Professional Documents
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Chegg - A Textbook Story of Fiction
Chegg - A Textbook Story of Fiction
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COPPERFIELD RESEARCH
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------------------------------------------------------------------Executive Summary
Question: What do you do when your stock price declines by 50%, your diluted share count
doubles due to egregious stock based compensation and poorly structured financing rounds
with ill-conceived ratchets, and your business model is structurally broken less than two years
after your mispriced IPO?
Answer: Why of course you announce a business model pivot on the back of nebulous nonGAAP metrics, concoct a story about a low-cost customer acquisition channel that ignores
intense competition from Amazon.com and other economic realities, alter past financial
metrics lower to overstate current period growth, create ebullient out-year financial targets
only to surreptitiously adjust the target date and growth rates when results are below plan,
reclassify your pro-forma revenue definition multiple times while including physical goodsrelated revenue in your newly classified digital revenue category (attracting SEC
correspondence in the process), further inflate revenue growth rates by recording one-time
inventory transfers as profitless revenue, boast about your strong 80% [monthly] customer
retention rate which translates into something closer to 93% annual churn when the fine
print is read, claim to grow subscribers 40% despite your own subscriber figure from the prior
years press release suggesting growth of 15%, inflate EBITDA by increasing capitalized
expenses 340% year-over-year (as a % of revenue), make 10 acquisitions that obfuscate
organic growth (and subsequently write-off multiple deals), and exclude non-recurring
items from adjusted financial results for ten consecutive quarters to magically transform deep
operating losses and cash burn into marginally positive adjusted EBITDA. And that run-on
sentence is just the beginning
Sell-side promotions and hope-based investments are often built on the foundation of a
strategic business model pivot. These stories dismiss years of disappointing operating and
financial execution as yesterdays news. Management teams and their cadre of sell-side
promoters instead encourage investors to focus on non-GAAP metrics and aspirational target
models years into the future. As a result, accounting warts, irreconcilable financial results, and
operating inconsistencies that would traditionally cause severe stock price declines, can be
marginalized and ignored at least until the story is busted.
We believe Chegg, Inc. (CHGG) is an orchestrated promote. The carefully constructed,
disingenuous bull thesis, is that CHGG is in the midst of a transition from a low margin
textbook rental business into a high growth, high margin digital educational services
company. This report extensively details why we believe CHGG has fabricated pro-forma
financial results, misrepresented its unit economics, and repeatedly provided misleading
metrics that are subsequently altered. Based on recent correspondence with the Securities and
Exchange Commission (SEC), and conspicuous changes to its financial reporting, we believe
CHGGs shenanigans discussed herein are under the microscope.
Like most promotes, CHGG and its sell-side partners use buzzwords and endorsements that
appear to legitimize the story. For example, the sell-side points out that the company was
initially funded by prominent venture capital firms such as Foundation Capital, Insight
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------------------------------------------------------------------Venture Partners, and Kleiner Perkins. The CEO, who was the former COO at Yahoo!, is a
veteran Silicon Valley executive who talks the talk when discussing the transition from a
capital intensive textbook rental business to a high margin digital services business. On its
most recent earnings call, the word Platform was used eleven times to describe the new
operating model, while Google, Netflix, Spotify, and Uber were audaciously listed as
compelling macro trend comps in the most recent investor deck. Bulls paint a compelling
picture of a textbook rental customer base that creates a low cost competitive advantage for
Chegg Services to acquire customers. Without appropriate diligence, managements elevator
pitch sounds enticing to retail investors and resonates with analysts.
We believe there is one problem with the compelling investment storyIT IS FICTION.
CHGGs strategic business model pivot has been marked by underperforming acquisitions,
weak execution, intense competition, and value destruction. Worse still, we believe CHGGs
management has utilized accounting gimmickry, deceptive segment reorganizations, and nonGAAP adjustments that directly violate SEC reporting standards. Management has
consistently inflated the companys non-GAAP profitability by excluding acquisition-related
compensation costs, transitional logistic charges, and/or restructuring charges for 10
consecutive quarters, while simultaneously including one-time gains on textbook
liquidations. Managements vague pro forma revenue metric is devoid of the reconciliations
required by the SECs Reg. G, while the companys aggressive and inconsistent investor
presentations appear designed to consistently overstate organic revenue growth.
CHGGs core textbook rental business is in secular decline marked by commoditization and
intense competition from Amazon, Pearson, and others. By managements own admission, the
textbook rental segment, which serves as the low-cost customer acquisition funnel for digital
services, will decline by at least 10% in 2016 and 2017. Rather than candidly address the
pervasive challenges in CHGGs core business, management has pursued a digital business
strategy through subscale, poorly performing acquisitions. Over the last six years, CHGG has
acquired 10 companies, of which four have been total write-offs, and just one has performed
to plan.
The amalgamation of these ten acquired properties represents CHGGs supposed high-growth,
high-margin digital services segment. But the facts tell a different story. We believe CHGGs
management made multiple alterations to its segment reporting to obfuscate the floundering,
low visibility, dynamics of its digital segment. Previously, management stated that its allimportant digital revenue growth would be 60% in 2016. Our analysis suggests 60% growth is
a blatant misrepresentation and digital revenue growth will be just 16% in 2016. Additionally,
based on CHGGs own disclosures, we show that customer churn in digital services is
approximately 93% annually. And while management claims its fastest growing services
business, Chegg Tutors, will pull blended corporate margins higher, our analysis shows this
segment generates a mere 30% gross margin.
We believe management has persistently altered its reporting methods to flatter digital
growth. As such, it comes as no surprise that CHGGs historical revenue reporting segments
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------------------------------------------------------------------are replete with discrepancies that fail to reconcile from quarter-to-quarter. In the last three
years, CHGG has reported three different revenue derivations, which we believe blatantly
overstates digital revenue growth and masks an inability to hit financial targets. The SEC
appears to share our confusion based on its correspondence with CHGG management asking
for an explanation for certain revenue segment reporting.
While managements promotional cadence has been self-enriching, shareholders have
suffered. In CHGGs 10-year history, management has raised more than $400 million,
including $180 million from the companys IPO just three years ago. Despite incessant capital
raises, CHGG has (i) never generated a profit, (ii) has an accumulated deficit of $370 million,
and (iii) will end 2016 with less than $60 million of cash in the bank before considering $35
million of acquisition earn-out obligations and expected free cash flow burn of $25 million.
No wonder sell-side analysts have been such unabashed supporters!
Like all promotes, the too-good-to-be-true story can only persist for so long before facts
trump fiction. While CHGG beat sandbagged Q3 guidance (Chegg Services revenue was
down sequentially despite only a partial quarter of its Imagine Easy acquisition in Q216), the
company guided Q4 below consensus estimates and cut 2017 expectations. We believe more
negative revenue revisions are coming. With CHGGs accounting shenanigans exposed,
competitive pressures intensifying, and 2017 guidance that appears highly unobtainable, we
believe the rubber will soon meet the road. CHGGs pivot is nearly complete and in 2017
management can no longer utilize its pro-forma revenue cookie jar to hide poor results. We
believe CHGG is trapped and managements only options are (i) attempt larger acquisitions to
plug the impending revenue hole, or (ii) confess that actual growth rates and profitability are
less than what management has led investors to believe.
We believe CHGGs intrinsic value is less than $2.00 per share, which would represent
75% downside from the current trading price.
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This initial report details the following topics, representing just the tip of the shenanigans on
the CHGG iceberg:
1) CHGGs inauspicious background and value-destroying CEO
I. Disastrous pre-IPO ratchets have caused substantial shareholder dilution
Increasingly onerous ratchet conditions on multiple rounds of pre-IPO financing and
indefensible stock-based compensation have resulted in the unjust enrichment of CHGGs
management at the expense of its unaffiliated shareholders. In less than three years,
shareholders have suffered nearly 100% dilution.
