|Shares Out. (in M):||84||P/E||0.0x||0.0x|
|Market Cap (in M):||720||P/FCF||0.0x||0.0x|
|Net Debt (in M):||-158||EBIT||0||0|
- eTextbooks: Electronic textbooks currently only account for 5-8% of all textbooks sold in the US and an equivalent proportion of those sold by CHGG, according to management. The slow rate of adoption has been a result of: 1) student preference for print; 2) limited cost savings at 80-90% retail price of paper-form; and 3) limited institutional adoption from professors. Although less capital intensive than print textbook rental, the eTextbook business has very low entry barriers and is already highly competitive. The growth of eTextbooks is likely negative for Chegg.
- Competitor Follett Corp recently launched includED, a program where it partners with colleges to include the cost of course materials in tuition. This program is fairly nascent but does present a challenge to the textbook rental business.- The IPO was led by JPM and BoA, both of which have a weak presence in Silicon Valley, indicating GS, MS and others passed on the offering.
|Entry||12/12/2013 10:25 AM|
Based on my discussions with folks in the textbook industry AMZN is seeing limited success with their rental business. Barnes and Noble via their on campus bookstoress starting competing with Chegg in like 2011 and they have been the biggest competitive threat. I agree that the textbook rental market is competitive but I think Chegg has a bigger piece of the pie than is indicated (don't something like 30% of college students interact with Chegg)?
Also - how do you think about the fact that on a YTD basis non-print is 20% vs 13% same time last year? Given that its growing super fast (95% in the YoY period), I presume it has substantially better economics than the mediocre textbook rental business, do you view that as a threat as it approaches a higher portion of revenue?
Also on the underwriting comment - is the reason Chegg didn't use GS and MS is because they were taking out Houghton Mifflin Harcourt at exactly the same time and there is some competitive dynamics there? I could be reading way too much into that but presumably there is some valid reason there.
|Subject||RE: Quick Questions|
|Entry||12/12/2013 12:11 PM|
Thank you for the questions.
Based on NACS, NCES and company data available, Chegg’s market share is 4.3% in textbook rental and 1.3% within all textbooks.
Market share (2012):
Enrolled students (2 and 4-year colleges): 21M
x ave. cost books and supplies: $660
Total spend: $13.9B
Chegg share of total textbooks: 1.3% ($185M/$13.9B)
Rental share of market: 31%
Total rental market: $4.3B
Chegg share of textbook rental: 4.3% ($185M/$4.3B)
Chegg claims it reaches 30% of college students (6.3M). While this may be true, it only has 1.7M paying customers indicating an 8.2% reach (“in 2012, our average revenue per customer was approximately $108").
Regardless, is Chegg’s market share really relevant given the economics of the business and competitive dynamics in the industry? The reality is Chegg will never be able to successfully compete with AMZN on price.
Chegg’s non-textbook revenue growth rate has been high (off a very small base), but the trend in FCF has gone the other way. Without a big potential contribution from the non-textbook side there really wouldn't be any story for WS to sell. At the end of the day the network effect Chegg seeks to create on its site is already present on Facebook. Its job lead generation segment competes with LinkedIn and Monster and its admissions services with The College Board and several others.
|Subject||RE: Margins on eTextbooks|
|Entry||12/12/2013 01:07 PM|
Lukai- I appreciate the quesiton.
Using 2010 as a baseline is problematic given the subsequent change in the competitive landscape (AMZN, BKS and EBAY had yet to enter the space and drive down margins).
Management has indicated that textbook rental GMs are currently ~20%. While CHGG likes to compare its business model to that of NFLX, CHGG management takes a different approach to presenting EBITDA. CHGG records textbook expense as capex and excludes all the costs of purchasing textbooks from cost of revenue in its EBITDA calculation. This would imply that there is no variable cost to running the textbook business. This is clearly not the case. Since the useful life of a textbook (according to management) is about 1 year, capex = maintenance. As you can see operating margins and EBITDA-textbook dep are negative.
|Subject||RE: RE: Margins on eTextbooks|
|Entry||12/12/2013 01:42 PM|
Where do you get the useful life of a textbook is one year? Scanning through the prospectus I found that they say:
"We depreciate our textbooks, less an estimated salvage value, over an estimated useful life of three years using an accelerated method of depreciation, as we estimate this method most accurately reflects the actual pattern of decline in the economic value of the assets."
