2U Inc.'s (TWOU 4.17%) stock has had an amazing run since the company went public, up over 500% since the March 2014 IPO. The online education company posted stellar 2017 results and has continued robust revenue growth in Q1 2018 with 42% year-over-year growth. But the company still hasn't posted a profit, with a net loss of $29.4 million in 2017, compared to a loss of $20.7 million in 2016. First-quarter results posted in early May showed a quarterly net loss of $14.9 million, and is the company projecting a full year net loss between $46.6 million and $44.7 million. 

Let's look at 2U's business model for its digital graduate programs and why the company is still not profitable.

How does 2U make money?

In 2017, 94% of 2U's revenue came from its digital graduate programs (DGPs), which are developed by 2U, but with a university's content and instructors. The resulting DGP is marketed under the university's name. Before starting work on a DGP, 2U enters into a long-term agreement with the university. 2U bears all the up-front costs for the development, and once the program is active, it collects 60% of the tuition. This share of tuition may seem steep, but 2U's up-front costs can range from $5 million to $10 million plus.

Before 2U begins development on a program for one of its customers, a detailed financial model is built in collaboration with the institution. An example of how the model works is shown in the table below, which is based on a model 2U presented.




Revenue share









Note: The above model assumes that tuition is $100 and split 60% to 2U and 40% to the university. Numbers are rounded.

2U's costs include marketing and sales, service and support, and development. The biggest university cost is instruction, along with other costs such as academic advising and admissions. On the bottom line, the university actually nets more than the company because it spends less. This financially risk-free model is highly attractive to 2U's customers, but it doesn't mean that every degree program will be a candidate to become a DGP.

Students on graduation day throwing their mortarboard hats in the air.

Image source: Getty images.

Selecting the right programs

At the KeyBanc Capital Markets Emerging Technology Summit in February, CFO Cathy Graham said the company has a proprietary model that picks content with the highest probability of success based on the university, degree, and region. The results have been impressive.

The company has 55 different programs across 25 universities, in 23 program verticals (which include nursing, public health, business, data science, speech pathology, and engineering). In the February earnings call, the company said its top program based on student enrollment last year was developed in 2010, which shows that the company's rigorous selection process has long-lasting benefits.

Chart showing digital graduate programs released by year. 2009 was the first year with one, rising to 14 named programs for 2018 and a target of 16 for 2019.

The circles represent digital graduate programs and showing 2U's accelerating launches in 2019. Image source: 2U.

Even though the company had 34 active programs collecting revenue in 2017, it didn't show overall profitability for the year, and there's a good reason.


Once a program is launched, it takes three to five years for 2U to recover the up-front costs. After that, the company expects to earn $5 million to $6 million per year in EBITDA from an active program. With long-term contracts of 10 to 15 years, the company is building a large portfolio of programs that will earn revenue and profits for years. But it will take some time for these profits to show up. About half of the company's active programs are two years old or younger, and development costs are going up as the company accelerates new program launches. In 2017, 2U launched 10 programs. It's targeting 14 programs in 2018, with 2019 currently projected at 16.

Doing some back-of–the–envelope math for 2018 using the range of development costs and EBITDA numbers mentioned earlier in the article, the company is spending more than it's making. For 2018, 2U has only 13 programs that are 4 years old or older, bringing in an estimated $65 million to $78 million in EBITDA. Development of 14 new programs in 2018 will cost between $70 million to $140 million. This is an overly simplified view of 2U's business, but it shows why the company isn't profitable yet.

The company has a long-term goal of over 200 domestic programs and is just getting started with its international graduate programs. (It announced in February that it had partnered with University College London to offer an MBA program -- its first international graduate program -- with a 2019 launch anticipated.)

It will take a while before program profits aren't reinvested in new program development. But with the company's healthy balance of cash and cash equivalents of $182 million as of the end of Q1, these rising development costs shouldn't worry investors.

2U is investing heavily to drive growth, and is projecting its DGPs will continue to deliver in excess of 30% top-line growth for the foreseeable future. What's even more exciting for investors is that the company is using the same selection process and invest-to-grow system for its short courses and international graduate programs. Profits may not be around the corner for the company, but with strong growth and a healthy cash position, investors should not be concerned.