Barron's Streetwise - The Netflix of Homework Help

Episode Date: September 3, 2021

Chegg CEO Dan Rosensweig talks about online tutoring, fixing college, and what he learned from Guitar Hero. Learn more about your ad choices. Visit megaphone.fm/adchoices

Calling all sellers, Salesforce is hiring account executives to join us on the cutting edge of technology. Here, innovation isn't a buzzword. It's a way of life. You'll be solving customer challenges faster with agents, winning with purpose, and showing the world what AI was meant to be. Let's create the agent-first future together. Head to salesforce.com slash careers to learn more. 50% of high school students don't go on to college. Of the 50% that do, 43% don't get a degree. The average salary when they graduate is $25,000.

Their debt is higher. So I ask you, what grade would you give a company if that was our performance? Welcome to the Barron Streetwise podcast. I'm Jack Howe. The voice you just heard is Dan Rosenzweig. He's the CEO of Chegg, a $12 billion company that sells online help for students. In a moment, we'll hear from Dan and a Wall Street analyst about how the pandemic

sparked ferocious growth in ed tech or education technology. And why there could be much more growth to come even now that kids have returned to classrooms. Dan, as he just heard, also has some strong opinions about the state of college in America. college in America. Listening in is our audio producer, Jackson. Hi, Jackson. Hi, Jack. It's back to school time and you're a man in your mid-twenties. I'm about twice that age. Neither of us are in school, but you're a lot closer to your school years than I am. A lot of people my age haven't heard of Chegg, but you are no doubt familiar with them. Am I right? You're right. Did you use it for school help? Yeah, I did. Did you have a subscription to it or did you use someone else's password? I used someone. May I remind you that you're under oath?

I used someone else's password. I plead guilty. Well, we're going to talk about that in a minute. I went to school before the internet era, back at the tail end of the ditto era. What's a ditto? Well, have a look sometime at a landmark 1982 study of American secondary education called Fast Times at Ridgemont High. Sorry I'm late. It's just like this new schedule is totally confusing. There's a scene where a stern teacher named Mr. Hand passes course materials out to the students. As a matter of habit, they raise the papers to their faces and sniff deeply.

to their faces and sniff deeply. These students are sniffing copies made on a ditto machine, also called a spirit duplicator, because the machines use solvents like spirits, which gave the purple ink on fresh dittos a distinct smell, kind of like dry erase markers, which is why Mr. Hand's students were sniffing them. If you went to school during the ditto era,

information transmission was spotty to say the least. If you needed homework help, and your parents, like most parents, weren't especially handy with the quadratic formula, then you needed a smart friend. And if all your friends were, let's say, more fun than smart, you were out of luck. Today, on the other hand, it's like a magic trick. High school and college students can take a picture of a handwritten math problem with

their smartphones. The internet will figure out what kind of problem they're working on and how to get the answer, and it'll teach them step by step. All kids effectively have a super smart friend on 24-hour standby, not at all like the ditto sniffers I hung out with. Ditto sniffer. It's like the next OK Boomer. The service I just described is called Math Solver, and it's one of a suite of online subscription products offered by a company called Chegg. Young people are already familiar with Chegg. In surveys, 87% of college students say they've heard of its services. Fellow Ditto-era alumni might want to get to know Chegg, too, because its stock is up more than 1,000% over the past five years.

We're going to talk a lot about Chegg because this company is absolutely built for the situation that we're in for digital remote learning. Now, if the pandemic left students and your family needing a little extra help with their schoolwork, you're not alone. family needing a little extra help with their schoolwork, you're not alone. Last year, revenues for Chegg jumped 56 percent, which was double the growth rate from the prior year before the pandemic. We recognize that there's no support for students. So if you start in high school and you start in the state of California, college guidance counselor to student ratio is one to 1,000, which is the equivalent of zero. So you have people of diverse backgrounds, diverse economic backgrounds, diverse racial backgrounds, diverse immigration backgrounds, and they get absolutely no support as they come up through the education system. So imagine when they take on college, there's no ability to meet with a professor. There's no tutoring.