II. Dan Rosensweigs dubious leadership track record
Mr. Rosensweig served as CEO or COO of three companies prior to CHGG. He destroyed
significant value at all three companies.
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Mr. Rosensweig was most recently CEO of Guitar Hero, one of the most popular video
game franchises in history. Under Mr. Rosensweigs stewardship, sales collapsed, a
leadership change ensued within one year, and Guitar Hero was temporarily discontinued.
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Since coming public three years ago, CHGGs stock price has declined by 45%,
underperformed the Russell 2000 by 60%, and management has repeatedly missed
performance targets. Nonetheless, Mr. Rosensweig has received nearly $24 million in
compensation.
6) Weak operating performance, cash burn, & acquisition earn-outs impair the
balanced sheet
I. Management has misrepresented recent business momentum
In Q216, CHGG management boasted that EBITDA more than doubled year-over-year.
Excluding one-time gains/losses on textbooks liquidations, EBITDA actually declined
year-over-year.
II. Significant increases in capitalized expenses may be overstating EBITDA
After exiting textbook rentals, CHGG should have minimal capital intensity.
Historically CHGG spent 2-3% of revenue on capital expenditures. However, YTD16
capitalized expenditures inexplicably jumped to 9% of revenue.
III. Management quietly pushed out its target operating model by one year
Throughout CHGGs transition from a textbook rental company to a digital business,
management has stated its target operating model of 25% revenue growth, 60% gross
margins, and 25% EBITDA margins would be achieved by 2017.
In early 2016, without explanation, management inexplicably moved its target model date
to 2018 and lowered its growth target in an investor presentation.
IV. CHGGs business model(s) perpetually destroy capital and burn cash
In its most recent earnings call, management stated CHGG generates a lot of cash.
This statement is patently false. In less than three years, CHGGs cash balance has
declined from $160 million to less than $60 million.
Despite relying on excessive stock-based compensation in lieu of cash compensation,
management expects to burn ~$25 million of free cash flow in 2016.
V. Imagine Easy earn-out payments may impair CHGGs balance sheet
In addition to paying $25 million to close its Imagine Easy acquisition, CHGG committed
to a $35 million incremental earn-out, with $27 million due in 2017.
With approximately $55 million of cash at year-end and an annual burn rate exceeding
$25 million, we believe CHGG will need to access the capital markets in 2017.
7) Rubber meets the road in 2017 & VCs and insiders are voting with their feet
I. CHGG will struggle to meet 2017 guidance
Based on our analysis Chegg Services revenue has decelerated for three years to under
30% growth. To achieve 2017 guidance, the segments growth must meaningfully
reaccelerate.
II. VCs and insiders heading for the exits before the next reset
Three of CHGGs top six pre-IPO investors have sold their entire positions for a loss.
Since August 2016, CHGGs Chief Product Officer has sold more than 80% of his
holdings.
8) CHGG is significantly overvalued
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------------------------------------------------------------------I. CHGG trades at a substantial premium to education-focused peers and a broader consumer
internet basket
CHGG trades at 42x EV/EBITDA compared to 5x -7x for publicly traded educationfocused peers.
Despite GAAP revenue declines, decelerating pro forma revenue growth, negative free
cash flow, and a structurally broken business model, CHGG trades at a substantial
premium to both AMZN and LNKD.
II. Generous valuation implies 75%+ downside
Applying a generous peer group valuation multiple, we believe CHGGs intrinsic value is
$1.72, or 75% lower than recent market prices.
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Amount
4,230
4,700
25,020
57,000
55,000
75,000
25,000
180,000
425,950
Valuation
8,080
21,300
66,190
551,550
N/A
714,600
655,970
1,217,850
How has CHGG managed to raise nearly half-a-billion dollars despite never generating a
profit, never trading above its IPO price, and attempting to redesign its operating model two
years after going public? One word ratchets. According to a Wall Street Journal article,
Valuation-Hungry Startups Should Heed Cheggs Disastrous IPO Ratchet, CHGGs
management chose to grant onerous ratchet provisions to investors to achieve the highest
possible valuation. 4 While it may be easy to argue the past is the past, we believe
management teams have hardwired DNA, and a troubling pattern exists at CHGG of selfserving actions that conflict with the interests of unaffiliated shareholders.
These ratchet provisions provide investors in specific rounds incremental shares if future
capital raises occur below a specified price (e.g., at IPO). While ratchet provisions provide
anti-dilution protection to certain investors, early investors and employees can suffer extreme
dilution.
CHGG management first offered ratchet provisions as part of the companys series D
financing round in 2009. 5 According to an early angel investor, and former CHGG board
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------------------------------------------------------------------member, Oren Zeev, CHGG received multiple financing offers without ratchets. Nevertheless,
CHGGs management chose the ratchet deal because it provided an initial 20% higher
valuation.6 In exchange for this paper-based wealth creation, CHGG provided Insight Venture
Partners a 2x ratchet provision. Simply, Insight would either double their money, or
CHGGs management would issue additional shares to Insight at the expense of earlier
investors and employees.7
Despite the notoriety of ratchet rounds, CHGG management raised two subsequent VC rounds
with ratchet provisions, each with conditions more onerous than the last. How aggressive was
management? Two of CHGGs fundraising rounds required the company to IPO at a price
greater than $25 in order to avoid triggering the ratchets.8 Due to clear missteps on the part of
management, CHGGs final round of pre-IPO financing, its Series F round, was raised at a
price below its previous two rounds (the dreaded down round). Although management must
have known the company faced a significant overhang due to its prior two ratchet rounds at
prices CHGG would not achieve, management again chose to raise capital with a ratchet
provision at $12.00.9
When CHGG filed its public prospectus, the IPO price range was set between $9.50 and
$11.50.10 Despite tepid institutional interest in its IPO, CHGG management priced its IPO at
$12.50, thus avoiding dilution from the additional Series F ratchet. While management was
protected, the stock price declined by 23% on its first day of trading and has never traded at
its IPO price. Due to the companys prior two capital raises with ratchet provisions, CHGG
was forced to issue 13.1 million additional shares on its IPO, which resulted in 25% dilution
to new shareholders.
Because of CHGGs costly ratchets and egregious stock compensation grants (detailed later),
pre-IPO shareholders have suffered nearly 90% dilution in less than three years.
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Dilution
24.1%
50.6%
67.8%
88.6%
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Source: CapitalIQ.
After the ZDNet debacle, Mr. Rosensweig joined Terry Semel in 2002 to transform Yahoo!
into a media business. Mr. Rosensweig served as COO at Yahoo! from 2002 to 2006, which
encompassed historic strategic blunders. During Mr. Rosensweigs tenure, Yahoo! (a) had the
chance to buy Google, (b) failed to buy Google, which subsequently usurped Yahoo!s search
dominance, (c) purchased Overture for $1.4 billion, (d) failed to integrate Overture
successfully, (e) failed on its opportunity to buy a start-up called Facebook for $1 billion, and
finally (f) was forced to undo its entire media strategy and revert back to Yahoo!s technology
roots.18 Mr. Rosensweig departed Yahoo! during a management shakeup in late 2006 that was
marked by investor and employee unrest.19 According to an Associated Press article at the
time, the reorganization represented Yahoos mea culpa for meandering aimlessly during the
past year, to the chagrin of investors and the delight of competitors like Google Inc. that lured
away online traffic and advertisers.20 In 2008, Business Insider ran an article titled, Was
Yahoos Terry Semel the Worst Internet CEO Ever? 21 If Mr. Semel was indeed in the
running for Worst Internet CEO Ever, what does that say about Mr. Rosensweig as COO?
