2U Inc Co-Founder and CEO Chip Paucek Talks the Future of Education From the Floor of CES 2017

Since its IPO in March 2014, 2U (TWOU -4.84%) stock is up over 160% as the company forges partnerships with famous schools, including Georgetown, Yale, Berkeley, and New York University.

Last week, Supernova analyst David Kretzmann spent time with company co-founder and CEO Chip Paucek at CES 2017. Tune in to learn more about 2U's unique business, Paucek's vision for the company, and what shareholders should watch in the coming years.

A full transcript follows the video.

David Kretzmann: David Kretzmann here with Motley Fool Supernova, and I'm thrilled to be joined by the co-founder and CEO of 2U, Chip Paucek. Chip, thank you so much for taking time out of your schedule to talk with us.

Chip Paucek: No problem. Thrilled to be here.

Kretzmann: Why don't we start off by [you explaining] just a little bit about 2U -- what the company does [and] what your mission is for people who aren't familiar with the company.

Paucek: We partner with top universities to build really high-quality online degree programs. Schools like USC, Georgetown, Berkeley, Chapel Hill. And all of these programs -- you're getting the same degree as you would on campus, but you're doing it online in live, face-to-face instruction with your professor.

The average class size across our portfolio is only 12 students. So super intimate live classes, and for the first time ever, you don't have to pick up your life, quit your job, and move to attend a great grad school, like getting an MBA, or a Master of Data Science, or even a Master of Nursing. So we do a lot of programs that people wouldn't know you could do online, like speech therapy, occupational therapy, and nursing.

Kretzmann: And once you have a program established at a college or university, what are steps that 2U takes to expand enrollment over time?

Paucek: We provide not only the funding to get the program going but a variety of services behind the scenes. One of the reasons most people haven't heard of us, even though we're public, is that we are inherently behind the scenes. These are Berkeley programs, or Northwestern programs -- they're not 2U students.

We provide the support to the students, we build all of the courses for the faculty, but it's the real faculty from the school. We do things like clinical placements for people that are doing, let's say, a midwifery degree. In one of our degrees, you're literally delivering babies, and you wouldn't want to go to a midwife that delivered a virtual baby. You have to go into the field. So we arrange those clinical experiences, and all of the technology associated with the entire experience is us.

Now, it's the same degree you would get on campus. It's the school's accreditation, the school's degree, the school's admissions decision. But one of the things we also do is help them recruit great students on a worldwide basis.

Kretzmann: And students who are enrolled in an online course. Do they get any sort of exclusive content or something that they wouldn't be able to get in the traditional classroom?

Paucek: Well, the way to think about it is it's like if you took the great campus instruction that you would see on campus, and you figured out how to bring that to life online. So the students are consuming a variety of content asynchronously. I hate that term, because people don't understand it but the canned content.

So we're filming professors creating high-quality online content, but then, each week, you're choosing a live class time, and you go to class with your other fellow online students, and you're live. So it looks a little bit like the beginning of The Brady Bunch -- not to date myself -- but with the squares.

You're literally live with your fellow classmates and a great professor. It's not like you're a camera at the back of the campus classroom. This is really you, live, with your fellow classmates, and people form relationships that you would not typically see in an online program. One of the things I'm proud of is when students describe what it feels like to be in one of our programs, the most common adjective is "intimate". You wouldn't think that was an online program, because you really meet people.

And then finally, you end up doing physical immersions where you go to the campus. Now, it's typically done over a weekend, so that you can do it on your own time. You don't have to quit your job. I would say, really, that's the biggest thing about 2U. I feel really blessed. The company's done really well.

We IPO'd three years ago. I would say it's a rare company that does well by doing good, and when students succeed in the programs, we succeed, because the business model is we share tuition revenue over a 10-year contract with a university. So when a student enrolls, we're taking more than half of that tuition toward 2U, because we're doing a bunch of things that might not be that sexy but are really important to deliver the degree.

Kretzmann: And what would you say is the biggest misconception either Wall Street, or the media, or the general public have about 2U or this movement toward online higher education?

Paucek: I guess I would say two things. As CEO, my biggest challenge is preconceived notions of online education are still really bad. People, in general, when they think online education, they think University of Phoenix, not Yale. And Yale is, indeed, one of our partners. So that will change over time, and we actually really believe that puts sort of a long-term wind at our back, because if you think about it, this is a moment where for the first time ever, you don't have to pick up your life, quit your job, and move to attend grad school. All of our programs are graduate programs. That's a pretty big secular change.

From a Wall Street perspective -- our IPO -- I give our underwriters Goldman Sachs and Credit Suisse a ton of credit, because we were a one-off IPO, and what I mean by that is Wall Street likes familiarity, and our comps weren't as obvious. Like we are a technology company that also is in education, but we're not a for-profit education company. So it's not our program, it's Georgetown's.

So they did a great job, and over time, educating the Street about our business model, and how it works, we've had 11 straight beaten raises and the company's done pretty darn well post-IPO.

Kretzmann: So you already have a lot of schools under your umbrella today. Do you have, say, a top three or five schools that you don't have yet that you would love to have? Then, kind of a second part to that question. What does the international opportunity look like for 2U?