There's no ability to meet with a professor. There's no tutoring. There's no affordable way to teach you to help mitigate all of the things that you didn't learn effectively in high school. Well, along comes Chegg, who says, you know what? We're here for you. That's Dan Rosenzweig, who was made CEO of Chegg back in 2010. The company traces its roots back 10 years before that, when some Iowa State University students started a message board called Chegg Post. The name Chegg is a combination of chicken and egg, as in, which came first, the chicken or the egg? It's meant to reflect that age-old frustration of recent graduates that you can't get a job without experience, and you can't get experience without a job. The company focused on helping students find internships and scholarships and fill out college applications. But around the time Netflix first rolled out streaming

capabilities, two of the early players in Chegg Post, Osman Rashid and Ayush Pumbra, players in Chegg Post, Osman Rashid and Ayush Pumbra, rebranded the company as Chegg and shifted the focus to a Netflix-style rental service for textbooks. And they eventually hired the CEO of the video game series Guitar Hero to run Chegg. Here's Dan. The plan was identify the biggest pain points for college students and then ultimately high school students and then in the future, recent grads and solve them for them. The biggest one, of course, is the cost of college, which is why we originally invented the textbook rental model. We couldn't control the cost of the curriculum or the class or, you know, how much they charge you to eat on the meal plan or go to college or the fact that or the fact that you have to pay $3.50

to take $10 out of the cash machines, all things that are just incredibly unfair. They just keep charging tolls for college kids all through their experience. So we focused on the cost of textbooks, which historically had actually been 25% of the cost of tuition, which if you think about that now is just nuts.

People paying thousands of dollars a year for textbooks. had actually been 25% of the cost of tuition, which if you think about that now is just nuts. People paying thousands of dollars a year for textbooks. So the textbook rental model, which we're still in, but it isn't the core to our business anymore, and we do millions and millions of books, we lower the cost on average from $200 a textbook to about $25 a textbook. Today, Chegg makes most of its money from services, including Chegg Study for homework help at $14.95 a month and Chegg Writing with personalized feedback on papers for

$9.95 a month. There's also a bundle for $19.95 a month that combines those two and the math solver I mentioned earlier. Chegg has a network of tutors who can provide live assistance. Jeff Silber, an analyst at BMO Capital Markets who covers edtech, says there are two reasons Chegg has gained so much financially during the pandemic. The first is that when students left campuses and returned home for online classes, they lost whatever support they had for schoolwork. The second reason, and Jackson, this part is for you, is more technical in nature. There had been a lot of password sharing on campus where, you know, use an example,

you had a fraternity that may have just gotten one license or one subscription and shared it with all the frat brothers. It was a lot harder to do when everybody was more dispersed. So again, folks went home. They couldn't just either reach across the room or go to the frat house and get somebody's password and log in. Password sharing has been curbed by security measures like multi-factor authentication. But still, is Chegg just a lockdown winner or is it a company that can use its lockdown boost to continue growing quickly? It bodes well that last quarter, when many students were already back to school, services revenues continued growing quickly by

38% year over year. Here's CEO Dan. Peloton, Netflix, Disney+, all those companies, they accelerated their growth. Chegg is different. We were doing phenomenally well before the pandemic. We did incredibly well through the pandemic, and we will continue to do extraordinarily well post-pandemic because what we do isn't dependent on where you are physically. What we do depends on whether or not you need help in learning or not. And so whether you're at a community college, an online school, whether you're in person, whether you're offline or online, whether you're global, you still need support in your academic help. And the more students are seeking help, the more they're seeking it online, the more they want quality and affordability. And on demand, they come to Chegg. Dan says Chegg has 67 million questions that have already been asked and answered and are sitting in its database. So when a student types a question into Google,

they're likely to see a Chegg page. That's the primary way the company gains new customers. It also benefits from word of mouth. Dan says his ambition pre-COVID was to grow revenue by 30% a year, and that now revenues are double what they were back then, and growth is even faster than what he had aspired to. The other fascinating thing about our model, and we're very fortunate, is it's one of those models where the cost of the next customer is actually cheaper than the previous one. So not only are we growing top line, we're growing profitability and growing percentage of free cash flow at the same time. There aren't a lot of businesses like this. So what's not to like as an investor? Well,

Jeff at BMO downgraded Chegg stock to neutral last year because much as he likes the company, he thought the stock had gotten ahead of itself. I was right for about a week, step back, and then went right back up again. And sales growth, earnings growth has gone beyond where we expected it a year ago. The multiple has contracted a bit. I'm not a technology analyst. I'm more of an education analyst. So looking at something at 15, 16 times sales, it was a little tough for me to recommend. It's a great company. And if you can get comfortable with the valuation, more power to you. We've talked about this many times in this podcast. It's always difficult to decide whether shares of a fast-growing company have gotten too expensive.

