2U has seen investor skepticism as other online education stocks like Chegg have faltered

2U co-founder and CEO, Chip Paucek, Credit: 2U

Ever since 2U, Inc (NASDAQ:TWOU) held its IPO in March, I've observed skepticism among investors given the less-than-stellar performance of its publicly traded peers in the education technology space. After all, shares of connected education platform specialist Chegg (NYSE:CHGG) plunged more than 22% last quarter, after its results came in better-than-expected but forward margin guidance underwhelmed Wall Street.

So when a company representative reached out last week offering an interview with 2U co-founder and CEO Chip Paucek, I jumped at the chance to explore what makes 2U different. Chip previously served as CEO of Hooked on Phonics, and also founded Cerebellum Corporation, the company behind the award-winning educational Standard Deviants television program on PBS.

Here's a transcript of our conversation:

Steve Symington:

Thanks for taking the time to chat with me, Chip. I've always told our readers I love finding companies which "responsibly change the way we do things." And what better way to do so in education than by revamping the way things work? I'm really impressed with what you've done.

Chip Paucek:

Well thank you. First and foremost, in building a great company -- which I really think we are -- I think the key is that we're focused on the right thing, which is the long-term outcome of the student.

Steve Symington:

That's one of the things that stood out as I read the Impact Report you released today. And there are many great stats, with an 82% retention rate, and post-graduation job placement of 92%. As the third venture-backed education technology company in the past five years -- what makes you different?

Chip Paucek:

I really think -- and not to speak about the other companies -- but we really focus on what matters. We told our board a long time ago as we started raising money that we thought there would be a long-term correlation between our financial success and the university students' outcome. And while the university is our client, ultimately if the students have the right outcome, everybody would win. The company is maniacally focused on it, honestly.

Steve Symington: 

You also have kind of a novel approach at identifying those university partnerships -- which include some impressive names like UNC, Georgetown, USC, and Berkeley -- by focusing on quality over quantity. Can you explain a little more about your thinking there?

Chip Paucek:

Well each program we launch is a substantial investment for the company. Our contracts are 10 to 15 years, depending on the contract.

Steve Symington:

Okay...

Chip Paucek:

...and over the life of the contract we share tuition revenue, so 2U will take between 60% and 70%. And the primary reason for that is because we have most of the cost structure. The reason I bring that up with regard to your answer is each one of these is between $5 and $10 million of net negative cash flow over, let's say, the first three years on 2U's side. So it's a substantial investment. We have to be careful and thoughtful about rolling them out. This is not some rush to roll out programs.

Steve Symington:

Makes sense.

Chip Paucek:

We honestly have gotten to a point where, operationally, we can roll out more than we are. We promised the Street we'd roll out no fewer than four programs per year. And today we've certainly surpassed that. But we're trying to be thoughtful of both quality and profitability. We're pretty focused on getting the company to profitability, not just growth. 

Steve Symington:

There's a lot of pressure at this point -- having held your IPO less than two months ago -- to create shareholder value. How would you respond to skeptics of your strategy?

Chip Paucek:

I think 2U, from an investors' standpoint, is very much a long-term play. Everything about the way we run the company and the way we think about the company is long-term. And the fact that we'll invest that much money over the first three to four years of the life of a program -- by definition our model requires somebody to think more long-term.

Steve Symington:

Patience is a virtue, right? And you know at The Motley Fool we have no problem with that and helping shareholders understand that. One thing I also noticed in the Impact Report is the big difference between what you do and a Massive Open Online Course. You do it much differently with an average class size of just 10.4 students.

Chip Paucek:

Yes. Very, very intimate. These students are becoming Tar Heels, Trojans, and Hoyas. They're not just master's students. They're really becoming full members of the University Community. And that really is the original insight that made the difference with 2U as not necessarily a technology story. It's about getting the will of a great institution to say -- to make these students equal to the on-campus students.

Steve Symington: 

I feel like some of the massive online courses bring with them a certain stigma, and perhaps make it seem like online education is less credible than its brick-and-mortar counterpart. I love that you're focusing on that intimacy and making them feel like they're an actual part of the campus. People say you can see every facial twitch when you're actually watching other people, so you feel like you're there, you're engaged...

Chip Paucek:

With 2U, segregation of online students has ended. We really believe that, done this way, it's exceptionally high-quality. And I think the universities that embrace this form of online learning will win long-term. Because, honestly, it's just better.

Steve Symington:

So what about your prime growth opportunities. Where are you really focused on growing at this point?

Chip Paucek:

The growth story for 2U is incredibly obvious. It's really rare to have this kind of organic growth potential if we just put capital to work doing what we know how to do. There are many different verticals -- when I say verticals like disciplines -- we haven't touched engineering, we haven't touched architecture. [...] Next year we'll launch our first communications degree with Syracuse Newhouse. And so continuing to roll out high quality degree programs with really high quality brands that want to scale on a global basis, and then launching second programs in existing verticals. Because our job is not just to find any student, but to find the right student. And not every student is right for every school.

Steve Symington:

There's also the matter of flexibility. The Impact Report states you "now" offer mobile apps. How crucial is mobile to your platform?

Chip Paucek:

Critical. We are 100% cloud-supported and mobile-enabled. We don't own a server. Students need their access whenever and wherever they want it. We have students who have done live sessions from the battlefield in Afghanistan. We had a woman do her live session in the MBA program from her delivery room. She was in labor, and she went to class.

Steve Symington:

[Laughs] Now that's focus! And I also see there's an emphasis on field placement. You have a substantial field placement infrastructure in place. Can you tell me more about that?

Chip Paucek:

Yeah, it's a huge part of what we do. Georgetown's not going to make someone a Master of Science in Midwifery -- it's one of our degrees -- with virtual babies. You actually have to deliver the babies. So we use our solution to find a placement for students -- wherever they are in the country -- and then find a preceptor who's trained by Georgetown on the solution. And we then have people to the clinicals in their local area. It's a huge part of our job and I think it not only drives outcomes but drives satisfaction across the board for the students and faculty. [...] Most programs when they go online are self-placed, whereas we actually deliver all that to the students.

Steve Symington:

So how focused are you on international growth?

Chip Paucek:

Right now it's about 6% of our student base, and we have an office in Hong Kong for a reason. We firmly believe that this is a global play, and I think you'll see that increase over time. Our L.L.M. with Wash U was designed specifically for the international audience. It is for foreign attorneys who would like a base of U.S. law, and if they get this degree they can actually sit for the bar in several states here in the U.S. So international is very much part of our present and part of our future on a growing basis.

Steve Symington:

Well I look forward to seeing where you go from here.

Chip Paucek:

Stay in touch with us. You'll see a lot of announcements coming from the company, and I really appreciate you giving us a moment and some of your time.

Steve Symington:

Thank you for joining me, Chip.

Foolish takeaway
In the end, I'm intrigued by 2U's long-term prospects, and think investors would be wise to keep an eye on them as well. I also asked Chip whether he had an approximate time frame for when 2U might achieve profitability. He suggested we chat after tonight's earnings call, which marks 2U's first quarterly report as a publicly traded company. I'll be listening closely to hear what they say, so check back here at The Fool for the latest on 2U.

Steve Symington has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.