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Investors with decades-long investing careers develop heuristics or algorithms based on what has worked for them and the mistakes they made along the way. As an active investor over the last two decades, I have made many mistakes, enjoyed successes and have kept an open mind when it comes to new strategies.
One such heuristic is paying attention to founder-led companies and another is companies where I have been using their products for a significant amount of time before they went public and that were uniquely positioned within their industry.
This aligns with Peter Lynch’s advice in his book One Up On Wall Street to invest in what you know. Despite having read the book in the early 2000s, I did not follow through on this intuition several times and missed out on huge gains following the IPOs of marketing automation company HubSpot (HUBS), productivity software company Smartsheet (SMAR), Alphabet (GOOG) (NASDAQ:GOOGL), Chipotle Mexican Grill (CMG) and many others. As outlined in an example in Lynch’s book, this strategy does not always work and just having a good product does not always translate into a good company or a superior investment. Following this strategy exclusively could also limit your hunting grounds as you look for new opportunities.
The mistake I was making with these companies was not being willing to pay up for quality and not using my imagination to see how the companies could grow into their valuation by maintaining a high level of growth. Growth eventually tends to slow but innovative companies know how to extend that growth curve by entering “adjacent” markets or going international. I was eventually able to overcome my value bias and invested in companies like Atlassian (TEAM), Twitter (TWTR), Twilio (TWLO) and Zillow (Z) because I was using their products and understood how uniquely these companies were positioned. In many of these cases, the companies were also founder-led, which made them even more attractive. Unfortunately, a large portion of the investing public came to the same conclusion and in late 2021, growth stocks got out of hand and it became very difficult to justify valuations even if you looked at a decade out. The only thing that seemed to matter was the story and the total addressable market.
Growth has taken a pretty big hit in recent weeks and as I joked on Twitter, the move from GAAP to non-GAAP continues. We have certainly moved away from Growth At Any Price (GAAP) to a sentiment where the bottom line and valuations matter once again. I discussed this in more detail in our 2022 outlook article for Seeking Alpha titled A Changing Of The Guard where I wrote the following on Dec 31, 2021,
“We are coming off two amazing stimulus fueled years where the S&P 500 and Nasdaq generated gains of 46% and 74%, respectively (at the time of writing) since the start of 2020. This is despite a recent pullback in growth stocks. Looking in from the outside and through the lens of a market participant in early 2020, this kind of performance during a global pandemic with multiple waves of infection is beyond comprehension. In other words, markets for the most part remain unpredictable. There’s one rule however that has managed to withstand the test of time and that is: “Don’t fight the Fed.” When the Fed decides to open or close the flood gates, it is better to go with the flow instead of fighting the strong current.
With both the government and market participants agreeing that inflation is not transitory, we’re likely to see Fed tightening and this could result in a “don’t fight the Fed” scenario, but in reverse. The key driver of the stock market is likely to be Fed action and sector/style rotation as a result of anticipated higher interest rates.
… the Fed is likely to play the largest role in the coming year and it’s a little surprising that we haven’t already seen a larger pullback once it became clear that the Fed will not just decelerate its bond buying program but might also consider raising interest rates much like the Bank of England did in late 2021.
If input costs in the form of commodity prices, labor costs and shipping charges increase, it’s likely to squeeze margins across different segments of the market. To see how high rates impact valuation multiples, all you have to do is take any Discounted Cash Flow model and see what happens to the output when you bump up the discount rate. Even small changes in the discount rate can have a big impact on the estimated intrinsic value of a stock. This is one of the reasons growth stocks have been volatile in Q4 2021.”
Coursera (COUR) is one of those high-flying growth companies that has seen its stock price cut nearly in half during the last six months and is down an astounding 68% from its post-IPO peak of $62.53 in April 2021.
Coursera was co-founded by Andrew Ng, who was a Stanford University Professor and co-founded Google Brain, a deep learning AI team at Google. He was also the Chief Scientist at Chinese internet giant Baidu (BIDU), often known as China’s Google.
Andrew Ng and co-founder Daphne Koller served as co-CEOs of the company until 2014 and Mr. Ng now serves as Chairman of the Board of Directors.
Andrew Ng launched a course called Machine Learning by Stanford on Coursera and the course has 4.1 million registered students. Several years ago, I started a Registered Investment Adviser (RIA) firm with a business partner and we focused on quantitative strategies based on insider transactions. After spending a couple of years developing strategies using traditional data analysis techniques, we decided to test the use of machine learning in our algorithms. To get a handle on using AI in quantitative investing, I took Andrew Ng’s course on Coursera. I then went on to complete a specialization called “Machine Learning Foundations: A Case Study Approach” offered through Coursera by the University of Washington. The power of ML became readily evident as the ML algorithms in just a few weeks were able to detect the same patterns we took years to identify through traditional data analysis.
This was my introduction to Coursera and I watched with interest as the company expanded beyond courses to offer specializations, over 40 certificates and more than 25 degrees.
I was even more intrigued when I noticed that Coursera’s CEO was Jeff Maggioncalda, who joined the company in 2017. Mr. Maggioncalda was previously the CEO of Financial Engines, a company that was founded in 1996 by William Sharpe, Professor of Finance, Emeritus at Stanford University and winner of the 1990 Nobel Prize in Economics. Mr. Sharpe (of Sharpe Ratio fame) launched Financial Engines to offer sophisticated investment advice to individuals and I think of them as one of the first “robo advisors.”
After struggling for a few years, they pivoted their business model to offer their products to 401(k) plan participants through their employers. The company went public in 2010 at $12 per share and was acquired in 2018 by Hellman & Friedman for $45 per share. Mr. Maggioncalda received his MBA from Stanford and was previously with McKinsey & Company.
