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2U (NASDAQ:TWOU) Reports Q3 In Line With Expectations, Gross Margin Improves


Full Report / November 09, 2021
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Online education platform, 2U (NASDAQ:TWOU) reported results in line with analyst expectations in Q3 FY2021 quarter, with revenue up 15.5% year on year to $232.3 million. 2U made a GAAP loss of $60.1 million, down on its loss of $52.5 million, in the same quarter last year.

2U (TWOU) Q3 FY2021 Highlights:

  • Revenue: $232.3 million vs analyst estimates of $232.3 million (in line)
  • EPS (non-GAAP): -$0.23 vs analyst estimates of -$0.25
  • The company reconfirmed revenue guidance for the full year, at $945 million at the midpoint
  • Free cash flow of $25.9 million, up from negative free cash flow of $27.09 million in previous quarter
  • Gross Margin (GAAP): 72.1%, up from 68.8% same quarter last year

Originally named 2tor after the founder's dog Tor, 2U (NASDAQ:TWOU) provides software for universities and colleges to deliver online degree programs and courses.

There is a growing demand for online courses; however, the poor completion rate of online classes shows that creating a successful online course is hard and requires more effort than just uploading a recording of the lecture online.

While universities are experts in teaching, they struggle to create engaging online courses. As the COVID pandemic makes it difficult for students to learn on-campus, there is a need for platforms that make it possible to replicate the offline learning experience.

2U provides schools with software as a service that helps them create online courses that are engaging and successful with students. The cloud-based software works as an operating system that the whole course runs on and includes all the user-facing technology for students to engage with their courses and behind the scenes infrastructure to host and administer engaging video content.

Using the software, schools can create instructor-led live classes, track student engagement and learning outcomes, and also provide a social network to connect students and other faculty. 2U also offers expert services to train universities on how to create engaging classes and insights on courses that are most likely to perform well.

Courses are available on the web and mobile platforms, which means they can be accessed from any location at all times. 2U generates revenue by taking a cut from tuition paid by students to schools. While it started by enabling some of the world’s top universities such as UC Berkeley and Yale to offer degree programs, it has since expanded into delivering boot camps, short courses, and professional programs to people trying to advance their careers.

The overwhelming trend of moving work, life and consumption of content online is starting to catch up with the education sector that has for a long time resisted the change and insisted on providing the courses and degrees in the same way as they did decades ago. This shift was massively accelerated by the Covid pandemic that often made in-person education not possible and further forced institutions into investing in creating digital courses, and that drives demand for software that enables them to do so.

Competitors in the online learning space include Stride (NYSE:LRN), Adtalem Global Education (NYSE:ATGE), Arco Platform (NASDAQ:ARCE), Strategic Education (NASDAQ:STRA), and schools that develop their online courses in-house.

Sales Growth

As you can see below, 2U's revenue growth has been strong over the last year, growing from quarterly revenue of $201 million, to $232.3 million.

2U Total Revenue

This quarter, 2U's quarterly revenue was once again up 15.5% year on year. But the revenue actually decreased by $4.83 million in Q3, compared to $4.73 million increase in Q2 2021. The drop isn't consistent with any trend we have observed in the past and we wonder whether shareholders might be a little concerned that management is guiding for the decline in sales to continue in the coming quarter.

Analysts covering the company are expecting the revenues to grow 15.1% over the next twelve months, although estimates are likely to change post earnings.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. 2U's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 72.1% in Q3.

2U Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.72 left to spend on developing new products, marketing & sales and the general administrative overhead. Significantly up from the last quarter, this is around the lower average of what we typically see in SaaS businesses. Gross margin has a major impact on a company’s ability to invest in developing new products and sales & marketing, which may ultimately determine the winner in a competitive market so it is important to track.

Key Takeaways from 2U's Q3 Results

With a market capitalization of $1.98 billion 2U is among smaller companies, but its more than $934.3 million in cash and positive free cash flow over the last twelve months give us confidence that 2U has the resources it needs to pursue a high growth business strategy.

It was good to see 2U improve their gross margin this quarter. That feature of these results really stood out as a positive. On the other hand, revenue growth is overall a bit slower these days. Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. The company is flat on the results and currently trades at $26.79 per share.

Is Now The Time?

When considering 2U, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. Although 2U is not a bad business, it probably wouldn't be one of our picks. Its revenue growth has been solid, though we don't expect it to maintain historical growth rates. But while its very efficient customer acquisition hints at the potential for strong profitability, unfortunately its gross margins aren't as good as other tech businesses we look at.

2U's price to sales ratio based on the next twelve months is 1.9x, suggesting that the market has lower expectations of the business, relative to the high growth tech stocks. In the end, beauty is in the eye of the beholder. While 2U wouldn't be our first pick, if you like the business, the shares are trading at a pretty interesting price point right now.

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