You Ask Chegg Answers: Potential Top AI Investment

Summary

• Chegg's stock has trended downward despite recent positive news and reaching new highs earlier in the year.
• The company's valuation suggests a potential upside of 40% based on comparisons to peers and Wall Street analysts.
• Chegg's deep value, earnings consistency, and industry-leading position in the education space make it an enticing investment if they can leverage AI, but there are risks to consider.

Sarah Kerver/Getty Images Entertainment

Smarter Answers = Better Product + Improved Returns

Chegg (NYSE:CHGG) has struggled over the last year of trading, moving down around 52% over the same period, despite reaching new 52-week highs around $30 about this time last year. Chegg specializes in textbooks and online materials for students, primarily in high school and college. Their tools (Figure 1) have become a vital part of learning communities, and this has allowed the company to grow at a very high clip over recent years. In more recent news, the company has begun to look into incorporating AI into their platform. This led to an around 20% gain over the last couple of months on the release of this news. The company has moved into Beta testing utilizing ChatGPT 4 capabilities and allows users to "join the waitlist" now. Nonetheless, the stock continues to trend downward as high growth, premium value names as a whole have fought headwinds in August/September.

Chegg Home Page

Figure 1. Chegg offers a variety of tools to help out students in the classroom

At current prices, Chegg's valuation could offer a potential upside of as much as 40% from current prices based upon comparisons to peers as well as Wall Street Analysts and as little as 20% downside if support holds up during any further macroeconomic headwinds. This presents an enticing 2:1 reward: risk investment opportunity going forward for a stock in the consumer technology industry. We believe these estimates may even be conservative if their AI platform takes off and their data is likely very valuable to bigger AI threats like ChatGPT & Google's Bard, making them a future takeover candidate.

Current Valuation

Chegg trades at a Price to Earnings ratio of just 9x forward earnings. This is much lower than peers, indicating the stock is trading at as much as a 35% discount to competitors, likely because growth has for the most part stagnated since the COVID pandemic. Furthermore, if the stock can again return to trading more as a high-growth tech name with moves in AI similar to peers such as Coursera (COUR) and C3.ai (AI), Chegg could then be valued much at much higher ratios as it was over the last 3 or so years of public trading. AI has been frowned upon in the educational space in the past, but acceptance has led to growth. The AI educational market is now expected to burst on the scene with a projected 34%+ CAGR over the next decade, which would signal a $30+ Billion TAM. This is good growth news for a struggling Chegg who anticipates the product to be available within the "next two semesters" which would come out to sometime between January and May 2024.

Data by YCharts

Figure 2. Value vs. Growth of Educational Stocks

This potential return to growth will be key in Chegg's path to success and should be monitored closely. Looking more towards growth metrics, we see that Chegg has done well growing EPS at around 25% annually over the last three years, hinting that the company has done well at cutting costs during this downturn. Furthermore, repurchases of stock will only leverage this number further.

Wall Street Analysts are behind Chegg as well (Figure 3) with an average analyst rating of $13.75 signaling as much as 35%+ upside from current prices. We believe this is reasonable, but could be conservative long term if AI lights a fire under Chegg, propelling their stock higher.

SA Ratings

Figure 3. Chegg has a number of buy and hold ratings placed on the stock

This combination of potential turnaround momentum powered by AI, and newfound value, is a decent case for investing in Chegg's stock going forward for the medium to long term.

Risks

Chegg currently has a debt of approximately $788 million. This is around 76% of their total equity and therefore should be monitored going forward as always. Promisingly enough, though, they have been paying this debt down and this number is nearly half of what it was just over a year ago. Continuing to pay this down as profits increase will aid in improving aspects such as the enterprise value of the stock, which trades at a premium to peers.

Based on historical data and when looking at the charts of Chegg's stock, it becomes apparent that there is a fairly strong line of support around the $8.6 mark, but could potentially pull back if new macroeconomic lows are tested. This would indicate as much as 20% downside risk going forward, barring any further macroeconomic headwinds caused by rapidly rising rates and inflation.