Paucek: To answer the second one first, we're being very careful, because I learned a long time ago. This is my third venture-backed company, and it's really the only one that had this kind of success. And when I think about what I would want to tell my 26-year-old entrepreneur at 46 is the peer-power focus. We've stayed really focused on delivering for our high-quality U.S. clients, because each program we build is a substantial capital investment -- $5 to $10 million of net negative cash -- so non-trivial expense to do each of these. So we haven't done a non-U.S. school yet, except a dual degree with a great school in Mexico and a school, here, in the United States, so Monterrey Tech and Wash. U.

Over time, we do believe it's a global story, so we recently announced that Lord David Willetts from the U.K. (the former Minister of Universities at the U.K.) has come to 2U now helping us plot our global strategy, and we have an office in Hong Kong for a reason. We do think the notion of being able to pick up your life, quit your job, and move ... that whole story does apply to a worldwide audience.

Kretzmann: The first question was the top three or five schools ...

Paucek: So I'd say the real success behind the scenes at 2U has been about leveraging data to really drive the company's performance, and so several years ago, we built an algorithm that helps us predict enrollment. So I can, with pretty high confidence, give a provost a prediction for what it would be if I took a program online.

And because of the cash investment, not every program is appropriate for 2U, so we actually have a really specific, targeted list and what I'm excited to say is since IPO, we've gradually increased the number of programs we'll do each year from four at IPO to 10 this coming year.

And so a pretty major expansion of our ability to work with new schools. I can't tell you who's about to come in, but we have some great new programs we'll announce. We just announced one with Berkeley. We'll announce some in the next 45 to 60 days, and I'll be very excited. You'll be my first call when we're able to.

Kretzmann: We're looking forward to that. So you have your hands, obviously, in higher education. You've followed the field for a long time. What are some of the biggest changes or trends we should be watching for over the next five to 10 years or so?

Paucek: I think right now, one of the reasons I feel very blessed to be here is this story is not about me. It's about a great team at the right time with the right idea that executed -- this notion of the sleeping giants awakening in higher ed. For a long time, online education was sort of only schools in the proprietary sector.

And the reality is the sleeping giants -- guess what? They're awake, because if you look at what's happening across our partner portfolio, you have schools like the University of North Carolina at Chapel Hill. Their MBA program now has over 1,000 students in that program, and they're exceptional, and so you have a great dean like Doug Shackelford at that school that realized the power of this and believed early and now is doing really well with us from that. I give the early advocates a huge amount of credit. So I think from a trend standpoint, you're going to see more and more non-profit schools coming online. For graduate education, it's super obvious.

And then, I think using data to help drive things like student retention -- I mentioned earlier that we're a company that does well by doing good. I'm not saying that to sound good. The reality is if a student comes into a program, and we've recruited that student, and they drop out, we lose a lot of money. As a student succeeds and then graduates, we actually have a really good financial outcome.

And the tie between that, really, if you look at the history of 2U [is] we had some investors early, some early venture capital investors that believed in the long-term correlation between our financial results and the student outcomes in the programs. So I think using data to help drive high-quality retention is pretty critical. Just a little plug for us is their overall retention rate is about 84%.

And then I guess I would say, finally, online education is not your grandfather's online education. This is a very intimate form where you're getting the same degree as you would on the campus, and it's really all about quality. I mean, the story of 2U is about doing the hard work to drive quality. This wasn't easy, and we'll be a difficult company to copy, because it's a complicated business. But super excited with where we are today, and I think over the next five to 10 years, I expect to be here, and I think we've got a really good run ahead of us.

Kretzmann: So along those lines, one last question for you. At The Motley Fool, we're investors focused on the long-term. What are some of the main metrics investors should be watching over the next three to five years to gauge the success of 2U?

Paucek: When we IPO'd, we told people we would reach adjusted EBITDA profitability in three to five years, because the early programs are generating profit, and the newer programs don't. It takes time for a newer program to start generating a return. And what's happening at 2U -- one of the reasons more people are getting interested in our company as an investment -- is that the company is getting significantly closer to that period. So this past year [of] 2016 was our first year of being adjusted EBITDA profitable as a company, and that's a couple of years ahead of where we thought it would be at the time of the IPO. So that's kind of a critical metric.

We've also told investors to expect that each program that we bring in can generate somewhere in the ballpark of $16 million of revenue per year when they get to a steady state. And so bringing in more programs, announcing more programs is a key catalyst for our company as an investment. So investors pay a lot of attention to our program announcements and as I mentioned, you'll see some soon.

Kretzmann: Great. Well, we'll leave it at that. Chip Paucek, thank you ...

Paucek: Can I give you my hashtag, though?

Kretzmann: Sure.

Paucek: Our hashtag is #NoBackRow.

Kretzmann: #NoBackRow?

Paucek: #NoBackRow. Everybody knows the back row -- the seats closest to the exits. What if you could eliminate that back row and bring every student forward? And we think that's what it feels like to be in one of our programs, because when you're in that Brady Bunch format, you're in the front row. You're definitely in the front row. So no back row.

Kretzmann: No back row. We'll leave it at that. Chip Paucek, co-founder and CEO of 2U, thank you so much for taking the time. We really appreciate it, and Fool on!