- 2U, Inc. is a money-losing education technology provider that partners with universities to market and manage online graduate degree and short course programs. Its one size fits all model is being disrupted by fee-for-service players with lower take-rates. Our Freedom of Information Act (“FOIA”) documents offer compelling evidence that 2U’s long term guidance will disappoint investors.
- Significant Number of Programs Are Underperforming: The Street is neglecting to understand the range of outcomes for both existing and future graduate programs. We have assembled a proprietary historical revenue model that estimates revenues for each individual graduate program using a combination of FOIA requests, conversations with industry participants, company filings, transcripts, publicly available enrollment data, and tuition costs. This proprietary model reveals a wide range of outcomes between programs that are successful and those that we would classify as failures. Most importantly, we have found that eight of the 14 programs launched between 2013 and 2015 are underperforming 2U’s steady state program expectations. Further, based on our findings, we believe that four of the top seven programs have peaked and/or seen enrollment declines. Our FOIA request for new student enrollments for MBA@UNC reveals that the 2U enabled MBA@UNC is now in decline as the last four starts have all seen YoY declines. We believe the Street is dangerously extrapolating 2U’s guided steady state program performance to model 2U’s new and future programs.
- GetSmarter Acquisition Likely A Diversion For Slowing U.S. Growth: At Spruce Point, we’ve successfully shorted numerous companies where we spotted early underlying business challenges being deflected by acquisitions. In the case of 2U, we find that it made its first acquisition of GetSmarter in May 2017, allowing it also to diversify internationally. We believe this validates our view that domestic growth is slowing. GetSmarter also exposes 2U to short courses, which is a lower quality business, with shorter duration revenue visibility, and fewer barriers to entry.
- Recent Equity Raise of +$330m Raises Questions: Alongside the COO appointment, 2U did a secondary stock issuance and raised $330m at $90/share (a 5.8% discount to the closing price of $95.53). The language in its capital raise differs from its capital raise just eight months prior (September 2017). The use of proceeds has now been expanded to include acquisitions, despite it having recently acquired GetSmarter, and not proven its ability to make good on its deal promises. Previous to this recent capital raise, 2U had $182m of cash on its balance sheet and has been talking to investors about its ability to become cash flow positive. Spruce Point believes 2U’s most likely motivation for issuing stock was to grab the money while investors aren’t attuned to its growing program failures and rising competitive threats. Otherwise, it is likely 2U is signaling a deferral of its time line to reach positive free cash flow.
- A Terrible Risk/Reward Owning 2U With Analysts Seeing Just 6% Upside, We See 30% – 50% Downside Risk:Insiders have made out like bandits, selling $148m of stock, despite 2U burning $225m of negative free cash flow since 2011. Approximately 25% of sales have been the CEO, who just adopted a new 10b5-1 program in March 2018 ahead of its recent capital raise, and can start selling again next week post lock-up. Analysts have relentlessly said “Buy” but at the current time analysts have an average price target of $99/sh, which represents just 7% upside, a poor risk/reward. Analysts fail to appreciate the change in competitive dynamics, and extrapolate 2U’s current performance into the future without having done the exhaustive FOIA and program analysis we’ve undertaken. Once reality sets in that 2U’s best days are behind it, and it begins disappointing unrealistic Street expectations, we expect significant valuation compression risk given its shares trade at 9.5x and 180x 2019E sales and Adj EBITDA, respectively.