once it really teaches you and you master the subject, there’s really no reason given the price is only $14.95 or $19.95, if you bought the bundle which gets you writing and math on top of that for you to stop using it. And every indication that we see suggest that they the more they experience it, the more they use it and the better results they get.


My comments:

It seems management is pretty upbeat about their Study Pack bundle and its impact on the business. Also, it doesn’t seem they believe that COVID is something that will go away once a vaccine comes around but something that will have more of a systemic shift to education especially online learning.

I haven’t listened to the most recent earnings call yet, but will post notes when I get a chance.

Valuation:

Chegg currently trades at a 25 TTM EV/S after today’s run-up (this is significantly higher than the 11 or so they started trading at earlier in the year) which seems reasonable for a company that has accelerating revenue in the 50-60s. I would assume if Chegg can accelerate revenue beyond the mid-50s this coming quarter, it can see further multiple expansion.

Closing:

I think COVID has disrupted traditional education and similar to the other businesses we follow is causing a major digital transformation in how students learn. Online learning likely will become more of a trend in the future and given the rise of student debt that the millennial and gen Z generations had to take on, I think there will be a lot more higher education online options that should come with a significantly lower price tag which should give a company like Chegg more room to grow given their inexpensive educational tool offerings and ability to supplement learning.

Finally, the way things are going currently, it is unlikely education in America will be the same at least for the 2020-2021 school year which should only give a bigger boost to Chegg.

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Thanks for bring this excellent prospect to our attention. For anyone who is interested do not rely on the seeking alpha transcript it is riddled with errors and omissions. I ten to listen to calls with the transcript in front of me, this one is very inaccurate.

Flygal

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I reviewed their earnings transcript from Q2 and here were a few highlights:

CEO - Dan Rosensweig

Long before the global pandemic, we believe the digital transition was coming and education would have to fundamentally change… class of 2020 predicted that higher education was the next bubble to burst and that institutions would experience irreversible decline if they continue to raise prices while delivering an antiquated product.

We made impassioned and specific recommendation to aggressively transition to a model that with higher education online, leverage technology to make learning available to students 24X7 and to expand and modernize their content to be more relevant to the modern workforce. Our research shows that the majority of students now feel online learning to be as legitimate, effective and rigorous as in person instruction. In fact, half of the students surveyed who had no prior online learning experience now want the option of hybrid or fully online education and 72% of students who had already had online experience expect the same.

We remain optimistic that this pandemic will end soon and when it does, one of the legacy will be that the door is permanently open to the promise of online learning. Affordable, scalable, on-demand and designed to support whatever the student’s primary goals are whether it’s academic learning, professional development or both.

CFO - Andy Brown

The momentum we are seeing in the business accentuated by the pandemic is likely to continue for the foreseeable future and we expect to be a high growth, high-margin company for years to come. As such, we’ve decided this is a moment in time where we need to lean in and reach more students globally with our high quality low cost services. Thus we have decided to celebrate incremental investment to build for our future. These include investing in international growth and development, the Chegg study pattern, device management technology and our skills-based learning service Thinkful along with additional infrastructure and resiliency investment that will allow us to scale rapidly.

Analyst

…if students do decide to wait the semester out, to stay sharp and productive, could you see some of those students scale up using Thinkful?

CEO

…whether it’s there school in-person their school of partially in-person or their school online or in the case of the folks you’re talking about, more likely to be people that will take a local online class and a local commute to college.

So they’re to be going school because there it really no gap here. There is no place in travel, there is no job or internship to have. So they’re going to be taking something and Thinkful could be one of those things and Thinkful is very early days with us…

Analyst

You mentioned a few times your focus internationally. Can we get a little bit more color, can you quantify how large your international student market is and clarify if these are folks that live overseas and are studying overseas not necessarily folks that are coming to the US or studying online at US universities.

CEO

I’ll start and I’ll let Andy talk about how we want to think about international growth. International growth is stellar right now and to your very specific question, only 1% of our international customers actually went to school in the US. So these are all new customers to us. So I know there has been some speculation as to whether or not these were international customers that went home and them subscribe at home, but we obviously monitor those things and frankly we are picking up brand-new customers around the world and over 99% of them are brand new to Chegg.

Analyst

As you look at Q3 gross margin guide, I was wondering if you can just break down that impact may be compared to last year, it looks like the guide of a 1,000 basis point lower. I guess to weigh down between the impact from the textbook business and maybe what other impact from the incremental investments you guys are making.

CEO

First thing is it’s a 100% textbook, period. It has nothing to do with the incremental investments that we’re making. It’s the fact that as you recall starting January 1 of this year, we started to own textbooks and then record the gross revenue. It has – what you’ll see is the change in the seasonality where you see high gross margins in Q2 and Q4 and slightly low gross margins in Q3, excuse me, in Q1 and Q3.

So that did exclusively and what I said right we also hope we’ll perform in textbook. So it kind of compounded itself a little bit, but I guess that’s the good news. So we have to talk about textbook because textbook continues to do actually really well. We believe we’re gaining share there too. So that’s the reason for the seasonality and the gross margin.


My take:

Seems like they’re really bullish on international and it may soon become material to the business. The pandemic is forcing adoption to online learning and getting help from educational tools which is likely a permanent tailwind to Chegg.

I was concerned about Gross Margins, but it’s clear their textbook business which had a 15% gross margin is causing an impact to their overall blended margin.

The Thinkful acquisition is interesting and could potentially open up incremental customers as well as expand their customer LTV when you think about the entire education process. i.e. Chegg for 2-4 years, where you use their software for 6 out of the 9 months and then use Thinkful for help with coding and getting a mentor.

While Chegg by no means is an Enterprise SaaS company, I do believe Chegg has pricing power given their relatively low monthly rates of $14.95 to $19.95 with incredibly high renewal rates, they are generally used for multiple years and they offer solutions for an industry that is only growing and looking for alternative learning solutions.

Given the relatively low multiple (20) for a company that is growing 50%+ and likely accelerating to the 60%+, mostly profitable and with high FCF margins, and high Gross Margins in the 70%+ range for their services, I would think that Chegg has room for multiple expansion which could mean a much higher share price in the coming months.

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