Despite his poor track record at ZDNet and Yahoo!, Mr. Rosensweig was again given a
wonderful opportunity when he became CEO of Guitar Hero, which was at the time the
fastest-selling video game ever. The franchise recorded more than $1 billion in revenue in
2007 and was a consumer juggernaut.22 Enter Mr. Rosensweig, who stated when he joined
Guitar Hero, With a platform and content that universally engages a wide range of
audiences, Guitar Hero has incredible growth potential. I look forward to continuing to
develop Guitar Hero into an even more successful enterprise.23 His new employer, Guitar
Heros parent Activision Blizzard, was equally enthusiastic about Mr. Rosensweig,
proclaiming, We are looking forward to leveraging [Rosensweigs] proven online experience
to build upon the billions of hours of entertainment we deliver each year in the Guitar Hero
network.24
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------------------------------------------------------------------After joining Guitar Hero, Mr. Rosensweig embarked on a process to expand distribution
through new business partners and spin-offs, such as DJ Hero and Band Hero.25 It would be
an understatement to say Rosensweigs strategy was not successful. In less than a year, the
Guitar Hero juggernaut was experiencing rapid sales declines and Mr. Rosensweig quickly
departed. 26 In 2011, Activision Blizzard was forced to shutter the entire Guitar Hero
division.27
2015
71,818
8.6%
2016G
65,500
(8.8%)
2017G
58,000
(11.5%)
When CHGG initially introduced its textbook rental offering in 2007, the concept was
revolutionary. 28 CHGG disrupted the prior model that forced college students to purchase
expensive, single use textbooks. Ten years ago, students paid approximately $1,200 per year
for textbooks and that cost has increased by nearly 50% over the last decade.29 CHGG had an
innovative model and a first mover advantage that resulted in revenue that grew from
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------------------------------------------------------------------essentially zero in 2007 to nearly $150 million by 2010.30 [Like most uneconomical models,
CHGGs losses grew at a faster rate than revenue, but that is beside the point.]
CHGGs impressive revenue growth attracted significant competition. Numerous upstart
competitors entered the market, with sites such as AbeBooks, Half.com, ValoreBooks,
eCampus, BookRenter, Textbooks.com, and Boundless all entering CHGGs market; it is
abundantly clear there are no barriers to entry for textbook rentals. CHGGs first mover
advantage was unsustainable given the lack of product differentiation (an intermediate
accounting textbook from CHGG is substantially similar to the same intermediate accounting
book from BookRenter or Half.com). In addition to intense direct competition, comparison
shopping sites such as dealoz.com, textbookrentals.com, TextSurf, and StudentRate began to
appear, which allowed students to compare rental sites for the best price.
Next, while limited brand differentiation and zero sustainable barriers to entry destroyed
most, if not all, economic profit potential among mono-line textbook rental companies,
Amazons entry into the market in further assured CHGGs demise. After launching a digital
textbook rental service in 2011, Amazon quickly followed with a full-scale physical textbook
rental program in 2012. Unsurprisingly, Amazons size, scale, and technological advantages
destroyed the incumbents. According to Uwire, a popular college student website, Amazon is
already considered one of the best places to buy or rent textbooks:
Through Amazon, students are able to order books based on condition, price and shipping.
Students can also order Kindle versions of textbooks, which can be used through the free
Kindle app. Book rentals are also provided and are priced based on how long one plans to
use the textbooks. Amazon provides students with one of the most cost effective routes for
purchasing or renting textbooks.
Today, CHGG is rarely the low cost option for students. For example, the textbook
Intermediate Accounting rents for $320.95, which is 123% more expensive than the lowest
cost option from knetbooks. Additionally, CHGGs most popular textbook, Campbell
Biology, also illustrates the price uncompetitive nature of CHGGs textbook rental
business.
Comparison Rental Pricing for Intermediate Accounting
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Source: dealoz.com, accessed 8/24/16. Rental prices may vary throughout a semester.
Source: dealoz.com, accessed 8/26/16. Rental prices may vary throughout a semester.
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------------------------------------------------------------------success, BNED recently announced the price-match program will be expanding in 2016 to the
majority of its campus bookstores.31 The program offers student a refund during the first week
of class if they find a lower price on used, new, or rental textbooks.32 CHGG will face the full
brunt of the implementation of this program in Q416, which could explain managements
implied guidance for Required Materials to decline by nearly 40% in Q416.
Amazon is also increasingly focused on attracting college student customers by rolling out
branded mailrooms on university campuses. The program, called Campus Pick-up Point,
was initially piloted in 2015 at Purdue University as a service for students who live in dorms
or apartments, where receiving packages can be challenging.33 In 2016, Amazon is expanding
the program to the University of California at Davis, the University of California at Berkeley,
the University of Texas at Austin, the University of Massachusetts at Amherst, the Georgia
Institute of Technology, and the University of Pennsylvania. 34 Amazon also has plans for
several more pickup points on or near other university campuses.35 As part of the program,
universities receive 2% of every Amazon purchase delivered, further aligning interests around
the program.36
And just last month, Pearson, one of the largest textbook publishers in the country, announced
a partnership with Follett Higher Education, the largest campus retailer nationwide. The
partnership will provide Folletts 1,200 campus bookstores nationwide access to Pearsons
Digital Direct Access model, which is a suite of e-textbooks and other digital content.37 Tom
Malek, Senior Vice President of Partnerships at Pearson, stated, By partnering with Follett,
were making these pricing and delivery models available to all of Folletts partners,
increasing student affordability and access, and improving faculty access to real-time data and
analytics.38
Given substantial and increasing competition in the textbook rental market, we believe
CHGGs purported low cost customer acquisition channel doesnt have a chance to compete
successfully.
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------------------------------------------------------------------We readily admit that while the table below is correct for a steady cohort, the analysis is
imperfect. Students may cancel their CHGG memberships at different points (e.g., over the
summer or winter holidays) and re-enroll later. However, no matter how the data is sliced, the
80% monthly renewal rate, or 20% monthly churn, creates retention challenges that are
typically only found in the online dating industry.
Chegg Study Renewal Rate Analysis
Month
Students
Monthly Renewal Rate
0
100
80%
1
80
80%
2
64
80%
3
51
80%
4
41
80%
5
33
80%
6
26
80%
7
21
80%
8
17
80%
9
13
80%
10
11
80%
11
9
80%
12
7
80%
7%
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Source: https://www.chegg.com/tutors/pricing/
III. Management has historically squandered shareholder capital through poor acquisitions
In a repeat of Mr. Rosensweigs playbook from ZDNet, CHGG has chased revenue growth
through murky acquisitions. In the last six years, CHGG has completed at least 10
acquisitions. We believe every current digital services offering came by way of acquisition, as
CHGG has not developed a single product internally. This begs the question, on what exactly
did CHGG spend $60 million in 2015 for technology and development?
Contrary to managements claim that its acquisition strategy has been a success, we believe
Cramster, which was renamed Chegg Study, is the only acquisition that has performed to plan.
Four of the ten products/companies acquired by CHGG have subsequently been shut down or
discontinued, while three others are behind plan. While it is too early to determine whether
Imagine Easy will be a success, the $139 million of wasteful acquisition expenditures to date
bode poorly for the return on the incremental $35 million of earn-out payments.
CHGG Acquisition Analysis
$ 000s
Target
Date
Price
CHGG Product
Courserank
8/19/10
N/A
Course Reviews
Cramster
12/8/10
N/A
Chegg Study
Notehall
6/22/11
4,700
N/A
Student of Fortune
8/23/11
5,200
N/A
Zinch
10/6/11
27,200
Enrollment Marketing
Bookstep
3/7/14
3,000
N/A
CampusSpecial
4/9/14
16,000
Chegg Deals
InstaEDU
6/5/14
30,000
Chegg Tutors
Internships.com
10/2/14
11,000
Careers
Imagine Easy
5/1/16
42,000
Writing Tools
Total
139,100
Source: Company filings, management commentary, and Factiva.