Is there somewhere else that points to one year vs. three? If it three instead of one doesn't that radically change your above calculus to something like:
3 years = 6 semesters
Book = $100
Rental = $27.50
Rent it for say 4 semesters (aka 2 yeas) then re-sell at some abitrary rate say 20% salvage value, which would equate to a total value of $130 which gets closer to the approx. 20% margins Lukai was referencing from 2010.
Am I misinterpreting the number of "turns" they get out of a textbook? I assume a new addition of a textbook does not come out every year so there is probably 2-3 years in between each re-fresh cycle. Which leads me to believe the math is somewhat like the above. Please let me know where I am astray.
|Subject||RE: RE: RE: Margins on eTextbooks|
|Entry||12/12/2013 02:33 PM|
The 12-14 month useful life and 2-2.5x rentals per textbook data point was provided by Chegg. FWIW these are also the numbers management has given the sell-side analysts that cover the company. I agree this seems low but it was supported by conversations with other textbook rental companies including BKS. In the table above, the reported EBITDA less textbook depreciation numbers are based on the depreciation method you noted – in 2010 this number was -$22M.
New versions of textbooks do not come out every year, however, with every passing year that a textbook is in print, the larger the supply of used books hits the market and the lower the salvage price declines (and the less compelling rent vs buy used becomes).
Thank you for the questions. I hope this helps.
|Entry||12/17/2013 10:37 AM|
Sorry for the delayed response.
The CHGG bull case is predicated on it rapidly growing textbook rental and its digital segment (primarily Chegg Study) while also significantly expanding its margins due to a mix shift to digital. The CapIQ EBITDA numbers do not include textbook depreciation.
BofA and JPM are calling for topline growth of 40-43% on the textbook side (2012-2015), driven by volume and price increases. If CHGG wants to increase volume there is no way it can raise prices (in Q3 it lowered prices to meet AMZN). This revenue growth rate could be attainable but ultimately it will mean larger exposure to an increasingly unattractive business. Sell-side is calling for 400% revenue growth from 2012 to 2015 on the non-textbook side, most of which is expected to come from Chegg Study. This is a subscription-based, online study aid product. CHGG had 320k customers in 2012 with an average customer life of 3-months. Given the number of readily available free alternatives it seems very unlikely the company will gain traction anywhere near the magnitude it predicts (seek to reach +1M students by 2015, a 3x increase requiring a 25% conversation rate from textbook rentals). Growth in eTextbook will be a struggle given the very low entry barriers and strength of existing competitors. The rest of the growth is to come from a hodgepodge of other services.
The Street’s estimated EBITDA (including textbook depreciation) jump from 2014 to 2015 is absurd.
2015E: $48M (price targets are of course all based on the 2015 number)
I would encourage you to read the risk factors in the filings and sell-side reports to get a sense of the challenges Chegg faces. Here are some from the BofA and JPM inits.
“Amazon has the ability to price aggressively and appears willing to accept low or negative margin on textbooks to drive share gains. In 3Q’13, Chegg was slow to react to pricing changes at Amazon.”
“..it may prove difficult for Chegg to duplicate the engagement Facebook already has with the college audience and we struggle to see what Chegg could offer that is not already integrated with Facebook. On the lead gen business, LinkedIn is already well-positioned with employers and could easily be a resource for internship opportunities or a lead generation tool.”
Zinch: “It is possible that Chegg has exhausted its easiest growth driver (adding schools)…”
|Subject||More price cuts on AMZN|
|Entry||01/14/2014 11:55 AM|
Over the last week AMZN has cut textbook rental prices again (5-10% among a sample of the top 5 textbooks) and has several new promotions on AmazonStudent. Campbell Biology, 9th Edition is now available for rent on AMZN for $22.80 per semester, down over 15% from $27.05 when this idea was posted in mid-December. CHGG has followed (but not matched) with a price cut to $25.49 from $27.50, over a 7% reduction since last month.
|Subject||Staples entering textbook rental|
|Entry||01/23/2014 03:11 PM|
SPLS entering the textbook rental fray. CHGG now competing with the #1 and #2 online retailers.
|Entry||02/02/2014 04:37 PM|
It seems to me the sentiment is overwhelmingly negative are you worried that if they just don't suck on their earnings call it will pop back (aka doesn't take much to win here)?
