Uncommon Idea: Software-as-a-Service for Education 2U TWOU

The Uncommon Idea in Brief

Buy 2U (TWOU) stock for the long term. (Published July 29, 2017)

– Build a long position below $50. Add moderately on a pullback into the $46 to $48 area and aggressively in the $42 to $45 range.

The Industry Opportunity

Knowledge is power, as you many know from “School House Rock.” The cost of an MBA from a top 20 school will run six figures over a two-year period and that doesn’t factor any leave of absence from work. Many older or working professionals can’t afford to leave the workforce for a two- or three-year period.

Graduate Degrees

Value: The average lifetimes earnings for an MBA graduate is more than twice that of an individual with a bachelor’s degree only. This can range from $2 million to $6 million over a 40-year career. In short, the return on investment for a graduate degree can range from 10x to 30x the cost over a lifetime of employment.

Ease of Access: The ability to offer and host intimate classroom-like settings via the internet during traditional school hours and on-demand allows colleges and universities the ability to attract traditional and non-traditional students from every part of the globe. Time and distance are no longer an obstacle.

First-Mover Advantage: Collaboration not competition: For-profit online education providers are not new. But in the past they’d been built as competition fighting for the same dollars as traditional colleges and universities rather than as a business that collaborates with traditional colleges and universities.

Where 2U in all of this?

2U holds partnerships with some of the nation’s top universities to offer online graduate programs while building back office platform support, content development and performance analytics.

What 2U Does

2U offers cloud based Software-as-a-Service (SaaS) for non-profit and other universities to deliver education to students. Solutions include an online campus, an online learning platform that enables its clients to offer educational content together with instructor-led classes in a live, intimate and engaging setting through proprietary web-based and mobile applications.

The company’s integrated back-end applications launch, operate and support clients’ programs, as well as provide clients with real-time data and analytic insight related to student performance and engagement, student satisfaction and enrollment.

2U also offers a suite of tech-enabled services including content development and student acquisition, admissions application advisory, student and faculty support, student field placement, accessibility, immersion support, faculty recruitment and state authorization services.

The Uncommon Market Position That Sets 2U Apart

2U’s ability to scale provides the company a significant advantage to the current market. When 2U creates a new feature on its platform, it can immediately implement it for all its clients. Those clients include a growing list of colleges and universities. 2U works with colleges and universities to provide online education rather than competing. The company receives a share of tuition for providing services.

USC, which accounts for 34% of 2U’s revenue, down from 55% in 2016, was the first partner with 2U for its platform. This includes USC’s No. 1 ranked physical therapy program. Top-ranked Rice’s Jones School of Business has partnered with 2U to offer an online MBA program and the University of Denver has done the same.

Recently, Georgetown and the University of North Carolina signed a long-term partnership agreement with 2U to develop online graduate programs as 2U’s total number of students now exceeds 77,000, despite maintaining an attractive average class size of only 12 students.

The company’s recent acquisition of GetSmarter provides an expansion for 2U beyond traditional education. The company collaborates with universities to offer premium online short courses for working professionals. GetSmarter’s partners include Cambridge, the London School of Economics, HarvardX, MIT, Harvard University Strategic Online Learning Initiative and Africa’s top 3 universities.

Financials – 2U’s Financials Headed to the Top of the Class

2U shares in student tuition with its partner universities. Despite only a small, but growing, number of partnerships, revenue in the first quarter of 2017 soared 37% year over year to $64.8 million. While the company’s net loss remained flat at $0.07 per share on negative $3.4 million, adjusted EBITDA grew to $3.9 million from $2.2 million the prior. Gross margins increased from 78.9% to an impressive 82.07% year over year. Furthermore, adjusted net income pushed higher to $500,000 from $200,000. The company is not sacrificing profitability for growth.

Management expects the second-quarter revenue to resemble first-quarter, although business seasonality will impact the bottom line. The company anticipates a net loss of $10.9 million to $11.4 million on gross revenue of $64 million to $64.4 million. The adjusted net loss of $5.4 million to $5.8 million will equate to a loss of $0.11 to $0.12 per share. This is not uncommon due to the aforementioned seasonality of the business.

