EQUITY RESEARCH REPORT | 1/14/20 Recommendation: NEUTRAL CHEGG INC (Ticker: CHGG) Business Rating: 5 Security Rating: 5 Author: Janice Quek BUSINESS RATING SECURITY RATING SELL BUY NEGATIVE POSITIVE d POTENTIAL FOR RETURN RISK LIMITED SIGNIFICANT LOW HIGH d Sector: Consumer Non-Cyclicals Industry: Educational Support Stock Price: $41.21 (1/14/20) Services CEO Score: Jarvis Rank: 521 $408M Enterprise Value: $5.2B Market Cap: $4,986M Revenue Fwd (TTM): ($381.1M) Fwd (TTM) 9.6x Revenue Growth Fwd Gross Margin: 76.5% +27.1% Price/Sales: (12.7x) (YoY): Fwd (FY20) ROIC1: 8.6% YTD Performance: +6.81% RSI: 61.2 Insider Transactions: Insiders sold 845,735 shares in the last 3 months. WHY WE RATE CHEGG (CHGG) A NEUTRAL We rate shares of Chegg Inc. a NEUTRAL at this time. Online Grab-and-Go learning is gaining traction as a convenient and affordable option to THESIS learn and interact with instructors. Chegg is a leading provider of An investment in Chegg is a play on learning tools and online tutoring, and its highly affordable rates and growing demand for web-based range of services make it standout to a price-sensitive audience. The platforms that facilitate e-learning. The company is a provider of learning tools company cleverly uses technology and its textbook rental and and online tutoring services, and purchase business to push services to clients, growing its subscriber operates a textbook rental and purchase base rapidly. Chegg’s recent acquisition of Thinkful expands business. To continue to be successful, Chegg’s TAM into the professional skill learning market, where the Chegg will need to ramp subscriber growth, offer more differentiated opportunity is large. However we think that the education and services, and expand its course offerings online learning environment is intensely competitive, and some of in the professional skills learning space. Chegg’s services have little differentiation and can be easily replicated by competitors. Competitors can also start expanding their portfolio, with little difficulty, in the medium term to match Chegg’s packaged offerings. Players will likely continue to compete on price, which could create a “race to the bottom” scenario, affecting profitability growt h in the long run. While Thinkful is a strong add to the business, the company is very small and revenue contribution is minimal. 1 Using non-GAAP net income. “Seeking Equity Returns 1 from High Yield Bonds” 0.94 EQUITY RESEARCH REPORT | 1/14/19 SUMMARY OF THE BUSINESS AND THE INDUSTRY Business Grab-and-Go Chegg Inc is a provider of an online learning platform TALKING POINTS for students. The company offers a range of services, which includes online tutoring, textbook solutions and Q&A help, writing tools, test prep and scholarship WHAT WE LIKE WHAT WE DON’T LIKE applications and textbook rental and purchases. Chegg E-learning and web- Highly competitive also ventured into the professional skills-based e- based learning services environment in a learning space, offering working professionals a way to expected to grow. price-sensitive market. upgrade their professional skills remotely. Services have little Strong subscriber differentiation and growth players compete on E-learning and web-based learning services are price. expected to grow The company is profitable, and has Expensive valuation high margins that are multiples. Learning mediums have evolved since the world projected to continue expanding. entered the digital age. The first computerized courses started in the 1960s but did not gain traction as many people did not own personal computers. After the internet arrived in the 1980s and home computers became more mainstream in the 1990s, the educational industry started creating software to provide interactive and remote learning experiences. By the early 2000s, the modern era of elearning began when educational institutions and companies began offering courses online. Since then, this space has evolved rapidly. Increasing internet penetration globally and smartphone use have made on-demand learning possible. Online tutoring and 24/7 homework help is now possible, and the availability of advanced technologies such as the use of AI, has created adaptive learning capabilities that have made remote learning highly effective, convenient and low cost. At the same time, the cost of higher education is increasing in America, and the stakes for failing to graduate are becoming higher. US news reports that in-state tuition at public colleges in the United States has increased by 243% since 1997. The debt owed by 2018 graduates averaged $30,000 per student, according to Student Loan Hero. About 37% of students do not graduate from a 4-year institution in 6 years or less, many who struggled with the workload and inadequate help with class material. The need for affordable class material and homework help to get students to complete courses and graduate is in great need today. The professional world is also benefitting from e-learning technologies. Organizations