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Is 2U Stock a Buy?

By Brian Withers - Nov 28, 2020 at 8:29AM

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The company is in the middle of transitioning its business. Can this pivot help it capture more market share?

2020 has been an especially difficult year for higher education with the unprecedented challenges brought on by COVID-19. Just about every college has adopted virtual learning in some form and is trying to make the best of a tough situation. But 2U ( TWOU 1.75% ) has been partnering with universities since 2008, creating engaging online experiences for hundreds of thousands of students. Given that online education is only growing, should investors get in on the stock? Let's find out. 

A business in transition

2U is in the midst of a massive transformation of its business. Four years ago, it was totally reliant on its graduate programs for revenue growth. This required the company to invest up to $10 million to develop each program with a partner university. As a quality program takes time to develop, it could be a year or more before 2U would see revenue from students. Once the completed online program is launched, it is branded under the university name, and tuition is set by the university as well. 

A few years ago, the company realized this operating model with heavy upfront investments wasn't sustainable long term. It has significantly reduced the number of high-end programs it was launching and reduced the investment for the ones it did create.

Another key part of this transition was two acquisitions: Get Smarter (a short course online development company) and Trilogy (an IT boot camp provider). These investments are focused on shorter learning programs that are quicker to develop and provide a faster return. They also provide 2U's more than 75 university partners a means to expand into new educational non-degree tracks. These could be an attractive alternative for adults wishing to enhance their skills without the cost and time burden of a graduate degree.

2U Metrics

Q3 2016

Q3 2017

Q3 2018

Q3 2019

Q3 2020

Total revenue

$52.0 million

$70.3 million

$107.0 million

$153.8 million

$201.1 million

Grad degree revenue

$52.0 million

$65.9 million

$89.7 million

$103.4 million

$122.0 million

Alternative credential revenue

N/A

$4.4 million

$17.3 million

$50.4 million

$79.1 million

Alternative credential % of total

N/A

6.3%

16.2%

32.8%

39.3%

Data source: Company earnings reports. Table by author.

You can see in the table above that over the last four years, the top line has almost quadrupled, thanks to a combination of more university partners, more program offerings, and more students.

Recent results show progress

In its most recent quarter, organic revenue growth accelerated to 31% year over year, up from 18% in the second quarter and 17% in the prior-year period. This strength was primarily attributed to its alternative credential segment which surged 57%.

Key quarterly metrics

Q3 2020

Q3 2019

YOY change

Revenue

$201.1 million

$153.8 million

30.7%

Loss from operations

($45.9 million)

($135.0 million)

N/A

Graduate program segment profitability

8.0%

1.2%

+6.8 percentage points

Alternative credential segment profitability

(7.6%)

(23.7%)

+16.1 percentage points

Cash and cash equivalents

$481.3 million

$154.1 million

212.3%

Long-term debt

$268.2 million

$245.9 million

9.1%

Net cash used in operating activities*

($6.9 million)

($85.7 million)

N/A

*For the first three quarters of 2020 and 2019, respectively. Data from company earnings report. Table by author.

In the most recent earnings call, CFO Paul Lalljie said that the company's focus on "improving operational efficiency, sharpening the way we allocate capital across the portfolio, and boosting our liquidity position" is paying off. It is clear that revenue growth is solid with expenses declining, and segment profitability, cash flows, and the balance sheet all improving year over year. But there's still work to be done. 2U still isn't cash flow positive, and its alternative credential segment is still a money-losing business.

But headwinds are blowing 

Even before the coronavirus, the value of an ever-increasing cost of higher education has been put into question. Tuition costs since 1998 have more than doubled. With COVID-19 driving the on-campus experience online, many students are wondering if an expensive degree is really worth it.

For the fall 2020 semester, enrollment for freshman college students is down an unprecedented 16% nationally, according to data from the National Student Clearinghouse Research Center. This deep drop in enrollment is putting colleges that were financially stretched in an even more tenuous financial situation.

Student taking notes while watching online class with his laptop.

Image source: Getty Images.

But there are even more headwinds for universities. Tech companies are getting in the game with alternative tools and educational opportunities. Amazon provides a platform for educators who want to publish educational material. Google, a subsidiary of Alphabet, provides tools to students and teachers while also offering Google-branded certificates for high-demand jobs like an IT support technician. IBM has its own skills academy, with state-of-the-art technological content provided for free. 

The coronavirus has accelerated the popularity of college-alternative programs. These less costly, highly-specific offerings will likely continue to attract students even after the pandemic is over. 

So is 2U a buy?

2U is starting to see positive results from its transformation efforts, and the stock has responded with a 39% gain over the past 12 months. Its upward momentum and clear progress may attract some investors, but for me, there are still too many unknowns. 

The coronavirus has heightened the acceptance of non-traditional educational paths. With large, deep-pocketed new entrants in the industry, it remains to be seen what long-term impact this increased competition could have.

And the company is still heavily dependent on its graduate segment, where its partners control the pricing of programs. If tuition is priced too high, the program may struggle to attract students (resulting in decreased revenue share for 2U). If tuition is cut to make the program a more attractive value, that also reduces 2U's revenue share. This is an especially critical decision now that higher education faces more uncertainty than ever.

Management is making all the right moves, but in the end, this company is a service provider, tightly tied to the success of its university partners. I suggest investors stay on the sidelines for now.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

2U, Inc. Stock Quote
2U, Inc.
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$23.79 (1.75%) $0.41
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AMZN
$3,507.07 (-1.53%) $-54.50
International Business Machines Corporation Stock Quote
International Business Machines Corporation
IBM
$117.10 (-1.18%) $-1.40
Alphabet Inc. Stock Quote
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