Thesis
Chegg (NYSE:CHGG) shares dropped over 20% to a price of $16.50 during Monday’s afterhours session on February 6th, 2023. They reported earnings of 40 cents per share after beating analysts’ estimates of 38 cents per share. They also reported revenue of $205.20 million versus a consensus estimate of $202.06 million. The plunge in stock price was a result of weak revenue guidance of FY23 total net revenue range of $745 million – $760 million.
I believe this plunge was an over-reaction by the market. Combine this with misunderstood ethical concerns and Chat GPT, Chegg is now at a beautiful price to potentially generously reward investors.
Ethics
One of the topics dragging this company down is the question regarding the ethical use of its service. Chegg offers a variety of services, but the main attraction is the study platform, which provides students with access to practice problems, course materials, and other study resources.
Some education professionals label this service as “cheating”. However, I think these professionals need to look in their mirror and ask themselves:
“Why would students see a reason to resort to such a service? Are my teachings not good enough?”
Essentially, if a student needs help with a problem, they can screenshot it or simply ask the Chegg community for help. In response, professionals will respond with the answers and explain how they arrived at the solution. Answers are then upvoted or downvoted, depending on the accuracy.
For some, this is considered cheating, because students can take their homework, post it online, receive the correct answer and then turn the assignment in for full credit. Others, however, rely on this service because either their professor was not clear enough or they were not available to help. It acts as an external way to learn, and we all know by now, everyone learns in their own way.
This leads to my argument that Chegg is perfectly ethical. In the current field of higher education, it doesn’t really matter how someone masters the information, so long as they can perform well on tests. In my experience, current syllabi are weighted on 80%-100% from tests and exams. If one student chooses to abuse Chegg, then rest assured, he or she will not do well on the tests. Also, if a student believes resorting to Chegg is the only option, I believe this is a problem with the professor, rather than the student.
This comes from a current student who uses recourses available to me like Chegg to further my education in ethical fashion. I will use this insight to give me an upper edge on the market as I believe Chegg is here to stay, and the ethical dilemma will sort itself out.
Chat GPT
Another topic bringing bearish sentiment is that chat GPT will replace services like Chegg. As much as I would like to believe this, it’s just not the case. The main attraction as to why Chegg is ideal for this environment, is it contains real people with real opinions and quality control through the comments, voting, and overall feedback.
Think of Chegg like Seeking Alpha. What good would it be to ask investment advice on ChatGPT?
This is something Chat GPT severely lacks because we have no way of knowing if the exported answer is correct. You also have to word questions a certain way for Chat GPT to understand your desired outcome, which sometimes isn’t possible. Another aspect is you can utilize images in Chegg. If I was given an antinomy book, mechanical design, art history, or circuit diagrams, I’d prefer to just screenshot my book and see if the Chegg community could help. This sure does beat trying to phrase my question in some odd way for Chat GPT to provide a useful answer.
I’m not saying Chat GPT isn’t useful, but for help with homework, it seems questions come in two tiers:
- Those that need Googled.
- Those that need Chegged.
Anything that can be found using Chat GPT, is most likely found using a quick Google search. If a quick Google search is not sufficient, I’m going to Chegg for help.
I also find it quite satisfying that people who describe the moat of Google, often times, the bring how “Google” is used as a common verb in today’s society. If you open your ears in a study hall today, the verb “Chegg” is often used. i.e. “I don’t know, let me Chegg that”.
I think this speaks to the power of the service.
Valuation
We will value Chegg through 3 different methods:
- Discounted Cash Flow Model (“DCF”).
- Multiples Compared to Industry.
- Historical Price to Free cash Flow (“P/FCF” or “FCF”).
Discounted Cash Flow
For the DCF, we will model out 10 years using revenue growth rates and FCF margin assumptions for a worst case, base case, and best-case scenario. The revenue growth rates are based on historical performance and research regarding education technology.
Overall, I find Chegg to be trading at worst case scenarios based on my DCF.
The following assumptions made, the model, and a sensitivity analysis are as presented.
Assumptions
Model
Sensitivity Table
Multiples Compared to Industry
Chegg also offers very low PE multiples and P/FCF multiple compared to industry.
Historical Price to Free Cash Flow
At the time of writing this, historical P/FCF is around 10, but at the low price of $16.50, P/FCF will hover around 8. This is not only cheap historically but is incredibly low compared to industry.
Conclusion
Chegg is in extreme value territory. Not only is this extremely profitable company eliciting favorable multiples, but it also performs well on a DCF with reasonable assumptions. Furthermore, the misunderstanding of the ethics and ChatGPT, help those who truly understand the value to take advantage of such an opportunity. I will be adding Chegg to the portfolio, not only because of my thesis, but as a sentiment of my appreciation of the service.
Chegg has helped get me into a situation where I have disposable income to invest, and I am excited to return the favor – while also making more money for me.
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