Other risks include the unknowns of AI in the educational space. Many schools have gone as far as to ban the use of AI in their institutions, and this could spell trouble for Chegg if they do not find ways to market their new tool without overstepping the bounds created by schools.

Investment Summary

AI from Chegg could be a powerful educational tool with their expansive collection of textbooks, homework, and answers. AI could be introduced for all users as soon as early 2024. This, to us, along with nearly a billion a year in robust revenue, high profit margins, and a discounted valuation, makes Chegg a fairly safe high-upside investment in a stock poised for resurgence. Most AI investments in the current market are overpriced, trading at a substantial premium, but Chegg offers a high AI upside at a discounted value.

With a potential upside of as much as 40% in an approximately 1-2 year time frame due to enhanced potential for ongoing momentum and reliable earnings consistency, Chegg looks to be a hold, if not a buy, going forward. Long term upside could be even more substantial if the educational AI market grows at the rate expected. In our opinion, there is still around 20% downside risk when looking at past levels of support, and this should be taken into account when weighing risk-reward strategies.

Analyst’s 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.

Comments

[peterod2]

I remember studying for the CPA exam with the Becker materials and thought it was so much better structured and easy to learn with their content than just going to lectures and reading the texts(and much cheaper than my degree). So I think the question at hand is weather or not the data set(or content) that they have is or will stay proprietary and will that be enough to ultimately make the product better. We can all use google now to search for info to questions on a topic in school but some people prefer using Chegg.

[ProbabilisticInvestor]

This is a dying company that was caught flatfooted by LLMs and has no good answers for it. Their subscription model is going to increasingly become untenable given that the GPT-4 subscription is about the same cost. Speaking as someone who still teaches at a large undergrad university, I can tell you (anecdotally of course) that the students i've talked to find sites like coursehero and chegg pretty worthless now. Professors are being incentivized to rethink the way we look at homework and tests both of which companies like chegg heavily rely on. Similarly, their AI tutoring sounds gimmicky, like a wrapper around gpt but which won't offer anything that the next generation of LLMs can't. IMHO, this is a dinosaur on the very long road to extinction.

[flat baroque]

@ProbabilisticInvestor -
A) you are speculating on what their AI platform will be.
B) I speak with college students regularly (mentoring, youth support, kids and their friends) all of whom swear that Chegg is a big help. Yes, some use it to cheat but most say they learn far better from Chegg than from their professors. (And at a dramatically lower cost).
C) If you listen to Chegg CEO (and don’t approach this topic with confirmation bias), I think you will see that not only does Chegg want to reduce/eliminate cheating, they are on the forefront of pushing for different ways to think about homework and testing.

Frankly the education is system is an expensive and outdated model and here you have a company trying to help initiate change. Most professors are so stuck in their classic process they can’t see the forest for the trees and just wish to complain.
I think there is far more risk in investing $100-$300k in a four year undergrad college degree hoping it will lead somewhere and struggling to learn from a tenured fossil than to believe that students (and others) will spend $19 a month to learn better

[ProbabilisticInvestor]

@flat baroque I have no issue with students using online platforms to learn (honestly, i couldn't care less if they use it to cheat or legitimately). My main point is that I know AI fairly well as my phd is in stats and my day job for the last five years has been a senior data scientist at a large tech company and companies like Chegg are having their entire business model pulled from under their feet.

A) I'm not speculating about their AI platform - they've announced their partnership with open AI and have been open about what they think it will be able to accomplish. It's not so different from what a lot of specific journals / companies are doing trying to train LLMs on specific datasets to have them become more specialized (in this case, tutoring / academic help). The idea behind is that maybe it would help keep the LLMs from hallucinating and making up things that aren't accurate (e.g. citing fake articles). They're not alone in this search and what they're presenting is a band aid for the business model, but it doesn't really change the fact that they're bleeding out. As the LLMs get more powerful, even the free versions of them will be as good as what Chegg is charging for so it's not that I think students won't be incentivized to use online resources, it's that now there are (almost) comparable resources that students can use for free like Chat-GPT3 and soon there will be better resources that will be free.

[BAII Capital]

@ProbabilisticInvestor I am a data scientist also and agree.