Fast-Growing 2U Files For $100M IPO, But Is It Poised To Be The Next Big Education Company?

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When 2U emerged in 2008, online education was still struggling to be taken seriously. Despite steadily increasing online enrollment, many remained skeptical. Both fairly and unfairly, online education was seen as a world of simple micro-correspondence courses, limited in quality, incapable of producing outcomes truly commensurate with on-campus education and therefore merely a supplement, not a replacement, to traditional learning.

First as 2Tor, now as 2U, the company has been on a mission to lift online education up by the bootstraps and give universities the tools and resources they need to build out online extensions of their on-campus courses and programs. Six-years later, the work appears to be paying off for the young education technology company, as it filed paperwork with the SEC this weekend, officially declaring its intention to go public.

The company has yet to determine how many shares will be offered nor the price range for the proposed offering. However, we do know that, at this point, 2U plans to raise up to $100 million through its IPO and intends to list its stock on the NASDAQ under the ticker symbol “TWOU.” Goldman, Sachs & Co. and Credit Suisse will serve as the lead underwriters for its public offering, the company said in an announcement this weekend.

It’s worth noting that figure the company shares in its preliminary IPO filing in regard to how much it intends to raise is used to come up with registration fees and is subject to change. In other words, 2U’s final IPO figure (the amount it plans to raise) could change with future filings, as it prepares to list.

Why Now?

2U, like many education startups tackling the higher education market, is looking to capitalize on the fast-increasing demand for, and proliferation of, digital learning content and online education programs. In its filing, for example, 2U cited recent figures from the U.S. Department of Education, which project that enrollment in online post-secondary degree programs will increase 13 percent to 23.8 million by 2021.

While “MOOC” platforms like Coursera plan to act as channels through which students consume educational content and take courses for credit and, eventually, earn a degree from traditional institutions, 2U has taken a slightly different tack. What’s more, the road to monetization will, by definition, be longer for the content provider-esque businesses like Coursera, whereas 2U’s alternative approach has begun to generate millions in revenue.

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What The Sam Hill Makes 2U So Special?

Rather than become a degree provider itself, the company gives schools access to its cloud-based, “online-education-as-a-service” platform, which essentially allows institutions to offer their own existing courses and degree programs, online, right alongside their on-campus programs.

Initially focused on graduate programs at launch, the company has since expanded to include undergrad, helping schools like U.C. Berkeley to build a virtual classroom for its new, exclusively-online data science degree program, for example. Today, the company has created online degree programs for 11 graduate schools and has partnered with an additional 10 schools to launch online semester programs.

Big Backing, Big Capital

Since launching in 2008, 2U has raised nearly $100 million in funding, which puts it in exclusive company in the world of education technology startups. The reason the company has raised so much capital? It boils down to 2U’s belief that providing top-flight undergrad and graduate institutions with a robust online degree program that can actually rival the quality of their offline equivalents requires a much higher level of capital investment than you’d traditionally find in online education.

Furthermore, 2U is swimming upstream when it comes to trying to convince institutions that they can see real R.O.I. by adding online degree programs. While being able to accept more students without needing to build dorms or undergo the typical capital expenditure has appeal right off the bat, universities tend to believe that, with scale (and more students), comes a diluted experience.

Friction

To incentivize institutions, 2U attempts to take as much of the configuration and legwork out of their hands by customizing its platform for each individual program, for example. It also works with faculty to get them trained and onboarded, designs the intercampus social networking tools to get students connected, provides the synchronous video infrastructure for interpersonal communication and teaching and the underlying Learning Management System that connects everything together.

Once that foundation is in place, 2U takes responsibility for vetting the first round of applicants to the online program, while designing and providing the support for the conveyance of interactive content — the kind of capabilities most teachers want to provide for their online courses.

Naturally, the amount of support, administration, infrastructure and capital (both human and technological) required to make it all work adds up quickly. As co-founder Jeremy Johnson explained after the company raised its Series D, it’s why 2U manages to invest as much as $10 million in each graduate program it helps create, and why it’s taken on close to $100 million over the years.

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Upsides

While its capital demands are high, the potential upside of 2U’s insistence on making that kind of investment is that it works toward buying the trust and loyalty of institutions, which it can then reinforce through a guarantee that it won’t accept payment unless the program is actually a success. Naturally, how it (and its partner institutions) define “success” varies.

But, by making a big investment, and by offering a rev share to its partners, one starts to see why universities can get comfortable signing contracts with 2U that last up to 15 years. It’s also how the startup has managed to ink partnerships, in addition to U.C. Berkeley, with schools like the University of Southern California, Georgetown and UNC.

The other potentially good sign as it heads toward IPO?

The startup said that its revenue rose 49 percent to $83.1 million in 2013, following annual revenue figures of $29.7 million in 2011 and $55.9 million in 2012. It shows that 2U is moving in the right direction and indicates that its business is growing at a fairly steady pace.

A second noteworthy figure from 2U’s filing can be found in the fact that a total of 8,540 unique students have enrolled in its clients’ programs since its inception. As E-literate points out, not all of those students will still be enrolled in 2013 but, using 8,000 students as an estimate for the lower bound, which combined are generating $83.1 million, that’s approximately $10,000/student. E-literate estimates that it’s more likely 2U has around 5,500 students (which they base on an 84 percent average retention rate), giving an upper bound of approximately $15,000/student.

