Chegg Is Too Cheap

 | Nov 23, 2013 | 3:00 PM EST  | Comments
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Chegg (CHGG) is in the penalty box. The company's recent initial public offering (IPO) saw its underwriters upsize the price to $12.50 per share a couple of weeks ago. Ever since it has started to trade, the stock has been falling down.

Today, the stock hit a new low, briefly breaking below $7.50 a share. At $7.50 per share, on a fully diluted basis, Chegg trades for an $800 million market cap with about $200 million cash in the bank.

Its trailing 12 months of revenue is about $250 million. Isn't it too cheap to be trading at 2.5x trailing 12-months sales? I thought this was supposed to be an Internet company and we were in a bubble where everything is up?

Here's the crux of why I believe Chegg has fallen down: Out of that $250 million of trailing year's revenues, $200 million of it is from Chegg's rental textbook business. Rental textbooks? Booo. That's not the Internet. That's not the stuff of dreams. That ties up cash. Yuck.

The remaining $50 million of revenue is from Chegg's nascent digital revenues. Chegg wants to own college kids and be a destination site for them in the way that LinkedIn (LNKD) is the go to place for work resumes and Yelp (YELP) is the go-to place to replace the Yellow Pages.

Chegg offers info to help kids applying to college to get scholarships. It offers student ratings of different professors. It tells you about different classes and helps you with your homework.

And it rents textbooks. In the old days – just a few years ago -- it rented only hard copy textbooks. Now, it also does digital -- but it's mostly still the hard copy kind.

Although Wall Street investors don't seem to like that business, Chegg does. Why? On their IPO roadshow, management said that this is still a profitable business (renting the textbooks) and, before it totally dies, it provides Chegg with a lot of great free marketing on college campuses. Why not continue to use it?

I can't say I disagree. So, let's pretend this profitable business doesn't exist. And let's only value the digital (real Internet) revenues. At a trailing value of $50 million, I get to a 12x multiple (taking out that $200 million in cash they have thanks to the IPO).

By comparison, Facebook (FB) gets about 16x trailing sales, Yelp gets 21x, and Twitter (TWTR) gets more than 50x.

I don't think Chegg deserves a Twitter-like multiple, but it does deserve more than Yelp. Why? Because it's much smaller and presumably it will grow that revenue at a much faster pace than those bigger companies.

I think 30x trailing sales is reasonable for Chegg's small size. So, let's say Chegg doubles its digital revenues in the next year -- which I don't think is unreasonable -- to $100 million. That's a $3 billion market cap for the company. Add back the cash and it's $3.2 billion. On a fully diluted share count basis, you get to a $30 stock price in a year.

Even if it's half the multiple, you've got a double from current levels. Chegg is too cheap right now.

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