Commentary
Discontinued
Performing well
Discontinued
Discontinued
Reset growth expectations Q3 14
Never provided
Discontinued
Behind plan as of Q4 15
No monetization until 2017
???
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Q2 15
Q3 15
750,000
550,000
200,000
700,000
540,000
160,000
825,000
560,000
265,000
700,000
700,000
825,000
825,000
Q1 16
Q2 16
Q3 16
750,000
182,218
(8.9%)
760,000
153,642
(4.0%)
800,000
275,345
3.9%
932,218
932,218
24.3%
913,642
75,000
838,642
19.8%
1,075,345
125,000
950,345
15.2%
Revenue Classification
Print Textbooks
Non-print Products and Services
Description
Online print textbook rentals
eTextbooks, subscription services, and enrollment marketing
2015
Print Textbooks
Digital Offerings
2016
Required Materials
Chegg Services
In 2015, management reorganized its reporting segments to include Print Textbooks and
Digital Offerings. While the change appeared innocuous, we believe the modification
contained details that had the undeniable impact of overstating digital segment growth. As
discussed in more detail below (and has garnered specific SEC attention), management
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------------------------------------------------------------------attributed Ingram commissions from print textbooks rentals to the companys digital
revenue group. While there was no net impact to consolidated revenue, the categorization of
print textbook rental commissions as digital revenue undeniably overstated digital growth,
which has become the most important metric for the investment community.
We believe the reporting reorganization in 2016 was an even more duplicitous attempt to hide
weak performance and further manipulate digital revenue growth. Management once again
changed CHGGs revenue segments, this time to Required Materials and Chegg Services.
Under the newest iteration, management shifted both its Ingram textbook rental commissions
and its eTextbooks revenues to Required Materials (formerly Print Textbooks).
Previously, both eTextbooks and the Ingram commissions had been classified under digital
services revenue. The attribution reconfiguration of these two sub-segments had the effect of
overstating year-over-year comparisons for digital revenues not once, but twice (as seen in the
illustration below).
In 2015, nearly all of the commission revenue from Ingram was new compared to the
previous year (the program was piloted in late 2014 and fully rolled out in 2015). Therefore,
including Ingram commissions (front print textbook rentals) as digital revenue vastly
improved the growth profile for this segment in 2015. However, these commissions would
need to be lapped in 2016, which would have created a challenging comparison for digital
growth. Supporting our belief that management manipulated its segment reporting, the
company moved the Ingram commissions out of digital (the segment management believed to
be appropriate in 2015) and into Required Materials in 2016. The net effect was that the
new Chegg Services segment faced a remarkably easier comparison in 2016.
In addition to shifting CHGGs Ingram commission revenue, management also inexplicably
removed its eTextbook business from the companys digital revenue category. Given
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------------------------------------------------------------------eTextbooks is a 100% digital business, why would management feel compelled to make this
arbitrary change? We believe the shift was a blatant attempt to hide slowing digital growth.
CHGGs eTextbook segment had historically been a fast growth business based on market
share gains versus print textbooks. However, in late 2015 publishers raised the relative prices
for eTextbooks (compared to print textbooks), which significantly curtailed eTextbook
growth. According to management, eTextbook unit growth was greater than 60% in 2014.43
However, because of the publisher pricing changes, management expected eTextbook revenue
to decline in 2016.44 As such, similar to managements conundrum regarding the companys
Ingram commissions, eTextbooks would become an unwelcome drag on digital revenue
growth in 2016. We believe the reason for the unorthodox maneuvers by management is
crystal clear: move eTextbooks and Ingram commissions to Print Textbooks (now Required
Materials) to hide the rapid deceleration of Digital revenue (now Chegg Services).
II. Normalized digital revenue growth is significantly below managements target
Our digital businesses are expected to grow better than 60% in Q4 and we anticipate
similar growth in 2015.
Andy Brown, CHGG CFO, Q314 earnings call, 11/3/14
As discussed above, we believe CHGG management reorganized its reporting segments to
hide slowing growth in its all-important digital segment. We also believe actual digital growth
is a fraction of what CHGG has represented publicly. At the end of 2014, management
unequivocally stated that it expected digital revenue to grow at least 60% in 2015, which was
prior to Ingram commission revenue shifting from print to digital. In fact, when asked in the
conference calls Q&A about this exact topic, (whether 60% forecast included or excluded
Ingram), CFO Brown unmistakably stated:
Question Douglas T. Anmuth: And can I just follow up on 2015, the 60% digital
growth number that you mentioned. Does that include and make some assumption for
how much of for a part of the business that is, of course, moving over to Ingram and
has revenues getting booked in digital?
Answer Andrew J. Brown: No Doug, it doesn'tanything that Ingram adds would
just be bigger [and] that would add to that total.45
Despite (a) the benefit of multiple acquisitions throughout 2014 that would have aided the
2015 year-over-year growth rate, and (b) shifting Ingram print textbook commissions to the
digital segment, CHGGs digital revenue slowed substantially in 2015 and was well below
managements stated target that excluded the large benefit that was ultimately received from
the Ingram segment reorganization.
________________________________________________________________________23
COPPERFIELD RESEARCH
2013
2014
2015
52,498
91,177
73.7%
140,005
53.6%
Entering 2016, CHGG was already behind its targeted growth plan and now faced the
difficulties of lapping its Ingram commission benefit. Management had committed to
substantial growth that would not be achievable. Rather than candidly address the
disappointing digital growth, as discussed above management again altered CHGGs revenue
reporting segments. We have not seen one sell-side report that identified managements
changes or attempts to independently analyze the actual growth rate of CHGGs digital
business. However, an estimate for the digital growth rate can be calculated.
Chegg Services revenue is simply the former digital revenue segment excluding the
companys Ingram commission and eTextbooks. We can therefore calculate historical implied
revenue for these sub-segments by deducting restated Chegg Services revenue from originally
reported Digital revenue. Next, if we assume revenue from Ingram and eTextbooks declines
in 2016 at the same rate as the overall guidance for Required Materials, we can determine
2016 estimated revenue for Ingram and eTextbooks. With this straightforward calculation, we
can create a clean compare for digital revenue growth by adding Ingram commissions and
eTextbooks to managements guidance for Chegg Services. The math is scary and illustrates
why we believe management has gone to such great lengths to avoid straightforward
reporting. Using the companys own segments, financials, and guidance, normalized digital
revenue growth will be just 16% in 2016. As discussed above, we believe the substantial
deceleration in digital revenue growth is the primary driver for managements unjustifiable
changes to its revenue reporting segments and altered long-term targets. Above all else, with a
16% normalized digital revenue growth rate, we believe the company will not achieve
managements 2017 guidance (which itself is already below prior consensus estimates).
________________________________________________________________________24
COPPERFIELD RESEARCH
2013
2014
2015
52,498
41,830
10,668
91,177
68,117
23,060
116.2%
140,005
94,286
45,719
98.3%
2016E
41,697
(8.8%)
III. Multiple revenue reclassifications have discrepancies with reported pro forma financials
Possibly because CHGG management has reclassified revenue so many times, or because of
creative retroactive changes to PowerPoint slides that artificially inflate current-year revenue
growth, historical pro-forma revenue disclosures fail to reconcile. For example, in an IR
presentation from August 2015, CHGG reported 2014 pro forma revenue of $142.7 million,
implying 2014 growth of 40% compared to $101.9 million in 2013. Just six months later, in
CHGGs 2016 IR presentation, the historical 2014 revenue was revised down by 6% to $134
million ($66M + $68M).
