COUR - Coursera: Secular Growth Prospects With EBITDA Profitability In Sight (Rating Upgrade)

2023-08-11 17:34:52 ET

Summary

• Coursera's revenue growth is expected to benefit from the increasing demand for reskilling and upskilling, as well as the demand for affordable education and degree courses.
• The company reported better-than-expected Q2 2023 earnings, with revenue increasing by 23% YoY and adjusted EPS beating estimates.
• Coursera is well-positioned to address the changing nature of work and the need for skill development, and its courses are seeing an increase in new learner registrations and global learner base.

Investment Thesis

Coursera’s ( COUR ) revenue should benefit from the long-term secular demand tailwinds arising from the growing need for reskilling and upskilling, as advancing AI and digitization take over low-skilled jobs. In addition good demand for affordable education from prestigious institutions and increasing traction towards degree courses should also support revenue growth moving forward.

On the margin front, gross margin is expected to be negatively impacted this year by incremental costs associated with a contract renewal with the company’s largest industry partner. However, beyond 2023, the company’s margins should benefit from easing comparisons, volume leverage, and cost-saving initiatives. Moreover, the adjusted EBITDA margin is also expected to turn positive moving into 2024 due to normalized levels of SG&A investments and improved operating leverage, paving the way for positive adjusted EPS in the coming years. Hence, the company has good top and bottom-line growth prospects. The valuation seems reasonable based on EV/Sales ((FWD)) of 2.58x. My biggest problem with new-age tech companies has been losses and cash burn and that's why I was neutral on Coursera till now. However, with EBITDA profitability in sight, I believe things are on the right track for Coursera, and as a result, I am upgrading my rating to buy given the improved visibility on profitable growth.

Q2 2023 Earnings

Late last month, Coursera, Inc. reported better-than-expected results for the second quarter of 2023. The company's revenue increased by 23% YoY to $153.7 million, which beat the consensus estimate by $7.5 million. Adjusted EPS declined by 38.2% YoY to -$0.21 but beat the consensus EPS estimate by $0.08. The adjusted gross margin declined by 1080 bps YoY to 53.3% and the adjusted EBITDA margin increased by 1060 bps YoY to -1.9%.

The revenue increase was driven by healthy demand for entry-level professional certificates and increasing enrollments in degree programs. The adjusted gross margin decline was due to incremental costs associated with a renegotiation of terms of a contract renewal with the company’s largest industry partner. Adjusted EPS and adjusted EBITDA margin increased as a result of volume leverage and lower SG&A as a percentage of sales.

Revenue Analysis and Outlook

In my previous article in April, I talked about Coursera’s good revenue growth prospects benefiting from healthy demand for online education. The company has reported its earnings for the first and second quarters of 2023 since then and similar revenue growth dynamics were seen there as well.

In the recent earnings of the second quarter of 2023, revenue growth momentum continued to benefit from good demand across the globe for entry-level professional certificates, driven by the need to re-skill and up-skill in career. In addition, the company also benefited from good growth in the Degree segment as a result of increasing traction toward online master's degrees and new course additions. This resulted in revenue growth of 23.2% YoY to $153.7 million.

Looking forward, I believe the company should be able to continue delivering good revenue growth, benefiting from healthy secular demand trends across the globe driven by the need to re-skill and up-skill in the wake of advancing AI and digitization. Coursera provides access to affordable education from prestigious institutions, workforce development to support national economies, and increasing traction towards degree courses.

In today’s world, the trend towards digitization is leading to increased automation of work processes, resulting in the displacement of certain low-skilled jobs by AI and other technologies. As technology continues to advance, this transformation is going to further accelerate. As a result, certain jobs may become obsolete or undergo significant changes. Re-skilling and up-skilling enable workers to transition into new roles that complement AI and automation, reducing the risk of job displacement. Further, the adoption of AI and digitization introduces new skill requirements in the workforce. For example, data analysis, machine learning, programming, and digital literacy are becoming increasingly important skills across different sectors. Re-skilling and up-skilling help individuals meet these emerging demands. AI and digitization can also enhance efficiency and productivity in many fields. Employees with updated skills can leverage these technologies to perform tasks more effectively, driving higher work productivity. Additionally, as technology evolves, certain job roles may evolve or disappear, while new roles emerge. By re-skilling and up-skilling, individuals increase their market relevance and broaden their career opportunities in the face of these changes. Lastly, digital transformation may lead to skills gaps in the workforce as human skills are also required to oversee and properly operate the AI and digital tools. As a result, demand for specific skills could surpass the available talent. So, re-skilling and up-skilling programs help address these gaps, ensuring that organizations have the skilled workforce they need.

Coursera is well placed to address this fundamentally changing nature of work and skills required in the job market. The need for re-skilling and up-skilling is also widely seen in the current job market, where lay-offs have become common as companies reduce their headcount for cost-savings and productivity benefits.

Coursera ’s courses fit right to meet this growing demand and the company is seeing a good increase in new learner registrations from both year-over-year and sequentially as a result. In Q2, the company added 5.7 million new registered learners and grew its global learner base to 129 million by the end of June, an increase of 20.5% YoY and 4% sequentially. So, these demand trends should continue to help the company’s top-line growth in the coming years.

Moreover, as I mentioned in my previous article , the rise of remote work has transformed the employment landscape, removing geographical barriers and allowing employers to access a global talent pool. This newfound flexibility has created exciting opportunities for job seekers, who are no longer limited by physical location when looking for work. As organizations embrace remote work arrangements, job seekers are eager to acquire relevant skills in order to take advantage of these global job opportunities. This is also increasing demand for skill development courses.

