2U (NASDAQ: TWOU) has built a fast-growing business on the back of the digital graduate programs it creates for colleges and universities. Because the company bears the upfront development costs for these programs and enters into a long-term revenue sharing contract, 2U's customers stand to benefit significantly from this relationship.
With a solid first quarter of growth in the books, 2U confirmed its guidance for 30% revenue growth for its domestic graduate programs (DGP) this year, and CEO Chip Paucheck sees that "growth rate accelerating into 2019 and 2020." With 87% of the company's top line driven by DGPs in the most recent quarter, this segment is incredibly important to the company.
And some of 2U's largest partners can offer investors insight into why this is happening.
University of Southern California (USC)
USC is 2U's first and largest customer, bringing in 27% of its revenue for 2017. In 2009, 2U launched its inaugural DGP with USC's School of Education, including three master's degrees and one doctorate program. The following year, 2U launched three more degrees with its School of Social Work, which was the company's top program last year based on student enrollment.
Due to the success of these initial programs, other departments at USC have partnered with 2U for six more programs since 2016. With two programs being added this year and two planned for 2019, USC is likely to remain 2U's largest customer. Because of the success USC has had with 2U, it built a new nursing school based on the company's recommendations, which launched in 2016. Paucek describes the surplus (or profits) USC has been generating as a result of its online programs as "profound".
It's impressive that Simmons College is 2U's second largest customer, especially since it only launched its first two programs in 2014 (in nursing and social work). But these two programs claim the No. 2 and No. 3 spots based on student enrollment for the company and have been a boon for the school. The revenue from 2U's DGPs for Simmons now exceed the tuition generated from its in-person graduate programs making it the biggest source of new revenue for the school.
The partnership with 2U is a great way for the college to grow beyond what it has been able to do on its own. After the first two programs launched, Simmons has come back and has partnered with 2U to add another five degrees in 2016. Dana Leeman, associate dean for online education at Simmons, sees these experiences becoming a way of life for students of higher education. "I'm tired of folks saying this is the way of the future," she said. "It's not. It's now." Simmons College accounted for 17% of the company's revenue in 2017.
Kent Syverud, president of Syracuse, has a long history with 2U. In 2010, as dean of Washington University's law school, he started to investigate building an online presence for the school. In 2013, 2U ended up launching the school's first online law program, but it was not an easy journey. Syverud overcame significant skepticism from those who were concerned about the school's reputation. But he said that his "most hostile faculty members to this at the beginning are very committed teachers in the program today."
Syverud moved to Syracuse as its president in 2014. Since then, the university has launched 12 degrees with 2U, including its nationally recognized communications program; an MBA; and master's degrees in computer science, cybersecurity, and public administration. He has a sense of urgency in implementing these online programs, using the example of the once-preeminent employer Kodak . The company filed for bankruptcy in 2012 and has struggled to become relevant ever since. Syverud says that he wants to avoid Kodak's fate and sees 2U as way to do that:
I feel this obligation to have an entity that changes enough to scale up and be bigger in impact. And so far, 2U has been really helping us do that. I mean, we're approaching 2,000 full-time students through 2U-related programs, which is a very significant part of our enrollment.
The success the company has had adding programs at Syracuse and other schools is no accident and a tremendous opportunity for the company.
2U CFO Cathy Graham explained in a recent interview at the KeyBanc Capital Markets Emerging Technology Summit that there are two reasons why the company is seeing acceleration of its DGP segment. First, 2U has captured big name schools like "Harvard and Yale", and she believes the company has reached a "tipping point" in the market where university partners believe "they can't afford to wait." Second, Graham believes that the company is "getting more and more demand from inside university clients that we already have. So that tends to go faster."
Existing customers are a great source of growth for the company. In May, the company announced that three current customers were adding additional DGPs: Tufts, Pepperdine, and the University of Dayton. With these announcements, the company updated its program list as of May 25. Looking through the list of universities, about 40% of the company's DGP partners have only one program.
How big could this opportunity be? It turns out that Graham was asked a combination of two questions in the Key Banc interview that provides some perspective. The interviewer asked "Could 2U see its relationship with USC grow beyond seven programs and is it possible to see other universities get to that level?"
Graham responded, "Yes, to both questions." That is a growth opportunity that investors should get excited about.
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