Chegg: Poised For Additional Growth & Upside

chgg

Background

Chegg ($CHGG) is an online book rental company that allows students to rent new/used textbooks for a fraction of the price of purchasing them.

This up-and-coming startup solves a real problem: it allows budget-savvy undergraduate and graduate students to rent books and avoid pricy on-campus book stores. For many students, renting books each semester is much more economical than purchasing them outright.

The company went public on November 13, 2013 and shares closed at $9.68 on the opening day and since then shares have lost roughly one-third of their value.

digitalbook

Shift To Digital

Shares of Chegg have been under siege lately as the company is undergoing a painful transition from a physical textbook rental service to a cutting edge eBook rental service. As a result of this shift in strategy, margins have suffered and the company has racked up some sizable losses.

Not too unlike Netflix, when they rolled out the ill-fated Qwikster and attempted to accelerate the adoption of streaming, investors typically get nervous when growth companies undergo such a drastic shift in strategy. Especially when the “old” model is driving such a large proportion of revenue/earnings.

Although some analysts have criticized Chegg’s management team for going “all in” on eBooks, I have full faith that Chegg is making the right call for two reasons.

  1. While the legacy print business currently accounts for the majority of Chegg’s revenues/margin, it’s a “slow growth” area and requires heavy cap-ex / depreciation / and inventory investments.

  2. eBooks are a high margin, high growth, high upside area: ebook sales are projected to surpass physical textbooks by 2017 according to PWC. It’s a relatively “lean” business model too, as it requires minimal Cap/Ex investments compared to the traditional book rental model.

chegg management

Bull Case

Despite the short term negativity towards Chegg shares, I am confident that this company has the right strategy by focusing on where the most upside is.. digital textbooks.

Three years ago, Chegg’s digital revenue was $0 and it increased to $16.7M in Q4 2013, which represents 70% growth year-over-year.

It amazes me how so many wise investors have overlooked this strong growth company simply because of their “legacy” business. I guess that is understandable though.

Investors do not typically get excited about high-cap ex / low growth sectors, rightfully so. However, they are completely forgetting that Chegg is at the forefront of an exciting new growth market with almost limitless upside.  Right now, the company is in the middle of a major inflection point and it represents a great opportunity for growth investors.

Chegg is doing EXACTLY what any growth company should consciously do: shift away from low growth / upside markets (print rentals) and move up the value chain towards high growth / upside markets (eTexts).

It reminds me of this quote from hockey great Wayne Gretzky..

A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.
- Wayne Gretzky

You can apply that principle to startups as well, as the truly great startups are focused on where the market is going and are not concerned with “what has worked” in the past.

Chegg’s management team, especially CEO Dan Rosenweig (fomer YHOO COO), certainly have a long road ahead, but I am confident they will prove the skeptics wrong.

Price Target

My proprietary DCF model suggests CHGG shares are worth at least $7.50, which represents ~15% upside.

Additional research and financial models are available for purchase – contact [email protected] for more information.



Disclosure: Long CHGG