Coursera collaborates with employers, universities and even governments to offer specialized content for their employees, students and constituents. According to the company’s S-1 filing,
“as of December 31, 2020, more than 77 million learners had registered on our platform, and over 2,000 organizations, 4,000 academic institutions, and 300 government entities had used our platform.”
The company now works with 261 company and university partners to offer 8,662 courses across 54 countries. Coursera’s university partners include Duke, Stanford, Columbia, University of Pennsylvania, Imperial College of London and many others.
A fascinating example of Coursera’s impact on a university is the partnership the company has with Manipal University, a leading private university in India. The university partnered with Coursera in 2017 and its student enrollment increased from 71,000 in 2018 to nearly 265,000 in 2020. 12,000 of these enrollments were in courses that were integrated into academic programs and had an average completion rate of 80%.
Coursera partnered with Google in 2017 to create a Google IT Support Professional Certificate and once again partnered with them in March 2021 to launch three new certificates with an emphasis on Data Analytics, Project Management and User Experience (UX) Design. The company can become an important partner for companies looking for new employees with current skills and also to retrain existing employees. Coursera’s corporate partners include Autodesk, Atlassian, Amazon, C3.ai, IBM, etc.
Coursera went public at $33 per share on March 31, 2021 and saw its share price climb as high as $62.33 just a week later. Over the subsequent weeks it gave back much of those gains and after the recent big decline in its stock price, now trades at $20.
The COVID-19 pandemic triggered a big shift to online learning globally and Coursera was positioned well to benefit from this trend. 2020 revenue increased 59% to $294 million from $184 million in 2019. Revenue grew 48% in 2018 and 30% in 2019. Q3 2021 revenue grew 33% to $110 million and its enterprise revenue, which accounts for 29% of total revenue, grew 75%. The company posted a GAAP net loss of $32.5 million but managed to eke out $7.1 million of positive free cash flow. As one would suspect, the bridge between GAAP losses and positive free cash flow is stock-based compensation expenses.
The company has benefited from rapid growth during the COVID-19 pandemic and the shift to online learning but we are likely to see a growth normalize in 2022 and beyond. Momentum from partnerships and a change in consumer behavior could provide tailwinds to the business for years to come.
On account of the big spike in revenue in 2020, the company’s gross margins improved and it spent less money as a percentage of revenue on R&D (26%) and G&A (13%). The company however chose to nearly double its spend to $107 million on marketing and sales, representing 37% of revenue compared to 31% of revenue in 2019.
Unfortunately, this trajectory has continued and the company spent 41% of its revenue on sales and marketing in the first nine months of 2021. I had built a model to value Coursera last year and updated the model based on actual results for the first nine months of 2021. The model assumes an improvement in gross margins over time, a gradual decline in operating expenses, a dip in the 2022 revenue growth rate and then an improvement in revenue growth and 10% shareholder dilution each year.
Coursera Financial Model
Asif Suria, InsideArbitrage.com
A financial model or a DCF model is only as good as its assumptions and it’s entirely possible that the company may generate losses for years as it chases market share, rewards employees with generous equity grants and fails to return value to shareholders. This is exactly what the company did in 2021 and the valuation my new model came up with is significantly below where it was last year. My original assumption of 50% growth in 2021 already fell short as the rate of growth has steadily decelerated in 2021, starting out with 64.6% growth in Q1 2021 and ending at 33% growth in Q3 2021. The company is expected to report Q4 2021 results on February 10, 2022, and at the mid-point of its guidance, Coursera expects Q4 2021 revenue of $111 million.
Plugging the EPS data from this model into the first five years of a DCF model and assuming an EPS growth rate of 50% in year 6, declining 5% a year through 2030, an 8% discount rate and a 2% terminal growth rate, I get an intrinsic value of $32.43 per share. The stock currently trades for well below that intrinsic value.
Coursera is exactly the kind of disruptor the education world needs and that students who are passionate about getting a quality education at a reasonable price could benefit from. The shift to online learning during the pandemic will help accelerate the adoption and acceptance of online degrees and certificates offered by Coursera. The thesis for Coursera is likely to take some time to play out and the volatility in the stock price is helpful in building a position over time. With an enterprise value just north of $2 billion, the company could also be an attractive acquisition target, although I hope the company will not sell before its full potential is realized.
I prefer not to average down on stocks, but in this case, given the volatility of the stock in recent weeks, it may be prudent to build a position gradually. Buying more over time is fine as long as that decision is made a priori or in response to general market conditions and not simply because the stock has declined and now appears even more attractive than your analysis initially suggested. The latter may point to a flaw in the initial analysis or business conditions that are probably deteriorating. I believe I have been conservative in building this model and that with economies of scale, the company is likely to surprise the upside in the coming years.
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This article was written by
I am an entrepreneur and investor with a focus on event driven strategies including merger arbitrage, spinoffs, (legal) insider trading, buybacks and SPACs. I was one of the earliest contributors on Seeking Alpha and started publishing here in 2005. For more than a decade I have been writing every week about M&A and interesting insider transactions. My work has been mentioned in Barron’s, Dow Jones, BNN Bloomberg and other publications.
I have been an active investor for more than two decades and my background in technology has helped me built tools that inform my investing process, especially as it relates to event-driven strategies that require updated data and processes. The focus on my Inside Arbitrage service is to provide investors with the right combination of tools and analysis to help them take advantage of strategies that can perform well across market cycles.
Disclosure: I/we have a beneficial long position in the shares of COUR, Z, TWTR, TEAM, TWLO either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Please do your own due diligence before buying or selling any securities mentioned in this article. We do not warrant the completeness or accuracy of the content or data provided in this article.
