2023-06-14 07:00:39 ET
Summary
- Chegg has seen the business harmed by students seeking help directly from generative AI software.
- The company is launching CheggMate to incorporate generative AI into a comprehensive learning tool, but the product isn't guaranteed to drive higher subscription rates.
- The current stock prices are supported by a business with solid cash flows to cushion the downside risk, while a winning AI product could lead to an AI boom.
The ongoing AI revolution hasn't been a positive for all stocks. Chegg ( CHGG ) was crushed when the connected learning platform ran into roadblocks with the potential disruption by generative AI platforms. My investment thesis is Bullish on the stock after the prior recommendation of buying the stock on dips set up perfectly for this very scenario.
Source: Finviz
Reorganizing For AI
Chegg has hit multiple speed bumps trying to recover from covid. First, student demand hasn't fully rebounded due to signs college professors aren't as rigorous as pre-covid. Now, generative AI is a disruptive force in educational learning as the AI tools like ChatGPT can help write papers and quickly answer questions, though with potential hiccups from systems that provide inaccurate answers.
The company provided very weak guidance for Q2 following an already weak Q1 where revenues fell 7% YoY. The major implication of the revenue guidance at only $175 to $178 million versus consensus estimates at $194 million was that students were bypassing subscription services for ChatGPT.
The biggest key is that ChatGPT might provide students with short cuts to finishing homework or writing a paper, but the generative AI tool doesn't necessarily help students actually learn. Chegg has announced CheggMate to quickly enter the AI arena, though the biggest hurdle is that over 50% of services delivered by Chegg are related to the Help category where students can potentially directly use generative AI tools.
The product utilizes GPT-4 from OpenAI to build an AI enhanced learning service. CheggMate uses the generative AI model to produce better outcomes for students by enhancing the learning via tailor-made quizzes and tests to help students actually learn.
Chegg just announced another restructuring with a 4% headcount cut to refocus on AI tools. Another cut suggests results are still struggling to rebound while the company waits for the full launch of CheggMate.
High Risk/Reward
Chegg has now fallen to only $10 following the weak Q2 guidance. The stock is a high risk/reward play now considering AI could disrupt the business forever, though a successful launch of CheggMate could actually provide a solution that has greater success with the implementation of AI tools to help students learn.
The stock traded above $30 only back a few months ago in the signs of the opportunity on releasing an AI product that boosts subscriptions. Not to mention, college professors should eventually start returning to more rigorous learning requirements pushing more students to seek help again while college enrollments are expected to rebound.
While the growth prospects are seen as muted by analysts, Chegg is still a highly profitable company now. The business still produces a $1+ EPS target in this tough environment and Chegg still reported a $0.27 profit in Q1.
The upside potential is that CheggMate leads the connected learning platform back to growth. The company would generate a higher EPS and the stock would see multiple expansion from the business model being a beneficiary of the AI boom.
The risk is that Chegg never regains growth and the stock languishes at these levels. The company has about $1.2 billion in cash and investments, but Chegg has convertible debt equally matching the cash balance.
The story gets intriguing with the company producing an impressive $73 million in operating cash during Q1 and free cash flow in the $57 million range. Chegg is a cash machine here considering the stock valuation is down to $1.3 billion while the company produced $150 million in free cash flow last year.
The worst case scenario would see these cash flows dwindle down over the years, but the company still provides solid cash flows to reduce the risk of the stock heading much lower. The BoD even recently announced a $150 million accelerated share repurchase program to reduce the outstanding share count.
Takeaway
The key investor takeaway is that AI has created a fork in the road for Chegg. The company has rightfully taken the path to create a superior AI product for students incorporating generative AI, but the plan isn't guaranteed to work.
The stock is potential high reward buy here with the ability to ride the AI boom higher, but Chegg isn't without high risk that failure to ride the AI wave leads to the ultimate demise of the business.
For further details see:
Chegg: AI Loser Could Turn Into Big Winner