Chegg Will Turn the Page

 | Feb 14, 2014 | 2:45 PM EST  | Comments
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Chegg (CHGG) delivered its first earnings call as a public company Thursday, following its disastrous initial public offering in November.

The college textbook renter and creator of a burgeoning suite of digital services for students debuted at $12.50 per share. Its stock never traded at that price, though. It dropped straight down from the moment it went live and bottomed out around $6.60 per share a couple of weeks ago. That gives the company an enterprise value of about $550 million as of Thursday's close. That enterprise value is down to about $440 million with today's near 20% decline.

Investors are slicing into the value of the company in part thanks to downgrades (including one from the co-manager of its IPO, Bank of America/Merrill Lynch) and tweaks to various sell-side models.

The culprit for all this negativity? Print textbook margins dropped in the fourth quarter. Everyone and his brother on the earnings call Thursday knew that it's because Amazon (AMZN) is coming into the space and pricing aggressively. This hurt Chegg's margins on print textbooks; however, Chegg still beat guidance handily for the quarter and provided first-quarter and full-year guidance above estimates. It also beat expectations on digital revenue, which came in at $16.7 million instead of $14.7 million.

Most bulls, like me, look at digital revenue as the real story. Chegg booked $50 million in 2013 with strong growth rates. It also promised that this growth would continue next year, along with many new services that it can launch. Chegg Study grew 66% year-on-year in the quarter. So, if Chegg can keep up the growth rate on digital and add more services to it, we could be talking about $100 million in digital revenue this year.

Growing at 80% a year, what's that worth? At the moment, the market is saying it's worth less than 10x trailing sales. Meanwhile, Facebook (FB) is worth 20x. That doesn't seem right. If it were 22x trailing digital sales, plus the cash Chegg has from the IPO, plus assuming the print business is worth nothing, you have a $14 stock. Yet the stock is trading at $6 and change.

But the market isn't giving the print business a zero; it's assigning a negative value on worries that Amazon is a big fish and it's going to put Chegg out of business by aggressively pricing textbooks.

It reminds me a little of Pandora (P) a few years ago, when the stock dropped to $8 after its IPO on news that Apple (AAPL) was working on a streaming music service. There's such a fear of a big player coming in to compete against the little guy that investors sell first and ask questions later. Yet Apple didn't put Pandora out of business. I have a feeling we will see the same thing play out here with Chegg.

Chegg isn't going out of business. There's too much value in its digital business that Amazon will never offer. But it will probably take about six months for this negative overhang to clear.

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