2023-05-02 07:29:35 ET
Summary
- Chegg has sold off 37.5% in after-market trading after disclosing that its business has been affected by ChatGPT.
- Reviewing the details of this, however, we see that Chegg maintained good user retention and didn't see a wholesale loss of customers - only new user signs ups were affected.
- Additionally, it is close to releasing its own AI product - and it is a company that is well-positioned to do so.
- It is also trading very cheaply right now, particularly on a cash basis. This makes for an interesting, high-risk, tactical trading opportunity based on its new product.
Overview
Chegg ( CHGG ) stock got annihilated in after-hours trading after announcing that its business was being directly impacted by ChatGPT. Online homework help may not have been the first place investors were expecting a disruption by AI, but it was. Chegg dropped 37.5% as of this article and appears to be in for a rough time.
As someone who used Chegg back in college I can't help but take a look back in on this stock and see if it's really done for. The good news is that I don't think it is. There is nuance around the company's recent earnings report and I don't expect it to go out of business any time soon.
Additionally, it's worth remembering that this is a scaled out digital business and that it has the fundamental resource for building products in the AI age: data. This can make Chegg an interesting competitor within AI in its own right. This article will review recent developments and provide commentary on how things could progress for Chegg in the near future.
Earnings
It's worth seeing exactly what was said by management in the latest earnings report. The CEO made clear that ChatGPT is impacting new user sign-ups but that retention has remained strong. This is better than it could have been, as it is showing that Chegg's product remains sticky with consumers and they are not wholesale transitioning to ChatGPT. Nonetheless the updated guidance timeframe of only one quarter out indicates a new degree of caution by management .
In the first part of the year, we saw no noticeable impact from ChatGPT on our new account growth, and we were meeting expectations on new sign ups. However, since March, we saw a significant spike in student interest in ChatGPT. We now believe it's having an impact on our new customer growth. Fortunately, we continue to see very strong retention rates, suggesting that those students who already understand the value of Chegg continue to choose us and retain us at high rates. We are also expecting a positive recovery in enrollment trends, which historically would be good news for Chegg. Because it's too early to tell how this will play out. We believe that it's prudent to be more cautious with our forward outlook. Therefore, we intend to provide only the next quarter's guidance at this time and Andy will walk you through those details shortly.
The other side of the coin is that Chegg is already on its front foot with building an AI-enabled product. Chegg has been working with ChatGPT creator OpenAI to build an AI learning assistant leveraging its data.
The first big step is the introduction of CheggMate, which we recently announced in cooperation with OpenAI. CheggMate will harness the power of ChatGPT paired with our proprietary data and subject matter experts to make learning more personalized, adaptive, accurate, fast and effective, all in an easy to use and conversational manner. The combination of Chegg's experience over the last 13 years of improving student outcomes and our proprietary learning taxonomy to 150,000 subject matter experts in our network and the billions of pieces of unique learning content that Chegg owns, when coupled with the real time conversational nature of ChatGPT will establish CheggMate as a powerful and distinctive learning tool offered exclusively from Chegg.
The product, CheggMate, becomes more interesting as we continue reading about it.
Based on our research, 85% of students would prefer to have human experts involved in their study support. Which is why we believe that the future of learning is a blend of AI technology with human based support to build trust and ensure accuracy and relevancy. Ultimately, we believe the introduction of CheggMate will lead to an increase in the size of the market we serve and strengthen our relationship with our users, while reducing content costs. Large language models are currently used horizontally, similar to search, but history suggests that over time focused and category leading verticals are where enduring value is created. CheggMate is being designed for learning and tailored to an individual studies -- individual students learning style and needs. It will offer personalized assessments, practice tests and instant feedback along with Chegg's proprietary step-by-step solutions . We are moving very fast with a beta launch of CheggMate later this month . And as we test and iterate, we will expand access throughout the year.
Chegg has established that vast majority students still prefer having humans involved in teaching them. As a side note this is interesting because Bill Gates speculated that this would be the case in his recent AI letter.
Of course, AIs will need a lot of training and further development before they can do things like understand how a certain student learns best or what motivates them. Even once the technology is perfected, learning will still depend on great relationships between students and teachers. It will enhance-but never replace-the work that students and teachers do together in the classroom. - Bill Gates
Notably Chegg is already set to release an early version of CheggMate later this month. This is certainly a fast response to significant changes in its market, and I like to see management taking a proactive approach on this. It is also sensible that Chegg, with its core competencies around providing information to students, is well-positioned to build a product like this.
I am inclined to believe that they will build a good product. Indeed, Chegg could very build a leading AI-enabled e-learning product - and actually end up benefitting from AI. There haven't been similar announcements from competing e-learning providers, and I'll reiterate that Chegg has the data to actually pull this off.
Along with this, Chegg is now trading cheaply against its sector comparisons - consumer discretionary and information technology.
Price/Op. Cash Flow ((TTM)) | Price/Op. Cash Flow ((FWD)) | |
CHGG | 8.41 | 7.68 |
CD Sector Median | 11.58 | 8.8 |
CD % Difference | -27.37% | -12.99% |
IT Sector Median | 19.33 | 17.91 |
IT % Difference | -56.49% | -57.12% |
Source: Excel, Seeking Alpha
This is a great price for a technology stock that has had 7 straight quarters of free cash flow and posted its best year yet in 2022. Free cash flow per share has also been very strong for 2 years, and at its price of $11 the company is generating 10.6% of its share price in free cash flow yearly.
Risk
The risk here is that Chegg's product will be a flop and it stops growing. Since students only attend college for 4 years, this means that its current user base - and cash flows - would be wiped out in 4 years if it does not generate user sign-ups. This would see a wholesale destruction in its cash flows and the stock selling off further. This is a significant risk and investors should consider this to be a high-risk, high-return investment at present.
Conclusion
If Chegg can get a quality AI product out the door, it can maintain its growth and keep its cash flows. I am on the optimistic side of things here and believe that Chegg has the data and learnings from customers to be able to pull this off. I am calling it a risky buy and am going to see how this trade plays out.
For further details see:
Chegg: Speculative AI Turnaround Buy