2U expects 47% of revenue for the second half of the year will be recognized in the third quarter. Often, the company will experience significant margin volatility driven by significant revenue growth when combined with this cost seasonality. The translation of the second half of the year should not be viewed as a run rate for the first half of the following year.

Managements guided revenue higher for the remainder of the fiscal year. Expectations are for revenues of $269.4 million to $270.9 million. While the company anticipates a net loss of $25 million to26.8 million, EBITDA is estimated at a gain of $9.5 million to $11 million.

The Technical Analysis – On a Breakout Over $52.50 or Pullback to $47.50, TWOU Is an Optimal Technical BUY

2U is a younger company, coming to market in 2014, so it’s essential to understand the technical picture, even on a weekly basis, is still developing. That often translates to volatility.

The TWOU technical picture of 2017 offers an almost picture-perfect lower-left-to-upper-right movement as the stock has traded in a consistent bullish trend. The strong channel offers $47.50 as support and $52.50 as resistance. Price has remained above the 13-week simple moving average (SMA) throughout the year and this is viewed as a secondary level of support trading just below the trendline. The consistency of the trend is appealing as price has neither extended above or below the trading channel in any significant manner. This should embolden traders to buy either breakout or test of support.

Momentum and trend remain very strong in terms of price action, while volume offers another clue as to an entry, which provides an attractive risk vs. reward. When volume has pushed above the 50-period moving average, a multi-week trend higher has developed. That lends support to the thesis buying a weekly close over the resistance level of $52.50 when paired with a surge in volume should trigger a strong move higher in price.

Almost as successful has been buying the support levels of the bullish channel as long as the weekly close remains above support on a closing basis. Preferably the intraweek low would remain above the 13-week SMA.

Should support fail, we’d anticipate a new consolidation channel to develop between $42.50 and $45. This is an area where we’d expect investors to become more aggressive buyers for the longer term.

Our initial target on a breakout, independent of fundamental views, would be $57.50 in short fashion with an ultimate upside of $65 within 12 months. 2U presents a strong bullish channel with clear support and resistance levels, so whether focusing on support or a breakout of resistance, the timing for entry should be clear.

Catalysts for the Thoughtful Investor

Collaboration, not competition, positions 2U as an ally to long-standing universities and colleges. Its services allow many higher institutions to expand their reach and offer programs and courses to students that otherwise may have fallen through the cracks or attended local universities. This makes 2U a compelling partner in a win-win setting.

As 2U’s attractive offering has created rapidly expanding partnerships. The company has already slotted five of its targeted 13 new domestic grad programs (DGP) for 2018 on its way to triple-digit DGPs by 2020. These sizeable and increasing number of domestic grad programs at positive margins enables 2U to invest in accelerating their program launch cadence to drive future revenue growth while continuing to improve margins. It’s not simply that the company can scale quickly with existing clients, but it can also expand quickly with each new client. Exponential growth rather than arithmetic growth creates a growth catalyst difficult to find in many companies.

The Bottom Line

1. 2U is an emerging leader in cloud based SaaS solutions for universities and colleges.

2. A strong base of prestigious universities and college partnerships has enabled 2U to expand gross margins, so it can focus on accelerating their program launch cadence to drive future revenue growth. Collaboration, not competition, is a driving force behind 2U’s early success.

3. 2U’s purchase of GetSmarter expands future revenue streams to include working professionals seeking shorter educational expenses, rather than multi-year MBA or other grad school programs.

4. In the range of $47.50 to $52.50 we like TWOU as a long-term buy and hold. Over $52.50, we like TWOU as a momentum breakout long. The small-cap nature, short interest, and new issue nature will make it volatile.

5. 2U can quickly scale new platform features across all its clients.

At the time of publication, neither the author nor the company held positions in the stocks mentioned, but positions may change at any time.

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