Perhaps the revenue changes were a mistake, but the lower 2014 revenue baseline obviously
flatters the 2015 growth rate. We have been unable to find any disclosure or explanation for
the change and it remains unclear why historical revenue would change well over a year after
it was initially reported. Based on what we believe to be a consistent pattern of
misrepresentation and misleading reporting, we would point out that the 2014 revenue
alteration resulted in 24% reported growth for 2015, as opposed to only 16% growth had the
originally reported revenue figures been maintained.
________________________________________________________________________25
COPPERFIELD RESEARCH
-------------------------------------------------------------------
Source: https://www.sec.gov/Archives/edgar/data/1364954/000000000015056977/filename1.pdf
If not clear by now, we believe CHGGs multiple revenue reclassifications and dubious
presentation of textbook rental commissions as digital are highly misleading. On December
8, 2015, the SEC sent a letter to Mr. Rosensweig, which appeared to focus on CHGGs digital
revenue classification.46 Specifically, the SEC inquired, Please tell us how you determined
commission fees related to the Ingram Content Group (Ingram) partnership, where Ingram
fulfills print text book transactions, are most appropriately presented as revenue from Digital
offerings.47
Less than two weeks later, CHGG responded with a vigorous defense, despite openly
conceding that the Ingram commissions are tied to physical product sales:
Response: Chegg respectfully advises the Staff that, although the product delivered by
the Ingram Content Group (Ingram) is physical in nature, Chegg provides a digital
service through its website by serving as the interface between the student and Ingram.
The marketplace service that Chegg provides is similar regardless of whether the
textbook is print or digital. When a student places an order on the Chegg.com website
for a textbook that is owned by Ingram, Chegg facilitates the transaction between the
student and Ingram but Ingram fulfills the rental textbook order. Chegg never takes
possession of the textbook; rather we offer a textbook owned by Ingram for rental by a
student. All of the activities required for Chegg to earn its commission from Ingram
are executed through the Chegg website and are digital, and thus we have determined
________________________________________________________________________26
COPPERFIELD RESEARCH
------------------------------------------------------------------to be similar in nature. Based on these considerations, Chegg records the commission
fees earned from Ingram on the transaction as component of digital revenue on its
Consolidated Statement of Operations. We continue to record revenue earned in
connection with orders of print textbooks owned by Chegg as a component of print
revenue. This differentiation of print versus digital revenue is useful to our investors
as it provides a view into our transition from owning a capital intensive print textbook
business to a fully digital business. This allows investors to properly model Cheggs
go-forward business.48
Despite vehemently defending its revenue characterization to the SEC on December 21, 2015,
management took the unusual step of completely reversing course and removing Ingram
commissions from its digital segment when it provided guidance for 2016. Concomitant with
this illogical step (based on the justification provided months earlier to the SEC), management
reclassified its Ingram commission revenue and renamed its segments Chegg Services and
Required Materials. On CHGGs Q415 earnings call, the companys CFO Andy Brown
stated, We will also be reporting and guiding separately on total Required Materials which
includes revenue from textbooks, eTextbooks as well as the Ingram commission. We are
doing this to increase transparency into our slow growth business, but more importantly it
matches the way students come to Chegg to search for textbooks and our goal is providing
students the textbooks they need in the format they want.49
While the explanation and new segment names implied broad changes, the only effective
modifications were to remove eTextbook and Ingram commissions from digital (both of
which are now in decline). Interestingly, when a sell-side analyst asked a question regarding
the reclassification, management admitted the change was driven entirely by the motivation to
remove Ingram commissions and eTextbooks from the digital segment:
So what's in the Required Materials is this. It is all of the Ingram commission, all of
the print books that we deliver, and all of the eTextbooks. And so essentially what is
done and let me put it in a different format. If you take what our Digital revenue was
last year, take out the Ingram commission and take out eTextbooks and put it with our
print, that gives you Required Materials. That's how it works. Andy Brown, CHGG
CFO, 2/22/16
Managements staunch defense to the SEC, which was immediately followed by another resegmentation, adds further support to our belief Messrs. Rosensweig and Brown orchestrated
their segment reporting in a misleading and inappropriate manner to overstate digital revenue.
V. Did CHGGs inventory transfer sales to Ingram artificially inflate revenue?
In August 2014, CHGG announced a strategic alliance with Ingram Content Group. Under the
agreement, CHGG would continue to market textbooks and provide customer service, while
Ingram would be responsible for textbook inventory, fulfillment, shipping, and returns. As
part of the deal, CHGG would transfer its textbook inventory to Ingram at cost.50 While the
transaction would clearly impact CHGGs balance sheet (debit to cash or accounts receivable
________________________________________________________________________27
COPPERFIELD RESEARCH
------------------------------------------------------------------and credit to inventory), the inventory transfer created no economic benefit and thus should
have had a non-recurring impact on CHGGs income statement. However, we believe these
transitory inventory transfers, which should have been recorded as one-time gains/losses,
were instead included as profitless revenue as yet one more mechanism to inflate perceived
growth. On CHGGs GAAP income statement (which unsurprisingly is not discussed by
management), the company reports three revenue line items:
1.
2.
3.
Based on the companys business drivers, rental revenue (1) and sales revenue (3) should be
highly correlated as both segments are tied to student demand for physical textbooks. Each
year, some students rent textbooks, while others purchase course materials. However, growth
in these two segments diverged significantly in 2014 and 2015, which coincided with
CHGGs Ingram alliance. In 2014, rental revenue declined by 4%, yet sales revenue increased
by 145%. Management did not bother to discuss this unique development and revenue driver.
CHGG "Sales" Revenue Analysis
$ 000s
2013
GAAP Rental Revenue
189,004
GAAP Sales Revenue
14,613
Rental Revenue Growth
Sales Revenue Growth
Source: Company filings.
2014
181,570
35,804
2015
120,365
49,012
(3.9%)
145.0%
(33.7%)
36.9%
YTD 15
93,199
46,019
YTD 16
32,081
32,157
(65.6%)
(30.1%)
What is more confounding than the revenue growth variance is the profit (or lack thereof)
generated on the Sales increase. In 2015, gross margin on sales revenue was only 2% and
year-to-date 2016 gross margin is negative 5%, which implies CHGG generates essentially
zero incremental profit on these transactions and thus further demonstrates the impressive
revenue growth may have been a function of profitless textbook inventory sales to Ingram.
VI. CHGG appears to be in direct violation with SEC Regulation G
The SEC implemented Regulation G in 2003 to prohibit material misstatements or omissions
that would make the presentation of a non-GAAP financial measure misleading to investors.51
Earlier this year, the SEC issued new Compliance and Disclosure Interpretations (C&DIs)
regarding the use of non-GAAP financial measures to further curb perceived abuse. 52
Specifically, the updated C&DIs state, a non-GAAP measure that is adjusted only for nonrecurring charges when there were non-recurring gains that occurred during the same period
could violate Rule 100(b) of Regulation G. 53 The SEC is effectively telling management
teams they may not exclude one-time charges while also including one-time gains when
reporting non-GAAP measures.
________________________________________________________________________28
COPPERFIELD RESEARCH
------------------------------------------------------------------Despite the SECs clear guidelines, CHGG management appears to continue its disregard for
regulatory reporting requirements. Specifically, for 10 straight quarters CHGGs management
has excluded acquisition-related compensation (which is clearly recurring at this point),
restructuring charges, and other one-time expenses from its adjusted EBITDA calculation.
Striking at the heart of the SECs newest C&DIs, CHGG has simultaneously included onetime gains repeatedly on the liquidation of textbooks. What is also noteworthy is that CHGGs
supposed one-time adjustments have grown from $1.2 million in 2013 to $12.2 million in
2015.
