Research Notes: The Case For Online Education Stocks
At some point, a company is going to truly change education. We look at two potential candidates.
Dot-com bubble optimism wasn’t wrong — it was early. The same is likely to be true for some of the growth stocks during 2020 and the first half of 2021.
With the education business so ripe for disruption, stocks that have disappointed may still offer long-term promise.
COUR looks like it could be one of those stocks — but there are near-term worries and a lot of work left to do.
LRN is a smaller swing but is showing solid results and a still-reasonable valuation.
As many pundits claim we have entered Internet Bubble 2.0, it's worth looking back on the first bubble to see what we can learn.
[The Dot-com bubble], like most, was fueled by overstated optimism. Bill Gates forecast widespread telecommuting by 2004 and companies like Webvan, Pets.com, and Beenz.com matched flawed business models with wildly overstated assumptions of Internet adoption.
At the peak of the bubble (February 25, 2000), Forrester Research projected online retail sales of $184 billion in 2004. Actual online sales in 2004? $66.5 billion, just over a third of the projection. (Forrester now projects the U.S. will reach that level in 2011, seven years later.)
I wrote that passage more than eleven years ago, amid a growing sense that we had entered a second tech/Internet bubble. It’s interesting to reread in the context of the current economy.
What jumps out to my eye is the fact that all of these crazy pie-in-the-sky predictions and business models have actually come to fruition in the 2020s. Telecommuting was becoming a material reality for millions of workers even before the pandemic. Webvan was an online grocery store which went bankrupt in 2001; similar models are now nearly ubiquitous worldwide.
Well-known hedge fund manager David Einhorn said Chewy CHWY 0.00 — which now has a market capitalization near $17 billion — was just another Pets.com. Beenz.com was digital currency a decade before Satoshi Nakamoto released his famous white paper. And in 2022, U.S. ecommerce sales cleared $1 trillion for the first time.
Dot-com bulls in 1999 and 2000 weren’t necessarily wrong, just early. Really, really, early, to be sure, and completely divorced from any fundamental realism, but not wrong. The world that investors, executives and reporters believed was on the way has finally arrived.
The 2020-2021 bubble will probably play out the same way, at least to some extent. The same two errors were made. Investors ignored valuation concerns, and again forecast that significant structural changes were going to happen far sooner than was actually possible. Zoom Video Communications ZM 0.00 is probably the paradigmatic example on both fronts.
But again, it seems likely that those changes will arrive at some point. There doesn’t appear to be the “buy Amazon AMZN 0.00 at $6 in 2001" kind of opportunity. But there no doubt will be at least a few names where the market simply lost patience too early, leaving attractive long-term opportunities.
That brings us to a pair of online education stocks, which might provide some value for investors with a long-term outlook.
Coursera: Disrupting Education
We believe the future of education will be characterized by blended classrooms, job-relevant education, and lifelong learning, and that online learning will be the primary means of meeting the urgent global demand for emerging skills.
More than any other stock in the space, Coursera exemplifies the potential opportunities from taking the long view. The company was founded in 2012 by a pair of Stanford computer science professors, one of which had launched a machine learning MOOC (massive open online course) the year before which attracted over 100,000 students.
Coursera has grown steadily since then, generating over $500 million in revenue in 2022. The company’s offerings range from “guided projects” that last less than two hours and cost $9.99 to full degrees priced as high as $45,000.
And when Coursera went public in 2021, and inserted the above quote in its S-1, there was plenty of reason to believe the company’s optimism. The pandemic upended higher education worldwide. Student loan debt — over $1.5 trillion in 2020, per the Federal Reserve (cited by the company) — is a significant and growing problem in the U.S. Even before 2020, the ‘old’ method of training teenagers in-person for four (or seven!) years in order to build a workforce was showing cracks that the pandemic seemed likely to expand.
Of course, the company also went public at a time when other “pandemic winners” were selling off sharply, and COUR has not been immune:
It’s not hard to be a little bit tempted. The size of the opportunity is enormous. Coursera noted in its S-1 that the global higher education market was $2.2 trillion in 2019 — and the online degree market just $36 billion, roughly 1.6% penetration. That figure should grow over time, and Coursera might be a reason why. Unlike, say, the University of Phoenix — the biggest online-only US player, now owned by P-E firm Apollo Global Management APO 0.00 — Coursera partners with existing and established universities. That in turn might strengthen the perceived value of the offering to both students and the employers they are trying to impress.
As with, say, online sales in 1999, customer behavior isn’t going to change overnight. But to at least some extent, it is going to change. And the valuation, relative to where most growth stocks currently trade, is not particularly aggressive. Coursera is not profitable, or particularly close when considering stock-based compensation. But the company does have almost half of its current market cap in cash and no debt, so solvency is not a concern. Meanwhile, on an enterprise basis, shares trade at less than 3x GAAP gross profit for 2022.
The near-term outlook, however, is more problematic. COUR has dropped 31% since its close on February 2. Part of the sell-off likely is due to the reversal in these kinds of battered names that rose so sharply at the beginning of the year (COUR was up 38% through the first four-plus weeks of 2023). But the fourth quarter earnings report highlighted some key concerns that have clearly dented market confidence.
Most notably, Coursera extended its key contract with a major customer — which appears to be Google — under clearly worse terms. The company is spending another ~$25 million in 2023 as a result, a roughly four percentage point hit to EBITDA margins. Gross margins are falling ~10 points and although that’s due more to a technical aspect of the revenue-sharing agreement (costs are moving from operating expenses to cost of revenue), a ~52% guide for 2023 does make the business model look less impressive.
Still, this remains a company with a massive opportunity in degrees, courses, and certificates that gets nearly half of revenue from overseas and is valued at ~3x 2023 gross profit (based on guidance).
