2U: Platform Shift Brings Speculative Opportunity (NASDAQ:TWOU)

2U (Nasdaq:2) is one of the leading players in the online higher education sector. Founded 15 years ago and going public in 2014, the company has an established reputation as a provider of technology. A platform that enables universities to offer online degree and non-degree study programs.

Earnings growth was very steady at +35% year-on-year over the past few years until 2021, when 2U made its massive $800 million acquisition of edX, a well-known large-scale open online course/MOOC platform. Powered by the edX acquisition, 2U will: Platform business. Considering the potential value creation from vertical integration of 2U and edX, this seems like a very attractive move.

However, the move also carries a high degree of risk.Transformation strategy including significant reductions Marketing spending to focus on profitability is also dampening near-term growth prospects. 2U expects growth of just 3% in 2023, slightly higher than around 1.8% in 2022 so far. Since last year, the stock has come under significant selling pressure, down +43% year-to-date and +62% year-on-year. .

At +$3 per share today, we consider 2U to be a speculative opportunity and assign a buy rating to stocks with this coverage.

Finance

Since going public in 2014, 2U’s growth has slowed from around 90% year-on-year to +35% levels over the next few years. From 2021 onwards, we will see a significant decline due to two key drivers: the macroeconomic downturn and a strong labor market that increases the opportunity cost of a degree, and reduced marketing spending due to strategic shifts.

The overall decline was primarily driven by degree program business. 2U has two revenue streams for him: degree programs and alternative credentials segments. In the degree programs sector, 2U partners with universities to offer undergraduate to graduate online degree programs. Last year’s revenue was +$570 million, making this business a significant portion of his 2U revenue. But it is also the region most affected by the macroeconomic slowdown. Enrollments for academic year 2022 have fallen by 1.5% and as a result, degree program income has fallen by 3.5%. The impact in Q1 2023 was a little more severe. Q1 revenue fell -9% year-on-year as the company also initiated further marketing cuts.

The Alternative Qualification segment, on the other hand, refers to short-term, non-degree programs offered by 2U in partnership with universities. These programs include short courses, boot camps, professional development courses and continuing education programs. Overall, the sector will continue to grow at 10% year-over-year in 2022, experiencing a modest decline in the first quarter, with quarterly sales down -1% year-over-year to $98 million, leading to a bit more recovery. I had power.

From 2022 onwards, improving profitability, especially at the Adjusted EBITDA level, will be the company’s primary focus. Overall, the improvement here is very noticeable, especially as the company has significantly reduced marketing expenses, traditionally its largest operating cost. item.

A 10% pps reduction in marketing and sales expenses in just over a year is a significant improvement. This is also a reflection of the value edX assets bring to his 2U. edX has established a very strong brand name in the online higher education market, has a strong online presence and generates a lot of organic traffic.

Considering that 2U has had several things happening at the same time that have impacted its financials over the last few years, I think the cut in marketing was more or less an important move to preserve capital. The company remains committed to capturing value from its 2021 acquisition of edX (2022 restructuring plan) as it works towards restructuring its debt. 2U now has more than $900 million in debt on his balance sheet and more spending $50-60 million per year in interest alone. As such, Adjusted EBITDA may not reflect 2U’s actual earnings outlook.

catalyst

On paper, taking full advantage of the edX + 2U combination will result in more efficient delivery/user acquisition (organic) and higher quality courses that may attract corporate customers (the two main competitors). Access creates a superior online education platform with a competitive advantage. Coursera (cool) and Udemy (UDMY) have already generated a lot of business from the enterprise market, and the combination of edX + 2U will create competitive enterprise offerings that drive revenue growth and enable better diversification. I think we can create it.

I would also like to highlight edX’s strong brand reputation. A famous online learning platform founded by Harvard University and MIT. edX is known for its extensive catalog of courses and collaborations with leading institutions around the world. While it is arguable that the $800 million purchase price is a bit high, the acquisition gives 2U access to a wider student base and edX’s strong network of university partners at a significantly lower annual acquisition cost. be able to make use of it. As I mentioned earlier, the 41% organic leads brought in by his edX in Q1 was a relatively good number. There is no doubt that 2U can further improve its organic strategy to further strengthen its marketing spend and drive higher quality conversions.

