One of my favorite stocks on Wall Street is digital education platform Chegg (NYSE::CHGG). The bull thesis on Chegg stock is simple. The world is becoming more digital than ever. This includes the education sector. But, there is currently no at-scale, uniform, low-cost provider of digital education services globally for high school and college students.
Chegg is providing these services, and it is growing very quickly because demand for these services is robust. But, Chegg is still in the first inning of this growth narrative, and as it plays out over the next several years, Chegg stock will stay on a winning trajectory.
That bull thesis missed one big thing, which only reinforces why Chegg stock is a long-term winner: a college bribery scandal.
Over the past several days, both the academic and celebrity worlds have been hit hard by a college bribery scandal that includes some big name Hollywood actors and actresses. Long story short, those big name actors and actresses, alongside 50 other wealthy parents, bribed people in the college admissions process to get their kids into good schools.
Believe it or not, this news is a big deal for Chegg. Indeed, it should provide a strong catalyst for Chegg’s services — namely its online SAT prep service — and that will provide a huge near, medium and long-term tailwind for this already supercharged growth narrative.
Overall, Chegg stock is a long-term winner, with or without the college bribery scandal. But, the college bribery scandal creates a huge tailwind that should propel the stock toward $50 over the next twelve-plus months.
You Can’t Pay Your Way Into College Anymore
The details of the college bribery scandal, which are now just coming to light aren’t important. Instead, what is important, is that this is just the tip of the iceberg. People everywhere, one way or another, have been trying to rig the college admissions process for a long time, so much so that it was somewhat becoming true that you could pay your way into college.
This trend is breaking. The scandal is an embarrassment for all involved parties. No one wants that kind of publicity. So, going forward, the involved parties will do everything to avoid this publicity. Higher education institutions will tighten up their admissions processes. Standardized test taking processes will likewise be tightened up. Parents will stop trying to shuffle money into these sort of bribery schemes.
In other words, the era of being able to pay your way into college is gradually coming to an end.
The financial implication of this is that more money than ever will flow into legitimate college admissions processes, such as test prep. Standardized test prep is already a huge industry. Millions of high school students take the SAT and ACT exams every year. Millions of dollars are already spent on preparing those students for those exams.
But, with this recent scandal, there will inevitably be a boom in the standardized test prep industry. That’s big for Chegg. The company is a streamlined, digital and low-cost provider of SAT prep solutions nationwide, with an exceptionally wide reach and high brand awareness. Naturally, as more dollars flow into the standardized test prep industry over the next several years, a lot of those dollars will find their way into Chegg.
As such, the recent college bribery scandal actually provides a big tailwind for CHGG stock.
Long-Term Upside Is Compelling
In the big picture, the college bribery scandal is just one of many reasons to like Chegg stock for the long haul. Those reasons are as follows:
- Digital is the future, and CHGG is the digital platform in the education space. Thus, the adoption of CHGG’s digital education tools will only grow over time.
- Chegg only has 3.1 million subscribers, representing less than 10% penetration among America’s 36 million high school and college students. Globally, the opportunity is much bigger, with over 200 million college students worldwide.
- Chegg is growing it’s sub base at a ~40% rate and Service revenues at a 35%-plus rate. Neither growth rate is slowing by much in a multi-year window.
- Gross margins are 75%-plus. The revenue model is largely subscription-based.
- Opex rates are falling quickly with revenue scale. Adjusted operating margins have climbed from a loss of 14% in 2014, to an increase of more than 20% last year. They are expected to head even higher next year.
Overall, Chegg is a big-growth, high-margin company that has a long runway ahead of it through robust subscriber growth. Because of this, I think CHGG projects as a steady 20%-plus revenue and sub grower over the next several years. Gross margins should remain steady around 75% during that stretch. Meanwhile, opex rates should keep falling with scale, implying healthy room for operating margin expansion.
Under those assumptions, I see Chegg as being able to do about $2.50 in earnings-per-share by fiscal 2025. At that point in time, the company should still be a big growth company with a huge international opportunity in front of it, and will consequently warrant a big forward growth multiple of 30. Based on the 30X forward multiple, $2.50 in fiscal 2025 EPS should reasonably lead to a fiscal 2024 price target for Chegg stock of $75.
Discounted back by 10% per year, that equates to a fiscal 2019 price target of over $45, implying healthy upside over the next several months.
Bottom Line on CHGG Stock
Chegg stock is a long-term winner. The recent college bribery scandal only reinforces that long-term bull thesis, and provides a healthy tailwind for operations over the next few quarters. As such, Chegg stock remains a buy at current levels.
As of this writing, Luke Lango was long CHGG.