On the whole, analysts have been growing more bullish on Chegg stock. At last count, 16 of the 18 who cover the company, according to FactSet, recommend buying shares. But shares do look expensive. This year, free cash flow is expected to approach $200 million. Two years from now, it could reach $300 million. That figure would put today's price at about 40 times free cash flow. I asked Dan how big he thinks Chegg can become, and he simply pointed out that half the world's population is below 30, which I take to mean pretty darn big. We'll see. Jeff at BMO is broadly bullish on ed tech. Investment opportunities there have expanded with some recent IPOs and

more are coming. I asked Jeff to share his top stock picks. What is called 2U, T-W-O-U is the ticker. And they've also been around probably for about, I think, 13 years. And they help traditional universities put programs online where they take all the risk, they make all the investment, and then they share revenues with the school once you start to get students in. So that's 2U. There's also Stride. Ticker is LRN. And their core business is actually running online public schools, and their core business is actually running online public schools, which most people didn't even know existed 18 months ago. Before COVID, you could actually go in certain states to a public school online for free. Obviously during COVID, everybody was going online,

but what you saw was a lot of the traditional public schools didn't do a great job online. Parents wanted to go with a company that had good experience. Their stride is that company. And they're also going into the skills market, like we talked about with Chegg as well. So is 2U. So there's a growth engine there as well, but you're only paying one-time sales for that one. You heard Jeff mention the skills market and how a lot of companies are getting involved. That consists of short, job-specific courses that aren't part of traditional degree programs and could be important beyond investing for people who are interested in improving the financial return of education spending. When I asked Jeff what's a product or service he's seen that's a slam dunk for improving education,

he mentioned those short courses or boot camps. The boot camps initially started for, you know, students that might have finished college, but for whatever reason, weren't successful in their own career and wanted to do something different, but didn't want to go back and get an MBA and go back to school full time. A lot of these boot camps for maybe, you know, 12, 15 week courses that you can get a specialty in either computer programming, they have them for healthcare, data sciences is another one that does it, where, again, it's a little bit intense. It's not for everybody. But after two to three months, you can probably get a job that you wouldn't have been able to get beforehand. And in many

cities, they're really pretty good paying jobs. So the return on investment for some of these short courses or boot camps are really dramatic. And I think the pandemic has only increased the acceptance of that. That's something two or three years ago we didn't see as much. I asked Dan at Chegg a similar question. What's the low-hanging fruit? To make education better, what should we change first? So we got to ask ourselves, if taxpayers are paying, if people are going to state schools, that school should be focused on educating the student for the modern workforce and modern society and not have tremendous amounts of money being spent on things unrelated to that.

Teachers should be teaching more than twice a week. You know, we invest in these tremendous research institutions and we should invest in research, but it shouldn't come out of the cost of tuition. institutions and we should invest in research, but it shouldn't come out of the cost of tuition. Fund research if you want to fund research. Fund education if you want to fund education. But don't fund teachers to go do research. Fund teachers to teach. That's first of all. Second of all, it has to be hybrid. You have to be able to get access to learning from wherever you are, whatever time of day you're available to do it. Because we live in a gig economy, are, whatever time of day you're available to do it, because we live in a gig economy, multifamily employment economy, long hours economy. And so people need to be able to learn not when the school says the class is available, but when they're capable of accessing the

information. One last question, and yes, it's about Guitar Hero. I asked Dan, what did you learn from your Guitar Hero days that you can use at Chegg? And by the way, can you shred? So my Guitar Hero game, unfortunately, sucked then and sucks now. So we created Band Hero so that I can play the drums, which I was much better on. But as a parent of teenage girls, being able to sign Taylor Swift, Eminem, and Jay-Z to the games made me an actual hero in my household for a year. What did I learn? Actually, it's a great story of what I learned from Guitar Hero. I think I learned a lot from Ziff Davis and being in computer magazines about the evolution and the power of what technology could do. I think I

learned from Yahoo the power of the cloud and on-demand where you can access whatever you want, whenever you wanted it, wherever you wanted it, from whatever device. But the thing I really took from Guitar Hero was that my customer was Walmart and my consumer was the kit. So I had to sell to Walmart who had to sell to the mom or the dad who then bought it for their kit. When I went to Walmart to convince them to take band hero, DJ hero and guitar heroes, we were going up against rock band Beatles. So this was like the moment. My assumption was I'm going to hold back the amount of games I give them because they're going to have tremendous demand for it. Right. And I'll be in control. They're like, this is great.

You just need to tell Eminem and Jay-Z to clean up their lyrics a little bit before you put the game in. I was like, okay, in order for me to sell my game, they have to change what they want to say to the world. And this is Eminem right after he's coming out of rehab, telling his own life story. I'm like, you know what? I'm just going to sell it all off Amazon because if I have to get shelf space from you by trying to do something your corporate office wants that has nothing to do with what your consumer wants, I can't be successful. Thank you for listening. Jackson Cantrell is our producer. He's no ditto sniffer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. If you listen on Apple, write us a

review. And if you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's at Jack Howe, H-O-U-G-H. See you next week.