Additionally, the fact that edX is a well-known online platform attracting over 240 million visitors annually is also a significant advantage for 2U in its core business as it provides a very strong organic distribution channel for its courses. For example, 2U can gain an advantage in future revenue sharing agreement negotiations with potential university partners to develop new degree or non-degree programs.

dangerous

The current 2U has many risk factors, which is why it remains a speculative opportunity for me. An ambitious transformation to a platform-centric organization, especially with edX integration, requires a significant investment of time, resources, and effort. The potential for value creation exists, but it may take longer than expected to reap the full benefits. Investors are urged to exercise patience and understand that any speculative opportunity associated with this transformation involves inherent risks, including implementation challenges, delays and potential initial deterioration in performance. increase.

With our current focus on driving revenue growth, we remain excited to see how 2U navigates the transition back to growth mode once the edX integration is fully completed. As 2U shifts its focus to becoming a platform, maintaining the desired flywheel effect can prove unexpectedly costly. Building and expanding our platform, attracting and retaining top university partners, and driving growth in student enrollment requires significant investment.

Separately, 2U’s Online Program Manager/OPM business model for partnering with universities to offer online degree programs is subject to: Regulatory oversight. Regulators may impose new regulations or change existing regulations, which can add to 2U’s compliance costs and operational complexity. A drastic change in regulation could affect the company’s ability to operate efficiently and expand its partnerships with universities, and pose risks to its revenue and growth prospects.

Recently, 2U has come under regulatory scrutiny from the US Department of Education regarding its OPM business model.Department store express concern About Potential Conflicts of Interest, Transparency, and Management of Academic Functions. 2U therefore responded by filing a complaint against the ministry.while being a company Downplayed potential impact in Q1 earnings callthe outcome of these discussions and the resulting action by the Ministry of Education remains unclear.

Rating/Pricing

In estimating the 2U price target, we consider earnings projections over the next five years based on a probability-weighted bull vs. bear scenario.

1. Bullish Scenario (90% chance) – Labor market conditions improve in favor of 2U in FY2024 and 2U revenue growth reaccelerates to 8% in the same year. 2U then makes good progress towards several attributes. the target modelEBITDA margin expanded to the +20% level and unutilized FCF margin was in the single digits, driven by a well-executed organic/paid marketing strategy. Also, as the company expands into the enterprise business, growth will gradually reaccelerate from 8% in 2025 to 10%-15% in 2027.
2. Bearish Scenario (10% probability) – Labor market conditions persist through FY2024. 2U anticipates regulatory impacts that negatively impact future partnership models and, ultimately, growth. We expect revenue growth of -1% to -2% over the next two fiscal years. After that, we expect the outlook to improve as the company enters the enterprise business in his 2026 fiscal year and his 2027 fiscal year. We believe we are a little far from our intended target. There is a need to improve this model, especially in terms of profitability, as there is a need to focus less on the enterprise segment, a business that is less affected by the regulatory situation than the bullish scenario for FY27.

We also upped the P/S for the bullish scenario to 3, believing that successful realization of value from edX integration to drive both growth and profitability, as well as enterprise business, should warrant a higher premium. assign. Nevertheless, I would like to be conservative and keep in mind that industry players across the online higher education market do not benefit from the high valuation premium. P/S 3, on par with Coursera already serving enterprise customers, is a reasonable number in my opinion. In a bearish scenario, we assign a P/S of 1. This means that 2U is basically valued according to annual revenue.

Integrating all of the above information into the model resulted in a weighted target price of $46 per share for 2027. Discounting that target price with a discount rate of 20%, the present value/PV weighted target price reached ~. $18 per share. A discount rate of 20% represents the expected annual return.

Approximately $18 per share is the highest price point at which an investor could purchase the shares and realize an expected return of 20% annually should the 2U shares reach their fiscal year 2027 target price of +$46. 2U is currently trading at around $3.50 per share, so the model suggests the stock is undervalued, creating a buying opportunity today.

Conclusion

With the acquisition of edX, 2U embarked on a major transformational effort to become a platform business. I expect the combination of these two businesses to offer promising value creation potential through vertical integration and economies of scale. However, this bold move is not without risks. Transformational strategies, such as reducing marketing spending to prioritize profitability, have impacted the company’s near-term growth prospects.

The situation is further exacerbated by the unfavorable macro and regulatory environment. Growth in 2023 is expected to be just 3%, up slightly from the previous year, dampening investor sentiment and driving down stock prices. As of today, the stock is trading at about $3.50 a share, down 43% year-to-date and 62% year-over-year.

I believe 2U presents a speculative opportunity. My target price model shows that the stock is undervalued today. Based on this, I rate the stock a Buy.