2U: This May Go To Zero

Summary

• 2U suffered its worst quarterly earnings on record, dropping nearly 40% in a single day as a result.
• Revenue growth has been decelerating over the past three quarters.
• In addition to that, full course enrollments in 2U's degree programs are down y/y.
• At the same time, 2U burns significant cash, and its balance sheet is already loaded with debt.
• Looking for a helping hand in the market? Members of Daily Tech Download get exclusive ideas and guidance to navigate any climate. Learn More »

Drazen_/E+ via Getty Images

Widespread growth stock corrections are also a fantastic time that over-hyped, low-quality stocks get weeded out of investors' favor, and I count 2U (NASDAQ:TWOU) squarely in this bucket. 2U, which describes itself as an educational technology company, but is really a disguised for-profit university, just reported fiscal Q4 results, and investors have never been burned more.

The problems here are manifold: declining enrollments, declining revenue growth, continued expectations of sluggish growth through FY22, and cash burn on top of an existing debt load. The stock market is none too pleased, and shares of 2U fell nearly 40% on the day after its earnings release. Now, as of the time of writing, the stock is down more than 80% from 52-week highs near $60.

Data by YCharts

There's often a strong urge to buy growth stocks after such large dips. In the case of other former high-fliers that saw steep declines like Peloton (PTON), a buy-the-dip strategy was eventually saved via acquisition rumors. In the case of 2U, however, I remain squarely bearish on the stock. There are a number of reasons why the fundamental risks here prevent an investment case in this stock from being viable:

• Reputational risk. 2U no longer seems to be able to mask the fact that it's a for-profit university. As I wrote in my prior article, the company was recently the subject of a scalding WSJ profile that highlighted its highly expensive degree programs (and aggressive marketing tactics to try to enroll students in these programs) that rarely yielded high-income jobs and forced students into debt.
• Unscalable business model. Most tech companies build one product, then sell that same product across all of its customers. 2U is quite different: it is responsible for digitizing and creating custom content for each university course it signs on. While there will certainly be a technology base that is repeatable across each new course additions, 2U is effectively taking on the role of a customized consultant for each new university partner.
• Deep red ink. 2U's losses and cash burn have widened in recent quarters, at a time when investors are far more sensitive to the bottom line than they were in the past. On top of an already-constrained balance sheet and the unlikelihood of raising additional capital when sentiment is at an all-time low, these circumstances may spell 2U's end.

In short here: 2U is getting a much-deserved fall. In my view, losses are only going to keep piling up from here, so don't jump in.

Q4 download

Let's now go through the highlights of 2U's latest fourth-quarter results to dig into why the quarter was so harshly panned by the market.

Starting with revenue growth:

2U Q4 revenue trends (2U Q4 earnings deck)

2U grew its revenue at a 13% y/y pace to $243.6 million in the quarter. This was the third straight quarter of revenue deceleration for 2U, despite the fact that it closed its education of edX in the quarter. Note that, unsurprisingly, 2U is not disclosing what organic growth is versus the edX contribution (the only clues to this regard that we have is that 2U previously disclosed edX did $84.7 million of revenue in 2020).

Note that this dour growth picture is expected to continue on through next year. The company is providing guidance for FY22 with a revenue range of $1.05-$1.09 billion, which points to 13% y/y midpoint growth. Again, if we account for the fact that edX is a ~$100 million slice of that base and that outside of a partial quarter in Q4, this revenue has no comp in FY21, we directionally arrive at a very poor organic growth picture for 2U.

2U's enrollments are telling basically the same story:

2U Q4 enrollments (2U Q4 earnings deck)

As seen above, total enrollments fell -1% y/y to 80.2k. Enrollments temporarily peaked in Q2 this year, and presumably there was a wave of program endings and graduations post-Q2 that the company hasn't fully built back up yet.

Here's some anecdotal commentary from CFO Paul Lalljie on how the company is positioning itself for next year and beyond, from his prepared remarks on the Q4 earnings call:

Looking out over the midterm, our goal is to deliver at least 12.5% revenue growth at a compounded annual basis 2021 to 2025, the consolidated adjusted EBITDA margins range between 15% and 20% by 2025, resulting in more than four times 2021 level of EBITDA. In addition, our goal is to generate positive unlevered free cash flow for the full year 2024, driven by higher program launches, growth and registered learners, lower marketing and sales expense and greater contribution from enterprise revenue.

Over the next four years, we expect to increase degree program launches, while decreasing the cumulative cash flow point for program. We also expect to double registered learners participating in our platform. Marketing and sales expense as a percentage of revenue is expected to decrease to less than 40% by 2025."

Losses are another big focal point for 2U. Take a look particularly at 2U's cash flow picture. Though the company likes to present its "unlevered" cash flow view that showcases what cash flow would have been in the absence of debt, the reality is that the company is shouldering a lot of debt. Unadjusted free cash flow was -$59.4 million in the quarter, a significantly steeper burn rate than -$14.5 million in the prior-year Q4.

2U Q4 FCF (2U Q4 earnings deck)

Full-year cash burn, meanwhile, was -$77.1 million. As a reminder, 2U's balance sheet already doesn't look pretty: with $233.9 million in cash and $845.3 million in debt, 2U will find it challenging to raise any additional capital.

Key takeaways

With each passing quarter, more and more of 2U's flaws are revealed, causing more air to be released out of its balloon. For a stock that relied so much on momentum rather than fundamentals to carry its stock price higher during the pandemic, there's not much hope for a recovery here, especially as the company continues to project rather slow revenue growth and enrollments. Steer clear here.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.