Chegg (CHGG 1.85%) is an education technology company that primarily serves college students. The company thrived at the pandemic's onset as millions of students were sent home to remote learning. Chegg's resources are helpful to students both online and in person, but more so online.
As vaccination against COVID-19 gained momentum and colleges asked students to return to campus, they balked at the idea. College enrollment fell considerably, and that has hurt subscriber growth at Chegg. The stock crashed 85% following the news, and management thinks the selling is overdone.
Chegg's buying back $2 billion in stock
On June 2, Chegg's board of directors authorized an increase to its share buyback program of $1 billion. That's on top of an existing $1 billion program it has nearly completed. That's a relatively massive stock buyback program. Chegg's market capitalization stood at $2.2 billion as of this writing. If it executes this most recent program in full, it could be that it buys back nearly 50% of its shares outstanding.
CHGG Market Cap data by YCharts.
Typically, when management undertakes a stock buyback, it signals to the market that it thinks the stock is undervalued. The signal is even more emphasized when the buyback is of this magnitude. So why is Chegg management so confident in the undervaluation of the business?
It could be that the fall in student enrollment is temporary. In the U.S., there are 1 million fewer students registered in college than before the outbreak. The employment market has been robust following the economic reopening with employers offering higher wages, sign-on bonuses, and other perks to attract workers to join. That has tempted many would-be college students to enter the workforce instead.
Another factor could be the overreaction to the news. Considering Chegg's 36% market share for U.S. college students, the fall in enrollment is likely to cost it $5.4 million in monthly revenue ($65 million annualized). To put that into context, the total revenue in 2021 was $776 million. In other words, the fall in enrollment is costing Chegg an estimated 8% of annual revenue.
Meanwhile, Chegg's stock price is down 85% off its high in late 2021 when news first started coming out about declining enrollment. The mismatch between the magnitude of the revenue decrease and the stock price decline could cause management to believe the stock is undervalued.
Investors can follow management and buy Chegg's stock
CHGG Price to Free Cash Flow data by YCharts.
Further substantiating its belief that the stock is undervalued is Chegg's price-to-free-cash-flow ratio of 15.7, which is the lowest its been in the previous five years. This is for a company that has grown revenue from $255 million to $776 million in that time and operating income from negative $23 million to a positive $78 million.
The icing on the cake is Chegg's business has a substantial competitive advantage. It owns 79 million pieces of proprietary content that students value highly. It has spent years and millions of dollars building this treasure trove of assets, making it difficult for a competitor to encroach on its business.
It's no surprise management is jumping at the opportunity to buy its stock at these prices. It would not be a bad idea for investors to follow suit.
