The kids are headed back to school … sort of.
Sept. 5, 2020
This article originally appears on The Motley Fool, written by Nicholas Rossolillo.
Many school districts, families with children, and college students are faced with a dilemma at the start of the 2020-21 school year: risk going back to the classroom or give it a go via video conferencing and remote learning. As a result, many remote education stocks (and of course Zoom Video Communications) have been off to the races since the market meltdown in March.
That’s where online education service outfit 2U (NASDAQ:TWOU) comes in. Shares are up more than 200% from their March lows on optimism this small company (with a current market cap of just $2.6 billion) could be a big part of the future of education. But before you buy, you should be aware of what could go wrong.
Some good stuff first
2U — which creates and provides online curriculums, undergraduate and graduate programs, professional certificates, and non-accredited studies — reported a 39% increase in revenue to $358 million through the first half of 2020. That included a 35% increase in the quarter ended June 30, although only 18% organic growth was reported with the balance coming from the $750 million acquisition of Trilogy Education last year.
This autumn, many universities will need at least a hybrid education model (a mix of on-campus and online instruction), so it’s no wonder 2U has been on investors’ radars this summer. And given the stock is still trading at less than half the value it reached in mid-2018 following its 2017 acquisition of GetSmarter, plus management’s expectation for organic revenue growth to accelerate in the second half of 2020, there’s reason to be optimistic.
COVID-19 could have long-term positive implications for the company’s online education and technology services. 2U mentioned on the latest earnings call that 73% of respondents to a company survey said the pandemic made them more likely to choose an online over on-campus education. Absent COVID-19, only 20% said they would have chosen online. Time will tell if attitudes revert once the coronavirus has been beaten, but for now, online learning is getting a boost from the current environment.
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Not exactly a fast track to education reform
Granted, 2U stock isn’t for the faint of heart. Though revenue growth has been consistent since the company went public back in 2014, there’s a reason share prices are still down by more than half from their all-time peak. For one, 2U isn’t profitable. Adjusted net losses amounted to $43 million in the first half of 2020. And though the company had nearly $195 million in cash and equivalents on hand at the end of June, it also had $263 million in debt — not exactly the most nimble of organizations. As pointed out by fellow Fool.com contributor Jon Quast, 2U invests in a new curriculum upfront and realizes revenue as a percentage of students’ tuition. Patience will therefore be required given the structure of the business.
Also to be considered is the fact that 2U itself admits education technology is a crowded space with a number of competitors. According to data compiled by research tool Noonum, they include Grand Canyon Education, Pearson, and Instructure (purchased by private equity firm Thoma Bravo). If remote education sticks beyond 2020, there are plenty of other tech firms out there ready to snap up the demand.
Nevertheless, no small-cap stock comes without significant risk. If it was clear sailing, it wouldn’t be a small-cap stock! Trading for just 3.9 times trailing 12-month revenue, 2U is an intriguing investment, although I would urge investors who do buy to stay appropriately diversified by adding 2U to a basket of small-cap stocks (I typically start with a position that makes up less than 1% of my portfolio value).
Given the current dynamics that could reshape the U.S. education system long term, there’s potential for this small education technologist to continue growing in the years ahead. Just remember to keep initial purchases small and strap in for a wild ride if you buy.
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