I am just wondering what the real consensus is (not sellside) but what the money on the line is actually pricing in. Not sure if you have any thoughts on that but I would love to hear if you do.
|Entry||02/14/2014 11:06 AM|
Despite management’s best efforts to avoid the topic and focus on topline growth, guidance confirmed how challenging the competitive environment has become for CHGG. The 700bp gross margin erosion in Q4 was well communicated to the market with the November IPO. In the current quarter CHGG is really coming under pressure – Q1 guidance indicates gross margins are getting cut in half, from 16% last year to 9% this year with EBITDA of -$22M to - $20M vs -$16M last year. Even these weaker near-term numbers will be a stretch to achieve given the ~10% textbook rental price cuts noted in January. On the call, management initially stated that over time they hope to make up for this recent pricing pressure by reducing textbook costs. They later conceded that any cost reductions will be moderate (publishers just aren’t cutting prices). Somehow FY2014 guidance has them generating a 26% gross margin following a 9% GM in Q1. If anything textbook rental pricing pressures will intensify as SPLS expands its efforts.
CHGG is now saying they don’t need to price match since they can offer value-added services like access to its internship jobs board. Internships are only relevant to students once a year and much larger, more focused job postings sites obviously already exist. There is a reason they don't disclose the number of paid subs, but highlight how much money they have saved students (clearly a decent portion of which has been at the expense of CHGG), number of members and number of trees planted (not joking). Regardless, if you look at any of the top textbooks rental prices online, you can see that CHGG is trying to match AMZN and others on price.
Curiously CHGG does not disclose textbook rental margins separately from non-textbook. It should also be worth noting that somehow CHGG has convinced its auditors that rented textbooks should be depreciated over 3 years when their actual useful life is just over 1 year (at the company’s own admission). The 2014 cash flow breakeven guidance isn’t credible under any accounting principles. Just consider that they have consumed $36M from the November IPO to December 31 alone. Stock is generously worth $3.00-3.50 today (cash + textbook library + non-textbook business – operating exp).
|Subject||RE: earnings update|
|Entry||02/14/2014 12:45 PM|
nice call and thanks for the update
|Subject||Q1 earnings update|
|Entry||05/02/2014 10:53 AM|
Reported Q1. Excluding the $2-3M of revenue that was pulled into Q1 (management described it as a seasonal shift), would have missed Q1 guidance. Regardless cash declined $20M in the quarter, total cash consumption since the Nov IPO is now up to $56M, yet management reiterated 2014 FCF of -$5M to $5M. Recent CEO comments at the Piper conference give you a sense of how delusional these guys are, “AMZN is not a threat to Chegg…they have improved awareness of textbook rental.” On the call yesterday Rosenweig commented that, “textbooks are a low cost customer acquisition platform.” The now disclosed digital GM of 55% implies a negative GM for rental -- not surprising and also clearly not a low cost acq mechanism.
Management has been selling stock as low as $5.72 through 16b3 in April. Expiration of IPO lockup later this month and then the real margin challenges will hit them in the first semester during Q3. There is a strong case for a <$3 stock given undisciplined spending and accelerating competition in textbook rental.
|Subject||RE: Recent Acqs|
|Entry||06/10/2014 09:21 AM|
Cross- That is the basic bull story that seems to have driven the recent move in the stock. The reality is non-textbook rental is less than a quarter of the business and CHGG is consuming cash at an alarming rate. CEO Rosenweig seems to have an undisciplined, topline-growth-at-any-cost mindset. Following the November IPO, CHGG had $150M in cash. This dropped to $94M by 3/31 and they have announced they are using $45M for acquisitions so far this quarter. This includes last week’s announced $30M acquisition of InstaEDU, a nascent online tutoring company that only gets 30k visitors a month according to Compete. Starting in May CHGG returned to matching AMZN rental prices and initiated a free shipping promo for all orders over $70. I remind you CHGG has stated that they need to spend +$100M on textbooks annually just to maintain their inventory. This is the yoke that will be their undoing. At this rate it appears they could potentially burn through all their cash by year-end.
