Chegg Crumbles After Earnings: Too Cheap To Ignore

Summary

• Chegg fell 30% after earnings - after having already fallen 70% from all-time highs.
• The stock now trades at the same levels it did 5 years ago.
• The company adjusted full year guidance lower while blaming inflation, the economy, and weak enrollment numbers.
• The near-term outlook might not be pretty, but the stock is too cheap to ignore here.
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Chegg (NYSE:CHGG) saw its stock tumble after reporting earnings and guiding on its forward outlook. The company blamed low enrollment, a weakening economy, and rising inflation as culprits for the weaker than expected financial outlook. The latest fall comes after the stock had already fallen 70% from all-time highs. The near-term headwinds means that even after the continued struggles, this might not be the bottom. Still though, the stock is very cheap and the long-term outlook remains promising. I rate the stock a buy for those brave enough to hold through the volatility.

Chegg Stock Price

CHGG peaked above $112 per share in early 2021 as the company's fundamentals were boosted by stay-at-home learning. The stock nosedived in late 2021 after a disappointing earnings report before nosediving yet again.

Data by YCharts

Now trading at around $17 per share, the stock trades as low as it did 5 years ago.

What is Chegg?

CHGG officially describes itself as an integrated platform of online education and tutoring services.

Chegg 2022 Q1 Presentation

Unofficially, CHGG is known as an enabler of academic cheating. One of the key perks of a Chegg membership is the large database of homework answers as well as the ability to ask for solutions to new homework problems. The company reportedly is able to do this through a large employment headcount of Indian graduates. In some sense, CHGG empowers the average student to have access to their own answer key. CHGG's business soared during the pandemic because with all learning done at home, it was much easier to cheat, if one wanted to.

Is this cheating and more importantly, is this business model sustainable? CHGG has been sued by Pearson for selling textbook answers, and appears to have a bad reputation among educators. My view is that CHGG's solutions are not inherently cheating, though one could use them to cheat if they wanted to. Just to explain that further, educators could theoretically reduce the emphasis on homework and place more emphasis on exams. In doing this, students would need to actually learn how to solve their homework problems on their own as they would not be able to pass the class just by acing the homework alone. In this manner, CHGG's resources would arguably be very helpful in assisting students with mastering the curriculum. Of course, the above solution may only work in a post-pandemic world as one would still need to ensure that students are not using Chegg real-time during class exams.

Chegg Stock Earnings

While CHGG saw robust growth in both subscribers and revenue in 2021, it is projecting a steep slowdown in growth this coming year.

Chegg 2022 Q1 Presentation

CHGG also expects significant margin compression, partly explainable by its acquisition of the language learning app Busuu.

Chegg 2022 Q1 Presentation

The real culprit for the stock’s weak price action was the guidance. CHGG guided for up to $770 million in full year revenue guidance, a steep guide down from the previously issued guidance for up to $850 million in revenue.

Chegg 2022 Q1 Presentation

CHGG remains free cash flow positive and has a solid balance sheet with $1.6 billion of cash and investments versus $1.7 billion of convertible notes. These convertible notes carry minimal interest and have conversion prices of $79.32 and $156.44 per share (net of capped call transactions). In other words, while CHGG does not have a net cash position, the debt effectively acts like 0% to 0.25% yielding debt for the next 3 to 4 years.

Is Chegg Stock A Buy, Sell, or Hold?

Looking forward, CHGG expects its decision to offload its textbook business to lead to modest accretion next year.

Chegg 2022 Q1 Presentation

I have not included consensus estimates because they will likely be restated downwards over the coming weeks. As of recent prices, CHGG is trading at a $2.4 billion market cap. That represents a 3x price to sales multiple and EV/EBITDA multiple of 10x. The company is profitable and trades at 20x projected free cash flow. CHGG was growing at a 31% rate pre-pandemic before the pandemic materially accelerated its business. The current stock price makes sense even if CHGG can grow at a single-digit rate long-term. I can see CHGG eventually returning to a 15% to 20% growth rate, which would justify a price to sales multiple of around 6x - the underlying assumptions include 30% long-term net margins and a 1x price to earnings growth ratio ('PEG ratio'). That reflects ample upside even with a modest 1x PEG ratio. The key risks here are arguably that of the company being "before its time." It's possible that the company loses its lawsuit with Pearson (PSO), which may prove itself to be an existential risk - though I wouldn't be surprised if a negative legal decision simply results in CHGG having to pay more royalties to textbook companies. Further, while I personally view CHGG to play a net positive role in academic learning, that is not the current sentiment and it may take many years for that to change, if ever. For that reason, CHGG may not be likely to earn the premium multiples it deserves. I rate the stock a buy due to the cheap valuation and my positive view of the long-term story, though caution that position sizes should be small until greater clarity emerges regarding the Pearson lawsuit and academic sentiment.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in CHGG over 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.

I am long all holdings of the Best of Breed portfolio.