Deep dive into Chegg ($CHGG)
A Turnaround Story or A Company In Freefall?
1.0 Introduction
Chegg CHGG 0.00%↑ began as a textbook rental service, aiming to reduce the high costs of purchasing textbooks. Over time, it evolved into a company that offers a range of educational services and tools.
The education system has plenty of flaws, creating demand for individuals and companies to assist in understanding a certain topic. There are plenty of amazing sources of knowledge, ranging from Coursera and edX to Udacity and even YouTube. However, they do not offer a solution to the homework, but rather an understanding of a certain topic.
This is where Chegg comes in. Its primary business is selling students monthly subscriptions for homework help. So, is Chegg a net positive for society?
Although it can be used for learning, I’d argue that it is an organization that supports academic dishonesty and acts as a cheating database for homework.
Some universities request data from Chegg to monitor their students and prevent cheating during exams. Chegg provides this information, including activity timestamps, IP addresses, and email details, which universities use to identify and suspend students involved in misconduct.
2.0 The pandemic surge & the beginning of the end
As expected, Chegg benefited from the pandemic, and the number of subscribers doubled between 2019 and 2021.
However, the beginning of the end has started, and it can be best illustrated through the following 5 points:
2.1 The competitive landscape is significantly different
Given the alternatives that exist today for solving homework problems, it is unlikely that the company will return to its growing days.
ChatGPT was introduced in November 2022, although the revenue decline already started in Q2-2022. Based on the last quarterly report (Q2-2024), the revenue is declining at a rate of 10% per year.
It is not only ChatGPT, there’s Caktus AI, Jenni AI, Numerade, Photomath, Course Hero, and many more.
Google Trends paints a great picture of how the demand for Chegg has changed in the last 5 years.
2.2 Being profitable is a challenge
Except for the pandemic period, the company is struggling to find its way to operating profitability, despite the ~70% gross margin.
If we add up the operating profit / (loss) of the last 7 years (which includes the pandemic boost), the company broke even.
With more competitors, lower demand, and decreasing revenue, it is difficult to make a case that Chegg is a company that will turn things around. It appears that Chegg’s best days are behind it, and the only way to survive longer - is by cutting costs.
Back in April, the company announced Nathan Schultz as the new CEO, and a restructuring plan was shared with the public. Part of the plan was reducing its global headcount by 23% which will lead to $40-$50m in savings as of 2025. This is a great decision when facing declining revenue. However, on its own, it is not enough to create long-term shareholder value. It is unclear how the management plans to reinvent the company with fewer employees.
2.3 Poor capital allocation
The previous management has a terrible record in capital allocation.
We can best illustrate that through the balance sheet of the company between the end of 2017, and June 2024:
Despite generating ~$1.3 billion in operating cash flow in this period, the company’s net cash position has decreased by $240m.
So, where did this ~$1.5 billion go to?
Acquisitions - $600 million (Busuu, Mathway, Thinkful, StudyBlue, WriteLab, Math42)
Capex - $550 million
Share buybacks (net of issuance) - $200 million
In Q2-2024, the company reported $481m in impairments (mostly in goodwill) - meaning they significantly overpaid for the past acquisitions, especially Busuu (acquired for $436m).
If you have a look at the Q2 investor presentation, you’ll see the following:
It is unclear to me where the capital returns are.
2.4 Convertible notes due date
The company issued convertible senior notes twice and the clock is ticking:
$243m outstanding (0.125% interest) - due in 2025
$358m outstanding (0% interest) - due in 2026
The management is in a difficult position and has two choices:
Use the existing cash - which will wipe out its liquidity. It is unlikely that the management will choose this option, given that the company had a negative free cash flow in the last quarter.
Refinance the debt - meaning it will come with a much higher interest rate (above 6%). This is more likely, as the management will have more time to figure things out (or throw in the towel).
2.5 Terrible reviews
The reviews of the company have been terrible.
Recently, there have been more accusations of customers with difficulties canceling their memberships or having been charged multiple times after they canceled the subscription.
The revenue the company reported is likely somewhat inflated and will continue to decrease in the quarters to come.
3.0 Valuation
Based on the above analysis, Chegg is a company with decreasing revenue and a low chance of finding a way to grow and become profitable. With that in mind, the value of the company is its liquidation value (which IS NOT its book value).
Based on my estimates, its liquidation value is around ~$160m (not that far from its market cap of $212m). Therefore, I do think the market is not expecting it to be a turnaround story.
Could the market be wrong? Of course!
Given the competitive landscape, and the 23% employee reduction, I struggle to envision a path, where the company reinvents itself and increases the number of subscribers. However, there is always a chance that a miracle happens, despite this chance being very low. With the restructuring plan in place, at least the company can survive for many years to come.
The company could get acquired for its customer base. The typical acquisition premium is around 20%, so the 7.7 million subscribers would have an average price of ~$33. I do think acquisition is a more likely scenario than bankruptcy.
I hope you enjoyed this post, feel free to share your thoughts.
love to see your analysis on chegg! My opinion is same - maybe no hope for turnaround, i'd guess.