So far, no one has done what Coursera hopes to do. Rival 2U TWOU 0.00, which we covered on Twitter last month, has lagged its own grand ambitions. As a result, its stock is down 90%-plus from 2018 highs. At some point, however, a company is going to truly change education. It’s just a matter of time.
Is Stride Finally Delivering?
Stride Inc. LRN 0.00 provides online services for K-12 students in the U.S., though a series of acquisitions in 2020 moved it into adult education as well. That latter market accounted for less than 6% of revenue in fiscal 2022 (ending June); the core business here is operating “school-as-a-service” as well as actual private schools which operate in either an online-only or blended model. Stride (then known as K12) launched the business in two states back in 2001, and went public in late 2007.
The market opportunity here isn’t nearly as large as that promised by Coursera. As Stride itself writes in the 10-K:
We anticipate that full-time online public schools will meet the needs of a small percentage of the overall United States K-12 student population, but that segment will still represent a large and growing opportunity for us in absolute terms.
Over time, LRN has been a mediocre investment. Since the IPO, shares have risen less than 4% on an annualized basis, but with a good deal of volatility along the way:
There’s been some controversy too. Back in 2013, hedge fund manager Whitney Tilson — a huge supporter of the charter school movement — eviscerated the company with a short thesis that compared the provider to predatory subprime mortgage lenders. A year later, the NCAA, the American regulatory body for college sports, said it would no longer accept coursework from 24 K12 customers to satisfy eligibility requirements. Many of those same schools were the subject of a detailed investigative report by a California newspaper in 2016, which accused the company of exploiting charity laws in the state.
But from 2016 lows, LRN has been a big winner. And it’s actually been one of the few true pandemic winners, notwithstanding a huge reversal during 2020:
source: YCharts, chart since 1/1/2020
Obviously, the pandemic itself had a huge impact. Even pro forma for the acquisitions, revenue soared 42% in fiscal 2021. Stride tacked on another 10% increase last year. After a hike following the fiscal Q2 report in late January, the company projects 6-7% growth this year.
But the company has also gotten its act together. The NCAA came around, the product appears to have improved, and profit margins have notably expanded. Adjusted EBITDA this year should more than double from FY20 levels.
Despite the rally — including a 29% spike after the Q2 release — valuation is not terribly onerous. LRN trades at about 17x this year’s consensus EPS estimate. There’s some stock-based comp in there, but not a ton: adjusted for dilution, shares are still at about 20x free cash flow.
There should be more room for growth ahead. Charter schools continue to increase enrollments; so do the number of families choosing home-schooling options. Given the political controversies over U.S. public education, those trends aren’t likely to fade away.
The pandemic has created significant structural change. One survey showed a ninefold increase in the number of school districts running a virtual school. Recent results from Stride itself too suggest that pandemic-driven changes aren’t necessarily going to reverse. The company has said it sees a ~$15 billion market in K-12 education; revenue this year should be about 12% of that figure.
It is a bit nerve-wracking to own the stock near the highs given recent history. LRN did soar after the Q2 report — but it tanked 29% after Q1 and 13% following the previous release:
But longer-term, this might be a stock where investors can put volatility to work for them. After all, the current price looks reasonably attractive. A cheaper price would look even better.
As of this writing, Vince Martin has no positions in any securities mentioned.
If you enjoyed this post you can help us by clicking the heart ❤️
Disclaimer: The information in this newsletter is not and should not be construed as investment advice. Overlooked Alpha is for information, entertainment purposes only. Contributors are not registered financial advisors and do not purport to tell or recommend which securities customers should buy or sell for themselves. We strive to provide accurate analysis but mistakes and errors do occur. No warranty is made to the accuracy, completeness or correctness of the information provided. The information in the publication may become outdated and there is no obligation to update any such information. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Contributors may hold or acquire securities covered in this publication, and may purchase or sell such securities at any time, including security positions that are inconsistent or contrary to positions mentioned in this publication, all without prior notice to any of the subscribers to this publication. Investors should make their own decisions regarding the prospects of any company discussed herein based on such investors’ own review of publicly available information and should not rely on the information contained herein.
It’s so long ago that four of the five links in the original version are broken. Readers will have to trust the research I did at the time.
For readers newer to the equity market, yes, less than two years after the 2009 market bottom claims of a new bubble already were circulating. In January 2011, an article published in Business Insider opened its case by noting the “eye popping fact” that a private company named Facebook had raised $500 million at a $50 billion valuation.
Our very first post began with a table highlighted in that 2011 piece showing the valuations of tech stocks at the peak. Cisco Systems CSCO 0.00 remains perhaps the shining example of how insane those valuations were. It's nearly impossible to argue that the company has been anything but dominant over the past 23 years. Its market cap is down more than 50% from the March peak, at which point it was the second most-valuable company in the world. (Proving that not only dot-com bulls made mistakes in 2020, the most valuable company at the time was General Electric GE 0.00, which has done even worse.)
There are no shortage of companies trying to disrupt education but not many have been particularly effective so the question is why? In particular, I don't think online learning is ever going to be an acceptable substitute for in-person learning. People (especially kids) need human interaction and accountability. There's also the social aspect to consider. Virtual reality may likely play a part in future education but I don't see any companies who are leading on that front. Coursera doesn't feel revolutionary but it is probably the most respectable option in terms of learning recognizable skills. Udemy is VERY hit and miss but also worth considering with ~600m annual revenues. It's possible we have no idea what the future of education really looks like.
This analysis needs to address the dozens of well funded and high valued private companies tackling the same market segments to be credible. Neither of these companies is founder-led nor do they have particularly interesting technology.