The point is: It’s an impressive revenue per user ratio, and one that bodes well for 2U going forward if it can begin to accelerate the rate at which it scales.

Furthermore, as E-literate again illustrates, if 2U made $83.1 million in revenue with eight of its nine customers, then the company is making $10 million in revenue per customer, per year. Again, not bad, right?

Key Peeps Join The Board

Another big vote of confidence for 2U from the perspective of potential shareholders? Over the past two days, in preparation for its IPO, the company has added some key names to its board. Among three recent additions, the most noteworthy would likely be Sallie Krawcheck, the former executive at Bank of America and Citigroup. More precisely, Krawcheck is the former president of the Global Wealth & Investment Management division of BoA, which includes Merrill Lynch and U.S. Trust, and is the largest wealth management business in the world. She also served as CEO of Citigroup’s Smith Barney Division, was promoted to CFO of Citigroup proper and also to CEO of Citi’s wealth management division.

In so doing, the financial exec has apparently earned a reputation for helping to lead big, ugly stinkers through equally big turnarounds. Cases in point: Sanford Bernstein, Smith Barney and Merrill Lynch. In the latter case, as BoA was in the process of acquiring Merrill, then CEO Ken Lewis apparently tried to nix the deal thanks to the perception that Merrill was in such poor shape financially. Nonetheless, the deal went through, and, under Krawcheck, BoA/Merrill Lynch saw $3.1 billion in profits over the next two years, and her division increased by 54 percent in Q2 2011, as BoA itself posted an $8 billion loss.

Sounds like a useful skill set to have on your board of directors.

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The Downsides

In spite of those high ratios, valuable customers and increasing revenue, 2U isn’t even close to profitable, and in fact, it’s losing money. And an increasing amount of it. In its preliminary filing, the company said that its net losses were $24.9 million, $23.1 million and $28 million for 2011, 2012 and 2013, respectively.

Plus, all told, of December 31, 2013, 2U had an accumulated deficit of $99.8 million, and as of its recent filing, only had $7 million in cash in the bank.

So, it seems as if 2U has uncovered this great, alternative business model, at least when compared to the MOOC providers. Like Coursera, target high-quality, name-brand institutions — in other words, top-ranked programs that are likely to have high(ish) tuitions — and give those institutions the ability to extend those elite programs to a limited number of students. So far, it appears to be a pretty lucrative formula.

Wait, That’s Expensive

2U talks a lot about how it is part of the movement to reduce the sky-rocketing costs of higher education. However, it’s worth noting that the programs it’s working with, at least on the graduate side, aren’t exactly on the cutting edge of affordable, job-preparatory post-secondary education. As E-literate illustrates, tuition for two year programs at these institutions is high, with UC Berkeley at $60K, USC at $34K, Georgetown at $77K and UNC at $80K, for example. Nonetheless, it still makes for a smart business model.

Oh, and speaking of schools, another big red flag for 2U in its current incarnation? It relies far too heavily on a single source of revenue. Last year, its two partnerships with USC accounted for 69 percent of the company’s revenue.

Need For Scale & The Chegg Hangover

While 2U’s ARPU is impressively high, its deficit is high and its cash is low. Likely, if the company is going to turn those around, it is going to need to start signing contracts with graduate programs at a faster rate than its current speed. In 2U’s own words, whether or not its business can get to the next level, depends “in large part on our ability to enter into agreements with additional non-profit colleges and universities for their offering of graduate programs online.”

Plus, 2U is not alone in the service it provides to universities. It has a number of big-name, well-backed rivals, like, say, Deltak, the company that Wiley bought for $220 million in late 2012, or Embanet, which Pearson acquired in 2012 as well. Not to mention that newer players like Udacity are looking to become technology infrastructure providers to both undergrad and graduate programs that want to offer courses and degrees online. More will be moving into this space, too, no doubt.

Lastly, despite a long struggle with changing markets, increasing competition and a million other things, Chegg was able to pull off a high IPO at a huge valuation. Yet, in spite of that, and a relatively strong first quarter as a public company, Chegg’s stock price has been plummeting as investors are biting their fingernails over its long-term prospects.

However, in the first half of 2013 alone, Chegg saw $117 million in revenue and was able to grow its top-line revenue at a material pace. That puts it at a favorable place in comparison with 2U. What’s more, Chegg has lost $170 million to date, and 2U is already sneaking up on it with just under $100 million.

Wall Street and its shareholders themselves don’t seem particularly sunny about Chegg’s financial prospects, nor its market. 2U has a more favorable hand in terms of the latter, but no one wants to be in the same analogy or sentence with Chegg right now.

The Last Note

Long story short, 2U has a long way to go and a serious uphill battle to prove that it won’t follow a similar course. 2U has the reputation among its partner institutions and faculty at those institutions for offering top-notch support, and the upside of its model is that it’s extremely high-touch. Universities love that.

When the company does IPO, however, pressure from investors to see increasing returns will grow, and the company will likely have to begin cutting costs or significantly ramping up expansion. With support infrastructure and a high-touch model, while creating a great customer experience, 2U could find its model restrictive of growth. The question is: Can 2U overcome this and break out of just being a boutique but lucrative business to one of the big honchos of education technology?

You be the judge.