Uncertainty About Chegg's Business Model Results In Fierce Post-IPO Selling

| About: Chegg, Inc. (CHGG)

Chegg (CHGG) made its public debut on Wednesday, November 13. Shares of the leading student connected learning platform ended their first day with losses of 22.6%.

An aggressively priced offering and concerns about the business model causes a lot of uncertainty among investors on the opening day. I remain on the sidelines.

The Public Offering

Chegg's leading student-first connected learning platform empowers students to take control of their education, save time and become smarter, according to the company itself. In reality, the company generates the vast majority of its revenues from renting out textbooks.

Chegg is driven to help students to become active consumers in the educational process. On its platform, the StudentHub, it offers rich experiences for participants. Some 5 million students use the service to improve the return on investment on their education.

The company has 180,000 unique titles in its library available for rent, with over another 100,000 eTextbook titles. The company also offers homework help, among others as a service to students.

The company now reaches 30% of all college students who combined rented or bought 4 million print textbooks and eTextbooks, with another 320,000 subscribing to homework services.

Chegg sold 15.0 million shares for $12.50 apiece, thereby raising $187.5 million in gross proceeds. Some 14.4 million shares were being sold by the company, which thereby raised $180 million, with the remainder of shares being offered by selling shareholders.

Initially, bankers and the firm set an initial price range of $9.5-$11.5 per share. Shares were eventually sold above the high end of the initial public price range.

Some 18% of the total shares were offered in the public offering. At Wednesday's closing price of $9.68 per share, the firm is valued at $802 million.

The major banks that brought the company public were JPMorgan (JPM), Jefferies, Bank of America/Merrill Lynch (BAC), Piper Jaffray, BMO Capital Markets and Raymond James.


Chegg partners with key constituents in the education system, including publishers and brands. The company sources its materials from leading publishers including Pearson, McGraw Hill and Wiley.

With an education being the biggest and most time-consuming investment for many, the decrease in affordability of education is a continuing trend. Chegg believes that technology can play a crucial role to reduce the cost of education.

Its StudentHub solution provides relevant content, products and services. On top of that is the Student Graph, which provides an interactive tool for students to personalize their hub and interact.

For the year of 2012, Chegg generated annual revenues of $213.3 million, up 24.0% on the year before. Net losses widened from $37.6 million to $49.0 million.

Reported revenues for the first six months came in at $116.9 million, up 26.4% on the year before. Net losses narrowed from $31.9 million to $21.2 million in the meantime.

The company operates with $21.6 million in cash and equivalents. Total debt, including operating leases, totaled $19.8 million, resulting in a modest net cash position of around $2 million.

Factoring in gross proceeds of $180 million from the offering, and Chegg will operate with an estimated net cash position of around $165 million.

With the equity in the business being valued around $802 million, Chegg's operating assets are valued around $635 million. This values operating assets of the firm at 3.0 times annual revenues.

Investment Thesis

As noted above, the offering of Chegg has been a mixed bag. The company priced the offering at $12.50 per share, some 19.1% above the midpoint of the preliminary offering range. Shares have given up these gains and more on their opening day, trading some 7.8% below the midpoint of the preliminary offering range.

The company founded back in 2005, has steadily grown its revenues, although losses kept mounting as well. With the majority of revenues tied to paper book renting, which is really capital intensive, the company has started to focus on e-books by now.

Yet the company faces a lot of troubles before turning this business into a success. This includes issues with publishing rights, and of course fierce competition from industry giants like Amazon.com (NASDAQ:AMZN). The focus is already shifting to eTextbooks with Chegg now offering 100,000 textbooks, compared to 180,000 traditional textbooks.

Other key risks are the continued losses, rapid technological changes, seasonal academic cycle influences, dependency on publishers as well as competing with competitors with greater resources.

As such, I am not convinced yet that Chegg could turn a profit, whenever this might be, and just how profitable the business might become given the current affairs. Attaching an $800 million valuation to such a business at the moment seems a bit rich, despite modest revenue growth in recent times.

I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.