recognize the value of continuous learning programs for their employees, and studies have shown that corporate training improve future profitability for firms. As professional courses have increased exponentially, prices have also fallen, and companies are now outsourcing their corporate training programs to e-learning companies as a cost-effective way to provide standardized, high quality, flexible and convenient training to their employees. Mid-career professionals, those transiting between jobs, and those starting out in the “Seeking Stocks that can 2 Double in 2-3 Years” 0.94 EQUITY RESEARCH REPORT | 1/14/19 professional world are also using e-learning platforms to educate themselves to get specific jobs, taking advantage of the flexibility of remote and self-paced learning options. With clear benefits to e-learning today, it is not surprising the industry has grown by more than 900% since 2000, according to Brandon Hall Group research. Wide range of services offered at low prices is differentiator. Entering the professional skilling market grows its market opportunity. Chegg earns its revenue through subscription fees for Chegg Services, and a commission from selling textbooks through its partner Ingram. Under Chegg Services, the company has Chegg Study – step-by-step solutions to problems in popular textbooks and expert Q&A; Chegg Tutors – a 24/7 online tutoring service; Chegg Math Solver – a web-based software that solves math equations, Chegg Writing – a tool that helps with creating citations, check for plagiarism and grammer; and Chegg Flashcards – software that allows you to create or use a database of flashcards on a wide variety of topics. Chegg Services has one of the industry’s broadest help database. At the end of FY2018, the company had an archive of 21 million Expert Answers and 5 million Textbook Solutions. The platform that these services are based on is built on proprietary technology designed to create a direct-to-student learning experience that is also personalized for each student, builds awareness of other available services, and connects the student to other third-party partners and brands. Students’ information is also combined with external sources of publicly available and private data to push relevant services and products to the student to deepen engagement. Chegg also has a “Required Materials” business segment, which allows students to rent, or buy books and eTextbooks from its platform. Fulfilment of print textbook rentals and sales is through its partner Ingram Content Group, and Chegg earns a commission through facilitating the sale/rental. This partnership began in 2014, but management recently announced a new arrangement going forward where Chegg will end its current partnership with Ingram, and began a new working agreement with logistics provider FedEx. A shift of the textbook landscape towards consignment and eTextbooks has made the business less capital intensive, and at Chegg’s current size, it is now better able to support the capital requirements to purchase print textbooks, and build a differentiated service offering in fulfillment and shipping and delivery speed. These considerations resulted in a new partnership with FedEx, with the transition expected to complete by end of 2020. LB•LOGIC Chegg’s “Required Materials” segment is an important business to acquire new customers and introduce Chegg’s services to them. Another new customer acquisition channel in the future is the company’s “Chegg Study Pack”, which bundles its services and provides greater value for customers. “Seeking Stocks that can 3 Double in 2-3 Years” 0.94 EQUITY RESEARCH REPORT | 1/14/19 Chegg is also growing its portfolio in a new direction. Its recent purchase of Thinkful adds professional skills courses to its portfolio, expanding Chegg’s target audience and addressable market. Thinkful provides online technology courses for professionals desiring to enter one of the most demanded industry. Similar to Chegg’s services, it has a direct-to-student model, which means Chegg will own the content, student data and the distribution channel, allowing it to introduce new courses quickly, control the quality of the content and keep prices low. The Thinkful system not only provides the courses, it also pairs students one-on-one with a mentor and a career coach. Integrated with Chegg’s platform to provide chat-based tutoring and expert Q&A, the company believes that these offerings will not only enhance the chances of successful completion and landing a job for the student, it also creates a competitive moat in the industry. Thinkful has about 85% of their customers graduate from their programs. LB•LOGIC We agree with management that Thinkful will differentiate Chegg from other players who are merely offering course content through partnerships with learning institutions. Under this model, dropout rates are high because dedicated help is not readily available. Moreover, margins are lower as platforms have to share revenue with their content partners.