|Subject||Fall semester pricing|
|Entry||07/29/2014 09:37 AM|
Textbook rental prices for the high volume fall semester are now out. Below is a screenshot of the prices for the most popular textbook Campbell Biology (ISBN 10: 0321558235) from August 19, 2013. CHGGs price was $50 then and as you can see is now $29 for the fall semester. Looking at the 60-day rental price sample from the ML initiation shows a 40% price drop across the board just since December. CHGG reports next week. This will likely have a much bigger impact on margins than CHGG has guided (2014 GM guidance of 28% vs 34% in 2013).
|Subject||RE: Ingram deal|
|Entry||08/07/2014 10:30 AM|
I was on the road so my apologies for the delayed follow-up.
Assuming Ingram is economically rational and not a related party, the terms of the deal as CHGG provided on the earnings call could not have been complete. Ingram’s GM on the textbook rental business would only be 3%. This assumes CHGGs 12% 1H’14 textbook rental remains flat and CHGG bears 50% of COGS (as would be implied by a 50% GM on the 20% commission CHGG noted). This clearly does not make sense for Ingram. There are a number of potential concessions CHGG may have failed to note: 1) Ingram gets to cherry-pick titles, 2) CHGG sells the books to Ingram at a discount, 3) Ingram can put the books back to CHGG, 4) CHGG guarantees Ingram a certain return/ margin. We have not been able to connect with Ingram to hear their side.
Regardless it appears that Ingram will be taking only 10% of CHGGs textbook inventory. If an agreement were in place for all inventory to be transferred I am sure Rosensweig would have told us about it. CHGG spends $100M on textbooks a year so this transfer equates to a $10M reduction in cash outlays, significantly less material than the stock’s move on the news would imply. Meanwhile fundamentals continue to deteriorate as evidenced by the 2014 guidance cut and the textbook rental pricing declines noted in comment #17.
|Subject||Thoughts on Quarter|
|Entry||02/24/2015 01:51 AM|
Any updated thoughts on the quarter? They seemed to be saying the right things (from an after hours action perspective). Hard to sort through marketing hype vs. meat here. But seems like they did a good job of eliminating some threats. What do you think?
|Entry||02/25/2015 09:28 AM|
I must say that management has performed a pretty impressive transformation from a high-capital, poor-return business into a potentially wonderful business. They believe they will be the student portal (yes, time machine to 1990s) to all-things (eTextbook, textbook rental, tutors, recruiters, financial products, etc.).
I wanted to understand ballpark numbers. If I understood call properly,
we have mkt cap ($8.70) = $757mm
net cash = $91mm
Over next two years, they will be monetizing the book inventory ($81mm) but also paying some transformation expenses. All-in, it look like they will be generating $60mm-ish of free cash flow. However, this number does not include stock comp.
I noted that they paid $35mm in stock comp in both 2013 and 2014. I have not followed the company closely and the issue was not discussed on call, but is this expected to be about the level going forward?
If so, then the stock comp will more or less wipe out the FCF and pro-forma TEV as of 12/31/16 will be about $666mm.
And we have mgmt projections of
Revenue (2017) = $300mm (all digital)
EBITDA (25% margin) = $75mm -- but again, this does not include stock comp.
From their numbers, I would guess that capex would be $10mm-ish.
If stock comp around $35mm per year, would give me $20mm-ish unlevered free cash flow in 2017. So trading at 33x 2017 number.
And they have business growing at 25+% top line . . .
Does anyone have thoughts about their ability to monetize online customer contact with students? Clearly, we can come up with some huge numbers here if this company becomes a dominant marketing platform for reaching students.
|Subject||Re: Re: Transformation|
|Entry||02/25/2015 10:58 AM|
I somehow missed that in the PR. Yes. Wow. Stock comp that is 20% of revenue. If $59mm is recurrung, then 2017 EBITDA less capex would be close to zero.
I have no position at present and would never go long at these levels, but I am also terrified at how far this could run if the story gains traction.
|Subject||Re: Author Exit Recommendation|
|Entry||06/20/2016 01:49 PM|
any particular reason for exit at this point, or just profit taking? Do you feel differently about the business than when you orig recommended? Is there any price you would go long on this? Thx.