Is 2U overvalued?

2U recently sold its common stock options priced at $49 per share to raise around $175m. This covered their acquisition of Getsmarter as well funding ‘growth’. Since then their share price has surged to $53. Seeking Alpha argue that 2U’s valuation, at 8.5x their annual revenue, is overvalued.

The classic case in favour of 2U would be of the Software as a Service disruptor, pioneering online degrees with elite brands. This certainly fits the conventional wisdom that has seen news headlines focus on the unaffordability of college, $1.4tn in student debt and affordable college a central plank of the 2016 US Presidential election. Coupled with a generation of digital natives and a need for more flexibility in terms of work and study and it seems obvious a digital disruptor would appear. 2U has seen rapid growth in programs, revenue and steadily built up a stable of elite brands, with their acquisition of GetSmarter they gained access to further brands such as Harvard (who recently announced a 2U course) as well as a profitable company — Game, Set and Match surely.

Not quite. There are two problems with 2U’s valuation. Seeking Alpha focus on the first, the fundamentals of the business, 2U they argue is perceived (and sold as) a software company who can scale quickly. In fact they argue, 2U is more a marketing company, ~50% of their costs are in marketing, specifically call centres whose costs don’t scale and secondly their enrolments per program have been dropping (directly impacting the bottom line). The second is what everyone else is doing.

1. Alternative platforms — 2U’s clients have a host of other options and are already using them in the form of MOOC platforms, indeed Harvard and MIT own edX and Harvard Business School also has its own platform
2. Online degree completion — The same platforms already run degrees or equivalents; Coursera and FutureLearn both run degrees and edX run MicroMasters which if not identical target the postgraduate market
3. Marketing and recruitment advantages — These platforms have large user-bases supported by their B2C and in some cases B2B businesses which can be used to recruit to online degrees. These might not scale perfectly, recruitment often involves Livechat or phone calls, they still provide a target audience that will likely mean a shallower cost curve when it comes to marketing online degrees
4. More flexible Online degrees — MOOC platforms have opened up some if not all of their degrees as open programs. Not only does that maximise the number of people who can be upsold, it allows people to learn at their own pace in a Pay as you go model, no need to front up tens of thousands of dollars.

2U do have strong proposition, they are seeing rapid revenue growth and have signed elite Universities such as Yale and Harvard and focused on a few key vertical such as Healthcare. Furthermore, GetSmarter gives them access to the Executive Education market which is more lucrative and less exposed to competition. Yet they don’t exist in a vacuum, their operations are costly and their clients own or have access to many alternatives. At the very least this suggests recruitment and profit margins will come under pressure at worst they could be more of a slicker version of the old OPM model than the harbinger of the new.