CHGG "One-Time" Gains and Losses
$ 000s
2013
2014
2015
YTD 16
(52,217)
10,078
36,958
(5,181)
(69,689)
11,160
36,888
(21,641)
(57,158)
11,511
38,775
(6,872)
(39,817)
10,001
32,701
2,885
1,186
4,555
4,326
523
1,186
4,135
8,690
7,904
12,230
3,488
4,011
(3,995)
(12,951)
5,358
6,896
________________________________________________________________________29
COPPERFIELD RESEARCH
------------------------------------------------------------------management introduced certain pro forma metrics to assist investors in understanding the
business model shift. Those same adjustments are now periodically included by management
in certain quarters, while excluded altogether in others.56
Ticker
BNED
BKS
SCHL
HMHC
AMZN
LRN
IAC
GRPN
ANGI
EBAY
LNKD
Market
Cap
458,886
801,734
1,425,076
1,359,241
352,754,126
535,875
5,187,939
2,322,926
456,666
31,480,809
25,887,986
YTD 16
Revenue
1,513,270
3,287,160
1,159,000
1,130,879
92,246,000
651,381
2,328,720
2,208,469
246,661
6,584,000
2,753,151
Chegg Inc
CHGG
812,286
143,023
32,701
Source: Bloomberg and company filings.
CHGG YTD 16 revenue based on pro forma information provided by management.
22.9%
________________________________________________________________________30
COPPERFIELD RESEARCH
------------------------------------------------------------------Because of CHGGs excessive stock compensation, the gap between basic and diluted shares
outstanding has a material impact when analyzing the companys market capitalization and
enterprise value. CHGG has nearly 16 million shares that would be included in its diluted
share count in the unlikely event the company ever achieves profitability, or the even less
likely event the company were to be acquired. Stock compensation (options, RSUs and PSUs)
does not impact CHGGs adjusted income statement and these potentially dilutive shares are
excluded from analyst models and adjusted financial results.
________________________________________________________________________31
COPPERFIELD RESEARCH
-------------------------------------------------------------------
While half of Mr. Rosensweigs stock awards were performance-based, and therefore
technically should have been subject to meeting pre-defined performance targets, it appears
the compensation committee ignored these benchmarks. While CHGG did not achieve a
single performance-based metric in 2015, the compensation committee determined that 33%
of [Mr. Rosensweigs] PSUs were earned.58 No explanation was provided about why these
performance grants were issued.
Target
Actual
Digital revenue
$143.6mm
$140.0mm
$135.9mm
N/A*
$26mm
($2.4)mm
Achievement
Since CHGG went public three years ago, its stock price has declined by 45%,
underperforming the Russell 2000 by 60%. Further, management has repeatedly missed its
performance targets. Yet over the same period that shareholders have suffered immense
losses, Mr. Rosensweig has received nearly $24 million in total compensation.
CHGG CEO Compensation v. Stock Performance
$ 000s
2013
2014
CEO Compensation
8,970
4,990
CHGG Stock Performance
(31.9%)
Russell 2000
5.9%
Over / (Under) Performance
(37.8%)
Source: Company filings and Bloomberg.
(18.8%)
4.9%
(23.7%)
2015
9,837
2016
N/A
(2.6%)
(4.4%)
1.8%
13.2%
11.6%
1.6%
________________________________________________________________________32
COPPERFIELD RESEARCH
------------------------------------------------------------------6) Weak operating performance, cash burn, & acquisition earn-outs impair
the balance sheet
I. Management has misrepresented recent business momentum
Like most stock promotes, managements public assessment of its financial performance is
often in stark contrast to an objective analysis of the financial accounts. In Q216, CHGG
management highlighted that EBITDA more than doubled compared to the prior year, with
the CFO proudly stating on the earnings call, as a result of the strong revenue and gross
margin performance, our adjusted EBITDA came in at $7.2 million, more than double the
prior year and another proof point that our new business model is working.59 What the CFO
failed to share was that excluding lumpy, non-recurring textbook sales, EBITDA would have
actually declined year-over-year. The benefit of selling textbook inventory for gains will
cease in 2017 as the Ingram inventory transfer is completed.
CHGG Adjusted EBITDA Analysis
$ 000s
Q2 15
(9,697)
3,241
(6,456)
Q2 16
(8,375)
3,491
(4,884)
Share-based Compensation
Restructuring Charges / (Credits)
Transitional Logistic Charges
Acquisition Related Compensation Costs
Total Adjustments
7,831
464
707
660
9,662
11,221
(154)
1,000
12,067
3,206
2,445
5,651
7,183
(2,191)
4,992
EBIT
Depreciation and Amortization Expense
EBITDA
________________________________________________________________________33
COPPERFIELD RESEARCH
------------------------------------------------------------------neither Mr. Rosensweig nor Mr. Brown addressed the issue in their prepared remarks on the
Q216 earnings call. When asked during the Q&A about the abnormal increase, Mr. Brown
stated, I think when you think about CapEx for Chegg, its a little bit of a misnomer. Most
people think its buildings and things like that, but we also capitalize a lot of our content cost
and things like that.60
Mr. Browns explanation for 18% of revenue going towards capex is that CHGG has
historically capitalized its content costs. But this explanation fails to reconcile. If capitalizing
content costs was a historical practice and does not represent a change in strategy, then
capitalized content costs dont explain the disproportionate increase in capitalized expenses
relative to revenue.
We believe the actual explanation is that CHGG management has shifted operating expenses
from its income statement to capitalized expenses on its balance sheet. While this strategy
inflates adjusted EBITDA by excluding the resulting depreciation, it does not alter the overall
cash flow of the business, which, as discussed below, continues to deteriorate.
CHGG Capex Analysis
$ 000s
Revenue
Capex
Capex % of Revenue
Source: Company filings.
2013
255,575
2014
304,834
2015
301,373
YTD 16
191,033
7,369
2.9%
5,083
1.7%
8,253
2.7%
17,834
9.3%
III. Management quietly pushed out its target operating model by one year
As CHGG has been pivoting from a textbook rental business to a 100% digital business,
management has repeatedly shared its target operating model. With the Ingram transition
expected to be completed by the end of 2016, management made the logical argument that its
target model would be achieved in 2017. Throughout 2015, CHGG included its target model
and timeline in every publicly filed investor presentation. As recently as November 2015, and
seen in the screenshots below, CHGG publicly endorsed achieving its target financial model
in 2017. On CHGGs Q315 earnings call, Mr. Brown again promised, During 2017 we
expect to reach our target model of 25% revenue growth, greater than 60% gross margins, and
25% EBITDA margins, along with strong free cash flow.61 That sounded pretty good.
However, when CHGG reported its Q415 earnings results just three months later, the widely
promoted target model was shifted by an entire year into 2018. In addition to shifting the
target model date from 2017 to 2018, management also quietly changed its revenue target
from 25% total Revenue Growth to 30% Chegg Services Revenue Growth. As is often
the case with this management team, there was no explanation provided for the meaningful
target model change or year-long push-out. As we discovered last week when management
________________________________________________________________________34
COPPERFIELD RESEARCH
------------------------------------------------------------------provided initial 2017 guidance for revenue growth of only 19%, we believe the revenue
growth target change is due to the fact CHGG is materially behind its operating plan.
IV. CHGGs business model(s) perpetually destroy capital and burn cash
We think it's important for people to know that we generate a lot of cash and we are able to
generate free cash flow. And that's something that is new to Chegg One of the wonderful
things that we can say for the first time since we've been public is we generate a lot of cash
from operations. Dan Rosensweig, CHGG Q216 earnings call, 8/1/16
With all due respect to Mr. Rosensweig, we believe this quote demonstrates either a lack of
understanding about the definition of cash flow or intent to deceive investors. While CHGG
has generated cash year-to-date, the primary sources are unsustainable or the result of timing.