Additionally, Coursera is constantly expanding its branded micro-credential course offerings, which are recommended by the American Council on Education (ACE). In a world where machines are increasingly capable of producing content on a large scale including educational content, these trusted institutions and notable credit recommendations will play an important role in education as students seek quality and accuracy. As a result, learners can earn branded academic credit toward a degree program or add-on skills at an affordable cost through Coursera, and universities are considering offering credit for these industry micro-credentials to supplement traditional curriculums with job-relevant skills. This should also help the demand remain at healthy levels and increase revenue growth.

Lastly, the company should also benefit from increasing traction toward online degrees. The pandemic has enabled the rise of online learning, opening up new opportunities for Coursera's degree segment. Through this platform, higher education institutions can shift from traditional education to online learning, expanding their global reach. This approach also benefits students by allowing them to earn a full-time degree from the comfort of their location and financial capabilities. Additionally, working adults can also pursue a degree while managing their jobs, making education more accessible.

To capitalize on these advantages, Coursera has been collaborating with a growing number of higher education institutions and introducing new master's programs. In the first half of 2023, they added 12 new degree programs, including various master's and bachelor's degrees, including programs in computer science and artificial intelligence.

These affordable degree programs are gaining significant traction, as evidenced by the double-digit growth in the degrees segment during Q2 2023. This shift from traditional to online education is also expected to fuel the company's sales growth in the future.

So, the company has various secular trends that should continue to help its sales growth moving forward. I believe these tailwinds should help offset the slowdown in the enterprise segment arising from lower demand from businesses in tough macroeconomic conditions. These slowdowns tend to be cyclical and Coursera’s diversified portfolio should help it sustain demand even during recessionary times. Moreover, I expect businesses to normalize their learning and development spending as the inflationary environment moves in the right direction. So, demand from businesses should start recovering as we move into next year, helping sales growth.

In a nutshell, I believe the company has good revenue growth prospects backed by secular demand trends across the globe driven by the need to re-skill and up-skill in the wake of advancing AI and digitization, access to affordable education from prestigious institutions, workforce development to support national economies, and increasing traction towards degree courses. Management has guided revenue growth of 18% (mid-point) this year, which I believe is achievable.

Margin Analysis and Outlook

In the second quarter of 2023, COUR’s gross margin was impacted by a renegotiated contract renewal with one of its largest industry partners, which shifted certain input costs from operating expenses to cost of sales. This resulted in an adjusted gross margin decline of 1080 bps YoY to 53.3%. Adjusted EBITDA margin was impacted by higher investments in advertising and marketing to expand its course offering. However, despite the Adjusted EBITDA losses, the margin has been moving towards profitability due to lower SG&A as a percentage of sales. This led to a 1060 bps YoY increase in adjusted EBITDA margin to -1.9%.

Looking forward, while the gross margin should continue to get impacted Y/Y in the second half of 2023 by renegotiated contract renewal with one of its largest industry partners, I think it should remain stable sequentially in the low to mid-fifties in the second half. However, gross margins should expand beyond 2023. Moving into 2024, the gross margin should benefit from easing comparisons and volume leverage as revenue continues to increase. Moreover, the company, just like many industries is focusing on technological enhancements to improve productivity and save on costs.

In the first quarter, the company launched an AI-assisted course-building pilot to support its educator partners. This new set of AI-powered features can auto-generate course content including an overall course structure, readings, assignments, and glossaries based on a few simple inputs from the author. This should allow enterprise customers to upload internal videos that can be automatically transformed into smaller clips and integrated into well-structured private courses. Further, these AI/ML investments will also enable language translation of the courses in an efficient way to make it more localized for authors and learners. According to management, human translation of a course today costs ~$13,000 on average, but through these AI investments that cost should come down meaningfully. So, through this AI-led pilot, the company should be able to reduce the time and cost of producing high-quality trusted content at scale. This should also help increase margins moving forward by reducing content costs (which is the largest component of the cost of revenue).

Further, the year-over-year improvement in the adjusted EBITDA margin over the past few quarters and sequential improvement in Q2 2023 gives some visibility for the company to turn breakeven on profitability as we progress forward in the year. This should be due to good volume leverage, and lower SG&A as a percentage of sales as the company gradually normalizes its elevated investments in marketing and advertising.

Moreover, year-to-date, the company has incurred an adjusted EBITDA loss of $10.4 million. In the Q2 2023 earnings release, management guided an adjusted EBITDA loss of $9 million to $14 million ($11.5 million at mid-point) for Q3, with a full-year expectation of $19 million to $24 million ($21.5 million at mid-point) adjusted EBITDA loss. If we do some math, this implies that the company should be able to achieve a slightly positive EBITDA of ~$0.4 million at the midpoint in Q4 2023. Hence, I believe the company should be able to achieve breakeven profitability beginning in Q4 2023 with further expansion in the coming years. Hence, I am optimistic about the company’s medium to long-term margin prospects ahead.

Valuation and Conclusion

COUR is trading at EV/Sales ((TTM)) of 2.77x and EV/Sales ((FWD)) of 2.58x. This isn’t pricey given the company has a multiyear growth runway ahead of it and can post mid to high teen revenue CAGR benefiting from various secular demand trends in the education industry driven by AI and digitization as well as the increased adoption of online learning post-pandemic. Moreover, over the past couple of quarters, management's good operational execution to reduce costs and leverage the top-line growth to progress toward profitability has also given me confidence in the medium to long-term margin growth and potential profitability of the company. So, I am encouraged by the growth prospects ahead and I'm upgrading my rating to buy.

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