2U: Fulfilling The Promise Of Online Learning (NASDAQ:TWOU)
Table of Contents
I believe adding a few speculative stocks to a diversified portfolio is a good way for investors to get better returns. One such company that piqued my interest after going through the company’s business strategy and fundamentals is online education provider 2U Inc (TWOU).
Business Analysis
Just a brief background on the company, 2U Inc is a provider of education technology for non-profit colleges and universities. The company builds delivers and supports a wide array of online and hybrid courses. The company has two main business segments namely, the Graduate Program Segment and the Alternative Credential Segment. These segments made up 72.6% and 27.4% of revenue in 2019 respectively.
The Graduate Program Segment works directly with non-profit colleges and universities to provide technology and resources to enable the digital delivery of degree programs. These programs are aimed to be of identical quality to the school’s in-person offerings. The Alternative Credential Segment provides online short courses and boot camps for specific technical skills. Bootcamps and Online courses are a dime a dozen nowadays as the platforms to stream video on the internet has become commoditized. However, what differentiates 2U’s offerings are its partnerships with non-profit colleges and universities. The company’s courses are built in collaboration with these schools and often times carry their branding.
Company investor presentation
The company essentially has two pillars that form its competitive advantage namely the technology platform and the relationships it has with its university partners. On the technology side, 2U provides front-end and back-end cloud-based SAAS technology for an online teaching platform, admissions/ CRM, and content development. The company also leverages data analytics and algorithms to select which offerings to launch as well as market to prospective students. The company also has relationships with 75 non-profit colleges and universities including some of the country’s top institutions. There are a couple of “heavy hitters” on that list such as Harvard, University of Pennsylvania, John Hopkins, etc.
Company investor presentation
Putting these two factors together forms a “narrow economic moat” for the company. I believe the company only has a narrow economic moat for two reasons. First, I believe that the technology used by the company is highly commoditized. There are multiple other learning content vendors as well as online learning platforms such as Lynda.com, Udacity.com among many others. This makes me believe that the technology used by 2U isn’t really that unique or special.
The other, more important, advantage the company has is the “prestige” branding of its offerings as it partners with well-known learning institutions. Currently, there are key benefits for universities to partner with 2U such as a Turnkey ready-made solution, an additional income source to leverage the school’s brand, and low upfront financial costs due to 2U’s revenue share model.
It is unknown to me how long schools would agree to this model especially if online education truly takes off. By shouldering the majority of the upfront costs for content development, 2U takes in a large percentage of the future revenue for the courses (last disclosed figure was 60% but this might have shifted since then). Eventually, it will reach a point where it would be cheaper for universities to just develop courses in-house. The company’s contracts with universities typically last 10- 15 years. Furthermore, the advantages of prestige branding only work if there is no perceived difference between a 2U course and a university course. This may not be the case for the company’s shorter courses.
The company is firing on all cylinders
In terms of short-term results, Q3 2020 revenue grew by 31% from $153.8 in Q3 2019 to $201.1 million in Q3 2020. Both segments showed reflected this growth with the Graduate Program Segment growing by 18% and the Alternative Credential Segment growing by 57%. Enrollment has grown at a healthy pace as well with the growth of 16.9% and 56.6% for the Graduate Program Segment and Alternative Credential Segment respectively year over year.
Company Q3 2020 Press Release
More importantly, the Alternative Credential Segment has seen revenue per full-time equivalent grow from $2,015 in Q4 2018 to $3,426 in Q3 2020. This growth reflects the shift to shorter courses and boot camps as part of the company’s overall growth strategy. In 2019, the company acquired boot camp course maker Trilogy to improve this segment’s offerings and from the looks of it that acquisition is paying off.
The company is guiding for full-year revenue at the range of $760 million to $775 million and a full-year net loss from $210 million to $225 million. Revenue-wise, the company should continue to benefit from the increasing demand for online courses especially in the wake of the coronavirus pandemic. The fact that the company is operating at a loss shouldn’t be too surprising as it shoulders the majority of the upfront costs to develop courses. Once a course is developed it takes comparatively much less to run therefore it becomes a cash-generating asset for the company.
During the third quarter of 2020, we continued to experience increasing demand from prospective and current university clients as universities planned for the Fall 2020 academic term and beyond, which we expect to have an increasing impact on our results of operations moving forward. For example, Amherst College and Simmons University are using our technology platform and services to offer certain of their courses for the Fall 2020 academic term in a high-quality, online format. We believe that COVID-19 will continue to accelerate university adoption of online education and that, over the longer term, online programs will constitute a larger portion of universities’ overall offerings
Company 10-Q
However, I am a bit concerned about the company’s Marketing and Sales cost which in YTD 2020 was $297.6 million or 53.2% of total revenue. Marketing and Sales cost grew by 14.3% year over year compared to revenue growth of 35.9%. This is an expense item to look out for as we would like to see Marketing and Sales cost as a percentage of revenue trend down over time. Controlling this cost is the key to properly scaling otherwise the company is simply paying for growth.
Company Q3 2020 Press Release
The company has a decent balance sheet with cash and equivalents of $499.5 against the long-term debt of $268.2 million. This means the company has a decent run-way in order to execute its growth strategy.
Valuation and Conclusion
In terms of valuation, the company is currently trading at a forward price to sales ratio of 2.79x which is a decent multiple for a high-growth company. The company has also been growing revenue at an impressive rate of 39.31% 5-year CAGR. I am a bit concerned with the company’s “narrow moat” however if the program’s alumni end up being successful then eventually 2U will build brand equity independent of its university partners. For sure there are certain pitfalls with the for-profit education sector however the partnerships with universities should ensure some level of quality of the company’s offerings. Maybe 2U is the company that fulfills the promise of online for-profit education. I have 2U as a speculative buy.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TWOU over the next 72 hours. 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.
Additional disclosure: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don’t know you or your specific circumstances, therefore, your tolerance and suitability to take risk may differ. This article should be considered general information, and not relied on as a formal investment recommendation.