Specifically, cash flow from operations has been distorted by the proceeds from the
liquidation of textbooks (which will cease next year) and the timing of fall semester rush
payments that will be remitted to Ingram in Q416. More importantly, based on
managements guidance that CHGG will end the year with $50 to $60 million in cash,
CHGGs operating free cash burn will be north of $25 million in 2016, which represents a 3x
increase over 2015.
Prior to 2015, when CHGG commenced its business transition away from print textbooks, the
company actually generated significant cash flow from operations. While the operating cash
flow never translated into free cash flow because of significant cash outflows for textbook
purchases, cash flow from operations was indeed positive. However, cash flow from
operations turned negative in conjunction with the digital transition in 2015, and in a direct
contradiction to Mr. Rosensweigs statement, the negative cash flow is expected to intensify
in 2016.
While there could be possible explanations for Mr. Rosensweigs inaccurate and misleading
public cash flow statements, it is our opinion that (a) Mr. Rosensweig misrepresented the
actual economics of the business, or (b) he does not understand the definition of free cash
flow. Unfortunately for shareholders, neither is a good explanation.
________________________________________________________________________35
COPPERFIELD RESEARCH
-------------------------------------------------------------------
2011
32,754
(4,428)
28,326
2012
54,681
(2,707)
51,974
2013
63,706
(15,148)
48,558
2014
68,475
(5,083)
63,392
2015
(82)
(8,253)
(8,335)
2016G
(2,608)
(22,500)
(25,108)
Purchase of Textbooks
(74,094) (104,518) (122,247) (112,814)
(32,297)
(795)
Proceeds from Liquidation of Textbooks
30,882
34,076
37,946
58,119
38,260
26,873
Net Textbooks (Purchase) / Proceeds
(43,212)
(70,442)
(84,301)
(54,695)
5,963
26,078
Source: Company filings.
2016 cash flow based on midpoint of management guidance from Q3'16 earnings call to end year with $50 to $60 million in cash.
2016 capex based on midpoint of management guidance from Q2'16 earnings call.
Assumes $3 million proceeds from liquidation of textbooks in Q4'16.
________________________________________________________________________36
COPPERFIELD RESEARCH
Purchase price
Contingent consideration
Total
Source: Company filings.
Q2 16
25,000
25,000
Q3 16
Q4 16
3,000
3,000
2017
17,000
7,350
24,350
2018
5,400
5,400
2019
2,250
2,250
Total
42,000
18,000
60,000
7) Rubber meets the road in 2017 & VCs and insiders are voting with their
feet
I. CHGG will struggle to meet 2017 consensus expectations
GAAP and pro forma become the same when we get to 2017, so there wont be any
difference. It will be just GAAP only. Andrew Brown, CHGG CFO, Q415 earnings call,
2/22/16
CHGG management has been 100% clear that the 2017 income statement will no longer
include arbitrary and misleading pro forma adjustments. As such, CHGGs pro forma 2016
guidance should provide a clean baseline off of which investors can bridge 2017 guidance.
Based on extensive analysis, we believe growth expectations are materially too high and
CHGG will disappoint investors throughout 2017. Management already lowered 2017
expectations when they provided initial revenue guidance approximately $5 million below
prevailing consensus estimates on the Q316 earnings call. We believe this is the first of many
negative revisions to come.
Pro forma Required Materials revenue growth has decelerated since 2013 and
managements 2016 guidance implies the segment will actually decline by nearly 9%.
CHGGs lack of product differentiation and the intense competitive environment should
prevent the segments performance trends from improving. Even management appears to
agree with this conclusion, as implied 2017 guidance assumes Required Materials decline
accelerates next year. While managements guidance implies Required Materials will decline
11.5%, based on recent trends and increasing competition, we believe Required Materials
decline worsens to 20% next year. Based on what we believe is a more realistic level of
decline, Chegg Services growth would need to re-accelerate from 28% (management
guidance for 2016) to nearly 40% to meet managements guidance. Considering Chegg
Services growth has consistently decelerated in each of the last four years, we do not believe
such a strong re-acceleration will occur. Even taking managements guidance at face value,
Chegg Services growth would need to re-accelerate to ~35% in order to achieve 2017
numbers. Finally, it is important to also keep in mind that as the Required Materials segment
disintegrates, CHGG will lose its purported low-cost customer acquisition funnel.
We are convinced that management will be forced to make more frequent (or larger)
acquisitions, or 2017 will be the year CHGGs promotional story unravels.
________________________________________________________________________37
COPPERFIELD RESEARCH
2013
57,192
41,830
99,022
2014
66,111
68,117
134,228
2015
71,818
94,286
166,104
2016G
65,500
120,500
186,000
2017E
52,400
167,600
220,000
YoY Growth
Required Materials
24.6%
15.6%
8.6%
(8.8%)
(20.0%)
Chegg Services
69.7%
62.8%
38.4%
27.8%
39.1%
Total Revenue
40.4%
35.6%
23.7%
12.0%
18.3%
Source: Company filings.
*2016G assumes midpoint of guidance and excludes $7 million estimate for ImagineEasy.
*2017E excludes $10 million estimate for ImagineEasy.
II. VCs and insiders heading for the exits before the next reset
CHGG raised significant venture capital during its six years as a private company. Many of
the early-stage VCs are trapped with large investment losses. Rather than continue to patiently
support CHGG through its highly anticipated digital transition, several of CHGGs most
knowledgeable investors have exited their positions. In fact, three of CHGGs top six pre-IPO
shareholders sold their entire investment. CHGGs largest pre-IPO shareholder, Ace ltd.,
exited its stake in 2015, which we believe is a particularly troubling development. Ace
benefited substantially from one of the aforementioned pre-IPO ratchet provisions its stake
increased by nearly 40% from 7.6 million shares to 10.5 million shares at CHGGs IPO and
the firm had been an investor in CHGG for less than five years. Venture firms are typically
patient, long-term investors, who support management teams through value-creating
transitions. Yet, despite its short holding period and substantial increase in ownership due to
the ratchet provision, Ace exited its entire investment before reaping the rewards from
managements promotional pivot.
CHGG Venture Capital Ownership Analysis
Ace Limited
Insight Venture Partners
Kleiner Perkins
Gabriel Ventures
MOOS LLC
Foundation Capital
Total
Source: Company filings.
Current Holdings
7,451,067
8,355,135
7,358,364
23,164,566
% Sold
100.0%
14.1%
0.7%
100.0%
100.0%
49.0%
In addition to many of CHGGs VCs exiting their investments (many at losses), corporate
insiders are also heading for the door. Charles Geiger, CHGGs Chief Product Officer, has
________________________________________________________________________38
COPPERFIELD RESEARCH
------------------------------------------------------------------dumped nearly $1 million of stock since August, decreasing his ownership position by more
than 80%.
Geiger Family Trust Transactions
Date
Shares Sold
Price
Amount
8/2/2016
74,334
8/4/2016
11,543
8/5/2016
33,457
8/11/2016
25,000
Total
144,334
Source: Company filings.
$6.06
$6.50
$6.53
$6.75
$6.32
$450,501
$75,030
$218,541
$168,800
$912,872
Shares Held
177,147
102,813
91,270
57,813
32,813
Why would VCs and insiders, who presumably understand CHGGs business and digital
transition better than unaffiliated holders, sell so much stock just as the company is on the
precipice of reaching its target model? We believe the answer is because VCs and insiders
know CHGG will not deliver on 2017 estimates, and managements business pivot will be
exposed as a stock promotion.
