The company I’m about to run through my C.H.A.O.S. tech stock screener is at the heart of one of the most staggering and undeniably “chaotic” trends in America today – the growing costs of higher education.
It shows absolutely no sign of slowing down, either.
As such, the company is perfectly positioned to capitalize on it – and generate handsome profits for investors.
Just consider a few of the mind-boggling facts in this industry…
- In 2013-2014, the average cost of tuition fees at private colleges and universities was $30,094, according to the College Board. The number drops to “only” $22,203 for out-of-state students attending public colleges.
- CNN says students who graduated in 2013 faced an average debt of $35,200. The total student loan debt burden is an eye-popping $994 billion.
- By 2023, student loan debt will exceed the median annual income for college graduates ($49,648), predicts The Huffington Post.
- And the most expensive place in the country to get educated? The Ivy League’s Columbia University in New York. It charges $47,246 per year, according to U.S. News & World Report.
And guess what? With this year’s graduation season having just passed, the bills will start rolling in soon – and recent graduates will be “congratulated” with a multi-year debt burden.
Talk about chaos!
And while this company won’t lower tuition fees, its technology is capitalizing on a stunning upward trend. But is the stock a “Buy”?
2U, Inc. (TWOU) is a software technology company that provides cloud-based, software-as-a-service (SaaS) solutions to the education sector.
Specifically, it allows universities and colleges to provide real-time online education to students through a comprehensive “online campus.” The web-based platforms provide the infrastructure and content management that enables institutions to attract, enroll, teach and support students across the world.
In doing so, it makes online and mobile education more immersive and engaging – and 2U is fast becoming the new standard here.
Today, however, C.H.A.O.S. will do the schooling…
And what you’ll learn will bring a whole new meaning to the term “financial aid.”
Let’s get going…
2U is a Wall Street newbie, having only debuted on March 27. But it’s done so with solid revenue growth…
The first quarter saw revenue jump by 36% from Q1 2013, to $26 million. That beat consensus revenue estimates by a solid $1 million.
Unfortunately, though, the company should take a business course on how to turn a profit.
Compared to Q1 2013, 2U fell deeper into the red by $4 million in the first quarter. That continued the trend from 2013, when year-over-year net income worsened from 2012.
Reason to worry? Not really. Not yet anyway. This is quite normal for companies of 2U’s age.
In fact, I’d argue that the improvement in 2U’s top-line growth outweighs its worsening bottom line. Why?
Because higher revenue is a clear sign of demand. Customers want what 2U offers.
But in order to satisfy that demand, 2U needs to ramp its business. And that means increasing its expenditures (i.e., its technology spending).
It’s already doing it. Spending rose to $19.5 million in 2013, versus just $5 million in 2011.
And as demand keeps rising, so will 2U’s spending on its platform development. It means 2U isn’t likely to see profits for some time. But if it can maintain its solid revenue, the investment should pay off in the end.
Meantime, the company has a healthy cash position, with $5.7 million in the bank and no debt.
Not too shabby, given that 2U was only founded in the heart of the 2008 recession and was almost forced to close its doors.
C.H.A.O.S. Meter: 17/20
2U’s technology could be labelled, “Online Education 2.0” – the next wave of today’s “anywhere” learning movement.
Its cloud-based platforms allow colleges and universities to deliver high-quality education to students anywhere in the world.
In fact, 2U’s cutting-edge technology is so promising, the Tech Council of Maryland named it “Technology Firm of the Year for EdTech Innovation.”
But here’s the problem…
There’s nothing proprietary about its technology.
Sure… the company has copyrights and trademarks on its labels and logos. And it has its own set of “trade secrets” that distinguish its brand.
But the company doesn’t have any patents.
Ultimately, this means anyone can do what 2U is doing. They might not be able to do it like 2U, but it’s still too risky.
C.H.A.O.S. Meter: 12/20
While 2U doesn’t have any patents, it does have one patent application pending that seeks to protect some of 2U’s technology.
If it’s approved, the technology will instantly become more valuable and attractive, relative to its competitors. And by cementing its value, shares could rise as a result.
