Chegg: Underappreciated COVID-19 Winner (NYSE:CHGG)

Thesis

Chegg (NYSE:CHGG) has transformed itself from a textbook provider well-known to college students into a digital-first education provider. The crown jewel is Chegg Study, which is a content machine that keeps giving. Chegg grew 60%+ in its recent quarter and showed profitability, a rare feat. I believe the recent sell-off in tech stocks presents a compelling opportunity to buy into the current state of education, which I do not see changing any time soon.

Source: Chegg.com

Acquisitions and Platform Play

Chegg offers a series of products aimed at helping students study better. These range from a paid Q&A service to live tutoring. Chegg has recently been buying companies to add to its capabilities, such as coding bootcamp Thinkful ($80m) and StudyBlue (content library), and others. I believe Chegg has built up a formidable balance sheet to buy technology-first education companies and build a unique asset within the space.

Chegg is building an all-in-one platform and using bundling to increase pricing power and TAM, the two most obvious areas that critics mention. Their growth in the UK and other English-speaking countries has been impressive to date. Their bundle is still a catalyst for medium-term growth.

Source: Chegg Investor Relations

State of Schools

School closures are plaguing re-opening plans. Every few days, we hear stories about schools temporarily closing again, like this one. The reality is that until we have a vaccine that is widely available, it is unlikely that schools will reopen. Once they do, they will likely open in waves. With students at home, parents are looking for new ways to help them learn. It really is a global crisis that is affecting our youth. Chegg stands as a digital-first option that parents are noticing and that showed up in recent financials.

Andy Brown, CFO, noted in a recent September 15th call that hybrid teaching is common and the online universities/community colleges are being benefitted. He highlighted that many colleges have extended virtual teaching through the spring of 2021. He also mentioned levers of users (3.9m versus TAM of 100m) and price ($14/mo) as areas of fundamental growth.

Misconception

Many investors look at Chegg and think 30% grower in an “average” industry. Education in the US is growing roughly at GDP which does not excite many growth investors. The 30% annualized growth also does not excite growth investors in today’s market with alternatives like Datadog (NASDAQ:DDOG) and CrowdStrike (OTC:CRWD).

The problem is Chegg is experiencing acceleration from Covid that I believe is here to last at least a few quarters given the state of physical schools. Chegg is now expecting 50% YoY growth for 2020, up from 30% in 2019. This is meaningful acceleration that hit the multiple but has since sold off.

Valuation

Chegg rode part of the wave of valuation expansion after March with the rest of tech stocks, but also blew out numbers in its recent quarter. Since then, it has steadily become cheaper. I can understand part of the rationale around lower gross margins with its services business, but we are still talking about 60%+ growth and profitability. Typically these metrics fetch 20x + EV/S in today’s environment.

One argument for appreciation of the asset is the lack of opportunities as the market eats up typical high growth plays that are in the limelight. Chegg is an under-the-radar company that does not get much visibility on social media networks or on TV. Further, Dan Rosensweig is an underappreciated CEO and his team has transformed the company.

At $605m 2020 revenue and 68% gross margins, the current $8.8 billion market cap implies a 14.5x 2020 EV/S multiple. For a business growing 50% YoY that seems light. I could see a re-rate to at least 20x.

Source: Koyfin

Further, looking at the share price versus analyst target, we can see Chegg is nearing 1-year highs away from the price target. After a strong quarter Chegg really popped but has since sold off. One argument could be a continued multiple compression, but tailwinds and the Fed are reasons why this should not happen.

Source: Koyfin

Risks

Given these dynamics, I have 30% upside from today’s prices. The weakest part of my thesis is recognizing this spread, the catalyst, which I believe will occur once the market prices in other high growth opportunities. The market has continually underpriced Chegg, except after its blowout Q2 earnings. I believe this is the weakest part of a quarterly view on an investment in Chegg. The narrative around edtech itself needs to change. Private market transactions like CourseHero and Byju’s are starting to show life and promise of this macro change, but I do not see a near-term catalyst outside of earnings for this play.

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.

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