________________________________________________________________________39
COPPERFIELD RESEARCH
------------------------------------------------------------------For example, we utilized LinkedIns current valuation, which embeds Microsofts 50%
acquisition premium.
Incredibly, despite declining GAAP revenue, decelerating pro forma revenue growth, negative
free cash flow, and a structurally broken business model, CHGG trades at a substantial
premium to AMZN, LNKD, and every other consumer internet or e-commerce peer we could
imagine. While it should presumably trade at a discount to the basket below, CHGGs stock
price trades at over a 100% revenue multiple premium and over a 300% EBITDA multiple
premium.
CHGG Comparable Company Valuation Analysis
$ 000s
Enterprise
Company Name
Ticker
Value
Education-focused Peers
Barnes & Noble Inc
BKS
852,055
K12 Inc
LRN
438,441
Barnes & Noble Education Inc BNED
474,980
Scholastic Corp
SCHL
1,149,576
Houghton Mifflin Harcourt Co HMHC
1,916,614
Mean
Median
Consumer-internet and E-commerce Peers
eBay Inc
EBAY
IAC/InterActiveCorp
IAC
Groupon Inc
GRPN
LinkedIn Corp
LNKD
Angie's List Inc
ANGI
Amazon.com Inc
AMZN
Mean
Median
32,466,809
5,599,071
1,833,810
23,713,531
476,942
353,395,126
Total Mean
Total Median
2016E
Revenue
2016E EV / 2016
EBITDA
Revenue
EV / 2016
EBITDA
4,019,333
905,500
1,857,000
1,785,500
1,377,125
202,500
96,400
70,000
149,000
200,571
0.2x
0.5x
0.3x
0.6x
1.4x
0.6x
0.5x
4.2x
4.5x
6.8x
7.7x
9.6x
6.6x
6.8x
8,989,727
3,110,444
3,124,250
3,780,200
327,444
136,868,325
3,456,222
500,600
157,947
1,129,100
22,491
15,060,875
3.6x
1.8x
0.6x
6.3x
1.5x
2.6x
2.7x
2.2x
9.4x
11.2x
11.6x
21.0x
21.2x
23.5x
16.3x
16.3x
1.8x
1.4x
11.9x
9.6x
Chegg Inc
CHGG
715,935
193,000
14,000
3.7x
51.1x
Source: Bloomberg and company filings.
CHGG 2016 revenue based on midpoint of pro forma guidance. 2016 EBITDA based on midpoint of guidance less
$5 million of estimated gain on liquidation of textbooks and acquisition-related compensation.
________________________________________________________________________40
COPPERFIELD RESEARCH
------------------------------------------------------------------reported $4 million YTD for these two items), CHGG should generate approximately $14
million of recurring EBITDA this year.
While we believe CHGG should trade in-line with its education-focused peers (i.e., 5-7x
EV/EBITDA), we have assumed the promote garners a broader, more generous peer group
multiple of 11.9x. After including CHGGs estimated year-end cash balance and deducting its
Imagine Easy earn-out obligations, CHGGs intrinsic equity value is $186 million.
Finally, while CHGG reported 91 million basic and diluted shares in Q316, this share count
excludes 11.2 million anti-dilutive shares. Using CHGGs correct fully diluted share count of
102 million shares, CHGGs intrinsic per share equity value is $1.82, or 77% downside from
the current share price.
CHGG EV / EBITDA Valuation Analysis
$ 000s
CHGG 2016E EBITDA
Multiple
14,000
11.9x
Enterprise Value
Year-end Estimated Cash
Imagine Easy Earn-out Requirements
CHGG Equity Value
166,312
55,000
(35,000)
186,312
91,059
11,244
102,303
$1.82
________________________________________________________________________41
COPPERFIELD RESEARCH
-------------------------------------------------------------------
http://www.wsj.com/articles/SB10001424052702304244904579278580848831864
http://www.iowastatedaily.com/news/article_4b64b1fa-08f2-531a-b714-7672985709d0.html
3
VentureSource, accessed 9/5/16
4
http://blogs.wsj.com/digits/2015/10/21/valuation-hungry-startups-should-heed-cheggs-disastrous-ipo-ratchet/
5
CHGG S-1, 10/31/13
6
http://blogs.wsj.com/digits/2015/10/21/valuation-hungry-startups-should-heed-cheggs-disastrous-ipo-ratchet/
7
Ibid
8
CHGG S-1, 10/31/13
9
CHGG S-1, 10/31/13
10
Ibid
11
BMO Capital Markets Initiation Report, 12/9/13
12
Bloomberg.
13
http://adage.com/article/news/zdnet-trudges-tech-site-rebuilds/1249/
14
Webvan raised $375 million in November, 1999 - https://en.wikipedia.org/wiki/Webvan
15
Bloomberg. ZDNets stock price declined from $36.00 on 3/31/99 to $9.00 on 6/30/00
16
http://adage.com/article/news/zdnet-trudges-tech-site-rebuilds/1249/
17
CapitalIQ.
18
http://www.bloomberg.com/news/articles/2016-07-25/what-sank-yahoo-blame-its-nice-guy-founders
19
http://www.ocala.com/news/20061207/yahoo-tackles-mess-of-its-own-with-sweeping-changes
20
Ibid
21
http://www.businessinsider.com/2008/6/was-yahoo-s-terry-semel-the-worst-internet-ceo-ever-yhoo22
http://prev.dailyherald.com/story/?id=135843
23
http://investor.activision.com/releasedetail.cfm?releaseid=372199
24
http://www.hollywoodreporter.com/news/rosensweig-plays-lead-guitar-hero-81142
25
https://www.theguardian.com/technology/2010/feb/02/guitar-hero
26
Ibid
27
http://www.wired.com/2011/02/guitar-hero-canceled/
28
http://www.nytimes.com/2009/07/05/business/05ping.html?_r=0
29
CHGG S-1
30
Ibid
31
http://www.newsobserver.com/news/business/article82494022.html
32
Ibid
33
http://fortune.com/2015/10/07/amazon-pick-up-college-campuses/
34
Ibid
35
Ibid
36
Ibid
37
https://campustechnology.com/articles/2016/09/14/pearson-follett-partner-on-digital-textbook-program.aspx
38
Ibid
39
http://investor.chegg.com/press-releases/press-release-details/2016/Chegg-Reports-Q3-2016Earnings/default.aspx
40
CHGG Q216 earnings call, 8/1/16
41
CHGG Q216 earnings call, 8/1/16
42
https://www.chegg.com/tutors/pricing/
43
CHGG Q415 earnings call, 2/22/16
44
Ibid
45
CHGG Q314 earnings call, 11/3/14
46
https://www.sec.gov/Archives/edgar/data/1364954/000000000015056977/filename1.pdf
47
Ibid
48
https://www.sec.gov/Archives/edgar/data/1364954/000136495415000195/filename1.htm
49
CHGG Q415 earnings call, 2/22/16
50
CHGG Q414 earnings call, 2/23/15
51
https://www.sec.gov/rules/final/33-8176.htm
2
________________________________________________________________________42
COPPERFIELD RESEARCH
------------------------------------------------------------------52
http://www.debevoise.com/~/media/files/insights/publications/2016/05/20160519_non_gaap_metrics_in_the_cro
sshairs_sec_issues_new_guidance.pdf
53
https://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm
54
https://www.sec.gov/rules/final/33-8176.htm#P154_25346
55
CHGG Q216 earnings release
56
Refer to Q315 earnings release
57
ISS Proxy Analysis
58
CHGG 2016 Proxy Statement
59
CHGG Q216 earnings call, 8/1/16
60
Ibid
61
CHGG Q315 earnings call, 11/2/15
62
CHGG Q414 earnings call, 2/23/15
________________________________________________________________________43