That’s the primary accelerant here – validation of 2U’s technology and evidence that it can separate itself from the pack.
And while profitability would help, the company has some believers…
- In May, Compass Point and Needham & Co. reiterated “Buy” ratings on the stock and set an $18 price target.
- Goldman Sachs (GS) reiterated a “Buy” on 2U, with a $17 price target.
- Oppenheimer (OPY) and Credit Suisse (CS) initiated coverage in April, giving 2U an “Outperform” rating and price targets of $18 and $20, respectively.
C.H.A.O.S. Meter: 15/20
2U’s clients are some of the leading colleges and universities in the nation.
Through its platforms, 2U does business with the likes of the University of Southern California (USC), Georgetown University, the University of North Carolina and UC Berkeley.
In its National University Rankings, U.S. News and World Report, ranked eight of the nine colleges that offer graduate through 2U’s technology in the top-75 undergraduate institutions.
So how does 2U get paid?
The company gets its revenue from long-term contracts – typically between 10 and 15 years.
Under those contracts, institutions get access to 2U’s cloud-based technology platforms, where they can then perform various functions themselves, or have 2U operate as a “back office.” That could entail marketing universities’ catalogs, advising students through career services, monitoring academic progress and developing academic content.
Through each contract, 2U gets a pre-determined percentage of the proceeds from each program’s tuition fees. 2U submits invoices to universities, based on enrollment reports.
Revenue has grown recently, as its list of university clients and course offerings have expanded. In fact, 2U just scored a major contract with Syracuse University, and its cloud-based platform will allow the university to enhance its iMBA program.
Each new contract expands its network of top-class educational institutions. And the company is leveraging that network for promotional purposes. Last month, for example, it launched a cross-program initiative, giving students an opportunity to extend their studies to other areas, with courses offered by the other universities in its network.
Ideas like this recently helped 2U enroll 10,000 students across all of its partner programs.
C.H.A.O.S. Meter: 18/20
Going forward, 2U’s ability to deliver new innovative platforms and enhance its technology will be its most important growth driver.
The bad news? It’s very expensive to do. And as I noted earlier, it’s one of the main reasons why 2U hasn’t turned a profit yet.
But the good news is, those long-term contracts that 2U has with its clients. As the company pulls in new revenue, those contracts will continue to generate revenue in the background.
These reliable revenue streams will give 2U a steady influx of capital that it can use to develop its technology.
And by evolving its technology, 2U won’t just create more powerful and engaging functionality for its current clients, it’ll also attract new clients from its widening competitive advantage.
Which brings me to its second growth driver – expanding its client base.
2U plans to do this in two ways…
- New Programs in New Academic Disciplines
According to the Department of Education, there were 1,000 academic disciplines offered by higher education institutions between 2011 and 2012. But only 140 of these disciplines saw more than 1,000 graduate degrees earned.
So by adding new graduate programs into new academic disciplines, 2U will generate new clients and students by offering a more flexible education model through its cloud.
- Expansion Within Existing Academic Disciplines
2U also plans to target new graduate-level clients within its existing disciplines and programs. This will have a snowball effect – the more clients that 2U gains, the more marketing leverage it can use to acquire new clients and students.
This will ultimately lower 2U’s current client and student acquisition costs – and, in turn, will help bring the company closer to profitability.
2U also plans to scale its business by expanding its undergraduate, doctoral and international presence.
Makes sense, given that total revenue for all post-secondary institutions is over $550 billion in the United States alone, according to the National Center for Education Statistics.
And since higher education is a large market outside the United States, too, 2U’s cloud-based, “anywhere learning” technology can meet rising global demand.
C.H.A.O.S. Meter: 18/20
Final Verdict: 2U is upgrading online education. And while it’s just shy of our key 85-point mark, it still boasts compelling features…
- Strong top-line growth.
- Immersive, cloud-based online and mobile education technology.
- Decent potential for acceleration.
- A solid revenue model that locks in orders for 10 to 15 years per contract.
And since 2U is so young (and quickly gaining popularity), it has plenty of room to grow.
While its lack of profitability and patents are concerns, I still believe the stock could push towards $20.
Your eyes in the Pipeline,